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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 26, 1999
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM S-1/S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
APPALACHIAN BASIN ROYALTY TRUST
(Exact name of registrant as specified in its charter)
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DELAWARE 1311 75-6550504
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
</TABLE>
BANK ONE TEXAS, N.A.
500 THROCKMORTON, SUITE 801
FORT WORTH, TEXAS 76102
(817) 884-4417
ATTN: CORPORATE TRUST DEPARTMENT
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
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EASTERN STATES OIL & GAS, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 1311 61-1093943
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
</TABLE>
2800 EISENHOWER AVENUE
ALEXANDRIA, VIRGINIA 22314
(703) 317-2300
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
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AS TO BOTH REGISTRANTS:
CLIFTON A. BROWN
PRESIDENT AND CHIEF EXECUTIVE OFFICER
2800 EISENHOWER AVENUE
ALEXANDRIA, VIRGINIA 22314
(703) 317-2300
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
Copies to:
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ANDREWS & KURTH L.L.P. BAKER & BOTTS, L.L.P.
600 TRAVIS, SUITE 4200 ONE SHELL PLAZA
HOUSTON, TEXAS 77002 910 LOUISIANA
(713) 220-4200 HOUSTON, TEXAS 77002
ATTN: G. MICHAEL O'LEARY (713) 229-1234
ATTN: JOSHUA DAVIDSON
</TABLE>
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, please check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
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CALCULATION OF REGISTRATION FEE
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PROPOSED MAXIMUM
TITLE OF EACH CLASS OF SECURITIES AGGREGATE OFFERING AMOUNT OF
TO BE REGISTERED PRICE(1)(2) REGISTRATION FEE
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Units of beneficial interests...................... $180,000,000 $50,040
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</TABLE>
(1) Includes trust units issuable upon exercise of the underwriters'
over-allotment option.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(o).
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
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<PAGE> 2
THE INFORMATION IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY BE
CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PRELIMINARY
PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN
OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT
PERMITTED.
Subject to Completion, dated August 26, 1999
PROSPECTUS
APPALACHIAN BASIN ROYALTY TRUST
TRUST UNITS
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This is an initial public offering of units of beneficial interest in the
Appalachian Basin Royalty Trust. Eastern States Oil & Gas, Inc., a wholly owned
subsidiary of Statoil Energy Inc., has formed the trust and is offering all of
the trust units to be sold in this offering. Eastern States will receive all
proceeds from the offering. The trust will not receive any proceeds from the
offering. Eastern States will continue to own trust units after this
offering, or trust units if the underwriters' over-allotment option is
exercised in full.
Prior to this offering there has been no public market for the trust units.
Eastern States expects that the offering price will be between $ and $
per trust unit. Eastern States intends to apply to have the trust units listed
on the New York Stock Exchange under the symbol " ."
THE TRUST UNITS. Trust units are units of beneficial ownership of the trust
and represent undivided beneficial interests in the assets of the trust.
They do not represent any interest in Eastern States or Statoil Energy.
THE TRUST. The trust owns net profits interests in natural gas producing
properties located in the Appalachian Basin area of Kentucky and West
Virginia. The net profits interests entitle the trust to receive:
- 80% of Eastern States' net proceeds from the sale of the production from
2,562 producing wells; and
- 10% of Eastern States' net proceeds from the sale of the production from
all wells drilled on or after October 1, 1999 on the leases in Kentucky
and West Virginia that are subject to the net profits interest.
THE TRUST UNITHOLDERS. As a trust unitholder, you will receive quarterly
distributions of cash that the trust receives attributable to its net
profits interests from the sale of natural gas produced from the underlying
properties.
INVESTING IN THE TRUST UNITS INVOLVES RISKS. RISK FACTORS BEGIN ON PAGE 14.
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PER TRUST UNIT TOTAL
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Public offering price............................ $ $
Underwriting discount............................ $ $
Proceeds, before expenses, to Eastern States..... $ $
</TABLE>
Eastern States has also granted the underwriters the right to purchase up
to an additional trust units at the initial public offering price less
the underwriting discount to cover over-allotments.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS ACCURATE OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
Lehman Brothers expects to deliver the trust units on or about
, 1999.
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JOINT BOOK-RUNNING MANAGERS
LEHMAN BROTHERS SALOMON SMITH BARNEY
CO-LEAD MANAGER
PAINEWEBBER INCORPORATED
CIBC WORLD MARKETS
CREDIT SUISSE FIRST BOSTON
DAIN RAUSCHER WESSELS
A DIVISION OF DAIN RAUSCHER INCORPORATED
DONALDSON LUFKIN & JENRETTE
A.G. EDWARDS & SONS, INC.
MCDONALD INVESTMENTS INC.
, 1999
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[MAP OF UNDERLYING PROPERTIES APPEARS HERE]
No dealer, salesperson or other person is authorized to give any
information or to represent anything not contained in this prospectus. You must
not rely on any unauthorized information or representations. This prospectus is
an offer to sell the trust units offered hereby, but only under circumstances
and in jurisdictions where it is lawful to do so. The information contained in
this prospectus is current only as of its date.
Through and including , 1999 (the 25th day after the date of
this prospectus), all dealers effecting transactions in these securities,
whether or not participating in this offering, may be required to deliver a
prospectus. This is in addition to a dealer's obligation to deliver a prospectus
when acting as an underwriter and with respect to an unsold allotment or
subscription.
i
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TABLE OF CONTENTS
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PROSPECTUS SUMMARY.......................................... 1
RISK FACTORS................................................ 14
FORWARD-LOOKING STATEMENTS.................................. 20
USE OF PROCEEDS............................................. 21
EASTERN STATES.............................................. 21
THE TRUST................................................... 22
PROJECTED YEAR 2000 DISTRIBUTABLE CASH...................... 22
THE UNDERLYING PROPERTIES................................... 30
COMPUTATION OF NET PROCEEDS................................. 46
FEDERAL INCOME TAX CONSEQUENCES............................. 49
STATE TAX CONSIDERATIONS.................................... 53
ERISA CONSIDERATIONS........................................ 54
DESCRIPTION OF THE TRUST AGREEMENT.......................... 55
DESCRIPTION OF THE TRUST UNITS.............................. 59
UNDERWRITING................................................ 62
SELLING TRUST UNITHOLDER.................................... 64
VALIDITY OF THE TRUST UNITS................................. 64
EXPERTS..................................................... 64
AVAILABLE INFORMATION....................................... 65
GLOSSARY OF OIL AND NATURAL GAS TERMS....................... 66
INDEX TO FINANCIAL STATEMENTS............................... F-1
INFORMATION ABOUT EASTERN STATES OIL & GAS, INC. ........... A-1
INDEX TO FINANCIAL STATEMENTS OF EASTERN STATES OIL & GAS,
INC. ..................................................... AF-1
RYDER SCOTT COMPANY, L.P. REVIEW REPORT FOR THE UNDERLYING
PROPERTIES................................................ XA-1
RYDER SCOTT COMPANY, L.P. REVIEW REPORT FOR THE NET PROFITS
INTEREST.................................................. XB-1
</TABLE>
ii
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PROSPECTUS SUMMARY
This summary may not contain all of the information that is important to
you. To understand this offering fully, you should read the entire prospectus
carefully, including the risk factors and the financial statements and notes to
those statements. You will find definitions for terms relating to the oil and
natural gas business in "Glossary of Oil and Natural Gas Terms." Eastern States
estimated the proved natural gas reserves at June 30, 1999 for the underlying
properties and the trust's net profits interests included in this prospectus.
Ryder Scott Company, L.P., an independent engineering firm, has reviewed these
estimates and copies of their review reports as of June 30, 1999 are located at
the back of this prospectus as Exhibits A and B. Historically, more than 99% of
production from the underlying properties has been natural gas and less than 1%
has been oil. The net profits interests conveyed to the trust will also include
net proceeds from the sale of oil production from the underlying properties. For
purposes of this prospectus, we use the phrase "sale of natural gas from the
underlying properties" to also include the sale of oil from the underlying
properties.
APPALACHIAN BASIN ROYALTY TRUST
Appalachian Basin Royalty Trust was formed in August 1999 by Eastern States
under the Delaware Business Trust Act. Eastern States is the largest owner of
proved natural gas reserves, and believes it is one of the lowest cost
producers, in the Appalachian Basin. Eastern States is a wholly owned subsidiary
of Statoil Energy. Statoil Energy owns and operates power plants in the
northeast and mid-Atlantic regions of the United States, is a leading trader of
wholesale electricity and natural gas and specializes in providing a broad range
of energy and risk management services involving the delivery of natural gas,
electricity and alternative fuels to large industrial, institutional and
commercial customers. Statoil Energy is a U.S. subsidiary of the Norwegian state
oil company "den norske stats oljeselskap a.s," which is also known as The
Statoil Group. The Statoil Group is one of the largest integrated energy
companies in the world.
Eastern States will convey to the trust, effective October 1, 1999, an 80%
net profits interest in 2,562 producing natural gas wells in Kentucky and West
Virginia and a 10% net profits interest in wells drilled on or after October 1,
1999 on substantially all of Eastern States oil and gas leasehold interests in
Kentucky and West Virginia. Eastern States' interests in the 2,562 producing
wells that will be subject to and burdened by the 80% net profits interests are
referred to as the 2,562 underlying wells or the underlying wells. Eastern
States' interests in the oil and gas leases that will be subject to and burdened
by the 10% net profits interest are referred to as the underlying leases. The
underlying leases contain 1,378 proved undeveloped drilling locations. The
underlying wells and the underlying leases are collectively referred to as the
underlying properties. The underlying properties will not include any properties
or interests acquired by Eastern States on or after October 1, 1999.
The net profits interests entitle the trust to receive 80% of the net
proceeds received by Eastern States from the sale of natural gas from the
underlying wells and 10% of the net proceeds received by Eastern States from the
sale of natural gas from wells drilled on the underlying leases on or after
October 1, 1999. Net proceeds generally means cash received from the sale of
production from the underlying properties after deducting property and
production taxes, production costs, gathering and compression charges,
development costs and administrative and drilling overhead attributable to the
underlying properties. The net profits interests will be calculated separately
for Kentucky and West Virginia. The first distribution will be paid to
unitholders of record as of March 1, 2000 on or before March 25, 2000 for the
production period October 1, 1999 through December 31, 1999.
Net proceeds payable to the trust depend upon production quantities, sales
prices of natural gas and costs to develop, produce, transport and market the
natural gas. If for any quarter aggregate costs should exceed gross proceeds,
the trust unitholders would not receive any cash distributions until future net
proceeds exceed the total of those excess costs, plus interest at the prime
rate. The trust will not be required to repay amounts to Eastern States;
instead, any amounts due to Eastern States will be deducted in calculating
future net proceeds payable to the trust.
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The underlying wells are characterized by a relatively high
reserve-to-production index of 21 years and a low expected production decline
rate averaging 5.5% for the initial five-year period following this offering. If
successful, Eastern States' planned development program is expected to reduce
this decline rate to 2% to 3%.
Reserves in the Appalachian Basin typically have a high degree of step-out
development success, that is, as development progresses, reserves from newly
completed wells are reclassified from the proved undeveloped to the proved
developed category and additional adjacent locations are added to proved
undeveloped reserves. As a result, the amount of total proved reserves tends to
increase as development progresses.
Eastern States operates all of the 2,562 underlying wells and intends to
operate all or substantially all of the wells drilled on the underlying leases
on or after October 1, 1999. Eastern States has an average net revenue interest
of 87% and an average working interest of 97% in the properties burdened by the
trust's net profits interests. This large percentage working interest provides
for significant control over the timing and amount of expenditures. Eastern
States believes that its operation of more than 4,800 wells and 3,200 miles of
gathering pipeline in Kentucky and West Virginia provides it with regional
economies of scale and a competitive advantage since it is able to maintain low
production costs relative to other producers in the Appalachian Basin. In
addition, the coordination of Eastern States' development program in these
states is facilitated by the integrated nature of its production, pipeline and
undeveloped leasehold positions.
Eastern States will market the natural gas produced from the underlying
properties and attempt to obtain the best prices available to it in the
marketplace. Generally, natural gas produced from the underlying properties will
be sold under existing contracts that have market-based pricing terms.
Currently, approximately 90% of natural gas produced by Eastern States is sold
under existing short-term contracts with its affiliate, Statoil Energy Services,
Inc., and affiliates of CNG Transmission Corp. For the six month period ending
June 30, 1999, approximately 65% of the natural gas produced by Eastern States
was sold to Statoil Energy Services and approximately 25% was sold to affiliates
of CNG Transmission. The remaining natural gas is sold to numerous purchasers
generally at market-based prices.
On federal income tax returns, investors will be required to include their
proportionate share of trust net income. Investors will also be entitled to
claim a depletion deduction relating to production from the underlying
properties. Because payments to the trust will be generated by depleting assets,
a portion of each distribution may represent a return of your original
investment rather than a return on your original investment. The deductions will
permit investors to defer or reduce taxes on a significant portion of the income
recognized as a result of owning an interest in the trust.
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EASTERN STATES' OWNERSHIP INTERESTS ARE ALIGNED WITH THE UNITHOLDERS
Eastern States' retained interest in the underlying properties entitles it
to 20% of the net proceeds from the sale of production from the 2,562 underlying
wells and 90% of the net proceeds from the sale of production from wells drilled
on the underlying leases on or after October 1, 1999. Eastern States will also
own up to 25% of the outstanding trust units. Eastern States believes that its
retained direct ownership interest in the underlying properties, as well as the
retained trust units, will provide it with sufficient economic incentives to
continue to operate and develop the underlying properties in an efficient and
cost effective manner. Eastern States is under no obligation to continue to own
the underlying properties, although it intends to do so. The following chart
shows the relationship of The Statoil Group, Statoil Energy, Eastern States, the
underlying properties, the trust and the public trust unitholders, assuming no
exercise of the underwriters' over-allotment option.
[CHART]
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(a) The Statoil Group holds its 99.9% interest in Statoil Energy through a
wholly owned subsidiary.
(b) If the underwriters' over-allotment option is exercised in full,
approximately 86% of the trust units will be owned by the public unitholders
and Eastern States will retain the remaining 14% of the trust units.
3
<PAGE> 8
THE UNDERLYING PROPERTIES
The underlying properties are located in the Appalachian Basin, which is
the oldest and geographically one of the largest natural gas producing regions
in the United States. As of June 30, 1999, Eastern States estimated the proved
developed reserves of the 2,562 underlying wells to be 340 Bcfe, with future net
cash flows discounted at 10% before income taxes of approximately $229 million.
Ryder Scott has reviewed these estimates. Approximately 65% of the future net
discounted cash flows before income taxes are represented by proved developed
reserves located in West Virginia and approximately 35% of the future net
discounted cash flows before income taxes are represented by proved developed
reserves located in Kentucky. As of June 30, 1999, Eastern States estimated its
proved undeveloped reserves for the underlying leases to be 399 Bcfe, which
estimate has been reviewed by Ryder Scott.
The areas in which the underlying properties are located are characterized
by wells with comparably low rates of annual decline in production, low
production costs and high Btu content. Once drilled and completed, wells in the
Appalachian Basin have low ongoing operating and maintenance requirements and
minimal capital expenditures. Wells in these areas have been producing for many
years, in some cases since the early 1900's. Reserve estimates for properties
with long production histories are generally more reliable than estimates for
properties with shorter histories.
Substantially all of the underlying wells are relatively shallow, with
depths ranging from 1,000 to 7,000 feet below the surface. Many of the
underlying wells are completed in multiple producing zones and production is
commingled. Commingled production lowers producing costs on a per unit basis
compared to isolated zone completions.
Eastern States' conveyances to the trust of net profits interests in the
underlying wells in Kentucky and West Virginia are intended to create a
diversity of well profiles and a diversity of value. The well with the highest
discounted net present value represents less than 0.5% of the value of all
underlying wells. The inclusion of a large number of future drilling
opportunities on approximately 1.2 million gross acres comprising the underlying
leases (excluding the Rome exploration area but before giving effect to the
other excluded interests described in the two paragraphs below) along with the
underlying wells will provide statistical and geological diversity in multiple
potential producing horizons in Kentucky and West Virginia.
The 2,562 underlying wells do not include wells in Kentucky and West
Virginia with any of the following characteristics:
- Section 29 properties which are owned by a financial institution and most
of which are operated by Eastern States;
- wells drilled during the 21 months ended September 30, 1999, each of
which has a limited production history and a relatively high decline
profile;
- wells located in the Rome exploration area of Kentucky, which is a high
risk exploration area characterized by high operating costs;
- wells with relatively high operating costs;
- marginal producing wells and associated leases;
- wells and associated leases with title issues; and
- wells in which Eastern States is not the operator.
The underlying leases do not include leases and interests in Kentucky and
West Virginia with any of the following characteristics:
- leases and mineral interests in Kentucky and West Virginia pertaining to
the Rome exploration area, which is characterized by high development
costs;
- leases which have been farmed out to third parties; and
- leases or interests with known conveyance or title issues, including all
potential coalbed methane exploration and developmental rights.
4
<PAGE> 9
PRODUCTION FROM THE UNDERLYING PROPERTIES RECEIVES PREMIUMS FOR LOCATION AND
HIGH ENERGY CONTENT
Natural gas produced in the Appalachian Basin has historically received a
premium over natural gas produced in other regions due to the region's close
proximity to the markets in the northeast United States. For the period 1991
through 1998, natural gas price indices for Appalachian Basin production have
averaged $0.25 per MMbtu more than prices for natural gas contracts traded on
the NYMEX for the delivery of natural gas at Henry Hub, Louisiana. During these
eight years, the average annual Appalachian Basin premium has ranged from $0.14
per MMbtu to $0.47 per MMbtu.
Natural gas sold from the underlying properties has historically received
an additional premium because of its higher Btu content. The average Btu content
for each cubic foot of natural gas produced from the underlying properties is
approximately 1,131, which has historically provided an average 13.1% premium
over the standard measure of 1,000 Btu per cubic foot when calculating realized
prices on a per Mcf basis.
Eastern States cannot provide any assurance that these premiums will
continue.
LOW COST PRODUCER
Eastern States believes that it is a low cost producer. Based on the
contractual costs to be charged by Eastern States on a per well basis for
production costs and based on the estimated production for the year 2000,
Eastern States estimates production costs and taxes allocated to the trust in
computing net proceeds to be $0.48 per Mcfe during 2000. For public reporting
companies in the United States, the average production cost from 1996 through
1998 was $0.61 per Mcfe.
LONG LIFE OF PROPERTIES
The productive lives of producing natural gas properties are often compared
using their reserve-to-production index. This index is calculated by dividing
total proved reserves of the property by annual production for the prior 12
months. The reserve-to-production index for the underlying properties at June
30, 1999 was approximately 21 years. This reserve-to-production index shows a
relatively long producing life compared to an average index of 8.8 years for
U.S. natural gas properties at year-end 1997. Because production rates naturally
decline over time, the reserve-to-production index may not be a useful estimate
of how long properties should economically produce. Based on the Ryder Scott
review report, production from the underlying properties is expected to continue
for at least 50 more years.
HIGH PERCENTAGE OF PROVED DEVELOPED RESERVES
Proved developed reserves are generally the most valuable and lowest risk
category of reserves because their production requires no significant future
development costs and production histories are established. Proved developed
reserves represent approximately 90% of the total volumes and 97% of the
discounted present value of estimated future net cash flows from the trust's
combined net profits interests in the underlying properties.
HISTORY OF LOW COST ADDITIONS TO PROVED RESERVES
Eastern States has a record of successfully adding reserves to the
underlying properties through development at costs which are generally less than
U.S. industry averages. Over the five years ended December 31, 1998, Eastern
States has added through development drilling approximately 114 Bcfe of proved
developed reserves at an average cost of $0.71 per Mcfe. For public reporting
companies in the United States, the average industry cost of adding natural gas
reserves from 1996 through 1998 was $0.76 per Mcfe.
SIGNIFICANT INVENTORY OF DRILLING OPPORTUNITIES
Eastern States currently has an inventory of approximately 1.2 million
gross acres (excluding the Rome exploration area but before giving effect to the
other excluded interests) comprising the underlying
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<PAGE> 10
leases, of which approximately 74% have not been developed. As of June 30, 1999,
Eastern States estimated the proved undeveloped reserves of the underlying
leases to be 399 Bcfe from 1,378 proved undeveloped drilling locations, with
estimated future net discounted cash flows of $75 million. These estimates have
been reviewed by Ryder Scott. Based upon current conditions, Eastern States
intends to drill an average of approximately 200 wells per year on the
underlying leases for at least the next five years. The trust will have a 10%
net profits interest in these wells. The development costs for drilling 200
wells, including drilling overhead, in the year 2000 is estimated to be
approximately $44 million, of which approximately $4.4 million will be
attributable to the net profits interest of the trust. The level of development
activity and the actual costs incurred, however, will depend on results of prior
development activities, natural gas prices and the development cost in
comparison to expected rates of return, as well as the types of wells drilled
and any unanticipated events. In the last five years, Eastern States has
completed approximately 98% of the wells it has drilled in Kentucky and West
Virginia.
EFFECT OF PLANNED DEVELOPMENT PROGRAM
Without future development, the underlying wells would typically experience
a 5.5% annual decline in production for the initial five-year period following
this offering. Projected development expenditures for the underlying properties
included in the Ryder Scott review report (totaling $256 million through 2006 or
$25.6 million net to the trust) are expected to reduce the natural rate of
decline in production to 2% to 3% per year. If Eastern States drills and
completes new wells or conducts other development activities related to the
2,562 underlying wells, those activities should serve to offset, at least in
part, the natural production decline from the underlying wells. The trust will
benefit from increased production, net of 80% of the related development costs
of the 2,562 underlying wells and net of 10% of the related development costs of
new wells drilled on or after October 1, 1999 on the underlying leases. Eastern
States' development plan will differ from that reflected in the Ryder Scott
review report because Eastern States typically drills a number of unproved
locations each year.
ADDITIONAL DEVELOPMENT OPPORTUNITIES
Eastern States believes that the underlying properties may offer economic
development projects that are not included in its existing proved reserves. For
the period January 1, 1998 to June 30, 1999, approximately 40% of all wells
drilled by Eastern States were on locations classified as unproved at the time
of drilling. These additional development opportunities could add production and
proved reserves beyond those contained in the Ryder Scott review report.
Eastern States expects costs per Mcfe associated with reserves added
through additional development projects to be comparable to its historical costs
of reserve additions in Kentucky and West Virginia. Development costs will be
deducted from the net profits interests as they are incurred and will result in
lower quarterly distributions than would exist if these costs were not incurred.
Production increases from these projects may ultimately increase future
distributions over what would have been distributed had the development
expenditures not been incurred. These development activities could be
attributable to either the 2,562 underlying wells (80% net profits interest) or
wells drilled on the underlying leases (10% net profits interest). These
development opportunities include:
- drilling unproved locations;
- deepening existing wells in locations or into formations that are not
classified as proved reserves in the Ryder Scott review report;
- opening new producing zones in existing wells;
- recompletions;
- adding pipelines and compression to improve production flow or to reduce
third party gathering and compression charges; and
- performing mechanical and chemical treatments to stimulate production
rates.
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Eastern States prioritizes resources for development based upon expected
rates of return. Expected rates of return for additional development
opportunities will depend on results of prior projects, natural gas prices and
the associated project costs.
PRO FORMA OPERATING MARGIN
The following table shows Eastern States' operating margins per Mcfe for
the underlying properties for the year ended December 31, 1998 and the six
months ended June 30, 1999 on a pro forma basis as if the offering had occurred
on January 1, 1998. Development costs are excluded for these periods since none
of the wells drilled by Eastern States in the period January 1, 1998 through
September 30, 1999 are included in the underlying properties because of their
limited production history.
<TABLE>
<CAPTION>
PRO FORMA
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YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
1998 1999
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(PER MCFE) (PER MCFE)
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Sales Price:
Average sales meter price after deducting third party
gathering and compression charges..................... $ 2.42 $ 2.23
Less Eastern States' gathering and compression
charges(a)............................................ (0.103) (0.094)
Less Eastern States' compressor fuel cost and line
loss(b)............................................... (0.14) (0.13)
Less pro forma reimbursement for depreciation and return
on investment(a)...................................... (0.127) (0.136)
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Pro forma average realized sales price................... 2.05 1.87
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Expenses:
Production costs(c)...................................... 0.24 0.25
Production and property taxes............................ 0.21 0.19
Overhead(d).............................................. 0.10 0.10
------- -------
Total expenses................................... $ 0.55 $ 0.54
------- -------
Operating margin........................................... $ 1.50 $ 1.33
======= =======
</TABLE>
- ---------------
(a) Eastern States' gathering and compression charges are shown as actual costs
of $0.103 per Mcfe for the year ended December 31, 1998 and $0.094 per Mcfe
for the six months ended June 30, 1999. In addition, a charge of $0.127 per
Mcfe for the year ended December 31, 1998 and of $0.136 per Mcfe for the
six months ended June 30, 1999 has been assessed by Eastern States to
reimburse it for depreciation and to provide a return on investment in its
gathering and compression systems. The charges for depreciation and a
return on investment have not been allocated in the past by Eastern States
and are assumed to be the same as those deducted in calculating projected
year 2000 distributable cash. This charge has not historically been
allocated by Eastern States for its gathering and compression systems since
Eastern States owns a 97% working interest in the properties burdened by
the net profits interests. See "Computation of Net Proceeds -- Net Profits
Interests."
(b) Eastern States has deducted compressor fuel costs and line loss from its
sales meter price. This percentage is based upon historical data. In the
future the amount of this charge will be based on actual volumes consumed
as fuel by Eastern States' compressors and actual volumes lost by Eastern
States in performing such services.
(c) Prior to the closing of this offering, Eastern States had actual direct
production costs of $0.19 per Mcfe for the year ended December 31, 1998 and
$0.20 per Mcfe for the six months ended June 30, 1999 relating to the
underlying properties. On a pro forma basis, production costs include a
reimbursement of $0.05 per Mcfe to Eastern States for depreciation and
amortization of its office expenditures, information systems and other
capitalized costs. See "Computation of Net Proceeds -- Net Profits
Interests."
7
<PAGE> 12
(d) Prior to the closing of this offering, Eastern States has not charged an
overhead fee. The pro forma overhead expense represents a monthly fee to be
charged by Eastern States of $65 per well to reimburse Eastern States for
its general and administrative costs.
PROVED RESERVES
Based on the Ryder Scott review report, proved reserves of the underlying
properties are over 99% natural gas. The following table provides, as of June
30, 1999, estimated proved reserves of natural gas and natural gas equivalents,
and undiscounted and discounted estimated future net cash flows for the
underlying properties and the net profits interests. The estimates below were
prepared by Eastern States and have been reviewed by Ryder Scott. Proved
reserves in the table below are based on natural gas and oil prices realized by
Eastern States as of June 30, 1999, which were $2.38 per Mcf of natural gas and
$15.00 per Bbl of oil. Natural gas equivalents in the table are the sum of the
natural gas and the oil, calculated on the basis that one Bbl of oil is the
energy equivalent of six Mcf of natural gas. These amounts exclude unproved
reserves that Eastern States may develop in the future. The amounts of estimated
future net cash flows from proved reserves shown in the table are before income
taxes. Discounted future net revenues are based on a discount rate of 10%.
Reserve estimates are subject to revision.
PROVED DEVELOPED RESERVES OF THE UNDERLYING PROPERTIES
<TABLE>
<CAPTION>
ESTIMATED FUTURE NET CASH
PROVED DEVELOPED RESERVES FLOWS FROM PROVED
---------------------------- DEVELOPED RESERVES
GAS EQUIVALENTS -------------------------
GAS (MMCF) (MMCFE) UNDISCOUNTED DISCOUNTED
---------- --------------- ------------ ----------
($ IN THOUSANDS)
<S> <C> <C> <C> <C>
Underlying wells by district:
Brenton, West Virginia................... 88,845 88,845 $165,384 $ 61,480
Madison, West Virginia................... 81,270 81,344 132,877 53,014
Weston, West Virginia.................... 46,891 48,329 84,374 33,972
Pikeville, Kentucky...................... 121,463 121,591 239,175 80,697
------- ------- -------- --------
Total............................ 338,469 340,109 $621,810 $229,163
</TABLE>
PROVED UNDEVELOPED RESERVES OF THE UNDERLYING PROPERTIES
<TABLE>
<CAPTION>
ESTIMATED FUTURE NET CASH
PROVED UNDEVELOPED RESERVES FLOWS FROM PROVED
---------------------------- UNDEVELOPED RESERVES
GAS EQUIVALENTS -------------------------
GAS (MMCF) (MMCFE) UNDISCOUNTED DISCOUNTED
---------- --------------- ------------ ----------
($ IN THOUSANDS)
<S> <C> <C> <C> <C>
Underlying leases by district:
Brenton, West Virginia................... 190,752 190,752 $263,073 $32,832
Madison, West Virginia................... 69,424 69,424 82,764 12,307
Weston, West Virginia.................... 7,342 7,342 9,694 1,266
Pikeville, Kentucky...................... 131,460 131,460 205,326 28,858
------- ------- -------- -------
Total............................ 398,978 398,978 $560,857 $75,263
</TABLE>
8
<PAGE> 13
TOTAL PROVED RESERVES OF THE UNDERLYING PROPERTIES
<TABLE>
<CAPTION>
ESTIMATED FUTURE NET CASH
TOTAL PROVED RESERVES FLOWS FROM TOTAL PROVED
---------------------------- RESERVES
GAS EQUIVALENTS -------------------------
GAS (MMCF) (MMCFE) UNDISCOUNTED DISCOUNTED
---------- --------------- ------------ ----------
($ IN THOUSANDS)
<S> <C> <C> <C> <C>
Underlying properties by district:
Brenton, West Virginia................... 279,597 279,597 $ 428,457 $ 94,312
Madison, West Virginia................... 150,694 150,768 215,641 65,321
Weston, West Virginia.................... 54,233 55,671 94,068 35,238
Pikeville, Kentucky...................... 252,923 253,051 444,501 109,555
------- ------- ---------- --------
Total............................ 737,447 739,087 $1,182,667 $304,426
</TABLE>
NET PROFITS INTERESTS
<TABLE>
<CAPTION>
PROVED RESERVES ESTIMATED FUTURE NET CASH
---------------------------- FLOWS FROM PROVED RESERVES
GAS EQUIVALENTS ---------------------------
GAS (MMCF) (MMCFE) UNDISCOUNTED DISCOUNTED
---------- --------------- ------------- -----------
($ IN THOUSANDS)
<S> <C> <C> <C> <C>
Underlying properties:
Net profits interests in underlying wells
(80%)(a)................................... 211,266 212,286 $428,286 $163,586
Net profits interests in underlying leases
(10%)(a)................................... 22,750 22,750 43,785 4,580
------- ------- -------- --------
Total net profits interest...................... 234,016 235,036 $472,071 $168,166
Per trust unit ( trust units)............... $ $
</TABLE>
- ---------------
(a) Proved reserves for the net profits interests attributable to the 2,562
underlying wells are calculated by subtracting from 80% of proved reserves,
reserve quantities of a sufficient value to pay 80% of the future estimated
production and development costs that are deducted in calculating net
proceeds, before overhead, trust administrative expenses and production and
ad valorem taxes. Proved reserves for the net profits interests
attributable to the proved undeveloped reserves owned by Eastern States in
Kentucky and West Virginia are calculated by subtracting from 10% of the
proved undeveloped reserves, reserve quantities of a sufficient value to
pay 10% of the future estimated production and development costs that are
deducted in calculating net proceeds before overhead, trust administrative
expenses and production and ad valorem taxes. Approximately 74 Bcfe of
proved reserves has been deducted to pay such future estimated production
and development costs for the underlying properties. Accordingly, proved
reserves for the net profits interests reflect quantities that are
calculated after reductions for future costs and expenses based on price
and cost assumptions used in the reserve estimates. For the year 2000,
administrative overhead is expected to be $1.6 million, drilling overhead
is expected to be $720,000, trust administrative expenses are expected to
be approximately $300,000 and ad valorem taxes are expected to be $2.9
million. These overhead, trust administrative expenses and production and
ad valorem taxes are not deducted in calculating reserve quantities
attributable to the net profits interests.
9
<PAGE> 14
HISTORICAL RESULTS FROM THE UNDERLYING PROPERTIES
The following table provides production and financial information relating
to the underlying properties for 1996, 1997 and 1998 and for each of the
six-month periods ended June 30, 1998 and 1999. Eastern States did not own all
of the underlying properties for each of the periods indicated. The audited
statements of revenue and direct operating expenses of the underlying properties
for the years ended December 31, 1996, 1997 and 1998 and the unaudited
statements for each of the six-month periods ended June 30, 1998 and 1999 begin
on page F-3 in this prospectus. This table reflects only historical costs and
does not include the incremental costs and charges that will be deducted by
Eastern States in calculating net proceeds payable to the trust.
<TABLE>
<CAPTION>
SIX MONTHS
ENDED JUNE 30,
-----------------
1996 1997 1998 1998 1999
------- ------- ------- ------- -------
($ IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Wellhead Volumes:
Natural gas (MMcf)............................ 19,646 20,326 19,372 10,145 9,185
Oil (MBbls)................................... 35 31 21 8 10
Average Realized Sales Prices:
Natural gas (per Mcf)......................... $ 2.84 $ 2.62 $ 2.19 $ 2.29 $ 2.01
Oil (per Bbl)................................. $ 19.32 $ 17.31 $ 11.83 $ 12.79 $ 10.27
Revenue:
Natural gas sales............................. $55,769 $53,192 $42,375 $23,220 $18,472
Oil sales..................................... 677 530 243 105 107
------- ------- ------- ------- -------
Total................................. 56,446 53,722 42,618 23,325 18,579
------- ------- ------- ------- -------
Direct Operating Expenses:
Production and property taxes................. 5,501 5,179 4,049 2,205 1,763
Production expenses........................... 6,395 5,232 3,720 1,860 1,860
------- ------- ------- ------- -------
Total................................. 11,896 10,411 7,769 4,065 3,623
------- ------- ------- ------- -------
Excess of Revenues over Direct Operating
Expenses...................................... $44,550 $43,311 $34,849 $19,260 $14,956
======= ======= ======= ======= =======
</TABLE>
YEAR 2000 PROJECTED DISTRIBUTABLE CASH
The following table provides a projection of distributable cash related to
estimated production for the 12 months ending December 31, 2000. This projection
assumes sales volumes and production and development costs estimated by Eastern
States, which estimates have been reviewed by Ryder Scott. A copy of the Ryder
Scott review report for the net profits interests is included as Exhibit B to
this prospectus. The calculations in the projection assume an average net
wellhead price of $2.61 per Mcf of natural gas, which is based on a NYMEX price
of $2.50 per MMbtu, and oil prices of $16.00 per Bbl. Eastern States has
prepared this projection as its best estimate of trust distributable cash for
the year 2000, on an accrual or production basis, based on these pricing
assumptions and other assumptions that are described in "Projected Year 2000
Distributable Cash -- Significant Assumptions Used to Prepare the Projected Year
2000 Distributable Cash." Because the projections are prepared on an accrual or
production basis for the year 2000, the projections represent an estimate of
cash that would be distributed to unitholders on or before June 25, September 25
and December 25, 2000 and March 25, 2001. The projections and the assumptions on
which they are based are subject to significant uncertainties, many of which are
beyond the control of Eastern States or the trust. ACTUAL YEAR 2000
DISTRIBUTABLE CASH, THEREFORE, COULD VARY SIGNIFICANTLY BASED UPON CHANGES IN
ANY OF THESE ASSUMPTIONS. Distributable cash is particularly sensitive to
natural gas prices. See "Projected Year 2000 Distributable Cash -- Sensitivity
of Projected Year 2000 Distributable Cash to Natural Gas Prices" which shows
estimated effects on projected year 2000 distributable cash from changes in
natural gas prices. As a result of typical production declines for natural gas
properties, and, subject to the success of the drilling of development wells,
production estimates generally decrease from year to year. Due to the seasonal
demand for natural gas, the amount of
10
<PAGE> 15
distributable cash may vary on a seasonal basis. ACCORDINGLY, THE PROJECTED YEAR
2000 DISTRIBUTABLE CASH IS NOT NECESSARILY INDICATIVE OF DISTRIBUTIONS FOR
FUTURE YEARS.
<TABLE>
<CAPTION>
PRODUCTION FROM
PRODUCTION FROM NEW WELLS ON COMBINED NET
UNDERLYING WELLS UNDERLYING LEASES PROFITS INTERESTS
---------------- ----------------- -----------------
($ IN THOUSANDS)
<S> <C> <C> <C>
Underlying Properties
Volumes Produced:
Natural gas:
Gross production (MMcf).................. 16,661 5,535 13,882
Less a 1% allowance for facilities
maintenance (MMcf)(a)................. (167) (55) (139)
------- -------- -------
Net production (MMcf).................... 16,494 5,480 13,743
Oil:
Gross production (MBbls)................. 15.6 -- 12.5
Less a 1% allowance for facilities
maintenance (MBbls)................... (.2) -- (.1)
------- -------- -------
Net production (MBbls)................... 15.4 -- 12.4
Assumed Average Net Wellhead Sales Price:
Natural Gas (per Mcf)(b)................. $ 2.61 $ 2.61 $ 2.61
======= ======== =======
Oil (per Bbl)............................ $ 16.00 -- $ 16.00
======= ======== =======
Calculation of Distributable Cash
Revenues:
Natural gas sales.......................... $43,050 $ 14,303 $35,870
Oil sales.................................. 247 -- 198
------- -------- -------
Total................................. $43,297 $ 14,303 $36,068
------- -------- -------
Costs:
Production and property taxes.............. 3,464 1,144 2,885
Production costs........................... 4,649 269 3,746
Development costs and drilling overhead.... -- 44,282 4,428
Overhead................................... 1,943 103 1,566
------- -------- -------
Total................................. 10,056 45,798 12,625
------- -------- -------
Net proceeds............................... 33,241 (31,495) 23,443
Net profits percentage..................... 80% 10%
------- -------- -------
Trust cash................................. 26,593 (3,150) 23,443
Trust administrative expenses.............. 300
=======
Trust distributable cash................... $23,143
=======
Trust distributable cash per trust unit
( trust units)..................... $
</TABLE>
11
<PAGE> 16
<TABLE>
<CAPTION>
CASH DISTRIBUTION AS A PERCENTAGE OF
AMOUNT $ TRUST UNIT PRICE
------ ------------------------------------
<S> <C> <C>
Per Trust Unit ( trust units):
Total cash distributions (and taxable income before
depletion)......................................... $2.20 %
Cost depletion tax deduction.......................... (0.86)
-----
Taxable income........................................ 1.34
Income tax rate(c).................................... 39.6%
-----
Income tax to unitholders............................. (0.53)
-----
Net cash distributions after tax to unitholder........ $1.67 %
=====
</TABLE>
- ---------------
(a) The 1% facilities maintenance allowance provides for an estimated loss of
production volumes due to the periodic shut-down of gathering and
compression facilities, transmission pipelines or other production
equipment.
(b) For the adjustments made to result in an assumed average net wellhead price
of $2.61 per Mcf, see the table under the caption "Projected Year 2000
Distributable Cash" on page 22 of this prospectus.
(c) Assumes maximum federal effective tax rate applicable to individuals, but
does not take into account state income taxes that may be payable by
unitholders to Kentucky and West Virginia or their state of residence.
12
<PAGE> 17
THE OFFERING
Trust units offered by Eastern
States..........................
Trust units outstanding......... trust units will be issued and
outstanding upon the closing of this
offering, of which trust units will
be owned by Eastern States. If the
underwriters' over-allotment option is
exercised in full, of the trust
units will be owned by Eastern States.
Use of proceeds................. Eastern States will receive all the net
proceeds from this offering, which will be
used to repay a portion of its existing
indebtedness to Statoil Energy Holdings, Inc.
NYSE symbol..................... The trust intends to apply for listing on the
New York Stock Exchange under the symbol
" ."
Conditional right of
repurchase...................... Eastern States will retain the right to
repurchase all, but not less than all, of the
outstanding units at any time if 15% or less
of the outstanding units are owned by persons
or entities other than Eastern States and its
affiliates. Any such repurchase will be made
at no less than the current market price.
Property trustee................ Bank One, Texas, N.A.
Delaware trustee................ Bank One Delaware, Inc.
INVESTING IN TRUST UNITS
Investing in the trust units differs from investing in corporate stock in
the following ways:
- trust unitholders are not owed a fiduciary duty by Eastern States;
- trust unitholders have limited voting rights;
- trust unitholders are taxed directly on their proportionate share of
trust net income;
- trust unitholders are entitled to federal income tax depletion
deductions;
- substantially all trust cash must be distributed to trust unitholders;
and
- trust assets are limited to the net profits interests which have a finite
economic life.
RISK FACTORS
Before investing in trust units, you should carefully consider the matters
described under "Risk Factors" beginning on page 14 of this prospectus.
13
<PAGE> 18
RISK FACTORS
RISKS ASSOCIATED WITH THE NATURAL GAS INDUSTRY AND THE UNDERLYING PROPERTIES
NATURAL GAS PRICE DECLINES AND MARKET VOLATILITY COULD RESULT IN LOWER CASH
DISTRIBUTIONS TO TRUST UNITHOLDERS.
The trust's revenues and quarterly cash distributions are highly dependent
upon the prices realized from the sale of natural gas. A material decrease in
the prices realized from the sale of natural gas by Eastern States could reduce
the amount of cash distributions paid to unitholders. Lower natural gas prices
may reduce the amount of natural gas that is economic to produce and reduce net
proceeds available to the trust. The volatility of energy prices reduces the
accuracy of estimates of future cash distributions to trust unitholders. Natural
gas prices can fluctuate widely on a month-to-month basis in response to a
variety of factors that are beyond the control of the trust and Eastern States.
These factors include, among others:
- weather conditions (primarily in the northeast United States);
- the supply and price of domestic and foreign natural gas and oil;
- delivery interruptions by upstream pipeline companies;
- the level of demand;
- worldwide economic conditions;
- the price and availability of alternative fuels;
- environmental regulations; and
- worldwide energy conservation measures.
Moreover, government regulations, such as regulation of natural gas
transportation or price controls, if imposed, could affect product prices in the
long term.
Also, any material decrease in the average premium received for Appalachian
Basin production could have an adverse impact on the proceeds received from the
sale of natural gas by Eastern States, resulting in lower cash distributions to
trust unitholders.
TRUST DISTRIBUTIONS ARE AFFECTED BY COSTS AND CHARGES DEDUCTED BY EASTERN
STATES IN CALCULATING NET PROCEEDS.
Production and development costs, gathering and compression charges and
overhead fees on the underlying properties are deducted in the calculation of
the trust's share of net proceeds. Accordingly, higher or lower production and
development costs, gathering and compression charges or overhead fees will
directly decrease or increase the amount received by the trust for its net
profits interests. Property and production and other taxes are also deducted.
The charges imposed by Eastern States for the production costs and both
administrative and drilling overhead rates will adjust each year beginning April
1, 2001 in accordance with an industry standard set forth in the accounting
procedures in the conveyances.
Because of the limited number of interstate pipeline transmission systems
available in these states as well as the difficult surface topography, producers
such as Eastern States must make significant investments in pipeline systems to
gather natural gas from each well drilled. In addition, Eastern States must have
extensive compression facilities to achieve sufficient line pressure to produce
into interstate transmission pipelines. To sustain its development drilling
program, Eastern States will have to make continuing investments in these
gathering and compression facilities. Eastern States will deduct from gross
proceeds a charge for gathering, compression and processing conducted using
Eastern States' facilities, which charge will include an amount to reimburse
Eastern States for the costs of such services, plus a reimbursement for
depreciation of the facilities and a return on its investment in such
facilities. Large investments in gathering and compression facilities in the
future could decrease the amounts received by the trust for its net profits
interests.
The development costs attributable to the net profits interest in the
underlying leases will be 10% of the development costs incurred by Eastern
States to drill wells in the future. Eastern States currently
14
<PAGE> 19
anticipates drilling an average of approximately 200 wells per year on the
underlying leases for at least the next five years. The effect of drilling these
new wells will be to reduce the amount of net proceeds received by the trust in
the near term, which will in turn reduce cash available for distribution by the
trust to its unitholders. The purpose of development drilling is to increase
production over levels that would be achieved in the absence of these
expenditures.
If the net proceeds from the underlying properties located in a particular
state are less than zero for any quarter, the trust will not receive net
proceeds from those properties until future proceeds from production in that
state exceed the total of the excess costs plus accrued interest during the
deficit period. Development activities may not generate sufficient additional
revenue to repay the costs.
PROVED RESERVE ESTIMATES ATTRIBUTABLE TO THE TRUST ARE UNCERTAIN.
The value of the trust units will depend upon, among other things, the
reserves attributable to the trust's net profits interests. The calculations of
proved reserves included in this prospectus are only estimates. These estimates
were prepared by Eastern States and reviewed by Ryder Scott. The accuracy of any
reserve estimate is a function of the quality of available data, engineering and
geological interpretation and judgment, and the assumptions used regarding
quantities of recoverable natural gas and natural gas prices. Petroleum
engineers consider many factors and make many assumptions in estimating
reserves. Those factors and assumptions include:
- historical production from the area compared with production rates from
other producing areas;
- the availability of pipeline delivery systems;
- the effects of governmental regulation; and
- assumptions about future commodity prices, production and development
costs, and severance and property taxes.
Changes in these assumptions can materially change reserve estimates.
Ultimately, actual production, revenues and expenditures for the underlying
properties will vary from estimates and those variations could be material.
The trust's reserve quantities and revenues are based on estimates of
reserves and revenues for the underlying properties. The method of allocating a
portion of those reserves to the trust is complicated because the trust holds an
interest in net profits and does not own a specific percentage of the natural
gas reserves. See "The Underlying Properties -- Reserves" for a discussion of
the method of allocating proved reserves to the trust.
WEATHER CONDITIONS MAY ADVERSELY AFFECT THE DEMAND FOR AND PRICES PAID FOR
NATURAL GAS.
Generally, natural gas prices in the Appalachian Basin tend to be higher
during the first and fourth quarters of the calendar year because a large
percentage of the usage is for heating purposes. As a result, warmer than normal
winter temperatures, particularly in the northeast United States, can
significantly decrease the demand for natural gas and consequently reduce prices
available in the marketplace. Also, warmer than normal winter temperatures will
generally decrease the amount of the Appalachian Basin premium, as occurred in
the winter of 1998/1999 when the Appalachian Basin premium realized by Eastern
States averaged $0.15 per MMbtu compared to an average of $0.36 per MMbtu for
the seven winter periods from 1991 through 1998. The result of these conditions
could decrease the amounts received by the trust for its net profits interests.
FACILITIES MAINTENANCE ON PIPELINE DELIVERY SYSTEMS COULD CREATE INTERRUPTIONS
IN THE DELIVERY OF NATURAL GAS PRODUCED FROM THE UNDERLYING PROPERTIES.
Eastern States depends on the availability of pipeline delivery systems to
transport its natural gas. Any extraordinary interruptions in the availability
of these systems due to maintenance requirements or other events could inhibit
the ability of Eastern States to sell its natural gas. For example Columbia
Transmission has announced that it will shut down one of its pipelines in
Kentucky in September and
15
<PAGE> 20
October 1999 for maintenance. This temporary shut-down will delay the delivery
and sale of approximately 30% of Eastern States natural gas production in
Kentucky, some of which is attributable to the underlying properties. These
interruptions could, therefore, decrease the amounts received by the trust for
its net profits interests.
RISKS ASSOCIATED WITH THE TRUST UNITS
NET PROCEEDS ARE DERIVED FROM THE SALE OF DEPLETING ASSETS.
The net proceeds payable to the trust are derived from the sale of
depleting assets. The reduction in proved reserve quantities is a common measure
of depletion. Future maintenance and development projects on the underlying
properties will affect the quantity of proved reserves and can offset the
reduction in proved reserves. The timing and size of these projects will depend
on the market prices of natural gas. If Eastern States, as operator of all of
the underlying properties, does not implement additional maintenance and
development projects, the future rate of production decline of proved reserves
may be higher than the rate currently expected by Eastern States.
Because net proceeds are derived from the sale of depleting assets, the
portion of distributions to trust unitholders attributable to depletion may be
considered a return of capital as opposed to a return on investment.
Distributions that are a return on capital will ultimately diminish the
depletion tax benefits available to the trust unitholders, which could reduce
the market price of the trust units over time.
THERE ARE RISKS INHERENT IN DRILLING NEW WELLS ON THE UNDERLYING LEASES.
Eastern States anticipates drilling an average of approximately 200 new
wells per year on the underlying leases for at least the next five years. No
assurance can be given that any new wells will be successful or produce in
commercial quantities or that the number of wells which are projected to be
drilled will actually be drilled. The failure of new wells in Kentucky and West
Virginia to produce in commercial quantities could cause the annual decline in
production from the underlying properties to exceed 2% to 3% per year.
PRODUCTION RISKS CAN ADVERSELY AFFECT TRUST DISTRIBUTIONS.
The occurrence of drilling, production or transportation accidents at any
of the underlying properties will reduce trust distributions by the amount of
uninsured costs. These accidents may result in personal injuries, property
damage, damage to productive formations or equipment and environmental damages.
Any of these types of costs would be deducted in calculating net proceeds
payable to the trust.
Eastern States insures against some, but not all, of the hazards associated
with the natural gas industry. Eastern States believes that this is standard
industry practice. This practice, however, may subject Eastern States to
liabilities or losses that could be substantial due to uninsured events.
THE TRUST DOES NOT CONTROL OPERATIONS AND DEVELOPMENT OF THE UNDERLYING
PROPERTIES.
Neither the trustee nor the trust unitholders can influence or control the
operation or future development of the underlying properties. Eastern States as
operator of all of the underlying properties is under no obligation to continue
operating the properties. Eastern States can sell any of the underlying
properties or relinquish its ability to control or influence operations. Neither
the trustee nor trust unitholders has the right to replace an operator.
EASTERN STATES MAY TRANSFER OR ABANDON THE UNDERLYING PROPERTIES.
Although it currently has no intention of selling any of the underlying
properties, Eastern States may at any time transfer all or part of the
underlying properties to another party. You will not be entitled to vote on any
transfer, and the trust will not receive any proceeds of the transfer. Following
any material transfer, the underlying properties will continue to be subject to
the net profits interests of the trust, but the net proceeds from the
transferred property would be calculated separately and paid by the transferee.
16
<PAGE> 21
The transferee would be responsible for all of Eastern States' obligations
relating to the net profits interests on the portion of the underlying
properties transferred, and Eastern States would have no continuing obligation
to the trust for those properties.
Eastern States or any transferee may abandon any well or property,
including the associated leases, if it reasonably believes that the well or
property can no longer produce in commercially economic quantities. This could
result in termination of the net profits interest relating to the abandoned
well.
NET PROFITS INTERESTS CAN BE SOLD OR THE TRUST MAY BE TERMINATED.
The trustee must sell the net profits interests if the holders of 66 2/3%
or more of the trust units approve the sale or vote to terminate the trust. The
trustee must also sell all the net profits interests in both states if the
annual net proceeds from the underlying properties are less than $3.5 million in
Kentucky for any two consecutive years after the year 2000 or less than $3.5
million in West Virginia for any two consecutive years after the year 2000. The
sale of all the net profits interests will terminate the trust. The net proceeds
from the sale of the trust's net profits interests will be distributed to the
trust unitholders.
EASTERN STATES' CONDITIONAL RIGHT OF REPURCHASE MAY FORCE INVESTORS TO SELL
THEIR TRUST UNITS AT AN UNDESIRABLE TIME AND PRICE.
Eastern States will retain the right to repurchase all (but not less than
all) outstanding units at any time at which 15% or less of the outstanding units
are owned by persons or entities other than Eastern States and its affiliates.
Any such repurchase will be made at no less than the current market price.
Because of this right, investors may be forced to sell their trust units at a
time and price that is undesirable to them.
EASTERN STATES' DISPOSAL OF TRUST UNITS MAY REDUCE THE MARKET PRICE FOR TRUST
UNITS.
At the completion of the offering, Eastern States will own trust
units assuming the underwriters' over-allotment option is not exercised. If the
underwriters' over-allotment option is exercised in full, Eastern States will
own trust units. It may use some or all of the trust units it owns for
a number of corporate purposes, including:
- selling them for cash; and
- exchanging them for interests in oil and natural gas properties or
securities of oil and natural gas companies.
If Eastern States sells these trust units or exchanges trust units in
connection with acquisitions, then additional trust units will be available for
sale in the market, which could result in a reduction in the market price of the
trust units.
EASTERN STATES MAY ENTER INTO CONTRACTS OR RECEIVE PAYMENTS THAT ARE NOT
NEGOTIATED IN ARM'S-LENGTH TRANSACTIONS.
Eastern States and some of its affiliates receive payments for services
relating to the underlying properties. Payments to Eastern States and its
affiliates will be deducted in determining net proceeds payable to the trust.
This will reduce the amounts available for distribution to the trust
unitholders. When calculating net proceeds from the underlying properties, the
following will be deducted by Eastern States:
- production costs to operate wells at a fixed rate per well of $170 per
month for those producing five or more Mcf per day on an annual basis and
$70 per month for those wells producing less than five Mcf per day on an
annual basis, subject to an annual adjustment beginning April 1, 2001 in
accordance with an industry standard set forth in the accounting
procedures in the conveyances;
17
<PAGE> 22
- development costs, plus a drilling overhead fee of $36,000 for each well
drilled on the underlying properties on or after October 1, 1999, subject
to an annual adjustment beginning April 1, 2001 in accordance with an
industry standard set forth in the accounting procedures in the
conveyances;
- Eastern States' charges to gather and compress the natural gas at actual
cost, plus reimbursement for depreciation and to provide a return on
investment of its gathering and compression systems based on a per Mcfe
gathered basis; and
- a fixed overhead fee per producing well of $65 per month, subject to an
annual adjustment beginning April 1, 2001 in accordance with an industry
standard set forth in the accounting procedures in the conveyances, to
operate the underlying properties, including engineering, accounting and
administrative functions.
In addition, Eastern States typically sells a portion of the production
from the underlying properties to its affiliate, Statoil Energy Services, at
market-based prices. Eastern States intends to continue to do so in the future,
to the extent the terms available from Statoil Energy Services are acceptable.
In 1998, approximately 65% of Eastern States' natural gas production was sold to
Statoil Energy Services. For a description of our current contract with Statoil
Energy Services, see "The Underlying Properties -- Gas Purchase Contracts."
EASTERN STATES MAY HAVE INTERESTS THAT ARE DIFFERENT FROM YOURS.
Because Eastern States has interests in natural gas properties in the
Appalachian Basin that are not included in the underlying properties, Eastern
States may have interests that are different from yours. For example,
- in setting budgets for development and production expenditures for
Eastern States' properties, including the underlying properties, Eastern
States may make decisions that could adversely affect future production
from the underlying properties. These decisions could include reducing
development expenditures on the underlying properties, which could cause
natural gas production to decline at a faster rate and ultimately result
in lower future trust distributions;
- Eastern States could continue to operate an underlying property and
continue to earn an overhead fee even though abandonment of the property
might result in more net proceeds being available to trust unitholders;
and
- Eastern States could decide to sell or abandon some or all of the
underlying properties, and that decision may not be in the best interests
of the trust unitholders. For example, Eastern States might sell some or
all of the underlying properties to a third party who could reduce
development expenditures on those properties, or Eastern States might
abandon a marginal well that otherwise would continue to produce a net
profit to the trust.
Except for specified matters that require approval of the trust unitholders
described in "Description of the Trust Agreement," the documents governing the
trust do not provide a mechanism for resolving these conflicting interests.
TRUST UNITHOLDERS WILL HAVE LIMITED VOTING RIGHTS AND NO ABILITY TO INFLUENCE
OPERATIONS OF THE UNDERLYING PROPERTIES.
Your voting rights as a trust unitholder are more limited than those of
stockholders of most public corporations. For example, there is no requirement
for annual meetings of trust unitholders or for an annual or other periodic
re-election of the trustee. Additionally, trust unitholders have no voting
rights in Eastern States and therefore will have no ability to influence its
operation and development of the underlying properties.
TRUST UNITHOLDERS WILL HAVE LIMITED ABILITY TO ENFORCE RIGHTS AGAINST EASTERN
STATES.
The trust agreement and related trust law permit the trustee and the trust
to sue Eastern States or any other future owner of the underlying properties to
honor the net profits interests. If the trustee does
18
<PAGE> 23
not take appropriate action to enforce provisions of the net profits interests,
your recourse as a trust unitholder would likely be limited to bringing a
lawsuit against the trustee to compel the trustee to take specified actions. You
probably would not be able to sue Eastern States or any future owner of the
underlying properties.
THE LIMITED LIABILITY OF TRUST UNITHOLDERS IS UNCERTAIN.
Consistent with Delaware law, the trust agreement provides that the trust
unitholders will have the same limitation on liability as is accorded under the
laws of Delaware to stockholders of a corporation for profit. No assurance can
be given, however, that the courts in jurisdictions outside of Delaware will
give effect to this limitation.
EASTERN STATES' LIABILITY TO THE TRUST IS LIMITED.
The net profits interest conveyances provide that Eastern States will not
be liable to the trust for performing its duties in operating the underlying
properties as long as it acts in good faith.
THERE ARE RISKS ASSOCIATED WITH THE FINANCIAL CONDITION OF EASTERN STATES AND
ITS AFFILIATES.
Eastern States is engaged primarily in the exploration, development,
production, transportation and marketing of natural gas in the Appalachian
Basin. The ability of Eastern States to operate the underlying properties in a
manner to generate net profits to the trust will be dependent upon its future
financial condition and economic performance, which in turn will depend upon the
supply and demand for natural gas, prevailing economic conditions and other
factors that are beyond the control of Eastern States.
From time to time, Eastern States may enter into hedging contracts for some
of its natural gas production at specified prices for a period of time. Any
gains or losses from hedging activities will not affect amounts paid to the
trust, but large losses under these hedging contracts could have an adverse
impact on the financial condition of Eastern States.
An affiliate of Eastern States, Statoil Energy Services, Inc., currently
purchases approximately 60% of the natural gas produced by Eastern States
pursuant to an existing contract. The ability of Statoil Energy Services to
perform its obligations under the contract will be dependent upon its future
financial condition and economic performance, which in turn will depend upon the
supply and demand for natural gas, prevailing economic conditions and upon
financial, business and other factors beyond the control of Eastern States and
Statoil Energy Services.
AN IRS RULING WILL NOT BE REQUESTED BY EASTERN STATES.
The trust has received an opinion of tax counsel that the trust is a
"grantor trust" for federal income tax purposes. This means that:
- the trust will not be taxed as a corporation;
- you will be taxed directly on your pro rata share of the net income of
the trust, regardless of whether all of that net income is distributed to
you; and
- you will be allowed depletion deductions equal to the greater of
percentage depletion or cost depletion, computed on the tax basis of your
trust units, and your pro rata share of other deductions of the trust.
See "Federal Income Tax Consequences."
Tax counsel believes that its opinion is in accordance with the present
position of the IRS regarding grantor trusts. Neither Eastern States nor the
property trustee has requested a ruling from the IRS regarding these tax
questions. Neither Eastern States nor the property trustee can assure you that
they would be granted a ruling if requested or that the IRS will continue this
position in the future.
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<PAGE> 24
Trust unitholders should be aware of possible state tax implications of
owning trust units. See "State Tax Considerations."
THE TRUST'S NET PROFITS INTERESTS MAY NOT BE RESPECTED IN A BANKRUPTCY
PROCEEDING.
Eastern States believes that the net profits interests should constitute
real property interests under Kentucky law, but not under West Virginia law. If
during the term of the trust Eastern States or any successor owner of the
underlying properties should become a debtor in a bankruptcy proceeding, it is
not entirely clear that the net profits interests would be treated as real
property interests under the laws of Kentucky, and they would not be so treated
under West Virginia law. If a determination were made in a bankruptcy proceeding
that a net profits interest did not constitute a real property interest under
applicable state law, it could be designated an executory contract. An executory
contract is a term used, but not defined, in the federal bankruptcy code to
refer to a contract under which the obligations of both the debtor and the other
party are so unsatisfied that the failure of either to complete performance
would constitute a material breach excusing performance by the other. If a net
profits interest were designated an executory contract and rejected in the
bankruptcy proceeding, Eastern States would not be required to perform its
obligations under the net profits interest and the trust would seek damages as
one of Eastern States's unsecured creditors.
FORWARD-LOOKING STATEMENTS
Some statements made by Eastern States in this prospectus under "Projected
Year 2000 Distributable Cash," statements pertaining to future development
activities and costs and other statements contained in this prospectus are
prospective and constitute forward-looking statements. These forward-looking
statements are based on Eastern States' current projections and estimates and
are identified by words such as "expects," "intends," "plans," "projects,"
"anticipates," "believes," "estimates" and similar words. These forward-looking
statements are not guarantees of future performance and involve known and
unknown risks, uncertainties and other factors that could cause actual results
to differ materially from future results expressed or implied by the
forward-looking statements. The most significant risks, uncertainties and other
factors are discussed under "Risk Factors" above.
Among the factors that could cause actual results to differ materially are:
- natural gas price fluctuations;
- the availability of funds for future development programs;
- the results of the planned development program;
- potential delays or failure to achieve expected production from the
underlying properties;
- potential disruption of operations because of our failure or the failure
of others with whom we have material relationships to achieve timely Year
2000 compliance; and
- potential liability resulting from litigation.
In addition, these forward-looking statements may be affected by general
domestic and international economic and political conditions.
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<PAGE> 25
USE OF PROCEEDS
Eastern States will receive all proceeds from the sale of trust units after
deducting underwriting discounts and costs of the offering paid by Eastern
States. The trust will not receive any proceeds from the sale of the trust
units. The net proceeds before deducting expenses will be approximately $
million, and will increase to $ million if the underwriters exercise their
over-allotment option in full. Eastern States intends to use the net proceeds
from the offering to repay outstanding indebtedness owed to Statoil Energy
Holdings, Inc.
EASTERN STATES
Eastern States, a corporation organized in Delaware, is an independent
energy company engaged in the development, production, acquisition, marketing,
gathering and transportation of natural gas and oil in the Appalachian Basin.
Eastern States is the largest owner of proved natural gas reserves in the
Appalachian Basin. Substantially all of Eastern States' natural gas and oil
reserves are located in Kentucky, Ohio and West Virginia.
For the years ended December 31, 1996, 1997 and 1998, Eastern States had
total revenue of $18.2 million, $65.4 million and $104.7 million, and for the
first six months of 1999, Eastern States had total revenue of $57.7 million. For
the years ended December 31, 1996, 1997 and 1998, Eastern States had net income
of $3.9 million, $9.2 million and $8.3 million, and for the first six months of
1999, Eastern States had net income of $6.0 million.
Eastern States currently owns and operates over 5,700 wells in the
Appalachian Basin. At December 31, 1998, Eastern States' net proved reserves
were 1,062 Bcfe. The estimated discounted future net cash flows of Eastern
States' proved reserves before United States income taxes were $675 million as
of December 31, 1998. For the six months ended June 30, 1999, total average net
sales meter natural gas and oil production was 104 MMcfe per day, 98% of which
was natural gas.
Eastern States is an indirect wholly owned subsidiary of Statoil Energy.
Statoil Energy also:
- through its indirect wholly owned subsidiary, Eastern States Exploration
Company, owns and operates approximately 600 wells in Pennsylvania, with
estimated net proved reserves of 39 Bcfe at December 31, 1998 and an
average net daily sales meter production of 6 MMcfe for the six months
ended June 30, 1999 (Eastern States does not own any interest in Eastern
States Exploration Company);
- owns and operates power plants throughout the northeast and the
mid-Atlantic region;
- is a leading trader of wholesale electricity and natural gas; and
- specializes in providing a broad range of energy and risk management
services involving the delivery of natural gas, electricity and
alternative fuels to large industrial, institutional and commercial
customers.
For the years ended December 31, 1996, 1997 and 1998 and the six months
ended June 30, 1999, Statoil Energy had revenue of approximately $0.6 billion,
$1.4 billion, $3.6 billion and $1.3 billion. For the years ended December 31,
1996, 1997 and 1998 and the six months ended June 30, 1999, Statoil Energy had
net income (loss) of approximately $5.9 million, $9.0 million, ($7.6) million
and $8.5 million.
Statoil Energy is an indirect wholly owned U.S. subsidiary of the Norwegian
state oil company "den norske stats oljeselskap a.s," which is also known as The
Statoil Group. The Statoil Group is one of the largest integrated energy
companies in the world, with $14 billion of revenue and $36 million of net
income for the year ended December 31, 1998. As of December 31, 1998, The
Statoil Group had over $18 billion in assets.
The Statoil Group is currently seeking a strategic partner to jointly
pursue the U.S. energy market. As currently contemplated, the assets and
businesses of Statoil Energy would be combined with the complementary assets and
business activities of a strategic partner. This combined enterprise, if
completed,
21
<PAGE> 26
will pursue business opportunities in the unregulated sector of the U.S. energy
market. Eastern States cannot assure you that such a strategic partnership will
be completed or, if completed, that it will be successful.
After the closing of this offering, Eastern States will continue to own and
operate the underlying properties from which the net profits interests were
conveyed. For additional information regarding Eastern States, see "Information
About Eastern States Oil & Gas, Inc.," beginning on page A-1. PURCHASERS OF
TRUST UNITS WILL NOT ACQUIRE INTERESTS IN OR OBLIGATIONS OF EASTERN STATES,
STATOIL ENERGY OR THE STATOIL GROUP. NONE OF EASTERN STATES, STATOIL ENERGY OR
THE STATOIL GROUP OWES ANY FIDUCIARY DUTY TO THE TRUST UNITHOLDERS.
THE TRUST
The trust was formed in August 1999 under the Delaware Business Trust Act
by the filing of a certificate of trust with the Delaware Secretary of State. At
the closing of this offering, the trust agreement will be amended and restated
and will contain the material terms described in "Description of the Trust
Agreement." Effective October 1, 1999, Eastern States will convey the net
profits interests to the trust in exchange for all of the trust units.
The trustee can authorize the trust to borrow money to pay trust
administrative or incidental expenses that exceed cash held by the trust. The
trustee may authorize the trust to borrow from the trustee as a lender. Because
the trustee is a fiduciary, the terms of the loan must be fair to the trust
unitholders. The trustee may also deposit funds awaiting distribution in an
account with itself, if the interest paid to the trust at least equals amounts
paid by the trustee on similar deposits.
The trust will pay the trustee a fee of 0.20% of trust cash (before
administrative expenses) per year, which would be approximately $46,800 for the
year 2000, and a fee of $7,500 for services to terminate the trust. The trust
will also incur legal, accounting and engineering fees, printing costs and other
expenses that will be deducted from the net proceeds received by the trust
before distributions are made to trust unitholders.
PROJECTED YEAR 2000 DISTRIBUTABLE CASH
The net profits interests will be created through two conveyances to the
trust of Eastern States' interests in the 2,562 underlying wells and all wells
drilled on the underlying leases on or after October 1, 1999. The net profits
interests entitle the trust to receive 80% of the net proceeds received by
Eastern States from the sale of natural gas from the underlying wells and 10% of
the net proceeds received by Eastern States from the sale of natural gas
produced by wells drilled on or after October 1, 1999 on the underlying leases.
Net proceeds equals the gross proceeds received by Eastern States from the sale
of production from the underlying properties less property and production taxes,
production costs, gathering and compression charges, development costs and
administrative and drilling overhead attributable to the underlying properties.
For a more detailed description of net proceeds, see "Computation of Net
Proceeds" on page 46 of this prospectus.
The amount of trust revenues and cash distributions to trust unitholders
will depend on:
- natural gas prices;
- the volume of natural gas produced and sold;
- the ability of Eastern States to successfully complete wells drilled
after the offering; and
- production, development and other costs.
PROJECTED YEAR 2000 DISTRIBUTABLE CASH
The following table provides a projection of distributable cash related to
the production for the 12 months ending December 31, 2000. This projection
assumes sales volumes and production and development costs estimated by Eastern
States, which estimates have been reviewed by Ryder Scott. A
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<PAGE> 27
copy of the Ryder Scott review report for the net profits interest is included
as Exhibit B to this prospectus. The calculations in the projection assume a
NYMEX price of $2.50 per MMbtu, increased by an Appalachian Basin premium of
$0.28 per MMbtu and a Btu adjustment of $0.36 per MMbtu based on an average Btu
content of 1,131 per cubic foot and reduced for third party gathering and
compression charges of $0.16 per Mcf, a 4.9% compressor fuel and line loss
charge by Eastern States of $0.14 per Mcf and Eastern States' gathering and
compression charge of $0.23 per Mcf, resulting in an average net wellhead price
of $2.61 per Mcf of natural gas. Oil prices of $16.00 per Bbl were also assumed.
Eastern States has prepared this projection as its best estimate of trust
distributable cash for the year 2000, on an accrual or production basis, based
on these pricing assumptions and other assumptions that are described in
"-- Significant Assumptions Used to Prepare the Projected Year 2000
Distributable Cash." Because the projections are prepared on an accrual or
production basis for calendar year 2000, the projections represent an estimate
of cash that would be distributed to unitholders on or about June 25, 2000,
September 25, 2000, December 25, 2000 and March 25, 2001. The projections and
the assumptions on which they are based are subject to significant
uncertainties, many of which are beyond the control of Eastern States or the
trust. ACTUAL 2000 DISTRIBUTABLE CASH, THEREFORE, COULD VARY SIGNIFICANTLY BASED
UPON CHANGES IN ANY OF THESE ASSUMPTIONS. Distributable cash is particularly
sensitive to natural gas prices. See "-- Sensitivity of Projected Year 2000
Distributable Cash to Natural Gas Prices" which shows estimated effects on
projected year 2000 distributable cash from changes in natural gas prices. As a
result of typical production declines for natural gas properties, and, subject
to the success of the drilling of development wells, production estimates
generally decrease from year to year. Due to the seasonal demand for natural
gas, the amount of distributable cash may vary on a seasonal basis. ACCORDINGLY,
THE PROJECTED YEAR 2000 DISTRIBUTABLE CASH IS NOT NECESSARILY INDICATIVE OF
DISTRIBUTIONS FOR FUTURE YEARS. A PORTION OF EACH DISTRIBUTION MAY REPRESENT A
RETURN OF YOUR ORIGINAL INVESTMENT, RATHER THAN A RETURN ON YOUR ORIGINAL
INVESTMENT. SEE "RISK FACTORS -- NET PROCEEDS ARE DERIVED FROM THE SALE OF
DEPLETING ASSETS."
<TABLE>
<CAPTION>
PRODUCTION FROM
PRODUCTION FROM NEW WELLS ON COMBINED NET
UNDERLYING WELLS UNDERLYING LEASES PROFITS INTEREST
---------------- ----------------- ----------------
($ IN THOUSANDS)
<S> <C> <C> <C>
Underlying Properties
Volumes Produced:
Natural gas:
Gross production (MMcf)................... 16,661 5,535 13,882
Less a 1% allowance for
facilities maintenance (MMcf).......... (167) (55) (139)
------- -------- -------
Net production (MMcf)..................... 16,494 5,480 13,743
Oil:
Gross production (MBbls).................. 15.6 -- 12.5
Less a 1% allowance for
facilities maintenance (MBbls)......... (0.2) -- (0.1)
------- -------- -------
Net production (MBbls).................... 15.4 -- 12.4
Assumed Sales Price of Natural Gas:
NYMEX (MMbtu)............................... $ 2.50
Plus Appalachian Basin Premium (MMbtu)...... 0.28
-------
Average Sales Meter Price (MMbtu)......... 2.78
Plus Btu Adjustment......................... 0.36
-------
Average Sales Meter Price (Mcf)........... 3.14
Less Third Party Gathering and Compression
Charge (Mcf).............................. (0.16)
-------
Average Net Sales Meter Price (Mcf)......... 2.98
Less Eastern States' Gathering and
Compression Charge (Mcf).................. (0.23)
Less Compressor Fuel Cost and Line Loss..... (0.14)
-------
Average Net Wellhead Price (per Mcf)...... $ 2.61 $ 2.61 $ 2.61
======= ======== =======
Assumed Sales Price of Oil (per Bbl)........... $ 16.00 -- $ 16.00
======= ======== =======
</TABLE>
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<PAGE> 28
<TABLE>
<CAPTION>
PRODUCTION FROM
PRODUCTION FROM NEW WELLS ON COMBINED NET
UNDERLYING WELLS UNDERLYING LEASES PROFITS INTEREST
---------------- ----------------- ----------------
($ IN THOUSANDS)
<S> <C> <C> <C>
Calculation of Distributable Cash
Revenues:
Natural gas sales........................... $43,050 $ 14,303 $35,870
Oil sales................................... 247 -- 198
------- -------- -------
Total.................................. $43,297 $ 14,303 $36,068
------- -------- -------
Costs:
Production and property taxes............... 3,464 1,144 2,885
Production costs............................ 4,649 269 3,746
Development costs and drilling overhead..... -- 44,282 4,428
Overhead.................................... 1,943 103 1,566
------- -------- -------
Total.................................. 10,056 45,798 12,625
------- -------- -------
Net proceeds................................ 33,241 (31,495) 23,443
Net profits percentage...................... 80% 10%
------- -------- -------
Trust cash.................................. 26,593 (3,150) 23,443
Trust administrative expenses............... 300
-------
Trust distributable cash.................... $23,143
=======
</TABLE>
<TABLE>
<CAPTION>
CASH DISTRIBUTION AS A PERCENTAGE OF
AMOUNT $ TRUST UNIT PRICE
------ ------------------------------------
<S> <C> <C>
Per Trust Unit ( trust units):
Total cash distributions (and taxable income before
depletion)......................................... $ 2.20 -- %
Cost depletion tax deduction.......................... (0.86)
------
Taxable income........................................ 1.34
Income tax rate(a).................................... 39.6%
------
Income tax to unitholders............................. (0.53)
------
Net cash distributions after tax to unitholder........ $ 1.67 -- %
====== =====
</TABLE>
- ---------------
(a) Assumes maximum federal effective tax rate applicable to individuals, but
does not take into account state income taxes that may be payable by
unitholders to Kentucky and West Virginia or their state of residence.
SIGNIFICANT ASSUMPTIONS USED TO PREPARE THE PROJECTED YEAR 2000 DISTRIBUTABLE
CASH
Timing of Actual Distributions. In preparing the projected year 2000
distributable cash described above and the sensitivity tables below, the
projected revenues and expenses of the trust were calculated based on the terms
of the conveyances creating the net profits interests. These calculations are
described under "Computation of Net Proceeds," except that amounts for the
projection and sensitivity tables were calculated on an accrual or production
basis rather than the cash basis prescribed by the conveyances. As a result, the
proceeds of production for the fourth quarter of the year 2000, and reflected in
the projection and tables, will actually enter into the calculation of net
proceeds to be received by the trust and distributed to unitholders on or before
March 25, 2001, since payments are made to Eastern States for sales of
production 55 to 60 days after the month of sale. Net proceeds from production
for the fourth quarter of 1999 will in fact be received by the trust and
distributed to unitholders in March 2000. The actual amount of the trust's
initial distribution will be based on actual production during the quarter
commencing October 1, 1999. Accordingly, the projections represent an estimate
of cash that would be distributed to unitholders on or before June 25, 2000,
September 25, 2000, December 25, 2000 and March 25, 2001 and relate to
production for the year 2000.
24
<PAGE> 29
Production Estimates. Production estimates for the year 2000 are based on
estimates by Eastern States for the net profits interests, which estimates have
been reviewed by Ryder Scott as described in their review report included as
Exhibit B to this prospectus. The Ryder Scott review report assumed constant
prices at June 30, 1999, based on the weighted average wellhead natural gas
price at June 30, 1999 of $2.24 per Mcfe. Production from the underlying
properties for the year 2000 is estimated to be 22.3 MMcfe, net to Eastern
States. Eastern States then adjusts such production estimates by deducting 1% as
an allowance for facilities maintenance (for example, from time to time
gathering or transmission pipelines, production equipment or other facilities
are shut down for scheduled or unscheduled maintenance, which can reduce volumes
produced from Eastern States' wells below expected levels). Differing levels of
production will result in different levels of distributions and cash returns.
Natural Gas Prices. Natural gas prices assumed in the year 2000 projected
distributable cash estimate are based on wellhead prices for natural gas. The
wellhead price of $2.61 per Mcf was determined as follows:
NYMEX Price. Eastern States assumed a NYMEX price of $2.50 per MMbtu
in calculating the average wellhead natural gas price, which price compares
to the NYMEX futures market for the year 2000 as of , 1999 of
$ per MMbtu.
Appalachian Basin Premium. Eastern States increased the NYMEX price of
$2.50 per MMbtu by an assumed Appalachian Basin premium of $0.28 per MMbtu.
For the period 1996 through 1998, natural gas price indices in the
Appalachian Basin have averaged an annual premium of $0.26 per MMbtu more
than prices for natural gas contracts traded on the NYMEX for the delivery
of gas at Henry Hub, Louisiana. During these three years, the average
annual Appalachian Basin premium has ranged from $0.14 per MMbtu to $0.47
per MMbtu. Historically, the premium has been higher in the first and
fourth quarters of the calendar year than in the second and third quarters.
The assumed Appalachian Basin premium of $0.28 includes a $0.02 per MMbtu
premium received by Eastern States pursuant to existing contracts that
provide for the sale of approximately 90% of Eastern States' natural gas
production. The inclusion of the Appalachian Basin premium results in an
average sales meter price of $2.78 per MMbtu.
Btu Adjustment. The average sales meter price of $2.78 per MMbtu is
increased by an assumed Btu adjustment of $0.36. This increase results in
an average sales meter price of $3.14 per Mcf. Eastern States assumes that
production from the underlying properties will have a Btu content for each
cubic foot of natural gas of 1,131 based on actual production data from the
underlying properties for the six months ended June 30, 1999. This high Btu
content has historically provided an average 13.1% premium over the
standard measure of 1,000 Btu per cubic foot when calculating realized
prices on a per Mcf basis. The Btu adjustment converts the price per MMbtu
into a per Mcf equivalent by increasing the sum of the NYMEX price plus the
Appalachian Basic Premium by 13.1%.
Third Party Gathering and Compression Charge. Eastern States subtracts
an assumed average of $0.16 per Mcf for third party gathering and
compression charges from the average sales meter price to arrive at an
average net sales meter price of $2.98 per Mcf. Eastern States assumed
$0.16 per Mcf based on its estimate of the costs to transport natural gas
production from the underlying properties in the year 2000 through third
party gathering systems. As a result of the completion of various pipeline
projects by Eastern States in 1998 and early 1999, approximately one-third
of Eastern States' natural gas production is subject to third party
gathering and compression charges. Third party gathering and compression
charges are typically approximately $0.50 per Mcf. The assumed $0.16 per
Mcf charge represents a weighted average of all of Eastern States natural
gas production, assuming third parties continue to gather and compress
approximately one-third of Eastern States projected year 2000 natural gas
production.
Eastern States' Gathering and Compression Charge. In accordance with
the conveyances, Eastern States will deduct an assumed $0.23 per Mcf for
its gathering and compression charge. This charge represents estimated
gathering and compression costs of $0.094 per Mcf (equal to the actual
25
<PAGE> 30
cost per Mcf incurred by Eastern States during the six months ended June
30, 1999 to gather and compress natural gas produced from the underlying
properties), plus reimbursement for depreciation and a return on investment
of its gathering and compression systems of $0.136 per Mcf (equal to the
charge per Mcf that would have been deducted by Eastern States during the
six months ended June 30, 1999 to reimburse it for depreciation and to
provide a return on its investment in its gathering and compression
systems). The projected charge of $0.23 per Mcf for natural gas gathered
and compressed by Eastern States has been projected in accordance with the
conveyance for projected year 2000 volumes assumed to be gathered and
compressed by Eastern States. See "Computation of Net Proceeds -- Net
Profits Interests."
Compressor Fuel Cost and Line Loss. In accordance with the conveyances
and in connection with gathering and compression services to be performed
by Eastern States, Eastern States will deduct a charge for volumes consumed
for compressor fuel and for volumes lost during gathering and compression
(referred to as line loss). For purposes of this presentation, an assumed
fuel cost and line loss of approximately 4.9% of the average net sales
meter price of $2.98 per Mcf has been deducted. This assumed fuel cost and
line loss charge equates to $0.14 per Mcf. The amount deducted (that is,
approximately 4.9% of the average net sales meter price) is based on
Eastern States' historical production data. The actual amounts to be
deducted will be based upon the actual volumes so consumed or lost by
Eastern States in performing these services, which will vary based upon the
actual volumes gathered and compressed by Eastern States. The combined
effects of this and the previous adjustments results in an average net
wellhead price of $2.61 per Mcf.
In early 1999, Eastern States completed a major pipeline project which
reduced the amount of its natural gas production subject to third party
gathering and compression charges which increased net proceeds. These reduced
third party gathering and compression charges and corresponding increase in net
proceeds will be offset in part by the reimbursement to Eastern States for
depreciation and a return on investment of its gathering and compression systems
described in the preceding paragraph. However, if location, quality and other
differentials return in the future to more normal levels, there may be more
significant differences between the natural gas price received and the NYMEX
price.
The adjustments to wellhead natural gas prices applied in the foregoing
tables are based upon an analysis by Eastern States of the historic price
differentials for production from the underlying properties with consideration
given to the Appalachian Basin premium, Btu content, both third party and
internal gathering and compression charges, and fuel and line loss that may
affect these differentials in the year 2000. There is no assurance that these
assumed differentials will recur in the year 2000 since they are dependent upon
numerous factors outside Eastern States' control. When natural gas prices
decline, the operators of the underlying properties may elect to reduce or
completely suspend production. No adjustments have been made to estimated year
2000 production to reflect potential reductions or suspensions of production.
Production Costs. For calendar year 2000, Eastern States will charge a
fixed fee per well for production costs to operate the wells on the underlying
properties. For those wells producing five or more Mcf per day on an annual
basis, Eastern States will charge $170 per month. For those wells producing less
than five Mcf per day on an annual basis, Eastern States will charge $70 per
month. Each of these fixed costs is subject to adjustment beginning April 1,
2001 in accordance with an industry standard set forth in the accounting
procedures in the conveyances. The estimated costs for year 2000 are based upon
Eastern States' projections, which have been reviewed by Ryder Scott and are the
subject of their review report included as Exhibit B to this prospectus. The
actual amount of production costs deducted when calculating net proceeds is
reduced by approximately 3%, which amount represents the average percentage
working interest in the underlying properties that Eastern States does not own.
It is assumed that the other working interest owners will bear the remaining
portion of production costs. For a description of production costs, see
"Computation of Net Proceeds -- Net Profits Interests."
26
<PAGE> 31
Development Costs and Drilling Overhead. In calculating net proceeds,
Eastern States will be reimbursed for all development costs attributable to the
underlying properties, plus a drilling overhead fee of $36,000 for each well
drilled on the underlying properties on or after October 1, 1999. This drilling
overhead fee is subject to adjustment beginning April 1, 2001 in accordance with
an industry standard set forth in the accounting procedures in the conveyances.
For the year 2000, Eastern States expects to drill approximately 200 wells on
the underlying leases resulting in development costs of approximately $44
million, which includes a drilling overhead fee of $7.2 million. See
"Computation of Net Proceeds -- Net Profits Interests." It is assumed that
Eastern States will own a 99% working interest in all wells drilled on or after
October 1, 1999.
Overhead. For the year 2000, Eastern States will charge a $65 per month
fixed overhead fee per producing well on the underlying properties. Prior to the
closing of this offering, Eastern States has not charged an overhead fee. This
fixed cost is subject to an adjustment beginning April 1, 2001 in accordance
with an industry standard set forth in the accounting procedures in the
conveyances. This overhead fee is in addition to the production fee described
under "-- Production Costs" above. The actual amount of overhead deducted when
calculating net proceeds is reduced by approximately 3%, which amount represents
the average percentage working interest in the underlying properties that
Eastern States does not own. It is assumed that the other working interest
owners will bear the remaining portions of overhead.
Administrative Expense. Trust administrative expense for the year 2000 is
assumed to be $300,000 ($ per trust unit). See "The Trust."
Projected After-Tax Cash Distributions as a Percentage of Trust Unit Price
of $______. Because the net profits interests are a depleting asset, a portion
of this distribution may be considered a return of your original investment.
Except for tax purposes, the portion that would be considered a return of
original investment is not determinable until the trust unit is sold by a trust
unitholder. For a discussion of alternative ways of measuring the depletion of
oil and natural gas assets, see "Risk Factors -- Net proceeds are derived from
the sale of depleting assets."
The Projected After-Tax Cash Distributions as a Percentage of Trust Unit
Price of $______ were computed by:
- taking into account a cost depletion tax deduction of $0.86 per trust
unit;
- determining the amount of federal income tax that would be paid on the
taxable income attributable to a unit at the highest effective tax rate
applicable to individuals for 1999 of 39.6%;
- subtracting the federal income tax to unitholders from the annual cash
distributions; and
- dividing the result by $______ per trust unit.
Cost depletion is calculated by multiplying the assumed trust unit purchase
price of $______ by the cost depletion rate of 4.3%. Cost depletion is
recaptured upon sale of the trust units, which results in the taxation of any
gain on sale as ordinary income, as opposed to capital gain, up to the amount of
cost depletion previously deducted.
When the distributions are less than $ per trust unit, the Projected
After-Tax Cash Distributions as a Percentage of Trust Unit Price of $______
would be the same or greater than the Projected Pre-Tax Cash Distributions as a
Percentage of Trust Unit Price because of cost depletion. In all instances, each
trust unitholder is assumed to have a regular federal income tax liability
sufficient to utilize the depletion deduction. Alternative minimum tax and state
income tax implications have not been considered.
27
<PAGE> 32
SENSITIVITY OF PROJECTED YEAR 2000 DISTRIBUTABLE CASH TO NATURAL GAS PRICES
Eastern States prepared the following unaudited tables, which demonstrate
the estimated effect that changes in the estimated year 2000 production and in
the price for natural gas could have on distributable cash by the trust. The
following tables show:
- the projected distributable cash per trust unit for year 2000 on the
accrual or production basis;
- the resulting projected distributable cash per trust unit as a percentage
of the purchase price of the trust unit; and
- the resulting projected distributable cash per trust unit as a percentage
of the purchase price of the trust unit, after payment of all federal
income tax, net of available deductions at the highest effective federal
tax rate applicable to individuals of 39.6%.
THE TABLES BELOW ARE NOT A PROJECTION OR FORECAST OF THE ACTUAL OR
ESTIMATED RESULTS FROM AN INVESTMENT IN THE TRUST UNITS. THE PURPOSE OF THE
TABLES IS TO ILLUSTRATE THE SENSITIVITY OF DISTRIBUTABLE CASH AND DISTRIBUTABLE
CASH AS A PERCENTAGE OF TRUST UNIT PURCHASE PRICE TO CHANGES IN THE PRICES OF
NATURAL GAS. THERE IS NO ASSURANCE THAT THE ASSUMPTIONS DESCRIBED ABOVE WILL
ACTUALLY OCCUR OR THAT THE PRICES OF NATURAL GAS WILL NOT CHANGE BY AMOUNTS
DIFFERENT FROM THOSE SHOWN IN THE TABLES.
Due to the seasonal demand for natural gas, the amount of quarterly cash
distributions from the trust is expected to vary during the year. Quarterly
distributions will also vary based on the timing of development expenditures and
the net proceeds, if any, generated by development projects.
SENSITIVITY OF PROJECTED TOTAL YEAR 2000 CASH DISTRIBUTIONS PER TRUST UNIT
<TABLE>
<CAPTION>
% OF YEAR 2000 RESERVE REPORT ESTIMATED PRODUCTION AVERAGE ANNUAL NYMEX NATURAL GAS PRICE PER MMBTU
- -------------------------------------------------- -----------------------------------------------------
$1.75 $2.00 $2.25 $2.50 $2.75 $3.00 $3.25
----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
90%.......................................... $1.07 $1.34 $1.61 $1.88 $2.15 $2.43 $2.70
95%.......................................... 1.19 1.47 1.76 2.04 2.33 2.61 2.90
100%......................................... 1.30 1.60 1.90 2.20 2.50 2.80 3.10
105%......................................... 1.41 1.73 2.04 2.36 2.67 2.99 3.30
110%......................................... 1.52 1.85 2.18 2.52 2.85 3.18 3.51
</TABLE>
SENSITIVITY OF PROJECTED YEAR 2000 PRE-TAX CASH DISTRIBUTIONS AS A
PERCENTAGE OF TRUST UNIT PRICE OF $
<TABLE>
<CAPTION>
% OF YEAR 2000 RESERVE REPORT ESTIMATED PRODUCTION AVERAGE ANNUAL NYMEX NATURAL GAS PRICE PER MMBTU
- -------------------------------------------------- -----------------------------------------------------
$1.75 $2.00 $2.25 $2.50 $2.75 $3.00 $3.25
----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
90%.......................................... 5.37% 6.72% 8.07% 9.42% 10.77% 12.13% 13.48%
95%.......................................... 5.93 7.36 8.78 10.21 11.64 13.07 14.49
100%......................................... 6.49 8.00 9.50 11.00 12.50 14.00 15.51
105%......................................... 7.06 8.63 10.21 11.79 13.37 14.94 16.52
110%......................................... 7.62 9.27 10.92 12.58 14.23 15.88 17.54
</TABLE>
28
<PAGE> 33
SENSITIVITY OF PROJECTED YEAR 2000 AFTER-TAX CASH DISTRIBUTIONS AS A
PERCENTAGE OF TRUST UNIT PRICE OF $
<TABLE>
<CAPTION>
% OF YEAR 2000 RESERVE REPORT ESTIMATED PRODUCTION AVERAGE ANNUAL NYMEX NATURAL GAS PRICE PER MMBTU
- -------------------------------------------------- ------------------------------------------------------
$1.75 $2.00 $2.25 $2.50 $2.75 $3.00 $3.25
----- ----- ----- ----- ----- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C>
90%......................................... 4.95% 5.77% 6.58% 7.40% 8.22% 9.03% 9.85%
95%......................................... 5.29 6.15 7.01 7.88 8.74 9.60 10.46
100%........................................ 5.63 6.54 7.44 8.35 9.26 10.17 11.07
105%........................................ 5.97 6.92 7.88 8.83 9.78 10.73 11.69
110%........................................ 6.31 7.31 8.31 9.30 10.30 11.30 12.30
</TABLE>
29
<PAGE> 34
THE UNDERLYING PROPERTIES
GENERAL
The underlying properties are located in the Appalachian Basin states of
Kentucky and West Virginia. The underlying properties consist of Eastern States'
interests in 2,562 existing producing natural gas wells and interests in wells
that Eastern States will drill on or after October 1, 1999 on all of Eastern
States' oil and gas leasehold interests in the states of Kentucky and West
Virginia, except for the limited number of excluded interests discussed below.
The trust will not have a net profits interest in any properties or interests
acquired by Eastern States on or after October 1, 1999. The working interests of
Eastern States comprising the underlying properties are held under leases and
farmout agreements with third parties. Substantially all of the working
interests are subject to landowners' royalties and may be subject to additional
royalties or other obligations burdening the working interests. These royalties
do not bear lease operating expenses, but reduce the revenue interests
attributable to the underlying properties.
Eastern States has, on average, greater than a 97% working interest and a
net revenue interest of approximately 87% in the underlying properties. Eastern
States estimates that 340 Bcfe of proved developed and 399 Bcfe of proved
undeveloped natural gas reserves are attributable to the underlying properties,
which estimates have been reviewed by Ryder Scott and are the subject of their
review report as of June 30, 1999 included as Exhibit A to this prospectus.
Eastern States estimates that 212 Bcfe of proved developed reserves and 23 Bcfe
of proved undeveloped reserves are attributable to the net profits interest free
of future costs and expenses, which estimates have been reviewed by Ryder Scott
and are the subject of their review report included as Exhibit B to this
prospectus.
Eastern States currently owns approximately 4,800 producing wells in
Kentucky and West Virginia. When selecting producing wells to be included in the
2,562 underlying wells, Eastern States excluded wells with any of the following
characteristics:
- wells owned by a financial institution that are Section 29 production
payment properties (approximately 1,350), most of which are operated by
Eastern States;
- wells drilled during the 21 months ended September 30, 1999, each of
which has a limited production history and a relatively high decline
profile (approximately 220);
- wells located in the Rome exploration area of Kentucky, which is a high
risk exploration area characterized by high operating costs;
- wells with relatively high operating costs;
- marginal producing wells and associated leases, i.e., producing less than
2 Mcf per day, which will most likely have to be abandoned in the next
five to ten years (approximately 300);
- wells and associated leases with title issues; and
- wells in which Eastern States is not the operator (approximately 300).
Eastern States' conveyance to the trust of a net profits interest in 2,562
underlying wells in Kentucky and West Virginia is intended to create a diversity
of well profiles and a diversity of value. The well with the highest discounted
net present value represents less than 0.5% of the value of all underlying
wells. The inclusion of a large number of future drilling opportunities on the
underlying leases along with the underlying wells will provide statistical and
geological diversity in multiple potential producing horizons in Kentucky and
West Virginia. Approximately 73% of the 2,562 underlying wells are located in
West Virginia and approximately 27% are located in Kentucky.
Eastern States excluded leases and other interests in Kentucky and West
Virginia from the underlying leases with any of the following characteristics:
- leases and mineral interests in Kentucky and West Virginia pertaining to
the Rome exploration area, which is characterized by high development
costs;
- underlying leases that have been farmed out to third parties; and
- leases or interests with known conveyance or title issues, including all
potential coalbed methane exploration and developmental rights.
30
<PAGE> 35
Eastern States has an inventory of approximately 1.2 million gross acres
(excluding the Rome exploration area but before giving effect to the other
excluded interests) comprising the underlying leases and has established a
drilling schedule for new sites in Kentucky and West Virginia. Eastern States
anticipates drilling an average of 200 wells per year on the underlying leases
for at least the next five years. Without future development, the underlying
properties would typically experience an average 5.5% annual decline in
production. Planned development expenditures included in the Ryder Scott review
report (totaling $256 million through 2006 or $25.6 million net to the trust)
are expected to reduce the natural rate of decline in production to 2% to 3% per
year. While the number of wells to be drilled on an annual basis following the
offering is subject to a number of factors beyond the control of Eastern States,
the underlying leases are expected to yield a number of drillsites which would
sustain development of the properties at current levels for the foreseeable
future.
Although Eastern States has not obtained title opinions with respect to the
drillsites, Eastern States is not aware of any title deficiencies that would
preclude it from drilling any of the locations. See "-- Title to Properties."
Eastern States has drilled over 400 wells in the Appalachian Basin since 1994
with a completion rate of approximately 98%, and expects the completion rate on
wells drilled on or after October 1, 1999 to be similar. Moreover, the
drillsites are expected to have the same general production characteristics as
the producing wells included in the underlying properties. No assurance can be
given, however, that any wells drilled on or after October 1, 1999 will be
successful or produce in commercial quantities.
Production from the wells to which the underlying properties relate is
typically subject to, in one degree or another,
- landowner royalties and other burdens and obligations retained under oil
and gas leases;
- relocation provisions under oil and gas leases with coal mining entities;
- overriding royalty interests; and
- other working interests in the wells.
Royalty and overriding royalty interests entitle the holders thereof to a
percentage of the oil and natural gas produced from the wells or the proceeds
therefrom and are generally delivered free of all expenses of production but may
be subject to post-production costs, such as,
- production or gathering taxes;
- costs to treat the natural gas to render it marketable; and
- transportation or gathering and compression costs.
Royalty interests are usually reserved by the lessor under an oil and gas
lease. Overriding royalty interests are carved out of a lessee's share of
production under an oil and gas lease and are generally reserved by a
predecessor in title or reserved under farmout agreements. Certain leases are
not burdened by any royalty interests and only a minor portion of the underlying
leases are burdened by overriding royalties.
THE APPALACHIAN BASIN
The Appalachian Basin is the oldest and geographically one of the largest
oil and natural gas producing regions in the United States. From 1859 to 1993,
more than 700,000 wells have been drilled in the Appalachian Basin and have
produced an estimated three billion barrels of oil and 42 trillion cubic feet of
natural gas. Although the Appalachian Basin has known sedimentary formations
indicating the potential for oil and natural gas reservoirs to depths of 13,000
feet or more, oil and natural gas is currently produced principally from shallow
blanket formations at depths of 1,000 to 7,000 feet. These formations are
generally characterized by low porosity and low permeability which results in
slow recovery of the reserves in place, low rates of production and wells that
generally produce for longer than 20 years and often more than 50 years.
Although commercial success varies widely from well to well, operators in the
Appalachian Basin historically have experienced drilling completion rates
exceeding 90% in these shallow formations.
31
<PAGE> 36
For the period 1991 through 1998, wellhead natural gas prices in the
Appalachian Basin have averaged on an annual basis $0.25 per MMbtu more than
prices for natural gas contracts traded on the NYMEX for the delivery of natural
gas at Henry Hub, Louisiana. During these eight years, the Appalachian Basin
annual premium has ranged from $0.14 per MMbtu to $0.47 per MMbtu. This premium
has averaged $0.26 MMbtu for the last three years. The higher average prices are
principally due to the proximity to a substantial number of industrial and
commercial end users in the northeast United States. The Appalachian Basin
premium is offset, at least in part, by the high gathering and compression costs
in the Appalachian Basin.
The combination of its long-lived production, low drilling costs, high
drilling completion rates at shallow depths and proximity to natural gas markets
has had a substantial impact on the development of the Appalachian Basin
resulting in a highly fragmented operating environment. In 1998, Kentucky and
West Virginia had more than 500 independent operators and more than 85,000
producing oil and natural gas wells. Also, the historical availability of tax
shelter capital has resulted in extensive drilling in the shallow formations
with these low technical risk characteristics.
DISTRICTS COMPRISING THE UNDERLYING PROPERTIES
The districts comprising the underlying properties are as follows:
Pikeville Area, Kentucky
The Pikeville Area includes approximately 34% of the total net proved
reserves in the underlying properties. The underlying properties in this
district are concentrated in Pike, Knott, Martin, Floyd and Breathitt counties,
Kentucky on approximately 265,000 gross acres, which excludes the Rome
exploration area. Natural gas is produced predominantly from the Maxton, Big
Lime, Berea and Devonian Shale formations at depths ranging from 1,000 to 5,500
feet. Sales meter production attributable to the underlying properties averaged
14 MMcfe per day during the first two quarters of 1999. Significant development
potential still remains in this district, with 470 proved undeveloped locations
identified for exploitation as of June 30, 1999.
Brenton Area, West Virginia
The Brenton Area includes approximately 38% of the total net proved
reserves in the underlying properties. The underlying properties in this
district are located mainly in Logan, Mingo, McDowell and Wyoming counties in
southern West Virginia on approximately 397,000 gross acres. Natural gas is
produced predominantly from the Maxton, Big Lime, Berea and Devonian Shale
formations at depths ranging from 2,000 to 7,000 feet. Sales meter production
attributable to the underlying properties averaged 15 MMcfe per day for the
first two quarters of 1999. Significant development potential still remains in
this district, with 624 proved undeveloped locations identified for exploitation
as of June 30, 1999.
Madison Area, Eastern West Virginia
The Madison Area includes approximately 20% of total net proved reserves in
the underlying properties. The underlying properties in this district are
located in Lincoln, Kanawha, Boone, Raleigh, Fayette, Nicholas and Clay counties
in south central West Virginia on approximately 374,000 gross acres. Natural gas
is produced predominantly from the Maxton, Big Lime, Big Injun, Weir, Berea and
Devonian Shale formations at depths ranging from 1,700 to 6,000 feet. Sales
meter production attributable to the underlying properties averaged 12 MMcfe per
day for the first two quarters of 1999. Significant development potential still
remains in this district, with 251 proved undeveloped locations identified for
exploitation as of June 30, 1999.
Weston Area, West Virginia
The Weston Area includes approximately 8% of the total net proved reserves
in the underlying properties. The underlying properties in this district are
located largely in Jackson, Gilmer, Doddridge,
32
<PAGE> 37
Roane, Calhoun, Harrison and Wetzel counties in northern West Virginia on
approximately 192,000 gross acres. Natural gas is produced from Upper Devonian
sandstone formations at depths ranging from 1,800 to 5,000 feet. Sales meter
production attributable to the underlying properties averaged 8 MMcfe per day
for the first two quarters of 1999. Some development potential remains in this
district, with 33 proved undeveloped locations identified for exploitation as of
June 30, 1999.
HISTORICAL RESULTS FROM THE UNDERLYING PROPERTIES
The following table provides oil and natural gas wellhead volumes, average
realized prices, revenues, direct operating expenses and development costs
relating to the underlying properties for 1996, 1997 and 1998 and for the
six-month periods ended June 30, 1998 and 1999. The related pro forma
adjustments for the year ended December 31, 1998 and the six months ended June
30, 1999 are also shown. Eastern States did not own all of the underlying
properties for each of the periods indicated. No development costs are included
for periods after December 31, 1997 because none of the wells drilled by Eastern
States during the period January 1, 1998 through September 30, 1999 are included
in the underlying properties because of their limited production history. In
addition, the 1996 and 1997 development costs exclude development costs incurred
by Blazer Energy prior to its acquisition by Eastern States on June 30, 1997.
The audited statements of revenues and direct operating expenses of the
underlying properties for the years ended December 31, 1996, 1997 and 1998 and
unaudited statements for the six-month periods ending June 30, 1998 and 1999
begin on page F-3 in this prospectus. The pro forma adjustments reflect changes
to historical results as if the offering had occurred on December 31, 1997 and
give effect to the adjustments described on page F-12 in this prospectus.
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
--------------------------- -----------------
1996 1997 1998 1998 1999
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER UNIT DATA)
<S> <C> <C> <C> <C> <C>
Wellhead volumes:
Natural gas (MMcf)........................... 19,646 20,326 19,372 10,145 9,185
Oil (MBbls).................................. 35 31 21 8 10
Average realized sales prices:
Natural gas (per Mcf)........................ $ 2.84 $ 2.62 $ 2.19 $ 2.29 $ 2.01
Oil (per Bbl)................................ $ 19.32 $ 17.31 $ 11.83 $ 12.79 $ 10.27
Revenues:
Natural gas sales............................ $55,769 $53,192 $42,375 $23,220 $18,472
Oil sales.................................... 677 530 243 105 107
------- ------- ------- ------- -------
Total................................ 56,446 53,722 42,618 23,325 18,579
------- ------- ------- ------- -------
Direct operating expenses:
Production and property taxes................ 5,501 5,179 4,049 2,205 1,763
Production expenses.......................... 6,395 5,232 3,720 1,860 1,860
------- ------- ------- ------- -------
Total................................ 11,896 10,411 7,769 4,065 3,623
------- ------- ------- ------- -------
Excess of revenues over direct operating
expenses.................................. $44,550 $43,311 $34,849 $19,260 $14,956
======= ======= ======= ======= =======
Development costs (excluding Blazer Energy
Corp.)....................................... $12,024 $22,445 N/A N/A N/A
======= =======
</TABLE>
33
<PAGE> 38
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, 1998 ENDED JUNE 30, 1999
----------------- -------------------
(IN THOUSANDS, EXCEPT PER UNIT DATA)
<S> <C> <C>
Excess of revenues over direct operating costs............. $34,849 $14,956
Pro Forma Adjustments:
Revenue.................................................. (2,317) (1,176)
Production expenses...................................... (923) (461)
Development costs and drilling overhead.................. -- --
Overhead................................................. (1,934) (967)
------- -------
Total pro forma adjustments...................... (5,174) (2,604)
Net proceeds............................................. 29,675 12,352
Net profits percentage................................... 80% 80%
------- -------
Trust cash............................................... 23,740 9,882
Trust administrative expenses............................ (300) (150)
------- -------
Trust distributable cash................................. $23,440 $ 9,732
======= =======
Trust distributable cash per unit ( units issued
and outstanding)...................................... $ $
======= =======
</TABLE>
DISCUSSION AND ANALYSIS OF HISTORICAL RESULTS FROM THE UNDERLYING PROPERTIES
The excess of revenues over direct operating expenses from the underlying
properties was $44,550,000 for 1996, $43,311,000 for 1997 and $34,849,000 for
1998. The excess of revenues over direct operating expenses was $19,260,000 for
the six months ended June 30, 1998 and $14,956,000 for the six months ended June
30, 1999. The changes in excess of revenues over direct operating expenses were
primarily related to changes in volumes and prices. Natural gas sales accounted
for greater than 99% of total revenues for the three-year period ended December
31, 1998 and the six-month period ended June 30, 1999.
Natural Gas Volumes. Natural gas sales volumes from the underlying
properties increased 3.5% from 1996 to 1997, decreased 4.7% from 1997 to 1998
and decreased 9.5% from the six-month period ending June 30, 1998 to the
six-month period ending June 30, 1999. The increase was primarily attributable
to development projects in 1996 and 1997 and the decrease in 1998 was primarily
attributable to the fact that none of the development wells drilled in 1998 and
1999 are included in the underlying properties. Also, the wells drilled in 1997
experienced a higher production decline in the six months ended June 30, 1998 as
compared to the six months ended June 30, 1999.
Natural Gas Prices. The average realized natural gas sales price decreased
7.7% from $2.84 per Mcf in 1996 to $2.62 per Mcf in 1997, decreased 16.4% from
$2.62 per Mcf in 1997 to $2.19 per Mcf in 1998 and decreased 12.2% from $2.29
per Mcf in the six-month period ending June 30, 1998 to $2.01 per Mcf in the
six-month period ending June 30, 1999.
Set forth below is a table that reflects average NYMEX closing prices and
average Appalachian Basin prices for 1996, 1997, 1998 and the six months ended
June 30, 1999, and the average annualized Appalachian Basin premiums for such
periods based upon such average annualized prices.
<TABLE>
<CAPTION>
AVERAGE AVERAGE AVERAGED
NYMEX APPALACHIAN ANNUALIZED
CLOSING BASIN APPALACHIAN
PRICES PRICES(A) BASIN
($/MMBTU) ($/MMBTU) PREMIUM
--------- ----------- -----------
<S> <C> <C> <C>
1996.................................................. $2.59 $3.06 18.1%
1997.................................................. 2.59 2.76 6.6
1998.................................................. 2.11 2.25 6.6
Six months ended June 30, 1999........................ 1.94 2.09 7.7
</TABLE>
- ---------------------
(a) Represents the average natural gas prices published by Inside
FERC -- Appalachian Basin for CNG Transmission Corp. and Columbia Gas
Transmission Corp.
34
<PAGE> 39
Natural gas prices have continued to increase since the spring of 1999 and
average realized prices in August 1999 are likely to exceed $2.50 per Mcf.
The average realized sales price of natural gas production from the
underlying properties during 1998 was $2.19 per Mcf, which is approximately
$0.08 above the average of the monthly closing NYMEX natural gas futures
contract prices in 1998. The average realized sales price of natural gas
production from the underlying properties during 1998 on a pro forma basis as if
the offering had closed on December 31, 1997 was $2.05 per Mcf, which is
approximately $0.06 below the average of the monthly closing NYMEX natural gas
futures contract prices in 1998. This difference in the NYMEX futures prices is
due to the lower than average Appalachian Basin premium in 1998, which resulted
primarily from significantly warmer than normal average prevailing winter
temperatures in 1998, as well as high gathering and compression charges.
Direct operating expenses. Direct operating expenses decreased 12.5% from
$11,896,000 in 1996 to $10,411,000 in 1997, followed by a 25.4% decrease to
$7,769,000 in 1998. The primary reason for the fluctuation among the three years
was the acquisition by Eastern States in July 1997 of approximately 80% of the
underlying properties. The production costs for 1996 and for the six months
ended June 30, 1997 show operating costs of the predecessor owner, Blazer
Energy. Since the acquisition, Eastern States has reduced these costs. For the
six-month period ending June 30, 1998 compared to the six-month period ending
June 30, 1999, direct operating expenses decreased 12.6% from $4,065,000 to
$3,623,000 due to continued efficiencies as a result of the assimilation of the
Blazer properties.
Development costs. Virtually all of the underlying properties were either
purchased or drilled by Eastern States in the three-year period from 1994 to
1997. Development costs rose 83.4% from $12,024,000 in 1996 to $22,445,000 in
1997 as major development projects were completed. Eastern States expects
development costs on the underlying leases to be approximately $44 million per
year for at least the next five years. None of the wells drilled in 1998 and
1999 are included in the underlying properties because of their higher decline
profile compared to the current decline profile of wells drilled in the three-
year period from 1994 to 1997. Development costs incurred by Blazer Energy prior
to its acquisition by Eastern States on June 30, 1997 have not been included in
the historical results table above.
RESERVES
Eastern States estimated oil and natural gas reserves attributable to the
underlying properties and the net profits interests as of June 30, 1999, which
estimates were reviewed by Ryder Scott and are the subject of their review
reports included as Exhibit A and Exhibit B to this prospectus. Numerous
uncertainties are inherent in estimating reserve volumes and values, and the
estimates are subject to change as additional information becomes available. The
reserves actually recovered and the timing of production of the reserves may
vary significantly from the original estimates.
Eastern States calculated reserve quantities and revenues for the net
profits interests from projections of reserves and revenues attributable to the
combined interests of the trust and Eastern States in the underlying properties.
Because the trust owns net profits interests and not a specific ownership
percentage of the oil and natural gas reserve quantities, proved reserves for
the trust's net profits interests attributable to the 2,562 underlying wells are
calculated by subtracting from 80% of proved reserves, reserve quantities of a
sufficient value to pay 80% of the future estimated production and development
costs, before overhead and trust administrative expenses that are deducted in
calculating net proceeds. Proved reserves for the net profits interests
attributable to the proved undeveloped reserves owned by Eastern States in
Kentucky and West Virginia are calculated by subtracting from 10% of the proved
undeveloped reserves, reserve quantities of a sufficient value to pay 10% of the
future estimated production and development costs, before overhead and trust
administrative expenses that are deducted in calculating net proceeds.
Accordingly, proved reserves for the net profits interests reflect quantities
that are calculated after reductions for future production and development costs
and expenses based on the price and cost assumptions used in the reserve
estimates. The total proved reserves deducted for the future costs and expenses
in determining the net profits interests were approximately 74 Bcfe.
35
<PAGE> 40
The standardized measure of discounted future net cash flows and changes in
discounted cash flows presented below were prepared using assumptions required
by the Financial Accounting Standards Board. These assumptions include the use
of June 30, 1999 prices for natural gas and costs for estimated future
development and production expenditures to produce the proved reserves.
Because natural gas prices are influenced by seasonal demand, use of June
30, 1999 prices, as required by the Financial Accounting Standards Board, may
not be the most accurate basis for estimating future revenues or reserve data.
Future net cash flows are discounted at an annual rate of 10%. There is no
provision for federal income taxes because future net revenues are not subject
to taxation at the trust level. The weighted average June 30, 1999 wellhead
natural gas price used to determine the standardized measure was $2.38 per Mcf
for the underlying properties and $2.24 per Mcf for the net profits interests.
The $0.14 per Mcfe difference represents reimbursement for depreciation and a
return on Eastern States' investment in its gathering and compression systems.
The weighted average sales price received by Eastern States in August 1999
was per Mcf.
During 1999, Eastern States filed estimates of operated oil and natural gas
reserves as of December 31, 1998 with the U.S. Department of Energy on Form
EIA-23. These estimates are consistent with the reserves reported in this
prospectus for the underlying properties as of December 31, 1998, with the
exception that Form EIA-23 includes only reserves from properties that had been
acquired and were operated by Eastern States at that date. Neither Eastern
States nor the trust has reported reserves for the net profits interests with
any Federal authority or agency prior to the filing of this prospectus.
Proved Reserves
The following table shows proved developed reserves, proved undeveloped
reserves, total proved reserves, future net revenues and the future net cash
flows at June 30, 1999 for the underlying properties, the underlying wells, the
underlying leases, a subtotal and the net profits interests. The Ryder Scott
review reports are included as Exhibits A and B to this prospectus.
<TABLE>
<CAPTION>
UNDERLYING UNDERLYING UNDERLYING NET PROFITS
PROPERTIES(100%) WELLS(80%) LEASES(10%) SUBTOTAL(A) INTERESTS
----------------- ---------- ----------- ------------ -----------
($ IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Proved developed reserves
Natural gas (MMcf).............. 338,469 270,775 270,775 211,266
Oil (MBbls)..................... 273 219 219 170
Natural gas equivalents
(MMcfe)...................... 340,109 272,087 272,087 212,287
Proved undeveloped reserves
Natural gas (MMcf).............. 398,978 39,898 39,898 22,750
Oil (MBbls)..................... -- -- -- --
Natural gas equivalents
(MMcfe)...................... 398,978 39,898 39,898 22,750
Total proved reserves
Natural gas (MMcf).............. 737,447 270,775 39,898 310,673 234,016
Oil (MBbls)..................... 273 219 -- 219 170
Natural gas equivalents
(MMcfe)...................... 739,087 272,089 39,898 311,987 235,036
Future net revenues............... $1,182,667 $497,448 $56,085 $553,533 $472,071
Standardized measure of discounted
future net cash flows........... $ 304,426 $183,330 $ 7,526 $190,856 $168,166
</TABLE>
- ---------------
(a) Represents 80% of reserves attributable to underlying wells and 10% of
reserves attributable to underlying leases before deducting reserve
quantities sufficient to pay $0.05 per Mcfe for office expenditures,
information systems and other capitalized costs which are included in
production costs and $0.14 per Mcfe for reimbursement for depreciation and
to provide a return on investment of
36
<PAGE> 41
Eastern States' gathering and compression systems. See "Computation of Net
Proceeds -- Net Profits Interests."
The following table summarizes the changes in proved reserves of the
underlying properties for the periods indicated. The data is presented assuming
the underlying properties were acquired before December 31, 1995. Reserve
estimates for underlying properties that Eastern States acquired in 1996 and
1997 are not available prior to the date acquired. For purposes of calculating
quantities of proved reserves of these properties as of December 31, 1995 and
1996, proved reserves were derived by assuming they equal the reserves at
December 31, 1997, plus production, less positive revisions from drilling by
Eastern States for the years 1996 and 1997. This table does not include any
revisions, extensions or discoveries prior to Eastern States' acquisition of
Blazer Energy on June 30, 1997.
<TABLE>
<CAPTION>
100% UNDERLYING PROPERTIES
--------------------------------------
NATURAL GAS
NATURAL GAS OIL EQUIVALENTS
(MMCF) (MBBLS) (MMCFE)
----------- ---------- -----------
<S> <C> <C> <C>
Balance, December 31, 1995............................... 673,368 338 675,395
Revisions, extensions, discoveries and additions...... 6,094 -- 6,094
Production............................................ (19,646) (35) (19,856)
------- --- -------
Balance, December 31, 1996............................... 659,816 303 661,633
Revisions, extensions, discoveries and additions...... 11,167 -- 11,169
Production............................................ (20,326) (31) (20,512)
------- --- -------
Balance, December 31, 1997............................... 650,657 272 652,290
Revisions, extensions, discoveries and additions...... 64,371 21 64,495
Production............................................ (19,372) (21) (19,498)
------- --- -------
Balance, December 31, 1998............................... 695,656 272 697,287
Revisions, extensions, discoveries and additions...... 50,976 11 51,045
Production............................................ (9,185) (10) (9,245)
------- --- -------
Balance, June 30, 1999................................... 737,447 273 739,087
======= === =======
Proved Developed Reserves
Balance, December 31, 1995............................... 367,315 338 369,342
Balance, December 31, 1996............................... 353,763 303 355,580
Balance, December 31, 1997............................... 344,604 272 346,236
Balance, December 31, 1998............................... 351,436 272 353,067
Balance, June 30, 1999................................... 338,469 273 340,109
</TABLE>
There are 1,378 proved undeveloped drilling locations in the underlying
leases identified for exploration. Eastern States expects to spend approximately
$44 million per year on development costs for at least the next five years. Of
these development costs, 10% will be attributable to the net profits interests
of the trust.
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<PAGE> 42
Standardized Measure of Discounted Future Net Cash Flows from Proved Reserves
The following table provides the summary calculation of the standardized
measure of discounted future net cash flows of the underlying properties, the
underlying wells, the underlying leases, a subtotal and the net profits
interests as of June 30, 1999. Because the underlying properties and the trust
are not taxable at the underlying property level or trust level, no provision is
included for income taxes.
<TABLE>
<CAPTION>
UNDERLYING UNDERLYING UNDERLYING NET PROFITS
PROPERTIES (100%) WELLS (80%) LEASES (10%) SUBTOTAL INTERESTS
----------------- ----------- ------------ --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Future cash flows............. $1,783,363 $ 649,721 $ 97,121 $ 746,842 $ 528,113
Future costs:
Production.................. 344,268 152,072 15,418 167,490 56,042
Development................. 256,428 201 25,618 25,819 --
---------- --------- -------- --------- ---------
Future net cash flows....... 1,182,667 497,448 56,085 553,533 472,071
10% discount factor......... (878,241) (314,118) (48,559) (362,677) (303,905)
---------- --------- -------- --------- ---------
Standardized measure........ $ 304,426 $ 183,330 $ 7,526 $ 190,856 $ 168,166
========== ========= ======== ========= =========
</TABLE>
NATURAL GAS SALES PRICES AND PRODUCTION COSTS
The following table sets forth the annual production, the average sales
price per Mcf produced and the average production costs per Mcf for each of the
years ended December 31, 1996, 1997 and 1998 and for the six-month period ended
June 30, 1999 for the underlying properties on a historical basis and for the
year ended December 31, 1998 and the six months ended on June 30, 1999 for the
net profits interests on a pro forma basis:
<TABLE>
<CAPTION>
PRO FORMA FOR NET PROFITS
HISTORICAL FOR UNDERLYING PROPERTIES INTERESTS(A)
---------------------------------------- -------------------------
SIX MONTHS SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED YEAR ENDED ENDED
--------------------------- JUNE 30, DECEMBER 31, JUNE 30,
1996 1997 1998 1999 1998 1999
------- ------- ------- ---------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C>
Wellhead volumes (MMcf)...... 19,646 20,326 19,372 9,185 19,372 9,185
Average realized sales price
per Mcf produced(b)........ $ 2.84 $ 2.62 $ 2.19 $ 2.01 $ 2.05 $ 1.87
Average production cost per
Mcf(c)..................... $ 0.61 $ 0.51 $ 0.40 $ 0.39 $ 0.45 $ 0.44
</TABLE>
- ---------------
(a) Pro forma figures are calculated by attributing 80% of production for the
underlying properties to the net profits interests and assuming gas
gathering and compression costs, production costs, development costs and
overhead provided for in the conveyances were in effect for the periods
indicated.
(b) Average realized sales price generally represents the wellhead price of
natural gas which is net of gathering and compression charges and excludes
hedging activity.
(c) Production costs as used in this table include, for all properties,
severance taxes, ad valorem taxes and lease operating costs. Overhead has
not been included as a production cost.
PRODUCING ACREAGE AND WELL COUNTS
For the following data, "gross" refers to the total wells or acres included
in the underlying properties in which Eastern States owns a working interest and
"net" refers to gross wells multiplied by the
38
<PAGE> 43
percentage working interest owned by Eastern States. The number of gross acres
shown below does not exclude the acreage attributable to the excluded wells or
excluded leases and other interests.
<TABLE>
<CAPTION>
WELLS
--------------
GROSS NET GROSS ACRES(A)
----- ----- --------------
<S> <C> <C> <C>
Brenton District............................................ 599 569 397,000
Madison District............................................ 613 611 374,000
Weston District............................................. 664 626 192,000
Pikeville District.......................................... 686 685 265,000
----- ----- ---------
Total............................................. 2,562 2,491 1,228,000
===== ===== =========
</TABLE>
- ---------------
(a) The number of gross acres reflected in this table excludes approximately
90,000 acres representing the Rome exploration area, but does not exclude
(1) leases that have been farmed out to third parties and (2) leases or
interests with known conveyance or title issues, including all potential
coalbed methane exploration and development rights.
The following is a summary of the number of natural gas wells drilled and
completed by Eastern States on the leases which comprise the underlying
properties during the last three years. There are no wells listed under the year
ended December 31, 1998 and the six months ended June 30, 1999 because all wells
drilled by Eastern States during this time period are excluded because of their
limited production history. This summary does not include wells drilled by
Blazer Energy prior to its acquisition by Eastern States on June 30, 1997.
Unless otherwise indicated, all wells drilled are developmental.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS
--------------------------------------- ENDED JUNE 30,
1996 1997 1998 1999
----------- ----------- ----------- --------------
GROSS NET GROSS NET GROSS NET GROSS NET
----- --- ----- --- ----- --- ------ ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Natural Gas Wells....................... 54 53 88 88 -- -- -- --
== === == === == === == ===
</TABLE>
OPERATIONS
All of the wells and properties to which the underlying properties relate
are currently operated by Eastern States, although Eastern States is under no
obligation to continue to serve as the operator for the properties. As operator,
Eastern States is responsible for conducting and directing all operations with
respect to the properties, as permitted and required by, and within the limits
of, any applicable operating agreements, including,
- producing the wells;
- discharging obligations of the joint account;
- holding funds for non-operators;
- maintaining records, filing and furnishing governmental reports;
- conducting drilling, testing, completing, reworking, and plugging
operations; and
- maintaining insurance for the joint account.
With respect to the underlying properties, Eastern States must act as a
reasonably prudent operator would act in the Appalachian Basin under the same or
similar circumstances if it were acting with respect to its own properties.
The trust will be entitled to bring actions against Eastern States to
enforce its rights under the conveyances. If the trustee fails to bring an
action on behalf of the trust, each unitholder has a statutory right under the
Delaware Business Trust Act to bring a derivative action in the Delaware Court
of Chancery on behalf of the trust to enforce the rights of the trust under the
conveyances, including rights relating to the standard of conduct owed to the
trust by Eastern States with respect to operations relating to the underlying
properties.
39
<PAGE> 44
Due to the criteria utilized in selecting wells to be subject to and
burdened by the net profits interests, the lands upon which the wells subject to
the net profits interests are located will, in many instances, also contain
other wells which did not satisfy the selection criteria and which therefore
will not become subject to the net profits interests. In these instances,
Eastern States will generally serve as the operator for all of the wells located
on lands subject to a particular lease. As the operator of this leased property,
Eastern States will generally have a contractual duty to any other working
interest owners to act as a reasonably prudent operator with respect to the
operations of the leased property.
SALE AND ABANDONMENT OF UNDERLYING PROPERTIES; SALE OF NET PROFITS INTERESTS
Eastern States and any transferees will have the right to abandon any well
or property included in the underlying properties if, in its opinion, the well
or property ceases to produce or is not capable of producing in commercially
paying quantities. Any determination to abandon any well or property must be
made under the reasonably prudent operator standard described above. Upon
abandonment, that portion of the net profits interest will be extinguished.
Eastern States may also sell a well or property free of the net profits interest
in lieu of the payment of abandonment costs or delay rentals, provided that the
trust receives its attributable percentage of the net proceeds of any sale.
Eastern States has the right to sell all or any portion of the underlying
properties without the consent of the trust or the unitholders; however, the
purchaser of any of the underlying properties will acquire the underlying
properties subject to the net profits interests relating thereto, except under
the circumstances described below where the trust may be required to release the
net profits interests, subject to its receipt of the fair value thereof. Upon
the transfer of all or a portion of the underlying properties, Eastern States
may retain the right to operate the underlying properties subject to the net
profits interest and the terms of the underlying conveyance. Following a
transfer, the underlying properties will continue to be subject to the net
profits interests, and the net proceeds attributable to the transferred property
will be calculated separately and paid by the transferee. The conveyances will
be recorded in the appropriate real property records to give notice of the net
profits interests to Eastern States' creditors and transferees. Any purchaser
will be subject to the standard of a reasonably prudent operator in the
Appalachian Basin with respect to development, operation and abandonment of the
underlying properties. A transferee of the underlying properties, by virtue of
the transfer, may be obligated to file reports under the Securities Exchange Act
of 1934.
Upon notice from Eastern States, the trust is required to sell, for cash,
net profits interests related to underlying properties which Eastern States is
selling to an unaffiliated party. These types of sales may not exceed $3 million
in any calendar year or $20 million on an aggregate basis for the life of the
trust. Under these circumstances, the trust will receive:
- 80% of the net proceeds from the sale of any of the 2,562 underlying
wells; and
- 10% of the net proceeds from the sale of any of the underlying leases or
the sale of any well drilled on the underlying leases on or after October
1, 1999.
In addition, as an owner of the underlying properties, Eastern States may
enter into farmout, operating, participation and other similar agreements
covering the property if Eastern States believes it to be advantageous to the
working interests owners of the property. The net profits interest held by the
trust would then be calculated on the interest retained by Eastern States under
the agreement and not on Eastern States' or the trust's original interest before
modification by the agreement. Eastern States may enter into any of these
agreements without the consent or approval of the trustee or any trust
unitholder. However, Eastern States' interest in entering into any of these
types of agreements should be parallel with that of trust unitholders because
Eastern States is retaining 20% of the net profits interest in the 2,562
underlying wells and 90% of the net profits interest in all wells drilled on the
underlying leases on or after October 1, 1999. Immediately after this offering,
Eastern States will also own up to 25% of the outstanding trust units.
40
<PAGE> 45
GAS PURCHASE CONTRACTS
Eastern States will market the natural gas produced from the underlying
properties and attempt to obtain the best prices available to it in the
marketplace. Generally, natural gas produced from the underlying properties will
be sold by Eastern States under existing contracts that have market-based terms.
Eastern States currently has significant contracts with affiliates of CNG
Transmission Corp and its own affiliate, Statoil Energy Services, Inc. Each of
these contracts expire in October 2000.
In 1998, approximately 90% of the natural gas produced by Eastern States
was sold under these contracts. For the six-month period ended June 30, 1999,
approximately 65% of Eastern States' natural gas production was sold to Statoil
Energy Services and approximately 25% was sold to affiliates of CNG Transmission
Corp.
Under the CNG contracts, affiliates of CNG purchase natural gas from
Eastern States based on the terms contained in confirmations which the parties
enter into from time to time. The CNG confirmations set forth the following:
- quantity;
- price;
- delivery point; and
- effective period of the confirmation.
The price under the CNG contracts has historically been based on the
published price of Inside FERC-Appalachian Basin for CNG on an MMbtu basis, plus
a $0.01 to $0.04 per MMbtu premium, less applicable gathering, compression and
processing fees. The price for the natural gas is inclusive of all taxes levied
on production or transportation of the natural gas up to the delivery point.
Payment from the CNG affiliate is due by the 55th day following delivery.
Each CNG confirmation sets forth the quantity of natural gas to be
delivered by Eastern States to the delivery point. The delivery point is, in
general, the point of the interconnection of Eastern States' gathering
facilities with the metering facilities of CNG's interstate transmission or
gathering pipeline system. Eastern States is responsible for delivery of natural
gas to the delivery point. Title and risk of loss to the natural gas pass to the
CNG affiliate at the delivery point. Each CNG confirmation sets forth the period
of time that the terms of the confirmation are effective. The effective period
of a confirmation with the CNG affiliates has typically been for 12 months.
The contract with Statoil Energy Services is also based on the terms
contained in confirmations which the parties enter into from time to time. These
confirmations set forth the following:
- quantity;
- price;
- delivery point; and
- effective period of the confirmation.
The price under the Statoil Energy Services contract has historically been
based on the published price of Inside FERC -- Appalachian Basin for Columbia
Gas Transmission Corp. (also known as "TCO") for natural gas delivered into
Columbia Gas Transmission's interstate transmission pipeline system, on an MMbtu
basis, plus a $0.02 per MMbtu premium, less gathering, compression and
processing fees. Eastern States is responsible for all taxes attributable to the
natural gas before the delivery point. Statoil Energy Services is responsible
for all taxes attributable to the natural gas after the delivery point. Payment
is due from Statoil Energy Services by the 55th day following delivery.
Each confirmation with Statoil Energy Services sets forth the quantity of
natural gas to be delivered by Eastern States to the delivery point. Title and
risk of loss pass to Statoil Energy Services at the delivery point. Each
confirmation also sets forth the period of time that the terms of the
confirmation are effective. The effective period of a confirmation with Statoil
Energy Services has historically been for 12 months.
41
<PAGE> 46
Eastern States has historically sold its natural gas on the spot market,
i.e., contracts of one year or less. However, Eastern States may enter into
longer term contracts in the future.
HEDGING ACTIVITIES
Eastern States has historically entered into hedging contracts with respect
to its natural gas production at specified prices for a specified period of
time. After the closing of this offering, Eastern States may continue to enter
into hedging contracts with respect to natural gas production from the
underlying properties only for the portion of natural gas that is attributable
to its retained interests. For example, Eastern States may enter into hedging
contracts for up to 20% of the production from the 2,562 underlying wells and up
to 90% of the production from wells drilled on the underlying leases after the
closing of this offering. Any gains or losses from these hedging activities will
not affect amounts paid to the trust. Long-term contracts for the physical sale
and delivery in the future of natural gas volumes are not hedging contracts.
REGULATION
Natural Gas Regulation. The availability, terms and cost of transportation
significantly affect sales of natural gas. The interstate transportation and
sale for resale of natural gas is subject to federal regulation, including
transportation rates, storage tariffs and various other matters, primarily by
the Federal Energy Regulatory Commission. Federal and state regulations govern
the price and terms for access to natural gas pipeline transportation. The
Federal Energy Regulatory Commission's regulations for interstate natural gas
transmission in some circumstances may also affect the intrastate transportation
of natural gas.
While natural gas prices are currently unregulated, Congress historically
has been active in the area of natural gas regulation. Eastern States cannot
predict whether new legislation to regulate natural gas might be proposed, what
proposals, if any, might actually be enacted by Congress or the various state
legislatures, and what effect, if any, the proposals might have on the
operations of the underlying properties.
Sales of crude oil, condensate and natural gas liquids are not currently
regulated and are made at market prices. The Federal Energy Regulatory
Commission implemented regulations on January 1, 1995, to establish an indexing
system for transportation rates for oil that could increase the cost of
transporting oil to the purchaser.
Eastern States' gathering operations are subject to occupational safety,
health and operational regulations relating to the design, installation,
testing, construction, operation, replacement and management of facilities.
Pipeline safety issues have recently been the subject of increasing focus in
various political and administrative arenas at both the state and federal
levels. Eastern States believes that its operations, to the extent they may be
subject to current natural gas pipeline safety or other health and safety
requirements, comply in all material respects with these requirements.
Eastern States is not able to predict what effect, if any, these
regulations might have.
Environmental Regulation. Companies that are engaged in the oil and gas
industry are affected by federal, state and local laws regulating the discharge
of materials into the environment or otherwise relating to environmental
protection. Those laws may impact operations of the underlying properties.
Eastern States believes that it is in substantial compliance with the
environmental laws and regulations that apply to the operations of the
underlying properties. Eastern States has not previously incurred material
expenses in complying with environmental laws and regulations that affect its
operations of the underlying properties. It does not currently expect that
future compliance will have a material adverse effect on the trust or the
quarterly distributions.
State Regulation. The states of Kentucky and West Virginia may regulate the
production, gathering and sale of oil and natural gas, including imposing
requirements for obtaining drilling permits, the method of developing new
fields, the spacing and operation of wells and the prevention of waste of oil
and gas resources. These states may also regulate rates of production, may
establish maximum daily production
42
<PAGE> 47
allowables from both oil and gas wells based on market demand or resource
conservation, or both, and may require that certain wells be shut-in.
The states of Kentucky and West Virginia also regulate the service which is
provided to customers by Eastern States in connection with the direct supply of
natural gas to homeowners.
The petroleum industry is also subject to compliance with various other
federal, state and local regulations and laws. Some of those laws relate to
occupational safety, resource conservation and equal employment opportunity.
Eastern States does not believe that compliance with these laws will have a
material adverse effect upon the trust unitholders.
TITLE TO PROPERTIES
Eastern States believes that its title to the underlying properties is, and
the trust's title to the net profits interest will be, good and defensible
according to the standards generally accepted in the Appalachian Basin oil and
gas industry.
The underlying properties are typically subject, in one degree or another,
to one or more of the following:
- royalties, overriding royalties and other burdens, under oil and gas
leases;
- relocation provisions under oil and gas leases with coal mining entities;
- contractual obligations, including, in some cases, development
obligations, arising under operating agreements, farmout agreements,
production sales contracts and other agreements that may affect the
properties or their titles;
- liens that arise in the normal course of operations, such as those for
unpaid taxes, statutory liens securing unpaid suppliers and contractors
and contractual liens under operating agreements;
- pooling, unitization and commutation agreements, declarations and orders;
and
- easements, restrictions, rights-of-way and other matters that commonly
affect property.
To the extent that these burdens and obligations affect Eastern States'
rights to production and the value of production from the underlying properties,
they have been taken into account in calculating the trust's interests and in
estimating the size and the value of the reserves attributable to the net
profits interests. Eastern States believes that the burdens and obligations
affecting the underlying properties and the net profits interests are
conventional in the industry for similar properties. Eastern States also
believes that the burdens and obligations do not in the aggregate materially
interfere with the use of the underlying properties and will not materially
adversely affect the value of the net profits interests.
Although the matter is not entirely free from doubt, Eastern States
believes that the net profits interests should constitute real property
interests under Kentucky law, but not under West Virginia law. Nevertheless,
Eastern States will record the conveyances in the appropriate real property
records of Kentucky and West Virginia. If during the term of the trust, Eastern
States should become a debtor in a bankruptcy proceeding, it is not entirely
certain that the net profits interests would be treated as real property
interests under the laws of Kentucky, and they would not be so treated under
West Virginia law. If a determination were made in a bankruptcy proceeding that
a net profits interest did not constitute a real property interest under
applicable state law, it could be designated an executory contract. An executory
contract is a term used, but not defined, in the federal bankruptcy code to
refer to a contract under which the obligations of both the debtor and the other
party are so unsatisfied that the failure of either to complete performance
would constitute a material breach excusing performance by the other. If a net
profits interest were designated an executory contract and rejected in the
bankruptcy proceeding, Eastern States would not be required to perform its
obligations under the net profits interest and the trust would seek damages as
one of Eastern States' unsecured creditors. Although no assurance can be given,
Eastern States does not believe that the net profits interests should be subject
to rejection in a bankruptcy proceeding as executory contracts.
43
<PAGE> 48
YEAR 2000
"The Year 2000 Problem," or the ability of computer systems to process
dates with years beyond 1999, affects almost all companies and organizations.
Computer systems that are not Year 2000 compliant by January 1, 2000 may cause
material adverse effects to companies and organizations that rely upon those
systems. The trust's timely receipt of royalty income and disbursement of
distributable income to trust unitholders will largely depend upon performance
of computer systems and computer-controlled equipment of Eastern States, the
trust's transfer agent and other third parties. These third parties include oil
and natural gas purchasers and significant service providers such as electric
utility companies and natural gas plant, pipeline and gathering system
operators. Because the trust will not use the trustee's computer systems to any
significant degree, the trustee's Year 2000 compliance should not significantly
affect the trust.
Eastern States has reviewed its computer systems and computer-controlled
field equipment and is making the necessary modifications for Year 2000
compliance. Eastern States is completing modifications and testing of its
primary accounting, geography and land computer programs. The remaining computer
systems have been assessed and are compliant. Eastern States expects to complete
remediation and testing of significant remaining systems by September 1999.
Some of Eastern States' critical field equipment, such as natural gas
compressors, are partially controlled or regulated by embedded computer chips.
Based on a preliminary review of all operating areas, Eastern States has
identified no significant compliance exceptions. Eastern States has completed
remediation and testing of identified exceptions for significant
computer-controlled field equipment. Based on its review, remediation efforts
and the results of testing to date, Eastern States does not believe that timely
modification of its computer systems and computer-controlled equipment for Year
2000 compliance represents a material risk to the trust. Eastern States
estimates that total costs related to Year 2000 compliance efforts will be less
than $200,000 of which approximately $100,000 has been incurred and expensed
through June 30, 1999. The trust will not incur any of Eastern States' Year 2000
costs.
Eastern States has identified significant third parties whose Year 2000
compliance could affect Eastern States and is in the process of formally
inquiring about their Year 2000 status. Eastern States has received responses to
over 98% of its inquiries. To date, all respondents except one have indicated
that they will be Year 2000 compliant by January 1, 2000. Despite its efforts to
assure that the third parties are Year 2000 compliant, Eastern States cannot
provide assurance that all significant third parties will achieve compliance in
a timely manner. A third party's failure to achieve Year 2000 compliance could
have a material adverse effect on Eastern States' operations and cash flow, and
therefore have a material adverse impact on timely trust distributions to trust
unitholders. For example a third party might fail to deliver revenue related to
the trust's net profits interest to Eastern States, or Eastern States might fail
to deliver the income of the net profits interest to the trust. In these
situations, the trustee would be unable to make distributions of those amounts
to trust unitholders on a timely basis. The potential effect of Year 2000
non-compliance by third parties is currently unknown.
Eastern States is currently identifying appropriate contingency plans in
the event of any potential problems resulting from failure of Eastern States' or
significant third party computer systems on January 1, 2000. Eastern States has
not completed any contingency plans to date. Specific contingency plans will be
developed by September 30, 1999 in response to the results of scheduled testing,
as well as the assessed probability and risk of system or equipment failure.
LITIGATION
Various legal actions that have arisen in the ordinary course of business
are pending with respect to Eastern States and its affiliates. None of these
proceedings would reasonably be expected to have a material adverse impact on
Eastern States' results of operations or financial position.
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Any liability relating to the underlying properties prior to October 1,
1999 will be borne by Eastern States. Any liabilities relating to activities on
the underlying properties on or after October 1, 1999 could reduce the amount of
net proceeds payable to the trust.
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COMPUTATION OF NET PROCEEDS
The provisions governing the computation of the net proceeds are detailed
and extensive. The following describes all of the material terms of the net
profits interests but the computation of net proceeds is subject to and
qualified by the more detailed provisions of the conveyances of the net profits
interests that are filed as exhibits to the registration statement. You should
review those exhibits before making an investment in the trust units. See
"Available Information."
NET PROFITS INTERESTS
The net profits interests are defined net profits interests carved from the
underlying properties. The net profits interest entitles the trust to receive
80% of the net proceeds from the sale of natural gas produced from the 2,562
underlying wells and 10% of the net proceeds from the sale of natural gas
produced from wells drilled by Eastern States on the underlying leases on or
after October 1, 1999.
The underlying properties are adjacent, in some cases, to other properties
in which Eastern States has an interest and which generally produce from the
same formations and horizons as the wells included in the underlying properties.
The trust will not receive a net profits interest in the net proceeds from the
sale of natural gas from these excluded properties.
The amounts paid to the trust for the net profits interests are based on
the definition of "net proceeds" contained in the conveyances and described
below. Under the conveyances, net proceeds are computed quarterly on a
state-by-state basis. Eastern States pays the net proceeds attributable to a
computation period to the trust on or before the 20th day of the third calendar
month following the end of each calendar quarter. Eastern States will not pay to
the trust interest on the net proceeds held by Eastern States prior to payment
to the trust. The trustee makes quarterly distributions to trust unitholders.
See "Description of the Trust Units -- Distributions and Income Computations."
Net proceeds payable to the trust equal the excess of aggregate gross
proceeds over aggregate costs.
Aggregate gross proceeds means 80% of the gross proceeds attributable to
the underlying wells plus 10% of the gross proceeds attributable to wells
drilled on the underlying leases on or after October 1, 1999. Aggregate costs
means 80% of the costs attributable to the underlying wells plus 10% of the
costs attributable to the wells drilled on the underlying leases on or after
October 1, 1999, plus excess costs as of the end of the prior computation
period, plus interest on the amount of excess costs as of the end of the prior
computation period calculated at the prime rate for the current computation
period.
Gross proceeds means the amounts received by Eastern States from sales of
natural gas and oil produced from the underlying properties. The following are
excluded from the calculation of gross proceeds:
- all general property (ad valorem), production, severance, sales,
gathering, excise and other taxes (other than income taxes) and gathering
and compression costs if they are deducted or excluded from the proceeds
of sales of production;
- any amount for nonconsent operations on the underlying properties as to
which Eastern States is a nonconsenting party;
- any amount for natural gas lost in the production or marketing thereof or
used for drilling, production or plant operations conducted for the
purpose of drilling for, producing, processing or marketing natural gas
from the underlying properties;
- any payment made to the owner of an underlying property for:
-- payments for the sale or transfer of the underlying properties (subject
to the net profits interest);
-- payments for the sale of equipment or other personal property,
fixtures, gathering systems and other tangible property located on the
underlying properties or used in connection therewith;
-- natural gas not taken, but to the extent payments are allocated to
natural gas taken in the future, payments are included, without
interest, in gross proceeds when the natural gas is taken;
-- damages, other than drainage or reservoir injury;
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-- rental for reservoir use; and
-- payments in connection with the drilling of any well.
Gross proceeds includes payments for future production if they are not
subject to repayment in the event of insufficient subsequent production.
Costs mean, on a cash basis, generally the sum of:
- all payments to mineral or land owners, such as royalties or other
burdens against production, delay rentals, shut-in natural gas payments,
minimum royalty or other payments for drilling or deferring drilling;
- any taxes paid by the owner of an underlying property to the extent not
previously deducted in calculating gross proceeds, including estimated
and accrued ad valorem and other property and production taxes;
- costs paid by the owner of an underlying property under any joint
operating agreement;
- a fixed per well production cost, which includes costs, expenses and
liabilities for operating and producing oil and natural gas, including
allocated expenses such as labor, vehicle and travel costs and materials;
- all development costs, which include all costs, expenses and liabilities
of exploring, drilling and reworking natural gas wells, including
allocated expenses such as labor, vehicle and travel costs and materials;
- seismic, geophysical and other exploration costs;
- third party costs and charges associated with gathering, compressing and
processing natural gas;
- Eastern States' costs and charges associated with gathering, compressing
and processing natural gas, plus reimbursement for depreciation and a
return on investment.
- interest costs;
- plugging and abandonment costs;
- overhead charges, which include a fixed per well general and
administrative fee and a fixed per well fee for drilled and completed
wells;
- costs of insurance, if any, pertaining to the ownership or operation of
the underlying properties;
- costs of any litigation pertaining to the underlying properties arising
from activities conducted after October 1, 1999, including settlements,
damages, refunds, fines, interest and penalties paid to third parties or
governmental authorities, provided that the owner of the underlying
properties has acted as a reasonably prudent operator;
- amounts previously included in gross proceeds but subsequently paid as a
refund, interest or penalty;
- costs and expenses for renewals or extensions of leases; and
- at the option of the owner of an underlying property, accruals for costs
approved under authorizations for expenditure.
Effective October 1, 1999, Eastern States will deduct costs when
calculating the net proceeds that it has not previously charged or, in some
cases, deduct higher costs than what it had previously charged. These costs were
not charged in the past because Eastern States owns approximately a 97% working
interest in the properties subject to the net profits interest and would,
therefore, bear substantially all of the costs.
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When calculating net proceeds, Eastern States will proportionately reduce these
costs based on the trust's percentage net profits interests. These costs are set
forth in the conveyances and include the following:
Production Costs. As payment for operating the wells included in the
underlying properties, Eastern States will deduct a monthly fixed production fee
of $170 per well for those wells producing five or more Mcf per day on an annual
basis and $70 per well for those wells producing less than five Mcf per day on
an annual basis. Each of these fixed production costs is subject to an annual
adjustment beginning April 1, 2001 in accordance with an industry standard set
forth in the accounting procedures in the conveyances. Approximately 85% of the
2,562 underlying wells are currently producing in excess of an average of five
Mcf per day.
Eastern States Gathering and Compressing Charges. Eastern States will
deduct from gross proceeds an amount equal to its costs incurred to gather,
compress and process production from the underlying properties on Eastern
States' facilities plus an amount to reimburse Eastern States for depreciation
of the facilities and to provide a reasonable return on its investment in such
facilities. The amount of this charge will vary as changes occur in Eastern
States' investment in facilities associated with the underlying properties, as
well as when changes occur in the costs incurred by Eastern States to perform
such services.
Overhead. Generally, fees are allocated among operating and non-operating
interests. Because Eastern States has historically owned and operated almost
100% of its properties, it has not charged or allocated an overhead fee to the
non-operator. Pursuant to the conveyances, Eastern States will deduct a monthly
overhead fee of $65 per producing well from the underlying properties, subject
to an annual adjustment beginning April 1, 2001 in accordance with an industry
standard set forth in the accounting procedures in the conveyances.
Development Costs and Drilling Overhead. Eastern States will deduct all
development costs in calculating net proceeds attributable to the underlying
properties, plus a drilling overhead fee of $36,000 for each well drilled on or
after October 1, 1999, subject to an annual adjustment beginning April 1, 2001
in accordance with an industry standard set forth in the accounting procedures
in the conveyances.
Excess costs are the excess of costs over gross proceeds, plus interest
accrued on such excess amount at the prime rate. Therefore, if costs exceed
gross proceeds for a computation period, the trust will receive no payment for
that period, and excess costs, plus interest accrued at the prime rate, will be
carried over to the following month as a cost in determining the excess of gross
proceeds over costs for that following month.
Gross proceeds and costs are calculated on a cash basis, except that some
costs, primarily ad valorem taxes and expenditures of a material amount, may be
determined on an accrual basis. For convenience in complying with state tax
laws, the net profits interests were created by two separate conveyances, one
for each of Kentucky and West Virginia, the two states in which the underlying
properties are located. Net proceeds are calculated separately for the
underlying properties covered by each conveyance, so excess costs in one state
do not reduce net proceeds from the other.
Any gains or losses from hedging activities by Eastern States will not
affect the calculation of net proceeds.
ADDITIONAL PROVISIONS
The trust is not liable to the owner of the underlying properties or the
operators for any operating, capital or other costs or liabilities attributable
to the underlying properties. The trustee is not obligated to return any cash
received from the net profits interests. Any overpayments made to the trust due
to adjustments to prior calculations of net proceeds or otherwise will reduce
future amounts payable to the trust until Eastern States recovers the
overpayments plus interest at the prime rate.
Eastern States must maintain books and records sufficient to determine the
amounts payable for the net profits interests. Quarterly and annually, Eastern
States must deliver to the trustee a statement of the
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computation of the net proceeds for each computation period. Eastern States will
cause the annual computation of net proceeds to be audited. The audit cost will
be borne by the trust.
As discussed under "The Underlying Properties -- Sale and Abandonment of
Underlying Properties; Sale of Net Profits Interests," Eastern States may convey
any or all of the underlying properties without the consent of the trust or the
unitholders. In this case, the trust's net profits interest must be paid by the
transferee to the extent attributable to the underlying properties transferred.
Neither the trust nor the unitholders are entitled to any of the proceeds from
any sale of the underlying properties. If, however, the net profits interests
are sold with the underlying properties, the trust will receive the proceeds
attributable to the sale of its net profits interests.
FEDERAL INCOME TAX CONSEQUENCES
This section summarizes all material federal income tax consequences of the
ownership and sale of trust units. Many aspects of federal income taxation that
may be relevant to a particular taxpayer or to some types of taxpayers subject
to specific tax treatment are not addressed. In addition, the tax laws can and
do change regularly, and any future changes could have an adverse effect on the
ownership or sale of trust units. The trust will not request rulings from the
IRS dealing with the tax consequences of ownership of trust units. Instead the
trust will rely on the opinion of Andrews & Kurth L.L.P. regarding the
classification of the trust and the federal income tax consequences described
below. Andrews & Kurth L.L.P. believes that its opinion is in accordance with
the present position of the IRS regarding grantor trusts. The opinion is not
binding on the IRS or the courts, however, and no assurance can be given that
the IRS or the courts will agree with it.
The summary contained in this section is based on current provisions of the
Code, existing and proposed regulations thereunder and current administrative
rulings and court decisions, all of which are subject to changes that may or may
not be retroactively applied. Some of the applicable provisions of the Code have
not been interpreted by the courts or the IRS. Currently pending proposed
Federal tax legislation may also, under certain circumstances, have a material
effect on a unitholder.
As a consequence, each prospective unitholder should consult his own tax
advisor with respect to his particular circumstances including, particularly,
his alternative minimum tax circumstances.
SUMMARY OF LEGAL OPINIONS
Andrews & Kurth L.L.P. is of the opinion that, for federal income tax
purposes:
- the trust will be treated as a grantor trust and not as a partnership or
a corporation; and
- the income from the net profits interests will be royalty income subject
to an allowance for depletion.
Andrews & Kurth L.L.P. advises that, unless noted otherwise, legal
conclusions stated in this section constitute its opinion.
Because no ruling is being requested from the IRS with respect to the trust
or trust unitholders, the IRS could challenge these opinions and statements,
which do not bind the IRS or the courts. The IRS could win in court if it did
challenge these matters.
CLASSIFICATION AND TAXATION OF THE TRUST
In the opinion of Andrews & Kurth L.L.P., under current law, the trust will
be taxable as a grantor trust. As a grantor trust, the trust will not be subject
to tax at the trust level. For tax purposes, the grantors, who in this case are
the trust unitholders, will be considered to own the trust's income and
principal as though no trust were in existence. A grantor trust simply files an
information return, reporting all items of income or deduction which must be
included in the tax returns of the trust unitholders based on their respective
accounting methods and taxable years without regard to the accounting method and
tax
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year of the trust. If, contrary to the opinion of Andrews & Kurth L.L.P., the
trust were determined to be a business entity, it would be taxable as a
partnership unless it elected to be taxed as a corporation. The principal tax
consequence of the trust's being treated as a partnership would be that all
trust unitholders would report their share of income from the trust on the
accrual method of accounting regardless of their own method of accounting.
DIRECT TAXATION OF TRUST UNITHOLDERS
Because the trust will be treated as a grantor trust for federal income tax
purposes, each trust unitholder will be taxed directly on his share of trust
income and will be entitled to claim his share of trust deductions. Each trust
unitholder will recognize taxable income when the trust receives or accrues it,
even if it is not distributed until later. Trust unitholders will report their
share of trust income and expenses consistent with their own method of
accounting and their own tax year.
REPORTING OF TRUST INCOME AND EXPENSES
The trust will make quarterly distributions to unitholders of record on
each quarterly record date established for that distribution. The terms of the
trust agreement, as described below, seek to assure to the extent practicable
that income attributable to distributions will be reported to the unitholder who
receives the distributions, assuming that he is the owner of record on the
quarterly record date established for the distribution. In certain
circumstances, however, a unitholder will not receive the cash giving rise to
that income. For example, if the trustee establishes a reserve or borrows money
to satisfy liabilities of the trust, income associated with the cash used to
establish that reserve or to repay that liability must be reported by the
unitholder, even though that cash is not distributed to him.
The trust will allocate income and deductions to unitholders based on
record ownership at quarterly record dates established for distributions to the
unitholders. The impact of such allocation method will be to treat the taxable
income of the trust for a particular quarter as income to unitholders of record
for that quarter unless otherwise advised by counsel. It is unknown whether the
IRS will accept that allocation or will seek to require income and deductions of
the trust to be determined and allocated daily or on some other basis, possibly
retroactively to the date of the consummation of the offering made hereby. If
the IRS were successful in doing so, trust income might be taxed to trust
unitholders other than those who received the distribution relating to that
income. Also, an accrual basis trust unitholder might realize royalty income in
a tax year earlier than that reported by the trustee.
ROYALTY INCOME AND DEPLETION
In the opinion of Andrews & Kurth L.L.P. the income from the net profits
interests will be royalty income qualifying for an allowance for depletion. The
depletion allowance must be computed separately by each trust unitholder for
each oil or gas property, within the meaning of Section 614 of the Internal
Revenue Code. Andrews & Kurth L.L.P. understands that the IRS is presently
taking the position that a net profits interest carved from multiple properties
is a single property for depletion purposes. Accordingly, the trust intends to
take the position that each net profits interest transferred to the trust by a
conveyance is a single property for depletion purposes. It will change this
position if a different method is established by the IRS or the courts.
The deduction for depletion is determined annually and is the greater of
cost depletion or, if allowable, percentage depletion. Royalty income from
production attributable to trust units owned by independent producers will
qualify for percentage depletion. An individual or entity with production of the
equivalent of not more than 1,000 barrels of oil per day is an independent
producer. Percentage depletion is a statutory allowance equal to 15% of the
gross income from production from a property. Percentage depletion is subject to
a net income limitation of 100% of the taxable income from the property,
computed without regard to depletion deductions and some loss carrybacks. The
depletion deduction attributable to percentage depletion for a taxable year is
limited to 65% of the taxpayer's taxable income for the year before allowance of
independent producers percentage depletion and some loss carrybacks. Unlike cost
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depletion, percentage depletion is not limited to the adjusted tax basis of the
property, although it reduces the adjusted tax basis, but not below zero.
Eastern States believes that trust unitholders who purchase trust units in
this offering will derive a substantially greater benefit from cost depletion
than from percentage depletion.
In computing cost depletion for each property for any year, the allowance
for the property is calculated by dividing the adjusted tax basis of the
property at the beginning of the year by the estimated total number of Bbls of
oil or Mcf of natural gas recoverable from the property. This amount is then
multiplied by the number of Bbls of oil or Mcf of natural gas produced and sold
from the property during the year. Cost depletion for a property cannot exceed
the adjusted tax basis of the property. Each trust unitholder will compute cost
depletion using his basis in his trust units. Information will be provided to
each trust unitholder reflecting how his basis should be allocated among each
property represented by his trust units. To the extent the depletion deduction
exceeds cash distributions per trust unit, that excess can be deducted from the
taxpayer's other sources of taxable income.
OTHER INCOME AND EXPENSES
It is anticipated that the trust's only other income will be interest
income earned on funds held as a reserve or pending distribution. Other trust
expenses will include any state and local taxes imposed on the trust and
administrative expenses of the trustee. Although the issue has not been finally
resolved, Andrews & Kurth L.L.P. believes that all or substantially all of those
expenses are deductible in computing adjusted gross income and, therefore, are
not the type of miscellaneous itemized deductions that are allowable only to the
extent that they total more than 2% of adjusted gross income.
ALTERNATIVE MINIMUM TAX
All taxpayers are subject to an alternative minimum tax. Alternative
minimum taxable income is the taxpayer's taxable income recomputed with various
adjustments plus items of tax preference. In the case of persons other than
independent producers, tax preferences include the excess of percentage
depletion deductions for an oil or natural gas property over the adjusted tax
basis of the property. Alternative minimum tax is the excess of a taxpayer's
tentative minimum tax on his alternative minimum taxable income for a tax year
over his regular tax for that year.
Because the effect of the alternate minimum tax varies depending upon each
trust unitholder's personal tax and financial position, each prospective
investor is advised to consult with his own tax advisor concerning the effect of
the alternate minimum tax on him.
UNRELATED BUSINESS TAXABLE INCOME
Some organizations that are generally exempt from tax under Internal
Revenue Code Section 501 are subject to tax on some types of business income
defined in Section 512 as unrelated business income. In the opinion of Andrews &
Kurth L.L.P., the income of the trust will not be unrelated business taxable
income so long as the trust does not incur any debt and the trust units are not
debt-financed property within the meaning of Section 514(b). In general, a trust
unit would be debt-financed only if the trust unitholder incurs debt to acquire
a trust unit or otherwise incurs or maintains a debt that would not have been
incurred or maintained if the trust unit had not been acquired.
SALE OF TRUST UNITS
Generally, a trust unitholder will realize gain or loss on the sale or
exchange of his trust units measured by the difference between the amount
realized on the sale or exchange and his adjusted basis for the trust units.
Except to the extent of the depletion recapture amount described below, gain or
loss on the sale of trust units by a trust unitholder who is not a dealer of the
trust units will be a long-term capital gain, taxable at a maximum rate of 20%,
if the trust units have been held for more than 12 months. A
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trust unitholder's initial basis in his trust units will be equal to the amount
he paid for the trust units. That basis will be reduced by deductions for
depletion claimed by the trust unitholder, but not below zero.
Upon the sale of the trust units, a trust unitholder must treat as ordinary
income his depletion recapture amount, which is an amount equal to the lesser of
the gain on the sale or the sum of the prior depletion deductions taken on the
trust units, but not in excess of the initial basis of the trust units. The IRS
could also take the position that a portion of the sales proceeds is ordinary
income to the extent of any accrued income at the time of the sale that was
allocable to the trust units sold even though the income had not been
distributed to the selling trust unitholder.
SALE OF NET PROFITS INTERESTS
A sale by the trust of a net profits interest will be treated for federal
income tax purposes as a sale of that net profits interest by the unitholder.
Thus, a unitholder will recognize gain or loss on a sale of a net profits
interest by the trust. A portion of that income will be treated as ordinary
income to the extent of depletion recapture.
TAXATION OF FOREIGN HOLDERS
Unless the election described below is made, a foreign holder, consisting
of a nonresident alien individual, foreign corporation, or foreign estate or
trust, will be subject to federal income withholding tax on his share of gross
royalty income from the net profits interests. The withholding tax will be at a
30% rate, or lower treaty rate if applicable and proper evidence is supplied to
the withholding agent, without any deductions. Gain realized on a sale of a
trust unit by a foreign holder will be subject to federal income tax only if:
- the gain is otherwise effectively connected with business conducted by
the foreign holder in the United States;
- the foreign holder is an individual who is present in the United States
for at least 183 days in the year of the sale;
- the foreign holder has at any time during the five-year period ending on
the date of sale owned more than a 5% interest in the trust; or
- the trust units cease to be regularly traded on an established securities
exchange.
Gain realized by a foreign holder upon the sale by the trust of all or any
part of the net profits interests would be subject to federal income tax.
Trust unitholders who are foreign holders may elect under Internal Revenue
Code Section 871 or Section 882 or similar provisions of applicable treaties to
treat income attributable to the net profits interests as effectively connected
with the conduct of a trade or business in the United States. The foreign holder
will then be taxed at regular federal income tax rates on the net income rather
than gross income attributable to the net profits interests, including gain
recognized on the disposition of trust units. Absent a treaty exception, the net
income of a corporate foreign holder which has made an election will also be
subject to the branch profits tax imposed under Section 884 to the extent such
net income is not reinvested in a United States trade or business. To claim the
deductions allowable in computing net income, including cost depletion, an
electing foreign holder must file a United States income tax return. To avoid
tax withholding, an electing foreign holder must provide proper certificates or
other evidence to the withholding agent. Once made, the election is irrevocable
unless an applicable treaty allows the election to be made annually. The
election is applicable to all income and gain realized by the foreign holder on
any real property interests located in the United States, including those
interests held through partnerships, fixed investment trusts, and other
pass-through entities.
BACKUP WITHHOLDING
In general, distributions of trust income will not be subject to backup
withholding unless the trust unitholder is an individual or other noncorporate
taxpayer and he fails to furnish his taxpayer identification
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number to the trustee in the manner required or he otherwise fails to comply
with certain reporting procedures.
TAX SHELTER REGISTRATION
Eastern States believes that the requirements for tax shelter registration
under Internal Revenue Code Section 6111 would be met if any trust unitholder's
investment base is substantially reduced by borrowing. To avoid any potential
penalty, the trust will be registered as a tax shelter with the IRS. The trustee
will furnish the tax shelter registration number to each trust unitholder. Each
trust unitholder must disclose this number by attaching Form 8271 to his tax
return.
ISSUANCE OF A TAX SHELTER REGISTRATION NUMBER DOES NOT INDICATE THIS
INVESTMENT OR THE CLAIMED TAX BENEFITS HAVE BEEN REVIEWED, EXAMINED OR APPROVED
BY THE IRS.
REPORTS
The trustee will furnish to trust unitholders of record quarterly and
annual reports to facilitate their computation of their tax liability. See
"Description of the Trust Units -- Periodic Reports."
STATE TAX CONSIDERATIONS
This section is a brief summary of the material state income tax and other
state tax considerations affecting the trust and the trust unitholders. No
attempt has been made in the following discussion to comment on all state tax
matters affecting the trust or trust unitholders. Moreover, the discussion
focuses on trust unitholders who are individuals and has only limited
application to corporations, estates, trusts or other trust unitholders subject
to specialized tax treatment, such as tax-exempt institutions, IRAs, REITs or
mutual funds. Accordingly, each prospective trust unitholder should consult, and
should depend on, his or her own tax advisor in analyzing the particular state
and local tax consequences to him or her of an investment in the trust.
INCOME TAX CONSIDERATIONS
The trust will own net profits interests burdening oil and gas properties
located in the states of Kentucky and West Virginia. These states impose income
taxes on residents and, for certain types of income, nonresidents. A trust
unitholder may be required to file state income tax returns and/or to pay taxes
in these states and may be subject to penalties for failure to comply with these
requirements. Trust unitholders may also be subject to taxation by their state
of residence on income derived from the trust.
The income tax laws of Kentucky and West Virginia are based on federal
income tax laws. Assuming the trust is taxed as a grantor trust for federal
income tax purposes, the trust will not be subject to Kentucky or West Virginia
state income taxation but, the trust unitholders will be subject to income tax
in both of these states on their share of income from the net profits interests
burdening properties located in that state. The trustee will provide information
concerning the trust sufficient to identify the income of the trust allocable to
each state. Individual nonresident trust unitholders with West Virginia adjusted
gross income from West Virginia sources in excess of the sum of West Virginia
personal exemptions are required to file a West Virginia state income tax
return. Individuals are currently allowed a West Virginia personal exemption of
$2,000 for each exemption allowed for federal income tax purposes. Individual
nonresident trust unitholders with gross income from Kentucky sources and $5,000
of total gross income must file a Kentucky state income tax return. It is
uncertain whether trust unitholders who are nonresidents of Kentucky or West
Virginia will be taxed in these states on gains from sales of trust units.
West Virginia requires certain types of entities to withhold taxes from
distributions made to nonresidents. The trust does not believe it is an entity
that is required to withhold West Virginia taxes from distributions to trust
unitholders who are not West Virginia residents and does not intend to do so
unless counsel advises that such withholding is required. The trust would, if
required, withhold 4% of the
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taxable income of each nonresident trust unitholder attributable to West
Virginia sources. Distributions to trust unitholders are not currently subject
to Kentucky withholding tax. If Kentucky enacts a nonresident withholding tax,
the trust may be required to withhold taxes from distributions made to
nonresident unitholders attributable to Kentucky source income. Taxes withheld
by the trust from a trust unitholder would be treated as a distribution to that
trust unitholder and allowed as a credit against that trust unitholder's state
tax liability.
PROBATE AND PROPERTY CONSIDERATIONS
The trust units may constitute real property or an interest in real
property under the inheritance, estate and probate laws of Kentucky or West
Virginia. If the trust units are held to be real property or an interest in real
property under the laws of a state in which the underlying properties are
located, the trust unitholders may be subject to devolution, probate and
administration laws, and inheritance or estate and similar taxes, under the laws
of that state.
ERISA CONSIDERATIONS
The Employee Retirement Income Security Act of 1974 regulates pension,
profit-sharing and other employee benefit plans to which it applies. ERISA also
contains standards for persons who are fiduciaries of those plans. In addition,
the Internal Revenue Code provides similar requirements and standards which are
applicable to qualified plans, which include these types of plans and to
individual retirement accounts, whether or not subject to ERISA.
A fiduciary of a qualified plan should carefully consider fiduciary
standards under ERISA regarding the qualified plan's particular circumstances
before authorizing an investment in trust units. A fiduciary should consider
- whether the investment satisfies the prudence requirements of Section
404(a)(1)(B) of ERISA;
- whether the investment satisfies the diversification requirements of
Section 404(a)(1)(C) of ERISA; and
- whether the investment is in accordance with the documents and
instruments governing the qualified plan as required by Section
404(a)(1)(D) of ERISA.
A fiduciary should also consider whether an investment in trust units might
result in direct or indirect nonexempt prohibited transactions under Section 406
of ERISA and Internal Revenue Code Section 4975. In deciding whether an
investment involves a prohibited transaction, a fiduciary must determine whether
there are plan assets in the transaction. On November 13, 1986, the Department
of Labor published final regulations concerning whether or not a qualified
plan's assets would be deemed to include an interest in the underlying assets of
an entity for purposes of the reporting, disclosure and fiduciary responsibility
provisions of ERISA and analogous provisions of the Internal Revenue Code. These
regulations provide that the underlying assets of an entity will not be
considered "plan assets" if the equity interests in the entity are a publicly
offered security. Eastern States expects that at the time of the sale of the
trust units in this offering, they will be publicly offered securities.
Fiduciaries, however, will need to determine whether the acquisition of trust
units is a nonexempt prohibited transaction under the general requirements of
ERISA Section 406 and Internal Revenue Code Section 4975.
The prohibited transaction rules are complex, and persons involved in
prohibited transactions are subject to penalties. For that reason, potential
qualified plan investors should consult with their counsel to determine the
consequences under ERISA and the Internal Revenue Code of their acquisition and
ownership of trust units.
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<PAGE> 59
DESCRIPTION OF THE TRUST AGREEMENT
The following information and the information included under "Description
of the Trust Units" summarize the material information contained in the trust
agreement. This summary may not contain all the information that is important to
you. For more detailed provisions concerning the trust, you should read the
trust agreement. A copy of the trust agreement is filed as an exhibit to the
registration statement. See "Available Information."
CREATION AND ORGANIZATION OF THE TRUST; AMENDMENTS
Eastern States will create the net profits interests and convey them to the
trust in exchange for
trust units. Conveyance of the net profits interest will be effective as of
October 1, 1999.
Eastern States organized the trust under the Delaware Business Trust Act to
acquire and hold the net profits interests for the benefit of the trust
unitholders pursuant to a trust agreement among Eastern States, the property
trustee and the Delaware trustee. Neither the trust nor the property trustee has
any control over or responsibility for costs relating to the operation of the
underlying properties. Eastern States has no contractual commitments to the
trust to conduct further drilling on or to maintain their ownership interest in
any of these properties. For a description of the underlying properties and
other information relating to them, see "The Underlying Properties."
The beneficial interest in the trust is divided into trust units. Each
of the trust units represents an equal undivided beneficial interest in the
assets of the trust. You will find additional information concerning the trust
units in "Description of the Trust Units."
Amendment of the trust agreement requires a vote of holders of 66 2/3% or
more of the outstanding trust units. However, no amendment may:
- increase the power of the property trustee to engage in business or
investment activities;
- alter the rights of the trust unitholders as among themselves; or
- permit the property trustee to distribute the net profits interests in
kind.
Certain amendments do not require the vote of the trust unitholders.
ASSETS OF THE TRUST
The assets of the trust consist of net profits interests and any cash and
temporary investments being held for the payment of expenses and liabilities or
for distribution to the trust unitholders.
DUTIES AND LIMITED POWERS OF THE PROPERTY TRUSTEE
The duties of the property trustee are specified in the trust agreement and
by the laws of the State of Delaware. The property trustee's principal duties
consist of:
- collecting cash attributable to the net profits interests;
- paying expenses, charges and obligations of the trust from the trust's
cash and assets;
- distributing distributable cash to the trust unitholders; and
- taking any action it deems necessary and advisable to best achieve the
purposes of the trust.
If a trust liability is contingent or uncertain in amount or not yet
currently due and payable, the property trustee may create a cash reserve to pay
for the liability. If the property trustee determines that the cash on hand and
the cash to be received is insufficient to cover the trust's liability, the
property trustee may borrow funds required to pay the liabilities. The property
trustee may borrow the funds from any person, including itself. The property
trustee may also mortgage the assets of the trust to secure payment of the
indebtedness. If the property trustee borrows funds, the trust unitholders will
not receive distributions until the borrowed funds are repaid.
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<PAGE> 60
Each quarter, the property trustee will pay trust obligations and expenses
and distribute to the trust unitholders the remaining cash received from the net
profits interests. The cash held by the property trustee as a reserve against
future liabilities or for distribution at the next distribution date must be
invested in:
- interest bearing obligations of the United States government;
- repurchase agreements secured by interest-bearing obligations of the
United States government;
- money market mutual funds; or
- bank certificates of deposit.
The trust may not acquire any asset except the net profits interests, cash
and temporary cash investments, and it may not engage in any investment activity
except investing cash on hand.
At the request of Eastern States, the property trustee must sell for cash
the net profits interests relating to the underlying properties sold by Eastern
States to an unaffiliated third party. However, these sales are required only if
the net profits interests sold do not exceed $3 million in any calendar year or
$20 million on an aggregate basis for the life of the trust. Upon such a sale,
Eastern States will, or will cause the purchaser to, pay to the trust the
portion of the purchase price allocable to the net profits interests sold, less
allocable expenses of the sale (including attorneys' fees).
The property trustee may sell the net profits interests in any of the
following circumstances:
- the sale does not involve trust assets of which the aggregate
standardized measure exceeds $30 million and is in the best interests of
the trust unitholders and a majority of the trust units represented at a
meeting of the trust unitholders where a quorum is present approve the
sale; or
- the sale involves trust assets of which the aggregate standardized
measure exceeds $30 million and is in the best interests of the trust
unitholders and holders representing at least 66 2/3% of the outstanding
trust units approve the sale.
Upon dissolution of the trust the property trustee must sell the net
profits interests. No trust unitholder approval is required in this event. The
trustee will distribute the net proceeds from any sale of the net profits
interests to the trust unitholders after payment of all liabilities of the trust
in accordance with law.
The property trustee may require any trust unitholder to dispose of his
trust units if an administrative or judicial proceeding seeks to cancel or
forfeit any of the property in which the trust holds an interest because of the
nationality or any other status of that trust unitholder. If a trust unitholder
fails to dispose of his trust units, the property trustee has the right to
purchase them and to borrow funds to make that purchase.
The property trustee may agree to modifications of the terms of the
conveyances or to settle disputes involving the conveyances. The property
trustee may not agree to modifications or settle disputes involving the royalty
part of the conveyances if these actions would change the character of the net
profits interests in a way that the net profits interests become working
interests or that the trust becomes an operating business.
LIABILITIES OF THE TRUST
Because the trust does not conduct an active business and the property
trustee has minimal power to incur obligations, Eastern States expects that the
trust will only incur liabilities for routine administrative expenses. These
might include the property trustee's fees and accounting, engineering, legal and
other professional fees.
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<PAGE> 61
RESPONSIBILITY AND LIABILITY OF THE PROPERTY TRUSTEE
Under the trust agreement, the property trustee is required to act in the
best interests of the trust unitholders at all times. The property trustee must
exercise the same judgment and care in supervising and managing the trust's
assets as persons of ordinary prudence, discretion and intelligence would
exercise.
The property trustee will not make business decisions affecting the assets
of the trust. Therefore, substantially all of the property trustee's functions
under the trust agreement are expected to be ministerial in nature. See
"-- Duties and Limited Powers of the Property Trustee" above. The trust
agreement, however, provides that the trustee may:
- charge a fee for its services as trustee;
- retain funds to pay for future expenses and deposit them in its own
account;
- lend funds at commercial rates to the trust to pay the trust's expenses;
and
- reimburse itself from the trust for its out-of-pocket expenses.
In discharging its duty to trust unitholders, the property trustee may act
in its discretion and will be liable to the trust unitholders only for fraud,
gross negligence or acts or omissions constituting bad faith. The property
trustee will not be liable for any act or omission of its agents or employees
unless the property trustee acted in bad faith or with gross negligence in their
selection and retention. The property trustee will be indemnified individually
or as property trustee for any liability or cost that it incurs in the
administration of the trust, except in cases of fraud, gross negligence or bad
faith. The property trustee will have a lien on the assets of the trust as
security for this indemnification and its compensation earned as property
trustee. The property trustee is entitled to indemnification from trust assets
or, to the extent that trust assets are insufficient, from Eastern States. Trust
unitholders will not be liable to the property trustee for any indemnification.
See "Description of the Trust Units -- Liability of Trust Unitholders." The
property trustee may not cause the trust to incur any contractual liabilities
that are not limited to the assets of the trust and will be liable for its
failure to do so.
CONDITIONAL RIGHT OF REPURCHASE
The trust agreement provides that Eastern States and any of its successors,
affiliates and transferees will retain the right to repurchase all (but not less
than all) outstanding trust units at any time during which 15% or less of the
outstanding trust units are owned by persons or entities other than Eastern
States and its affiliates. Subject to the following sentence, any such
repurchase would be at a price equal to the greater of
(1) the highest price at which Eastern States or any of its affiliates
acquired trust units during the 90 days immediately preceding the
determination date; and
(2) the average closing price of trust units on the NYSE for the 30
trading days immediately preceding the determination date.
If Eastern States or any of its affiliates acquires trust units (other than an
acquisition from Eastern States or any affiliate) during the period that is
three trading days after the determination date at a price per trust unit
greater than that at which an acquisition was made during the 90-day period
referred to in clause (1) of the preceding sentence, then for purposes of clause
(1) of the preceding sentence the highest price used therein shall be such
greater price. The determination date is three trading days prior to the date
that notice of the exercise is delivered to trust unitholders. Any repurchase
would be conducted in accordance with applicable Federal and state securities
laws.
If Eastern States elects to purchase all the trust units, Eastern States
and the property trustee will, prior to the date fixed for purchase, give all
unitholders of record not less than 15 days' nor more than 60 days' written
notice. The notice will specify the time and place of the repurchase, calling
upon each trust unitholder to surrender to Eastern States (or its agent) on the
repurchase date at the place designated in the notice its certificate or
certificates representing the number of trust units specified in the
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notices. On or after the repurchase date, each holder of trust units must
present and surrender to Eastern States (or its agent) its certificates for its
trust units at the place designated and thereupon the purchase price of the
trust units shall be paid to or on the order of the person or entity whose name
appears on the certificate or certificates as the owner thereof. In no event may
fewer than all of the outstanding trust units represented by the certificates be
repurchased (except for any units held by Eastern States and any of its
affiliates).
If Eastern States and the property trustee give a notice of repurchase and
if, on or before the date fixed for repurchase, the funds necessary for the
repurchase shall have been set aside by Eastern States, separate and apart from
its other funds, in trust for the pro rata benefit of the holders of the trust
units then, notwithstanding that any certificate for the trust units has not
been surrendered, at the close of business on the repurchase date the holders of
units shall cease to be unitholders and shall have no interest in or claims
against Eastern States, the trust, the Delaware trustee or the property trustee
by virtue thereof and shall have no voting or other rights with respect to the
trust units, except the right to receive the purchase price payable upon
repurchase, without interest thereon and without any other distributions for
record dates after the date of notice of the repurchase, upon surrender (and
endorsement, if required by Eastern States) of their certificates. The trust
units evidenced thereby will no longer be held of record in the names of the
unitholders. Subject to applicable escheat laws, any monies so set aside by
Eastern States and unclaimed at the end of two years from the repurchase date
will revert to the general funds of Eastern States, after which reversion the
holders of units so noticed for repurchase may look only to the general funds of
Eastern States for the payment of the purchase price. Any interest accrued on
funds so deposited would be paid to Eastern States from time to time as
requested by Eastern States.
If Eastern States exercises and consummates its right of repurchase, then
at its option it may cause the trust to be terminated by providing written
notice thereof to the property trustee and the Delaware trustee. Within 30 days
following written notice of Eastern States' decision to terminate the trust, the
property trustee and the Delaware trustee must cause all net profits interests
(and, subject to the rights of unitholders with respect to the receipt of
distributions for which a record date has been determined, all proceeds of
production attributable to the net profits interests) and any other assets of
the trust to be conveyed to Eastern States or its assignee (subject to the right
of the property trustee and Delaware trustee to create reasonable reserves in
connection with the liquidation of the trust).
DURATION OF THE TRUST; SALE OF NET PROFITS INTERESTS
The trust will dissolve if:
- the trust sells all of the net profits interests;
- annual net proceeds are less than $3.5 million for West Virginia for each
of two consecutive years after the year 2000 or less than $3.5 million
for Kentucky for each of two consecutive years after the year 2000;
- the holders of 66 2/3% or more of the outstanding trust units vote in
favor of termination;
- Eastern States exercises its conditional right of repurchase; or
- a judicial dissolution of the trust occurs.
The property trustee would then sell all of the trust's assets, either by
private sale or public auction, and, after payment of liabilities of the trust,
distribute the net proceeds of the sale to the trust unitholders. Thereafter the
trust will terminate.
DISPUTE RESOLUTION
Any dispute, controversy or claim that may arise between Eastern States and
the property trustee relating to the trust will be submitted to binding
arbitration before a tribunal of three arbitrators.
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COMPENSATION OF THE PROPERTY TRUSTEE AND THE DELAWARE TRUSTEE
The property trustee's and the Delaware trustee's compensation will be paid
out of the trust's assets. See "The Trust."
MISCELLANEOUS
The property trustee may consult with counsel, accountants, geologists and
engineers and other parties the trustee believes to be qualified as experts on
the matters for which advice is sought. The property trustee will be protected
for any action it takes in good faith reliance upon the opinion of an expert.
DESCRIPTION OF THE TRUST UNITS
Each trust unit is a unit of beneficial ownership in the trust and
represents an undivided beneficial interest in the assets of the trust. Each
trust unitholder has the same rights regarding each of his trust units as every
other trust unitholder has regarding his units. The trust will have
trust units outstanding upon completion of the offering.
DISTRIBUTIONS AND INCOME COMPUTATIONS
Each quarter, the trustee will determine the amount of funds available for
distribution to the trust unitholders. Available funds are the excess cash
received by the trust from the net profits interests and other sources that
quarter, over the trust's liabilities for that quarter. Available funds will be
reduced by any cash the property trustee decides to hold as a reserve against
future liabilities. Trust unitholders that own their trust units on the record
date, which is the first business day of the third calendar month after the end
of the respective quarter, will receive a quarterly distribution no later than
the 25th day of the third month after the end of the respective quarter. The
first distribution will be made on or before March 25, 2000 to trust unitholders
owning trust units on March 1, 2000 for the production period October 1, 1999
through December 31, 1999.
Unless otherwise advised by counsel, the property trustee will treat the
income and expenses of the trust for each quarter as belonging to the trust
unitholders of record on the record date for that quarter. See "Federal Income
Tax Consequences."
TRANSFER OF TRUST UNITS
Trust unitholders may transfer their trust units by sending their trust
unit certificate to the property trustee along with a transfer form that is
properly completed. The property trustee will not require either the transferor
or transferee to pay a service charge for any transfer of a trust unit. The
property trustee may require payment of any tax or other governmental charge
imposed for a transfer. The property trustee may treat the registered owner of
any trust unit as shown by its records as the owner of the trust unit. The
property trustee will not be considered to know about any claim or demand on a
trust unit by any party except the record owner. A person who acquires a trust
unit after any record date will not be entitled to the distribution relating to
that record date. Delaware law will govern all matters affecting the title,
ownership, warranty or transfer of trust units.
PERIODIC REPORTS
The property trustee will mail to trust unitholders quarterly reports
showing the assets, liabilities, receipts and disbursements of the trust for
each quarter except the fourth quarter. No later than 120 days following the end
of each year, the property trustee will mail to the trust unitholders an annual
report containing audited financial statements of the trust.
The property trustee will file all required trust federal and state income
tax and information returns. The property trustee will prepare and mail to trust
unitholders annually reports that trust unitholders need to report their share
of the income and deductions of the trust.
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Each trust unitholder and his representatives may examine, for any proper
purpose and during reasonable business hours the records of the trust and the
property trustee.
LIABILITY OF TRUST UNITHOLDERS
Under the Delaware Business Trust Act, except as otherwise provided in the
trust agreement, trust unitholders will be entitled to the same limitation of
personal liability extended to stockholders of private corporations for profit
under the General Corporation Law of the State of Delaware.
VOTING RIGHTS OF TRUST UNITHOLDERS
Trust unitholders have more limited voting rights than those of
stockholders of most public corporations. For example, there is no requirement
for annual meetings of trust unitholders or for annual or other periodic
re-elections of the property trustee.
The property trustee or trust unitholders owning at least 15% of the
outstanding trust units may call meetings of trust unitholders. Meetings must be
held in Fort Worth, Texas. The property trustee must send written notice of the
time and place of the meeting and the matters to be acted upon to all of the
trust unitholders at least 20 days and not more than 60 days before the meeting.
Trust unitholders representing a majority of trust units outstanding must be
present or represented to have a quorum. Each trust unitholder is entitled to
one vote for each trust unit owned.
Unless otherwise required by the trust agreement, a matter is approved by
the vote of a majority of the trust units held by the trust unitholders at a
meeting where there is a quorum. This is true, even if a majority of the total
trust units did not approve it. The affirmative vote of the holders of 66 2/3%
of the outstanding trust units is required to:
- dissolve the trust;
- amend the trust agreement for matters that adversely affect the right of
trust unitholders in a material respect; or
- approve the sale of all or any material part of the assets of the trust.
The property trustee must consent before all or any part of the trust
assets can be sold except in connection with the termination of the trust or
limited sales directed by Eastern States in conjunction with its sale of
underlying properties. The property trustee may be removed, with or without
cause, by the vote of the holders of a majority of the outstanding trust units.
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COMPARISON OF TRUST UNITS AND COMMON STOCK
You should be aware of the following ways in which an investment in trust
units is different from an investment in common stock of a corporation.
<TABLE>
<CAPTION>
TRUST UNITS COMMON STOCK
----------- ------------
<S> <C> <C>
Voting Limited voting rights. Corporate statutes provide
specific voting rights to
stockholders on electing
directors and major corporate
transactions.
Income Tax The trust is not subject to Corporations are taxed on
tax; trust unitholders are their income, and their
directly subject to income stockholders are taxed on
tax on their proportionate dividends received.
share of trust net income,
adjusted for tax deductions.
Distributions Substantially all trust cash Stockholders receive
receipts are distributed to dividends at the discretion
trust unitholders. of the board of directors.
Business and Assets Interest is limited to A corporation conducts an
specific assets with a finite active business for an
economic life. unlimited term and can
reinvest its earnings and
raise additional capital to
expand.
Fiduciary Duties To the extent provided in the Officers and directors have a
trust agreement, the property fiduciary duty of loyalty to
trustee has a fiduciary duty stockholders and a duty to
to the trust unitholders. use due care in management
Eastern States does not owe and administration of a
the trust unitholders a corporation.
fiduciary duty.
</TABLE>
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UNDERWRITING
Under the terms and subject to the conditions contained in the underwriting
agreement, the form of which is filed as an exhibit to the registration
statement, the underwriters named below, for whom Lehman Brothers Inc., Salomon
Smith Barney Inc., PaineWebber Incorporated, CIBC World Markets Corp., Credit
Suisse First Boston Corporation, Dain Rauscher Wessels, a division of Dain
Rauscher Incorporated, Donaldson, Lufkin & Jenrette Securities Corporation, A.G.
Edwards & Sons, Inc., and McDonald Investments Inc. are acting as
representatives, have severally agreed to purchase from Eastern States, and
Eastern States has agreed to sell to each underwriter, the number of trust units
set forth opposite the name of such underwriter below:
<TABLE>
<CAPTION>
NUMBER OF
TRUST UNITS
UNDERWRITERS -----------
<S> <C>
Lehman Brothers Inc. .......................................
Salomon Smith Barney Inc. ..................................
PaineWebber Incorporated....................................
CIBC World Markets Corp. ...................................
Credit Suisse First Boston Corporation......................
Dain Rauscher Wessels.......................................
Donaldson, Lufkin & Jenrette Securities Corporation.........
A.G. Edwards & Sons, Inc. ..................................
McDonald Investments Inc. ..................................
--------
Total.............................................
========
</TABLE>
Eastern States has granted to the underwriters an option to purchase up to
an additional trust units, exercisable solely to cover
over-allotments, at the initial public offering price, less the underwriting
discounts and commissions shown on the cover page of this prospectus. Such
option may be exercised at any time until 30 days after the date of the
underwriting agreement. To the extent that the option is exercised, each
underwriter will be committed, subject to certain conditions, to purchase a
number of the additional trust units that is proportionate to such underwriter's
initial commitment as indicated on the preceding table.
The following table shows the per trust unit and total underwriting
discounts and commissions to be paid to the underwriters by Eastern States.
These amounts are shown assuming both no exercise and full exercise of the
underwriters' option to purchase additional units.
<TABLE>
<CAPTION>
PAID BY EASTERN STATES
---------------------------
NO EXERCISE FULL EXERCISE
----------- -------------
<S> <C> <C>
Per trust unit..............................................
Total.......................................................
</TABLE>
The underwriters propose to offer the trust units to the public at the
initial public offering price set forth on the cover page of this prospectus and
to certain dealers at such initial public offering price less a selling
concession not in excess of $ per trust unit. The underwriters may allow,
and such dealers may reallow, a concession not in excess of $ per trust unit
to certain other underwriters or to certain other brokers or dealers. After the
initial offering of the trust units to the public, the offering price and other
selling terms may from time to time be changed by the representatives.
The underwriting agreement provides that the obligations of the
underwriters to pay for and accept delivery of the trust units offered hereby
are subject to approval of certain legal matters by counsel and to certain other
conditions, including the condition that no stop order suspending the
effectiveness of the registration statement is in effect and no proceedings for
such purpose are pending or threatened by the SEC, and that there has been no
material adverse change or development involving a prospective material adverse
change in the condition of the trust or the underlying properties from that set
forth in the
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registration statement otherwise than as set forth or contemplated in this
prospectus, and that certain certificates, opinions and letters have been
received from Eastern States and its counsel. The underwriters are obligated to
take and pay for all trust units (other than those covered by the underwriters'
over-allotment option described below) if any such trust units are taken.
Eastern States and the trust have agreed in the underwriting agreement to
indemnify the underwriters against certain civil liabilities, including
liabilities under the Securities Act, and to contribute to payments that the
underwriters may be required to make in respect thereof. The trust's indemnity
obligations are limited to the assets of the trust, and neither the trustee nor
any unitholder will have any obligation to indemnify the underwriters.
Eastern States has agreed that they will not, without the prior written
consent of Lehman Brothers Inc., during the 180 days following the date of this
prospectus, (1) offer for sale, sell, pledge or otherwise dispose of (or enter
into any transaction or device which is designed to, or could be expected to,
result in the disposition by any person at any time in the future of) any trust
units or any securities that are convertible into, or exercisable or
exchangeable for, or that represent the right to receive, trust units, or (2)
enter into any swap or other derivatives transaction that transfers to another,
in whole or in part, any of the economic benefits or rights of ownership of such
trust units.
The underwriters have advised Eastern States that they do not intend to
confirm any sales to accounts over which they exercise discretionary authority.
Until the distribution of the trust units is completed, the rules of the
SEC may limit the ability of the underwriters and certain selling group members
to bid for and purchase trust units. As an exception to these rules, the
representatives are permitted to engage in certain transactions that stabilize
the price of the trust units. Such transactions may consist of bids or purchases
for the purpose of pegging, fixing or maintaining the price of the trust units.
In addition, if the representatives over-allot (i.e., if they sell more
trust units than are set forth on the cover page of this prospectus), and
thereby create a short position in the trust units in connection with the
offering, the representatives may reduce that short position by purchasing trust
units in the open market. The representatives may also elect to reduce any short
position by exercising all or part of the over-allotment option described
herein.
The representatives may also impose a penalty bid on certain underwriters
and selling group members. This means that if the representatives purchase trust
units in the open market to reduce the underwriters' short position or to
stabilize the price of the trust units, they may reclaim the amount of the
selling concession from the underwriters and selling group members who sold
those shares as part of the offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a syndicate short position could cause the price of the security to be
higher than it might otherwise be in the absence of such purchases. The
imposition of a penalty bid might have an effect on the price of a security to
the extent that it were to discourage resales of the security by purchasers in
the offering.
Neither Eastern States, the trust nor any of the underwriters makes any
representation or prediction as to the direction or magnitude of any effect that
the transactions described above may have on the price of the trust units. In
addition, neither Eastern States, the trust nor any of the underwriters makes
any representation that the representatives will engage in such transactions or
that such transactions, once commenced, will not be discontinued without notice.
Prior to the offering, there has been no public market for the trust units.
The initial public offering price was negotiated between Eastern States and the
representatives. The factors considered in determining the initial public
offering price of the trust units include prevailing market conditions,
estimates of distributions to trust unitholders and the overall quality of the
underlying properties. The initial public offering price set forth on the cover
page of this prospectus should not, however, be considered an indication of the
actual value of the trust units. Such price will be subject to change as a
result of market conditions and other factors. There can be no assurance that an
active trading market will develop for the
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trust units or that the trust units will trade in the public market subsequent
to the offering at or above the initial public offering price.
Eastern States estimates that the total expenses of the offering, other
than underwriting discounts and commissions, will be approximately $ .
The trust intends to apply to have the trust units listed on the NYSE under
the symbol " ."
Because it is expected that the National Association of Securities Dealers,
Inc. will view the trust units offered hereby as interests in a direct
participation program, the offering is being made in compliance with Rule 2810
of the NASD's Conduct Rules. Investor suitability with respect to the trust
units should be judged similarly to the suitability with respect to other
securities that are listed for trading on a national securities exchange.
SELLING TRUST UNITHOLDER
Eastern States currently owns 100% of the outstanding trust
units. It is offering trust units in this offering, or trust
units if the underwriters exercise their over-allotment option in full.
Eastern States may sell trust units, exchange them for oil and natural gas
properties or use them for other corporate purposes.
Prior to this offering there has been no public market for the trust units.
Eastern States cannot predict the effect on future market prices, if any, of
market sales of trust units or the availability of trust units for sale if it
disposes of its trust units. Nevertheless, sales of substantial amounts of trust
units in the public market could adversely affect prevailing market prices.
VALIDITY OF THE TRUST UNITS
Counsel for Eastern States and the trust, Andrews & Kurth L.L.P., Houston,
Texas will give the tax opinion described in the section of this prospectus
captioned "Federal Income Tax Consequences" and other matters. Richards, Layton
& Finger, PA will give a legal opinion as to the validity of the trust units.
Certain legal matters in connection with the trust units offered hereby will be
passed upon for the underwriters by Baker & Botts, L.L.P., Houston, Texas.
EXPERTS
Information appearing in this prospectus regarding the June 30, 1999
estimated quantities of reserves of the underlying properties and net profits
interests owned by the trust, the future net revenues from those reserves and
their present value is based on a review by Ryder Scott Company, L.P.,
independent petroleum engineers, of the estimates of the reserves and present
values prepared by or derived from estimates prepared by Eastern States.
Ernst & Young LLP, independent auditors, have audited the Statements of
Revenues and Direct Operating Expenses of the Underlying Properties of Eastern
States Oil and Gas, Inc. for each of the three years in the period ended
December 31, 1998, the Statement of Assets and Trust Corpus of Appalachian Basin
Royalty Trust as of August 19, 1999, the Consolidated Financial Statements of
Eastern States Oil and Gas, Inc. at December 31, 1998 and 1997, and for each of
the three years in the period ended December 31, 1998, and the Consolidated
Financial Statements of the domestic operations of Blazer Energy Corp. for the
year ended September 30, 1996, as set forth in their reports. We have included
these financial statements in the prospectus and elsewhere in the registration
statement in reliance on Ernst & Young LLP's reports, given on their authority
as experts in accounting and auditing.
64
<PAGE> 69
AVAILABLE INFORMATION
The trust and Eastern States have filed with the SEC in Washington, D.C. a
registration statement, including all amendments, under the Securities Act of
1933 relating to the trust units. As permitted by the rules and regulations of
the SEC, this prospectus does not contain all of the information contained in
the registration statement and the exhibits and schedules to the registration
statement. You may read and copy the registration statement or other information
at the SEC's public reference room at 450 Fifth Street, N.W., Washington, D.C.
20549. You may request copies of these documents, upon payment of a duplicating
fee, by writing to the SEC at the address in the previous sentence. To obtain
information on the operation of the public reference rooms you may call the SEC
at (800) SEC-0330. Eastern States' filings will also be available to the public
on the SEC Internet Web site at http://www.sec.gov.
Bank One, Texas, N.A. is the property trustee of the trust. The property
trustee's address is 500 Throckmorton, Suite 801, Fort Worth, Texas 76102,
Attention: Corporate Trust Department.
65
<PAGE> 70
GLOSSARY OF OIL AND NATURAL GAS TERMS
In this prospectus the following terms have the meanings specified below.
Bbl -- One stock tank barrel, or 42 US gallons liquid volume, of crude oil
or other liquid hydrocarbons.
Bcf -- One billion cubic feet of natural gas.
Bcfe -- One billion cubic feet of natural gas equivalent, computed on an
approximate energy equivalent basis that one Bbl equals six Mcf.
Btu -- A British Thermal Unit, a common unit of energy measurement.
Estimated Future Net Cash Flow -- The result of applying current prices of
oil and natural gas to estimated future production from oil and natural gas
proved reserves, reduced by estimated future expenditures, based on current
costs to be incurred, in developing and producing the proved reserves, excluding
overhead.
MBbl -- One thousand Bbl.
Mcf -- One thousand cubic feet of natural gas.
Mcfe -- One thousand cubic feet of natural gas equivalent, computed on an
approximate energy equivalent basis that one Bbl equals six Mcf.
MMbtu -- One million Btus.
MMcf -- One million cubic feet of natural gas.
MMcfe -- One million cubic feet of natural gas equivalent, computed on an
approximate energy equivalent basis that one Bbl equals six Mcf.
Natural Gas Revenue -- Includes revenue related to the sale of natural gas,
natural gas liquids and plant products.
Net Wells or Acres -- Determined by multiplying "gross" wells or acres by
the interest in such wells or acres represented by the underlying properties.
Net Profits Interest (also called a net overriding royalty interest) -- A
nonoperating interest that creates a share in gross production from an operating
or working interest in oil and gas properties. The share is measured by net
profits from the sale of production after deducting production and property
taxes, development and production costs and overhead.
NYMEX -- New York Mercantile Exchange, where futures and options contracts
for the oil and natural gas industry and some precious metals are traded.
Overriding Royalty Interest -- A royalty interest created or "carved" out
of a working or operating interest. Its term extends for the same term as the
working interest from which it is carved.
Proved Developed Reserves -- Proved reserves that can be expected to be
recovered through existing wells with existing equipment and operating methods.
Proved Reserves -- The estimated quantities of crude oil, natural gas and
natural gas liquids which, upon analysis of geological and engineering data,
appear with reasonable certainty to be recoverable in the future from known oil
and natural gas reservoirs under existing economic and operating conditions.
The Securities and Exchange Commission definition of proved oil and gas
reserves, per Article 4-10(a)(2) of Regulation S-X, is as follows:
Proved oil and gas reserves. Proved oil and gas reserves are the estimated
quantities of crude oil, natural gas, and natural gas liquids which geological
and engineering data demonstrate with reasonable certainty to be recoverable in
future years from known reservoirs under existing economic and operating
66
<PAGE> 71
conditions, i.e., prices and costs as of the date the estimate is made. Prices
include consideration of changes in existing prices provided only by contractual
arrangements, but not on escalations based upon future conditions.
(1) Reservoirs are considered proved if economic producibility is
supported by either actual production or conclusive formation test. The
area of a reservoir considered proved includes (A) that portion delineated
by drilling and defined by gas-oil and/or oil-water contacts, if any; and
(B) the immediately adjoining portions not yet drilled, but which can be
reasonably judged as economically productive on the basis of available
geological and engineering data. In the absence of information on fluid
contacts, the lowest known structural occurrence of hydrocarbons controls
the lower proved limit of the reservoir.
(2) Reserves which can be produced economically through application of
improved recovery techniques (such as fluid injection) are included in the
"proved" classification when successful testing by a pilot project, or the
operation of an installed program in the reservoir, provides support for
the engineering analysis on which the project or program was based.
(3) Estimates of proved reserves do not include the following: (A) oil
that may become available from known reservoirs but is classified
separately as "indicated additional reserves"; (B) crude oil, natural gas,
and natural gas liquids, the recovery of which is subject to reasonable
doubt because of uncertainty as to geology, reservoir characteristics, or
economic factors; (C) crude oil, natural gas, and natural gas liquids, that
may occur in undrilled prospects; and (D) crude oil, natural gas, and
natural gas liquids, that may be recovered from oil shales, coal, gilsonite
and other such sources.
Proved Undeveloped Reserves -- Proved reserves that are expected to be
recovered from new wells on undrilled acreage, or from existing wells where a
relatively major expenditure is required.
Reserve-to-Production Index -- An estimate, expressed in years, of the
total estimated proved reserves attributable to a producing property divided by
production from the property for the 12 months preceding the date as of which
the proved reserves were estimated.
Royalty Interest -- A real property interest entitling the owner to receive
a specified portion of the gross proceeds of the sale of oil and natural gas
production or, if the conveyance creating the interest provides, a specific
portion of oil and natural gas produced, without any deduction for the costs to
explore for, develop or produce the oil and natural gas. A royalty interest
owner has no right to consent to or approve the operation and development of the
property, while the owners of the working interest have the exclusive right to
exploit the mineral on the land.
Standardized Measure of Discounted Future Net Cash Flows -- Also referred
to herein as "standardized measure." It is the present value of estimated future
net revenues computed by discounting estimated future net revenues at a rate of
10% annually. The Financial Accounting Standards Board requires disclosure of
standardized measure of discounted future net cash flows relating to proved oil
and gas reserve quantities, per paragraph 30 of Statement of Financial
Accounting Standards No. 69, as follows:
A standardized measure of discounted future net cash flows relating to an
enterprise's interests in (a) proved oil and gas reserves and (b) oil and gas
subject to purchase under long-term supply, purchase, or similar agreements and
contracts in which the enterprise participates in the operation of the
properties on which the oil or gas is located or otherwise serves as the
producer of those reserves shall be disclosed as of the end of the year. The
standardized measure of discounted future net cash flows relating to those two
types of interests in reserves may be combined for reporting purposes. The
following information shall be disclosed in the aggregate and for each
geographic area for which reserve quantities are disclosed:
a.Future cash inflows. These shall be computed by applying year-end prices
of oil and gas relating to the enterprise's proved reserves to the
year-end quantities of those reserves. Future price
67
<PAGE> 72
changes shall be considered only to the extent provided by contractual
arrangements in existence at year-end.
b.Future development and production costs. These costs shall be computed by
estimating the expenditures to be incurred in developing and producing
the proved oil and gas reserves at the end of the year, based on year-end
costs and assuming continuation of existing economic conditions. If
estimated development expenditures are significant, they shall be
presented separately from estimated production costs.
c.Future income tax expenses. These expenses shall be computed by applying
the appropriate year-end statutory tax rates, with consideration of
future tax rates already legislated, to the future pretax net cash flows
relating to the enterprise's proved oil and gas reserves, less the tax
basis of the properties involved. The future income tax expenses shall
give effect to tax deductions, tax credits and allowances relating to the
enterprise's proved oil and gas reserves.
d.Future net cash flows. These amounts are the result of subtracting future
development and production costs and future income tax expenses from
future cash inflows.
e.Discount. This amount shall be derived from using a discount rate of 10
percent a year to reflect the timing of the future net cash flows
relating to proved oil and gas reserves.
f.Standardized measure of discounted future net cash flows. This amount is
the future net cash flows less the computed discount.
Working Interest (also called an operating interest) -- A real property
interest entitling the owner to receive a specified percentage of the proceeds
of the sale of oil and natural gas production or a percentage of the production,
but requiring the owner of the working interest to bear the cost to explore for,
develop and produce such oil and natural gas. A working interest owner who owns
a portion of the working interest may participate either as operator or by
voting his percentage interest to approve or disapprove the appointment of an
operator and certain activities in connection with the development and operation
of a property.
68
<PAGE> 73
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
UNDERLYING PROPERTIES
Report of Independent Auditors............................ F-2
Statements of Revenues and Direct Operating Expenses for
the Years Ended December 31, 1996, 1997 and 1998 and
for the Six Months Ended June 30, 1998, and 1999....... F-3
Notes to Statements of Revenues and Direct Operating
Expenses............................................... F-4
APPALACHIAN BASIN ROYALTY TRUST
Report of Independent Auditors............................ F-8
Statement of Assets and Trust Corpus as of August 19,
1999................................................... F-9
Note to Statement of Assets and Trust Corpus.............. F-10
Pro Forma Statement of Distributable Cash for the Year
Ended December 31, 1998 and for the Six Months Ended
June 30, 1999 (Unaudited).............................. F-11
Notes to Pro Forma Statement of Distributable Cash
(Unaudited)............................................ F-12
</TABLE>
F-1
<PAGE> 74
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholder
Eastern States Oil & Gas, Inc.
We have audited the accompanying statements of revenues and direct
operating expenses of the Underlying Properties of Eastern States Oil & Gas,
Inc. for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the statements referred to above present fairly, in all
material respects, the revenues and direct operating expenses of the Underlying
Properties for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Vienna, Virginia
August 23, 1999
F-2
<PAGE> 75
UNDERLYING PROPERTIES
STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
AND FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1999
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED JUNE 30,
-----------------
1996 1997 1998 1998 1999
------- ------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues
Gas sales.................................. $55,769 $53,192 $42,375 $23,220 $18,472
Oil sales.................................. 677 530 243 105 107
------- ------- ------- ------- -------
Total.............................. 56,446 53,722 42,618 23,325 18,579
------- ------- ------- ------- -------
Direct Operating Expenses
Production and property taxes.............. 5,501 5,179 4,049 2,205 1,763
Production expenses........................ 6,395 5,232 3,720 1,860 1,860
------- ------- ------- ------- -------
Total.............................. 11,896 10,411 7,769 4,065 3,623
------- ------- ------- ------- -------
Excess of Revenues over Direct Operating
Expenses................................ $44,550 $43,311 $34,849 $19,260 $14,956
======= ======= ======= ======= =======
</TABLE>
See accompanying Notes to Statements of Revenues and Direct Operating Expenses.
F-3
<PAGE> 76
UNDERLYING PROPERTIES
NOTES TO STATEMENTS OF REVENUES AND
DIRECT OPERATING EXPENSES
1. UNDERLYING PROPERTIES
The underlying properties (the "Underlying Properties") are predominantly
working interests in producing properties currently owned by Eastern States Oil
& Gas, Inc. (the "Company") in the Appalachian Basin in the states of West
Virginia and Kentucky. Effective October 1, 1999, the Company will convey an 80%
net profits interests in 2,562 producing wells in Kentucky and West Virginia and
a 10% net profits interest in certain undeveloped properties in Kentucky and
West Virginia (together, the "Net Profits Interests") to the Appalachian Basin
Royalty Trust (the "Trust"), excluding certain specified interests. Estimated
proved reserves attributable to the Underlying Properties are approximately 1%
oil and 99% natural gas, based on discounted present value of estimated future
net revenues as of June 30, 1999. See Note 5.
All of the Underlying Properties were acquired by the Company from 1994
through 1998. Significant property acquisitions were made by the Company during
the three-year period presented in the accompanying financial statements. The
accompanying statements include the historical revenues and direct operating
expenses from these acquired properties for all years presented.
2. BASIS OF PRESENTATION
The statements of revenues and direct operating expenses of the Underlying
Properties were derived from the historical accounting records of the Company
(and prior owners for acquisitions occurring during the three-year period
presented), and are presented on the accrual basis of accounting before the
effects of conveyance of the Net Profits Interests. The statements do not
include depreciation, depletion and amortization, general and administrative or
interest expenses.
Royalty income of the Trust is determined based on an 80% net profits
interest percentage of net proceeds of the underlying wells and a 10% net
profits interest percentage of underlying leases. The computation of net profits
interest includes deductions for development costs. For the periods presented,
development costs (in thousands) were $12,024 in 1996 and $22,445 in 1997, none
in 1998 and none for the six months ended June 30, 1999 since all wells drilled
in 1998 through June 30, 1999 have been excluded from the Underlying Properties.
In addition, the 1996 and 1997 development costs are only those incurred by
Eastern States and exclude development costs of Blazer Energy, Corp., which
owned a majority of the Underlying Properties prior to July 1, 1997, the
effective acquisition date by Eastern States. Since the Company owns greater
than 97% working interest in the properties, it did not charge an overhead fee
to the properties in 1996 through 1998, but the trust will be charged an
overhead fee in the computation of trust income. Accordingly, royalty income of
the Trust will be materially different from the excess of revenues over direct
operating expenses from the Underlying Properties.
3. RELATED PARTY TRANSACTIONS
The Company sells approximately 65% of its natural gas production from the
Underlying Properties to the Company's affiliated marketing company, Statoil
Energy Services, Inc., generally at amounts approximating monthly market prices.
Sales from the Underlying Properties to the Company's marketing affiliate
Statoil Energy Services, Inc. were as follows (in thousands): $7,896, $27,624,
$28,437, $14,449, and $12,551 for the years 1996, 1997, 1998 and the six months
ended June 30, 1998 and 1999, respectively.
4. CONTINGENCIES
The Company is involved in various legal actions and claims arising in the
normal course of business. Based upon its current assessment of the facts and
the law, management does not believe that the outcome of any such action or
claim will have a material adverse effect upon the value of the Underlying
Properties. However, these actions against the Company are subject to the
uncertainties inherent in any litigation.
F-4
<PAGE> 77
UNDERLYING PROPERTIES
NOTES TO STATEMENTS OF REVENUES AND
DIRECT OPERATING EXPENSES -- (CONTINUED)
5. SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED)
Proved oil and natural gas reserves of the Underlying Properties have been
estimated by the Company as of June 30, 1999, and have been reviewed by Ryder
Scott Company, L.P., independent petroleum engineers. Reserves for the years
ended December 31, 1998 and 1997 were internally prepared by the Company's
petroleum engineers. Since the Company does not have comparable reserve reports
for periods prior to December 31, 1997 due to its property acquisitions in 1996
and 1997, such estimates prior to December 31, 1997 have been internally
developed by the Company's petroleum engineers by adding back actual production
volumes to arrive at estimated reserve balances at December 31, 1995 and 1996.
As a result of this method, the following tables reflect no reserve estimate
revisions for periods prior to 1998. Drilling activities on these properties
during 1996 and 1997 have represented development of these proved reserves. The
reserve estimates provided for the Underlying Properties were calculated before
the effects of conveying the Net Profits Interests to the Trust. In accordance
with Statement of Financial Accounting Standards No. 69, estimates of future net
revenues from proved reserves have been prepared using year-end oil and natural
gas prices and current costs to produce and develop the proved reserves,
excluding overhead. The standardized measure of future net cash flows from oil
and natural gas reserves is calculated based on discounting such future net cash
flows at an annual rate of 10%. Year-end oil prices were $22.50 per barrel for
1996, $15.00 per barrel for 1997 and $9.00 per barrel for 1998. For the
six-month period ending June 30, 1999, oil prices were $15.00 per barrel.
Year-end weighted average natural gas prices were $3.68 per Mcf for 1996, $2.57
per Mcf for 1997 and $2.71 per Mcf for 1998. For the six-month period ending
June 30, 1999, the weighted average natural gas price was $2.38 per Mcf.
F-5
<PAGE> 78
UNDERLYING PROPERTIES
NOTES TO STATEMENTS OF REVENUES AND
DIRECT OPERATING EXPENSES -- (CONTINUED)
<TABLE>
<CAPTION>
PROVED RESERVES GAS (MMCF) OIL (MBBLS)
- --------------- ---------- -----------
<S> <C> <C>
Balance, December 31, 1995.................................. 673,368 338
Revisions................................................. -- --
Extensions, discoveries and other additions............... 6,094 --
Production................................................ (19,646) (35)
Balance, December 31, 1996.................................. 659,816 303
Revisions................................................. -- --
Extensions, discoveries and other additions............... 11,167 --
Production................................................ (20,326) (31)
Balance, December 31, 1997.................................. 650,657 272
Revisions................................................. 64,371 21
Extensions, discoveries and other additions............... -- --
Production................................................ (19,372) (21)
Balance, December 31, 1998.................................. 695,656 272
Revisions................................................. 50,976 11
Extensions, discoveries and other additions............... -- --
Production................................................ (9,185) (10)
Balance, June 30, 1999...................................... 737,447 273
</TABLE>
PROVED DEVELOPED RESERVES
<TABLE>
<CAPTION>
GAS (MMCF) OIL (MBBLS)
---------- -----------
<S> <C> <C>
December 31, 1995........................................... 367,315 338
December 31, 1996........................................... 353,763 303
December 31, 1997........................................... 344,604 272
December 31, 1998........................................... 351,436 272
June 30, 1999............................................... 338,469 273
</TABLE>
F-6
<PAGE> 79
UNDERLYING PROPERTIES
NOTES TO STATEMENTS OF REVENUES AND
DIRECT OPERATING EXPENSES -- (CONTINUED)
The standardized measure of future net cash flows is not intended to
represent the fair value of the Underlying Properties. Numerous uncertainties
are inherent in estimating volumes and values of proved reserves and in
projecting future production rates and timing of development expenditures. Such
reserve estimates are subject to change as additional information becomes
available. The reserves actually recovered and the timing of production may be
substantially different from the original estimates. Also, because natural gas
prices are influenced by seasonal demand, use of year-end prices, as required by
the Financial Accounting Standards Board, may not be representative in
estimating future revenues or reserve data.
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO PROVED
RESERVES
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS
------------------------------------- ENDED JUNE 30,
1996 1997 1998 1999
----------- ---------- ---------- --------------
<S> <C> <C> <C> <C>
Future cash inflows........................ $ 2,342,182 $1,684,041 $1,891,728 $1,783,363
Future costs:
Production............................... (365,261) (317,217) (326,534) (344,268)
Development.............................. (182,529) (172,966) (189,211) (256,428)
----------- ---------- ---------- ----------
Future net cash flows...................... 1,794,392 1,193,858 1,375,983 1,182,667
10% discount factor........................ (1,244,286) (827,857) (983,876) (878,241)
----------- ---------- ---------- ----------
Standardized measure of discounted future
net cash flows........................... $ 550,106 $ 366,001 $ 392,107 $ 304,426
=========== ========== ========== ==========
</TABLE>
CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS FROM PROVED
RESERVES
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS
------------------------------- ENDED JUNE 30,
1996 1997 1998 1999
-------- --------- -------- --------------
<S> <C> <C> <C> <C>
Standardized measure, beginning of period...... $372,323 $ 550,106 $366,001 $392,107
Revisions:
Prices and costs............................. 161,239 (229,046) 27,548 (53,145)
Quantity estimates........................... -- -- 41,412 25,584
Accretion of discount........................ 54,293 55,346 30,194 31,502
Production rates and other................... 5,607 26,771 (14,038) (5,861)
-------- --------- -------- --------
Net revisions............................. 221,139 (146,929) 85,116 (1,920)
Extensions, discoveries and other additions.... 6,869 7,190 -- --
Production..................................... (56,446) (53,723) (42,618) (18,545)
Development costs.............................. 6,221 9,357 (16,392) (67,216)
-------- --------- -------- --------
Net change................................ 177,783 (184,105) 26,106 87,681
-------- --------- -------- --------
Standardized measure, end of period............ $550,106 $ 366,001 $392,107 $304,426
======== ========= ======== ========
</TABLE>
F-7
<PAGE> 80
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholder
Eastern States Oil & Gas, Inc.
We have audited the accompanying statement of assets and trust corpus of
the Appalachian Basin Royalty Trust as of August 19, 1999. This financial
statement is the responsibility of the management of Eastern States Oil & Gas,
Inc. Our responsibility is to express an opinion on this financial statement
based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statement is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statement. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the statement referred to above presents fairly, in all
material respects, the assets and trust corpus of the Appalachian Basin Royalty
Trust as of August 19, 1999, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Vienna, Virginia
August 23, 1999
F-8
<PAGE> 81
APPALACHIAN BASIN ROYALTY TRUST
STATEMENT OF ASSETS AND TRUST CORPUS
AS OF AUGUST 19, 1999
<TABLE>
<S> <C>
Cash........................................................ $1,000
======
Trust Corpus................................................ $1,000
======
</TABLE>
See Accompanying Note to Statement of Assets and Trust Corpus.
F-9
<PAGE> 82
APPALACHIAN BASIN ROYALTY TRUST
NOTE TO STATEMENT OF ASSETS AND TRUST CORPUS
1. TRUST ORGANIZATION
Appalachian Basin Royalty Trust (the "Trust") is a grantor trust that was
created on August 18, 1999 by Eastern States Oil & Gas, Inc. (the "Company"), a
wholly owned subsidiary of Statoil Energy Holdings, Inc. The Statement of Assets
and Trust Corpus reflects the Company's initial cash contribution to the Trust
of $1,000.
The Trust was formed to hold net profits interests entitling it to 80% of
the net proceeds received by the Company from the sale of oil and natural gas
from 2,562 producing wells in Kentucky and West Virginia and 10% of the net
proceeds received by the Company from the sale of oil and natural gas in certain
undeveloped properties in Kentucky and West Virginia (the "Underlying
Properties"). These net profits interests will be conveyed to the Trust by the
Company upon completion of a successful public offering of beneficial interests
("Units") in the Trust.
The Trust will terminate upon the first occurrence of: (a) disposition of
all net profits interests pursuant to terms of the Trust Agreement, (b) when net
proceeds attributable to the Underlying Properties are less than $3.5 million
per year for each of two successive years after the year 2000 in the state of
West Virginia or less than $3.5 million per year for each of two successive
years after the year 2000 in the state of Kentucky, or (c) a vote of at least
66 2/3% of the Trust Unitholders to terminate the Trust in accordance with
provisions of the Trust Agreement. These termination clauses will be finalized
upon execution of the Trust Conveyance Agreement.
F-10
<PAGE> 83
APPALACHIAN BASIN ROYALTY TRUST
UNAUDITED PRO FORMA STATEMENT OF DISTRIBUTABLE CASH
FOR THE YEAR ENDED DECEMBER 31, 1998 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
1998 1999
------------ ----------------
<S> <C> <C>
Revenue:
Gas sales................................................. $42,375 $18,472
Oil sales................................................. 243 107
------- -------
Total revenues.................................... 42,618 18,579
------- -------
Direct Operating Expenses:
Taxes on production and property.......................... 4,049 1,763
Production expenses....................................... 3,720 1,860
------- -------
Total expenses.................................... 7,769 3,623
------- -------
Excess of Revenues over Direct Operating Expenses........... 34,849 14,956
------- -------
Pro Forma Adjustments (Note 2):
Revenue................................................... (2,317) (1,176)
Production expenses....................................... (923) (461)
Overhead.................................................. (1,934) (967)
------- -------
Total pro forma adjustments....................... (5,174) (2,604)
------- -------
Pro Forma Net Proceeds(1)................................... 29,675 12,352
Net Profits Interests Percentage............................ 80% 80%
------- -------
Trust Cash.................................................. 23,740 9,882
Less Trust General and Administrative Expenses.............. (300) (150)
------- -------
Distributable Cash.......................................... $23,440 $ 9,732
======= =======
</TABLE>
- ---------------
(1) There were no development costs for the period January 1, 1998 through June
30, 1999, since all wells drilled by the Company during that period were
excluded from the Underlying Properties. The Company expects to incur
development costs averaging approximately $4.4 million per year, net to the
Trust, for at least the next five years, which will reduce distributable
cash by a corresponding amount per Unit.
See Accompanying Notes to Pro Forma Statement of Distributable Cash.
F-11
<PAGE> 84
APPALACHIAN BASIN ROYALTY TRUST
NOTES TO PRO FORMA STATEMENT OF DISTRIBUTABLE CASH
(UNAUDITED)
1. BASIS OF PRESENTATION
Appalachian Basin Royalty Trust (the "Trust") was created in August 1999 by
Eastern States Oil & Gas, Inc. (the "Company"). The Company will convey certain
net profits interests (the "Net Profits Interests") from the Underlying
Properties to the Trust in exchange for all of the units of beneficial interest
in the Trust.
The pro forma statement of distributable cash of the Trust for the year
ended December 31, 1998 and six months ended June 30, 1999 has been prepared
from the historical statement of revenues and direct operating expenses of the
Underlying Properties, adjusted, and based on the following assumptions:
a.The Trust was formed and the Net Profits Interests were conveyed to the
Trust prior to January 1, 1998.
b.Distributable cash of the trust is calculated based on the gross proceeds
from the Underlying Wells. For the period presented there is no pro forma
distributable cash attributable to the 10% net profits interest since all
wells drilled by Eastern States during this time period are excluded from
the Underlying Properties. Net Proceeds is a defined term in the Net
Profits Interests conveyances to the Trust.
c.Administrative expense is estimated to be $300,000 annually. Such expense
generally would include Trustee fees and costs incurred by the Trustee to
administer the Trust and report Trust results to Unitholders, including
the expense of attorneys, independent auditors, reservoir engineers,
printing and mailing.
2. PRO FORMA ADJUSTMENTS
The following pro forma adjustments were made to the historical revenues
and direct operating expenses of the Underlying Properties to present Trust pro
forma distributable cash for the year ended December 31, 1998 and six months
ending June 30, 1999:
a.The Net Profits Interest conveyances to the Trust provide for the Company
to receive gathering and compression fees which cover actual costs
incurred plus depreciation and to provide a return on invested capital.
The adjustment to record depreciation and return on invested capital is
reflected as a reduction to revenue in the pro forma statement.
b.The conveyances to the Trust will provide for the Company to charge
production expenses at fixed rates, subject to adjustment, which exceed
actual costs incurred by the Company. Such additional charges are shown
as an increase in production expenses in the pro forma statement.
c.A Company overhead charge of $1,934,000 and $967,000 for the year ended
December 31, 1998 and six months ended June 30, 1999, respectively, were
deducted. The overhead charge is based on a monthly count of active wells
operated by the Company and is specified by the terms of the Net Profits
Interests conveyances to the Trust.
3. FEDERAL INCOME TAXES
As a grantor trust, the Trust will not be required to pay federal income
taxes. Accordingly, the accompanying pro forma statement of distributable income
does not include a provision for federal income taxes.
F-12
<PAGE> 85
APPALACHIAN BASIN ROYALTY TRUST
NOTES TO PRO FORMA STATEMENT OF DISTRIBUTABLE CASH -- (CONTINUED)
4. CONTINGENCIES
The Company is involved in various legal actions and claims arising in the
normal course of business. Based upon its current assessment of the facts and
the law, management does not believe that the outcome of any such action or
claim will have a material adverse effect upon the value of the underlying
properties. However, these actions against the Company are subject to the
uncertainties inherent in any litigation.
5. PRO FORMA SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION
Proved oil and natural gas reserves of the Trust have been estimated by the
Company as of June 30, 1999, and have been reviewed by Ryder Scott Company,
L.P., independent petroleum engineers. In accordance with Statement of Financial
Accounting Standards No. 69, estimates of future net revenues from proved
reserves have been prepared using year-end oil and natural gas prices and
current costs to produce and develop the proved reserves. The standardized
measure of future net cash flows from oil and natural gas reserves is calculated
based on discounting such future net cash flows at an annual rate of 10%. Crude
oil prices were $15.00 per barrel at June 30, 1999. The weighted average spot
gas price was $2.24 per Mcf at June 30, 1999. Since the Trust is not subject to
taxation at the trust level, no provision is included for federal income taxes.
Reserve quantities and revenues for the Net Profits Interests were
estimated from projections of reserves and revenues attributable to the
Underlying Properties. Since the Trust has a defined Net Profits Interest, the
Trust does not own a specific ownership percentage of the oil and natural gas
reserves or production quantities. Accordingly, reserves and production
allocated to the Trust pertaining to its interests in 80% of the net cash
proceeds from the underlying wells and 10% of the net cash proceeds from the
undeveloped properties have effectively been reduced to reflect recovery of the
Trust's 80% and 10% portion, respectively, of applicable production and
development costs, excluding overhead and trust administrative expenses. Because
Trust reserve quantities are determined using an allocation formula, any
fluctuations in actual or assumed prices or costs will result in revisions to
the estimated reserve quantities allocated to the Net Profits Interests.
The Net Profits Interests' share of production and development costs have
been deducted in calculating distributable cash attributable to the Net Profits
Interests. Accordingly, these costs are not shown separately as future costs in
calculating the standardized measure. Only production taxes, calculated at the
same rate as incurred on the Underlying Properties, is included in future
production costs in calculating the standardized measure.
The standardized measure of future net cash flows is not intended to
represent the fair value of the Trust. Numerous uncertainties are inherent in
estimating volumes and values of proved reserves and in projecting future
production rates and timing of development expenditures. Such reserve estimates
are subject to change as additional information becomes available. The reserves
actually recovered and the timing of production may be substantially different
from the original estimates. Also, because natural gas prices are influenced by
seasonal demand, use of year-end prices, as required by the Financial Accounting
Standards Board, may not be representative in estimating future revenues or
reserve data.
<TABLE>
<CAPTION>
NATURAL GAS (MCF) OIL (BBLS)
----------------- ----------
(IN THOUSANDS)
<S> <C> <C>
PROVED RESERVES
Balance, June 30, 1999...................................... 234,016 170
PROVED DEVELOPED RESERVES
June 30, 1999............................................... 211,266 170
</TABLE>
F-13
<PAGE> 86
APPALACHIAN BASIN ROYALTY TRUST
NOTES TO PRO FORMA STATEMENT OF DISTRIBUTABLE CASH -- (CONTINUED)
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
RELATING TO PROVED RESERVES AT JUNE 30, 1999
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
Future cash inflows......................................... $ 528,113
Future production taxes and development..................... (56,042)
---------
Future net cash flows....................................... 472,071
10% discount factor......................................... (303,905)
---------
Standardized measure of discounted future net cash flows.... $ 168,166
=========
</TABLE>
F-14
<PAGE> 87
APPENDIX A
INFORMATION ABOUT
EASTERN STATES OIL & GAS, INC.
THE TRUST UNITS ARE NOT INTERESTS IN OR OBLIGATIONS OF
EASTERN STATES OIL & GAS, INC.
<PAGE> 88
EASTERN STATES OIL & GAS, INC.
Eastern States Oil & Gas, Inc. is an independent energy company engaged in
the development, production, acquisition, marketing, gathering and
transportation of natural gas and oil in the Appalachian Basin. We are the
largest owner of proved natural gas reserves in the Appalachian Basin.
Substantially all of our natural gas and oil reserves are located in Kentucky,
Ohio and West Virginia. We also have properties in Indiana, Maryland, Michigan
and Virginia. In this appendix, "Eastern States" or "we" refers to Eastern
States Oil & Gas, Inc. and its subsidiary, Eastern Seven, LLC, on a consolidated
basis.
Over the last five years, Eastern States has grown through developmental
drilling and acquisitions of natural gas and oil producing properties. During
this period, we spent approximately $658 million on 18 acquisitions, including
the acquisition of Blazer Energy Corp., formerly Ashland Exploration, Inc., in
July 1997. The acquisition of Blazer Energy increased our estimated proved
reserves in the Appalachian Basin by approximately 769 Bcfe. Eastern States and
Blazer have since combined their assets in the Appalachian Basin.
For the years ended December 31, 1996, 1997 and 1998, Eastern States had
total revenues of approximately $18.2 million, $65.4 million and $104.7 million,
and for the first six months of 1999, we had total revenues of approximately
$57.7 million. For the years ended December 31, 1996, 1997 and 1998, Eastern
States had net income of approximately $3.9 million, $9.2 million and $8.3
million, and for the first six months of 1999, we had net income of
approximately $6.0 million.
Eastern States currently owns and operates over 5,700 gross wells in the
Appalachian Basin. At December 31, 1998, Eastern States' estimated net proved
reserves were 1,062 Bcfe, of which 709 Bcfe, or 67%, were proved developed. The
estimated discounted future net cash flows of Eastern States' proved reserves,
before United States income taxes were $675 million as of December 31, 1998. For
the six months ended June 30, 1999, total average net sales meter natural gas
and oil production was 104 MMcfe per day, of which 98% was natural gas.
Eastern States is an indirect wholly owned subsidiary of Statoil Energy,
Inc. Statoil Energy also:
- through its indirect wholly owned subsidiary, Eastern States Exploration
Company, owns and operates approximately 600 wells in Pennsylvania, with
estimated net proved reserves of 39 Bcfe at December 31, 1998 and an
average daily net sales meter production of 6 MMcfe for the six months
ended June 30, 1999 (Eastern States does not own any interest in Eastern
States Exploration Company);
- owns and operates power plants throughout the northeast and the
mid-Atlantic region;
- is a leading trader of wholesale electricity and natural gas; and
- specializes in providing a broad range of energy and risk management
services involving the delivery of natural gas, electricity and
alternative fuels to large industrial, institutional and commercial
customers.
For the years ended December 31, 1996, 1997 and 1998 and the six months
ended June 30, 1999, Statoil Energy had revenue of approximately $0.6 billion,
$1.4 billion, $3.6 billion and $1.3 billion. For the years ended December 31,
1996, 1997 and 1998 and the six months ended June 30, 1999, Statoil Energy had
net income (loss) of approximately $5.9 million, $9.0 million, ($7.6) million
and $8.5 million.
Statoil Energy is an indirect wholly owned U.S. subsidiary of the Norwegian
state oil company "den norske stats oljeselskap a.s" which is also known as The
Statoil Group. The Statoil Group is one of the largest integrated energy
companies in the world, with $14 billion of revenue and $36 million of net
income for the year ended December 31, 1998. As of December 31, 1998, The
Statoil Group had over $18 billion in assets.
A-1
<PAGE> 89
The Statoil Group is currently seeking a strategic partner to jointly
pursue the U.S. energy market. As currently contemplated, the assets and
businesses of Statoil Energy would be combined with the complementary assets and
business activities of a strategic partner. This combined enterprise, if
completed, will pursue business opportunities in the unregulated sector of the
U.S. energy market. We cannot assure you that such a strategic partnership will
be completed, or, if completed, that it will be successful.
BY PURCHASING TRUST UNITS YOU WILL NOT ACQUIRE AN OWNERSHIP INTEREST IN ANY
OF EASTERN STATES, STATOIL ENERGY OR THE STATOIL GROUP.
Eastern States is a Delaware corporation. Its principal executive offices
are located at 2800 Eisenhower Avenue, Alexandria, Virginia 22314 and the
telephone number is (703) 317-2300.
RISK FACTORS APPLICABLE TO EASTERN STATES
NATURAL GAS PRICE DECLINES AND MARKET VOLATILITY COULD ADVERSELY AFFECT OUR
FINANCIAL RESULTS.
Even relatively modest changes in natural gas prices may significantly
change our revenues, results of operations, cash flows and value of proved
reserves. The markets for natural gas have been volatile and are likely to
continue to be volatile in the future. Prices for natural gas can fluctuate
widely in response to relatively minor changes in the supply of and demand for
natural gas, market uncertainty and a variety of additional factors that are
beyond our control, such as:
- weather conditions (primarily in the northeast United States);
- the supply and price of domestic and foreign natural gas and oil;
- delivery interruptions by upstream pipeline companies;
- the level of demand;
- worldwide economic conditions;
- the price and availability of alternative fuels;
- environmental regulations; and
- worldwide energy conservation measures.
Moreover, government regulations, such as regulation of natural gas
transportation or price controls, if imposed, could affect product prices in the
long term.
Natural gas produced in the Appalachian Basin has historically received a
premium over natural gas produced in other regions because of the region's close
proximity to the markets located in the northeastern United States. For the
eight-year period from 1991 through 1998, the Appalachian Basin premium has
ranged from $0.14 per MMbtu to $0.47 per MMbtu, with an average premium of $0.25
per MMbtu. Any material decrease in this average premium could have an adverse
impact on the proceeds received from the sale of natural gas by Eastern States.
WE MAY NOT BE ABLE TO OBTAIN ADEQUATE FINANCING TO EXECUTE OUR OPERATING
STRATEGY.
Our business is capital intensive and, to maintain our base of proved gas
reserves, a significant amount of cash flow from operations must be invested in
development activities. We make substantial capital expenditures for the
development, acquisition and production of natural gas reserves. Historically,
we have financed these expenditures primarily from the following sources:
- cash generated by operations;
- bank borrowings; and
- loans and capital contributions from The Statoil Group.
A-2
<PAGE> 90
Our management believes that we will have sufficient cash generated from
operations to fund planned capital expenditures through at least the year 2000.
If our revenues significantly decrease as a result of lower natural gas prices,
operating difficulties or declines in reserves, we may not be able to expend the
capital necessary to undertake or complete future development programs or
acquisition opportunities. Without these timely investments, our gas production
and reserves will decline. We cannot assure you that The Statoil Group will
continue to fund the excess of our future capital expenditures over the cash
generated from our operations. In addition, we cannot predict the impact, if
any, of The Statoil Group's search for a U.S. partner or its or the new entity's
ability to fund any portion of our future capital expenditures, including funds
required for acquisitions.
LEVERAGE MATERIALLY AFFECTS OUR OPERATIONS.
Our outstanding indebtedness under the promissory note with Statoil Energy
Holdings, Inc., an indirect subsidiary of the Statoil Group, was $505.5 million
at July 31, 1999 and matures on December 31, 2001. Our intercompany indebtedness
with affiliates of Statoil Energy at July 31, 1999 was approximately $45
million. Our ability to meet our debt service obligations and reduce our total
indebtedness will depend on our future performance. Our future performance, in
turn, depends on many factors that are beyond our control such as general
economic, financial and business conditions. We cannot assure you that economic
conditions and financial, business and other factors will not adversely affect
our future performance.
ESTIMATES OF NATURAL GAS RESERVES ARE UNCERTAIN.
The calculations of proved reserves of natural gas and oil included in this
document are only estimates. These estimates were prepared by Eastern States and
reviewed by Ryder Scott Company, L.P., independent petroleum engineers. The
accuracy of any reserve estimate is a function of the quality of available data
and engineering and geological interpretation and judgment and the assumptions
used regarding quantities of recoverable natural gas and oil reserves and prices
for crude oil, natural gas liquids and natural gas. Actual prices, production,
development expenditures, operating expenses and quantities of recoverable oil
and natural gas reserves will vary from those we assume in our estimates, and
those variances may be significant. Any significant variance from the
assumptions used could result in the actual quantity of our reserves and future
net cash flow being materially different from the estimates in our reserve
reports. In addition, results of drilling, testing and production and changes in
crude oil, natural gas liquids and natural gas prices after the date of the
estimate may result in substantial upward or downward revisions.
WE MAY NOT BE ABLE TO REPLACE PRODUCTION WITH NEW RESERVES.
Without successful exploration, development or acquisition activities, our
reserves and revenues will decline over time. The continuing development of
reserves, acquisition activities and, to a lesser extent, exploration, will
require significant expenditures. If our cash flow from operations is not
sufficient for this purpose, we may not be able to obtain the necessary funds
from other sources.
WE MAY NOT BE SUCCESSFUL IN DRILLING NEW WELLS.
We currently anticipate drilling an average of approximately 200 to 250 new
wells per year in Kentucky and West Virginia for at least the next five years.
We cannot assure you that any of the new wells will be successful or produce in
commercial quantities or that we will be able to drill approximately 200 to 250
wells per year.
FACILITIES MAINTENANCE ON THIRD PARTY PIPELINE DELIVERY SYSTEMS COULD CREATE
INTERRUPTIONS IN THE DELIVERY OF NATURAL GAS WE PRODUCE.
We depend on the availability of third party pipeline delivery systems to
transport our natural gas. Any extraordinary interruptions in the availability
of these systems due to maintenance requirements or other events could inhibit
our ability to sell our natural gas. For example, Columbia Transmission Corp.
A-3
<PAGE> 91
has announced that it will shut down one of its pipelines in Kentucky in
September and October 1999 for maintenance. This temporary shut-down will delay
the delivery and sale of approximately 30% of Eastern States' natural gas
production in Kentucky.
WE MAY NOT INSURE AGAINST ALL HAZARD LOSSES.
We insure against some, but not all, of the hazards associated with our
business. We believe this is standard practice in our industry. This practice,
however, may subject us to liability or losses that could be substantial due to
events that we do not insure.
HEDGING TRANSACTIONS MAY LIMIT OUR POTENTIAL GAINS.
In order to manage our exposure to price risks in the marketing of our gas,
we enter into hedging arrangements relating to a portion of our expected
production. In the past these hedges have involved a number of arrangements at a
variety of fixed prices and other provisions, including price floors and
ceilings. In the future, we may enter into natural gas futures contracts,
options, collars and swaps. Our hedging activities are subject to a number of
risks, including instances in which:
- production is less than expected;
- there is a widening of price differentials between delivery points
required by fixed price delivery contracts to the extent they differ from
those on our production; or
- counterparties to our futures contract are unable to meet the financial
terms of the transaction.
While the use of hedging arrangements limits the risk of declines in
natural gas prices, it may also limit the extent to which we benefit from
increases in the price of natural gas.
WE MAY INCUR SUBSTANTIAL COSTS TO COMPLY WITH ENVIRONMENTAL AND OTHER
GOVERNMENTAL REGULATIONS.
Environmental and other governmental regulations have increased the costs
to plan, design, drill, install, operate and abandon oil and natural gas wells
and other facilities. Increasingly strict environmental laws, regulations and
enforcement policies thereunder, and claims for damages to property, employees,
other persons and the environment resulting from our operations, could result in
substantial costs and liabilities in the future.
FORWARD-LOOKING STATEMENTS
Certain information included in this appendix contains forward-looking
statements relating to our operations and the oil and gas industry. Such
forward-looking statements are based on management's current projections and
estimates and are identified by words such as "expects," "intends," "plans,"
"projects," "anticipates," "believes," "estimates" and similar words. These
statements are not guarantees of future performance and involve certain risks,
uncertainties and assumptions that are difficult to predict. Therefore, actual
results may differ materially from what is expressed or forecasted in such
forward-looking statements.
Among the factors that could cause actual results to differ materially are:
- natural gas and oil price fluctuations;
- the availability of funds for our future development programs and
acquisitions;
- the results of our development program;
- potential delays or failure to achieve expected production from existing
and future exploitation and development projects;
- potential disruption of operations because of our failure or the failure
of others with whom we have material relationships to achieve timely Year
2000 compliance; and
- potential liability resulting from pending or future litigation.
A-4
<PAGE> 92
In addition, these forward-looking statements may be affected by general
domestic and international economic and political conditions.
BUSINESS AND PROPERTIES
HISTORICAL DEVELOPMENT OF OUR BUSINESS
Eastern States was organized in April 1994 to engage in the acquisition,
exploration and development of natural gas, oil and other mineral interests.
Eastern States has developed a significant reserve base, primarily through:
- acquisitions of proved natural gas and oil reserves and undeveloped
leaseholds;
- strategic acquisitions of other companies engaged in the development and
production of natural gas and oil; and
- development and exploitation of these leaseholds and acquired properties
through drilling, recompletions of existing wells and construction of
pipelines and compression projects.
Our estimated net proved reserves increased from 38 Bcfe at December 31,
1994 to 1,062 Bcfe at December 31, 1998. Our average daily production increased
from 2 MMcfe per day at December 31, 1994 to over 100 MMcfe per day at December
31, 1998. Our acquisitions have added a total of approximately 900 Bcfe to our
reserve base. Additionally, we have expended a total of $81 million to drill 418
net wells during the last five years, developing approximately 114 Bcfe of net
proved developed reserves. Approximately 97% of our wells drilled during this
five-year period were completed as producing wells. The direct finding costs for
our drilling program averaged $0.71 per Mcfe during the same period.
Acquisitions. Since our formation, we have made a series of acquisitions of
natural gas and oil producing properties, including the following:
- In August 1994, we acquired natural gas and oil properties, including
gathering lines, in West Virginia and Kentucky from Southeastern Gas
Company for approximately $17 million in cash.
- In April 1996, we acquired natural gas and oil properties, including
gathering lines, in West Virginia from CNG Transmission Company for
approximately $16 million in cash.
- In May 1996, we acquired natural gas and oil properties, including
gathering lines, in Ohio from General Motors Corporation for
approximately $34 million in cash.
- In July 1997, we acquired Blazer Energy for approximately $567.1 million
in cash. Immediately thereafter, we sold Blazer Energy's Gulf of Mexico
properties to our affiliate Statoil Exploration U.S., Inc., an indirect
wholly owned subsidiary of The Statoil Group, for approximately $82
million. In 1998, we sold a portion of Blazer Energy's proved developed
reserves, along with undeveloped acreage, located outside the Appalachian
Basin to an unaffiliated third party for approximately $24 million.
For additional information regarding Eastern States' acquisitions, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" beginning on page A-24.
Appalachian Basin Royalty Trust. In August 1999, Eastern States formed the
Appalachian Basin Royalty Trust, which will hold net profits interests in the
Appalachian Basin area of Kentucky and West Virginia. The net profits interests
will entitle the trust to receive:
- 80% of the net proceeds received by Eastern States from the sale of
natural gas from 2,562 producing wells owned by Eastern States in
Kentucky and West Virginia; and
A-5
<PAGE> 93
- 10% of the net proceeds received by Eastern States from the sale of
natural gas from all wells drilled after October 1, 1999 in the leases in
Kentucky and West Virginia that are subject to the net profits interests.
The net profits interests to be contributed to the trust contain
approximately 235 Bcfe of proved reserves.
Eastern States will receive all of the net cash proceeds from the sale of
trust units in an underwritten public offering, which proceeds are currently
estimated to be $ million before expenses of the offering. We intend to use
the net proceeds of the offering to repay a portion of the existing indebtedness
to Statoil Energy Holdings.
OUR BUSINESS STRATEGY
Our business strategy is to increase cash flow by increasing both our
reserves and production through:
- the development and exploitation of existing properties; and
- the selective acquisition of additional properties with development and
exploitation potential.
Enhancing Our Appalachian Basin Position
We are continuing to develop our large leasehold position in the
Appalachian Basin, where we own approximately 1.4 million gross acres and 1,158
proved undeveloped drilling locations at December 31, 1998. We currently expect
to drill 200 to 250 wells per year for at least the next five years, which is
expected to require approximately $44 million to $55 million per year in capital
spending. Our level of capital expenditures may vary in the future depending on
a number of factors, including energy market conditions and other related
economic factors.
Pursuing Growth Through Targeted Acquisitions
We are continually evaluating opportunities to acquire producing and
undeveloped properties that possess, among others, one or more of the following
characteristics:
- close proximity to our existing operations;
- potential opportunities to increase reserves through production
enhancement of existing reserves and the discovery of reserves on
undeveloped properties; and
- potential opportunities to reduce production expenses through more
efficient operations.
Our multi-disciplined due diligence teams have evaluated approximately 100
acquisition opportunities during the past five years. These same teams have also
been directly involved in the assimilation, exploration and development of
acquired properties. We believe this continuity and focus as well as our
established operating presence will enhance our competitive ability to complete
future acquisitions.
PROPERTIES AND DEVELOPMENT ACTIVITIES
At December 31, 1998, we estimated our total estimated net proved reserves
at 1,062 Bcfe. Estimated net proved developed reserves were 709 Bcfe,
representing 67% of our total net proved reserves. Except for one producing well
located in the Michigan Basin, all of our estimated net proved reserves are
located in the Appalachian Basin. All information in this appendix relating to
estimated natural gas and oil reserves and the estimated future net cash flows
before taxes attributable to those reserves is based on estimates prepared by us
that have been reviewed by Ryder Scott Company, L.P., independent petroleum
engineers. Under a review report, the independent petroleum engineers review
estimates prepared by a company's engineering staff. The following table
summarizes our estimated net proved reserves as of December 31,
A-6
<PAGE> 94
1998, in each state in which we own proved reserves, based on the standardized
measure before United States income taxes.
<TABLE>
<CAPTION>
DECEMBER 31, 1998 PROVED RESERVES
------------------------------------------------------------------
NATURAL % OF TOTAL
GAS TOTAL STANDARDIZED STANDARDIZED
STATE (MMCF) OIL (MBBLS) (MMCFE) MEASURE(1)(2) MEASURE
- ----- --------- ----------- --------- ------------- ------------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
West Virginia.................... 583,037 345 585,112 $364 54%
Kentucky......................... 394,812 62 395,184 258 38%
Ohio............................. 57,933 1,585 67,440 41 6%
Other(3)......................... 13,932 12 14,002 12 2%
--------- ----- --------- ---- ---
Total.................. 1,049,714 2,004 1,061,738 $675 100%
</TABLE>
- ---------------
(1) Standardized measure before United States income taxes as of December 31,
1998.
(2) Does not include the value of Section 29 tax credits attributable to certain
Devonian Shale and tight sands natural gas properties and future plugging
and abandonment liabilities. See "-- Section 29 Tax Credits."
(3) Includes proved reserves located in Maryland, Michigan and Virginia.
At December 31, 1998, we had identified 1,158 additional proved undeveloped
drilling locations, many of which will be drilled as part of our planned
drilling programs over the next five years. For the period January 1, 1998 to
June 30, 1999, approximately 40% of all wells drilled by Eastern States were on
locations classified as unproved at the time of drilling. Our total net gas
production from the Appalachian Basin in 1998 averaged approximately 100 MMcf
per day, with minimal associated oil or water production. We have an average
working interest of 94% (84% average net revenue interest) in our wells in the
Appalachian region.
Natural gas produced in the Appalachian Basin has historically received a
premium over natural gas produced in other regions due to the region's close
proximity to the major gas consuming markets in the northeastern United States.
For the period 1991 through 1998, wellhead natural gas prices in the Appalachian
Basin have averaged on an annual basis $0.25 per MMbtu more than the Henry Hub
and NYMEX wellhead natural gas prices. During these eight years, the average
annual Appalachian Basin premium has ranged from $0.14 per MMbtu to $0.47 per
MMbtu. In addition, natural gas produced by Eastern States also typically
receives an "energy content" premium since it contains an average of 1,116 Btu
per cubic foot as compared to NYMEX prices which are quoted based on 1,000 Btu
per cubic foot.
Eastern States will convey to the trust, effective October 1, 1999, an 80%
net profits interest in 2,562 producing natural gas wells in Kentucky and West
Virginia and a 10% net profits interest in substantially all of its current oil
and gas leasehold interests in Kentucky and West Virginia, containing an
estimated 235 Bcfe. Eastern States will retain the rights to the Rome
exploration area in Kentucky and West Virginia, leases farmed out to third
parties and leases with known conveyance or title issues, including all
potential coalbed methane exploration and development rights. Eastern States
also will retain Section 29 credit wells, wells drilled during the 21 months
ended September 30, 1999, Rome wells, wells with title issues, wells with high
operating costs, marginal producing wells, and non-operated wells.
The Appalachian Basin is the oldest and geographically one of the largest
natural gas producing regions in the United States. We operate over 5,700 gross
(5,400 net) wells, 3,500 miles of gathering pipelines and 104 compressor
stations in 47 counties in five states in the region. Our wells in the
Appalachian Basin produce from geologic formations that are Pennsylvanian to
Cambrian in age. Our wells range from 1,000 to 8,000 feet, with an average depth
of approximately 5,000 feet. Individual wells often have economic lives of up to
50 years. The costs to develop Appalachian Basin reserves are low compared to
other regions of the United States because of the relatively shallow reservoir
depths and the low incidence of dry holes. Over the past five calendar years, we
have drilled 418 net wells in the Appalachian region, with a 97% completion
rate.
Our wells in the Appalachian Basin are characterized by a relatively high
reserve-to-production ratio of over 27 years and a low natural production
decline rate averaging 7% to 8% for the first five years.
A-7
<PAGE> 95
Reserves in the Appalachian Basin have a high degree of development success,
that is, as development progresses reserves are reclassified from the unproved
to the proved category and additional layers of offset reserves are added as
proved undeveloped reserves.
We believe that we realize operational efficiencies and therefore are able
to maximize the return on our investment in the Appalachian Basin because of:
- our large acreage position;
- our substantial ongoing development program conducted over a number of
years and the experience and expertise gained from these activities; and
- our extensive gas gathering system.
Our Appalachian gas gathering system is interconnected with various
intrastate and interstate transmission lines that allow access to both local and
major markets in the northeastern United States. Some of our Appalachian natural
gas production is connected directly to end users through our pipelines. We have
acquired and are continuing to seek acquisitions of gathering facilities from
transmission companies to allow for direct connection to transmission pipelines.
Our gas gathering system is also used to carry third party natural gas to market
through purchase/resale or transport arrangements.
The principal Appalachian Basin properties are as follows:
Pikeville Area, Kentucky
The Pikeville Area includes approximately 37% of Eastern States' total net
proved reserves. Eastern States' interests in this area are concentrated in
Pike, Knott, Floyd, Breathitt, Morgan, Elliott and Carter counties, Kentucky on
approximately 355,000 gross acres, which includes the Rome area. We produce
natural gas predominantly from the Maxton, Big Lime and Berea and Devonian Shale
formations at depths ranging from 1,000 to 8,000 feet. Sales meter production
attributable to Eastern States' net interest averaged 32 MMcfe per day during
the first two quarters of 1999. Eastern States drilled 46 gross development
wells and three gross exploratory wells in this area during fiscal 1998 with 45
of the development wells and one of the exploratory wells currently producing at
a combined rate of approximately 4.0 MMcf per day. In the six month period ended
June 30, 1999, Eastern States drilled and completed 24 wells. We had 461 proved
undeveloped locations identified for drilling as of December 31, 1998.
Brenton Area, West Virginia
The Brenton Area includes approximately 30% of Eastern States' total net
proved reserves. Eastern States' interests are located mainly in Logan, Mingo,
McDowell and Wyoming counties in southern West Virginia on approximately 397,000
gross acres. We produce natural gas predominantly from the Ravencliff, Maxton,
Big Lime and Berea and Devonian Shale formations at depths ranging from 2,000 to
7,000 feet. Sales meter production attributable to Eastern States' net interest
averaged 28 MMcfe per day for the first two quarters of 1999. Eastern States
drilled and completed 57 gross wells in the area during 1998, which are
currently producing at a combined rate of approximately 6.5 MMcf per day. In the
six month period ended June 30, 1999, Eastern States drilled and completed 18
wells. We had 429 proved undeveloped locations identified for drilling as of
December 31, 1998.
Madison Area, Eastern West Virginia
The Madison Area includes approximately 17% of Eastern States' total net
proved reserves. Eastern States' interests are located in Lincoln, Kanawha,
Boone, Raleigh, Fayette, Nicholas and Clay counties in South-Central West
Virginia on approximately 374,000 gross acres. We produce natural gas
predominantly from the Maxton, Big Lime, Big Injun, Weir, Berea and Devonian
Shale formations at depths ranging from 1,700 to 6,000 feet. Sales meter
production attributable to Eastern States' net interest averaged 18 MMcfe per
day for the first two quarters of 1999. Eastern States drilled and completed 50
gross wells during 1998, all of which are currently producing at a combined rate
of approximately 4.3 MMcf per
A-8
<PAGE> 96
day. In the six month period ended June 30, 1999, Eastern States drilled and
completed 21 wells. We had 208 proved undeveloped locations identified for
drilling as of December 31, 1998.
Weston Area, West Virginia
The Weston Area includes approximately 9% of Eastern States' total net
proved reserves. Eastern States' interests are located largely in Jackson,
Gilmer, Doddridge, Roane, Calhoun, Harrison and Wetzel counties in northern West
Virginia on approximately 192,000 gross acres. We produce natural gas from Upper
Devonian sandstone formations at depths ranging from 1,800 to 5,000 feet. Sales
meter production attributable to our net interest averaged 15 MMcfe per day for
the first two quarters of 1999. We drilled and completed 11 gross wells during
1998, all of which are producing at a combined rate of approximately 0.8 MMcf
per day. We had 20 proved undeveloped locations identified for drilling as of
December 31, 1998.
Noble/Cambridge Area, Ohio
The Noble/Cambridge Area includes approximately 6% of Eastern States' total
net proved reserves. Eastern States' interests are located largely in Trumbull,
Mahoning, Portage, Coshocton, Licking, Noble and Monroe counties in eastern Ohio
on approximately 87,000 gross acres. We produce natural gas predominately from
the Silurian Clinton sandstone at depths ranging from 3,500 to 6,000 feet.
Additionally, natural gas and minor amounts of oil are produced from the
Cambro-Ordovician Knox Group at depths approximating 7,000 feet, and
Mississippian and Devonian sandstones at depths of 2,000 to 3,000 feet. Sales
meter production attributable to our net interest averaged 10 MMcfe per day for
the first two quarters of 1999. Eastern States drilled and completed 11 gross
wells during 1998. Of these, nine gross wells are producing at a combined rate
of approximately 0.4 MMcfe per day. We had 40 proved undeveloped locations
identified for drilling as of December 31, 1998.
Additional Properties
Eastern States also owns additional producing properties in the Appalachian
Basin and Michigan Basin, accounting for the remaining 1% of net proved
reserves. Eastern States owns approximately 151,000 gross acres in the Illinois
Basin, approximately 5,000 gross acres in the Michigan Basin, and approximately
an additional 7,000 gross acres outside the Appalachian, Michigan and Illinois
Basins.
DEVELOPMENT ACTIVITIES
Our development activities involve technical, economic, land, and field
investigations that result in the drilling of new wells, recompleting or
deepening existing wells and optimizing production systems. We pursue
opportunities which cost effectively maximize production from our properties. A
team composed of geologists, reservoir and production engineers, landmen, and
drilling supervisors identify these opportunities through their integrated
efforts. The teams also look for opportunities to farm-in or acquire additional
acreage and wells that enhance their area's performance. Certain properties we
deem uneconomic or non-strategic are farmed-out for exploitation by third
parties.
Development drilling accounts for approximately 95% of our drilling capital
expenditures. The remaining amount is used to conduct drilling within our
exploration project areas. Our experienced geoscience staff of six professionals
coordinate our exploration efforts in the Appalachian Basin with additional
support provided by consultants. Currently, our primary exploration targets are
(1) Cambrian Rome sandstones of northeastern Kentucky and western West Virginia,
(2) Knox carbonates and sandstones of eastern Ohio, and (3) Devonian and
Silurian horizons coincident with our southern West Virginia acreage which can
be tested by extending the drill depth of our shallower development wells in
this area by 200 to 1,000 feet.
A-9
<PAGE> 97
RESERVES
We operate producing properties primarily in West Virginia, Kentucky and
Ohio in the Appalachian Basin. We also own smaller producing properties in
Virginia, Michigan and Maryland and operate wells in Indiana which are currently
shut-in. The following table shows quantities of our net proved natural gas and
oil reserves and cash flows at December 31, 1996, 1997 and 1998.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------------------
1996 1997 1998
-------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Proved developed:
Natural gas (MMcf).............................. 123,518 701,726 697,474
Oil (MBbls)..................................... 1,038 2,323 1,972
Proved undeveloped:
Natural gas (MMcf).............................. 46,404 309,567 352,240
Oil (MBbls)..................................... 87 14 32
Total proved:
Natural gas (MMcf).............................. 169,922 1,011,293 1,049,714
Oil (MBbls)..................................... 1,125 2,337 2,004
Estimated future net cash flows(1):
Before income tax............................... $495,748 $1,940,860 $2,157,655
After income tax................................ 340,150 1,393,163 1,524,826
Present value of estimated future net cash flows,
discounted at 10%(1):
Before income tax............................... $192,584 $ 680,432 $ 700,196
After income tax................................ 136,175 519,709 538,401
</TABLE>
- ---------------
(1) Includes the value of Section 29 tax credits and future plugging and
abandonment liabilities.
Ryder Scott Company, L.P. reviewed the estimates prepared by Eastern States
of Eastern States' proved reserves and the future net cash flow and present
value of cash flow attributable to proved reserves at December 31, 1996, 1997
and 1998. As prescribed by the SEC, proved reserves were estimated using natural
gas and oil prices and production and development costs as of December 31 of
each year, without escalation.
The proved natural gas and oil reserves represent estimated quantities of
natural gas, oil and natural gas liquids which geological and engineering data
demonstrate to be recoverable in future years from known reservoirs under
existing economic and operating conditions. The proved reserves are further
classified as developed and undeveloped. The reserves described below and the
related standardized measures of discounted net cash flows are estimated only
and do not purport to reflect realizable values or fair market values of Eastern
States' reserves. Reserve estimates are inherently imprecise. Substantial
revisions to existing reserve estimates occur periodically due to additional
production history from each well, current-year drilling activity and other new
geologic or reserve characteristic information that may be discovered each year.
The standardized measure of discounted future net cash flows (discounted at
10%) relating to proved natural gas and oil reserves is prescribed by SFAS
Statement No. 69, "Disclosures About Oil and Gas Producing Activities." The
statement requires measurement of future net cash flows through assignment of a
monetary value to proved reserve quantities and changes therein using a
standardized formula. The amounts shown above were developed as follows:
1. An estimate was made of the quantity of proved reserves and the future
periods in which they are expected to be produced based on year-end
economic conditions.
2. Year-end prices in effect for each respective year were applied to the
estimated quantities of year-end reserves. Prices remained constant,
except in instances where fixed and determinable gas price
A-10
<PAGE> 98
escalations are provided by contracts. The average prices used at
December 31, 1996, 1997 and 1998 were $3.68, $2.57, and $2.71 per Mcf of
natural gas and $22.50, $15.00, and $9.00 per barrel of oil,
respectively. As of September ____, 1999, the prevailing price of
natural gas in the Appalachian Basin for Columbia Gas Transmission, as
reported by Inside FERC, was $____ per MMbtu.
During 1999, Eastern States filed estimates of operated oil and natural gas
reserves as of December 31, 1998 with the U.S. Department of Energy on Form
EIA-23. These estimates are consistent with the reserves reported in this
appendix as of December 31, 1998.
Standardized Measure of Discounted Future Net Cash Flows from Proved Reserves
The following table provides, at December 31, 1998, the summary calculation
of the standardized measure of discounted future net cash flows attributable to
our estimated net proved reserves at that date. These estimates, which we
prepared, have been reviewed by Ryder Scott Company L.P. Dollar amounts are
presented in millions.
<TABLE>
<S> <C>
Future gross revenues...................................... $2,902
Future production costs.................................. (549)
Future development costs................................. (195)
------
Total future costs......................................... (744)
------
Future net revenues before future income taxes............. 2,158
Discount at 10% per annum.................................. (1,458)
------
Standardized measure before future income taxes(1)......... 700
Discounted future income taxes(2).......................... (162)
------
Standardized measure after future income taxes(1).......... $ 538
======
</TABLE>
- ---------------
(1) Natural gas and oil prices used in calculating estimated values at December
31, 1998 were $2.71 per MMBtu and $9.00 per Bbl of oil. At September ____,
1999, the published price for natural gas in the Appalachian Basin for
Columbia Gas Transmission, as reported by Inside FERC, were $____ per MMBtu,
and $____ per Bbl of oil.
(2) Future income taxes before discount were $633 million.
In computing this data, we used assumptions and estimates. We cannot assure
you that these assumptions and estimates will be indicative of future economic
conditions. We determined the future net revenues by using estimated quantities
of proved reserves and the periods in which they are expected to be developed
and produced based on December 31, 1998 economic conditions. The estimated
future production is priced as of December 31, 1998, except where fixed and
determinable price escalations are provided by contract. The resulting estimated
future gross revenues are reduced by estimated future costs to develop and
produce the proved reserves based on December 31, 1998 costs levels, but not for
debt service, general and administrative expenses and income taxes. Prices for
natural gas and oil are subject to substantial fluctuations as a result of
numerous factors. You should not construe the standardized measure as the
current market value of estimated natural gas and oil reserves. For additional
information concerning the discounted future net cash flows to be derived from
these reserves and the disclosure of the standardized measure information in
accordance with the provisions of Statement of Financial Accounting Standards
No. 69, you should review "Supplemental Disclosures About Oil and Gas Producing
Activities" in Note 13 to our consolidated financial statements included
elsewhere in this appendix.
Based upon the results of operations for the year ended December 31, 1998,
and excluding the effect of our hedging program, a change of $0.10 per Mcf in
the average price of natural gas throughout such period would result in
corresponding changes in operating and net income of $3.8 million and $2.5
million, respectively.
A-11
<PAGE> 99
ACREAGE AND PRODUCTIVE WELLS
The following table shows the approximate amount of our developed and
undeveloped acreage (in thousands) at December 31, 1998. Approximately 95% of
our acreage is held by production.
<TABLE>
<CAPTION>
DEVELOPED
ACRES UNDEVELOPED ACRES TOTAL ACRES
----------- ----------------- ---------------
GROSS NET GROSS NET GROSS NET
----- --- ------ ------ ----- -----
<S> <C> <C> <C> <C> <C> <C>
Appalachian Basin...................... 332 298 1,073 966 1,405 1,264
Other.................................. 11 7 152 125 163 132
--- --- ----- ----- ----- -----
Total........................ 343 305 1,225 1,091 1,568 1,396
=== === ===== ===== ===== =====
</TABLE>
The following table shows at December 31, 1998 the number of producing
wells in which we own an interest and includes 1,550 wells associated with
Section 29 tax credit monetization:
<TABLE>
<CAPTION>
TOTAL PRODUCING WELLS
----------------------
GROSS NET
----- ---
<S> <C> <C>
Natural Gas...................................... 5,732 5,388
Oil.............................................. 4 4
----- -----
Total.................................. 5,736 5,392
===== =====
</TABLE>
DRILLING ACTIVITIES
During the periods indicated, we drilled or participated in the drilling of
the following exploratory and development wells.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED
-------------------------------------------- JUNE 30,
1996 1997 1998 1999
------------ ------------- ------------- -----------------
GROSS NET GROSS NET GROSS NET GROSS NET
----- --- ----- --- ----- --- ----- ---
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Exploratory wells:
Productive.................... 5.0 3.0 4.0 2.3 3.0 2.4 2.0 2.0
Nonproductive................. 0 0 4.0 2.2 4.0 3.5 1.0 0.5
Development wells:
Productive.................... 73.0 71.5 116.0 113.0 171.0 168.1 59.0 58.5
Nonproductive................. 1.0 1.0 1.0 1.0 1.0 0.5 0 0
----- ---- ----- ----- ----- ----- ---- ----
Total................. 79.0 75.5 125.0 118.5 179.0 174.5 62.0 61.0
</TABLE>
As of July 31, 1999, we were drilling nine wells in the Appalachian Basin.
NET PRODUCTION, UNIT PRICES AND COSTS
Our lease operating expenses, including both well tending and gathering and
compression costs, averaged $0.41 per Mcfe for the year ended December 31, 1998
and $0.40 per Mcfe for the six months ended June 30, 1999. Over the past three
fiscal years we have reduced our drilling cost per well in the region by
approximately 10%.
A-12
<PAGE> 100
The following table provides information with respect to our net production
and average unit prices and costs for the periods indicated. Since natural gas
represents over 98% of our production, this information is presented in Bcfe or
Mcfe:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------ ----------------
1996 1997 1998 1998 1999
------ ------ ------ ----- -----
<S> <C> <C> <C> <C> <C>
Production (wellhead):
Gas Equivalents (Bcfe)..................... 6.6 24.7 38.7 19.5 20.0
Average sales price (hedged):
Gas Equivalents ($/Mcfe)................... $2.76 $2.62 $2.46 $2.57 $2.66
Average sales price (unhedged):
Gas Equivalents ($/Mcfe)................... $2.94 $2.80 $2.28 $2.41 $2.26
Average lease operating expenses ($/Mcfe).... $0.40 $0.55 $0.41 $0.41 $0.40
</TABLE>
MARKETING AND CONTRACTS
General. The close proximity of Appalachian production to a substantial
number of industrial and commercial end users in the northeastern United States
has traditionally provided producers a premium to Henry Hub, Louisiana prices.
This premium has averaged $0.26 per MMBtu over the past three calendar years.
For the period 1991 through 1998, wellhead natural gas prices in the Appalachian
Basin have averaged on an annual basis $0.25 per MMbtu more than Henry Hub and
NYMEX wellhead natural gas prices. During these eight years, the Appalachian
Basin annual premium has ranged from $0.14 per MMbtu to $0.47 per MMbtu over
NYMEX prices. In addition to its location premium, our Appalachian Basin gas
production has a higher Btu (or energy) content than natural gas produced in
many other areas of the United States, which also results in premium pricing
since index prices are typically based on an energy content of 1,000 Btu per
cubic foot.
We balance our spot and term natural gas sales to end-users and local
distribution companies and utilize multiple pricing structures. Eastern States
currently has two significant market-based contracts, one with affiliates of CNG
Transmission Corp. and the other with its own affiliate, Statoil Energy
Services, Inc. Each of these contracts expires in October 2000. In 1998, over
80% of the natural gas produced by Eastern States was sold under these
contracts, with 59% sold to Statoil Energy Services and 23% sold to CNG. During
the six months ended June 30, 1999, 60% of our natural gas was sold to Statoil
Energy and 30% to CNG. Eastern States believes that it will be able to sell its
natural gas under comparable terms should these contracts not be renewed.
Substantially all of the remaining portion of our supplies is sold pursuant to
multi-month and/or one-year term agreements.
CNG. Under the CNG contract, affiliates of CNG purchase natural gas from
Eastern States based on the terms contained in confirmations which the parties
enter into from time to time. The CNG confirmations set forth the following:
- quantity;
- price;
- delivery point; and
- effective period of the confirmation.
The price under the CNG contracts has historically been based on the
published price of Inside FERC-Appalachian Basin for CNG, plus a premium based
on the higher Btu content, less applicable gathering, compression and processing
fees. The price for the natural gas is inclusive of all taxes levied on
production or transportation of the natural gas up to the delivery point.
Payment from the CNG affiliate is due by the 55th day following delivery.
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<PAGE> 101
Each CNG confirmation sets forth the quantity of natural gas to be
delivered by Eastern States to the delivery point. The delivery point is, in
general, the point of the interconnection of Eastern States' gathering
facilities with the metering facilities of CNG's pipeline system. Eastern States
is responsible for delivery of natural gas to the delivery point. Title and risk
of loss to the natural gas pass to the CNG affiliate at the designated delivery
point.
Each CNG confirmation sets forth the period of time that the terms of the
confirmation are effective. The effective period of a confirmation with the CNG
affiliates has typically been for 12 months.
Statoil Energy Services. The contract with Statoil Energy Services is also
based on the terms contained in confirmations similar to the CNG confirmations
which the parties enter into from time to time.
The price under the Statoil Energy Services contract has historically been
based on the published price of Inside FERC -- Appalachian Basin for Columbia
Gas Transmission Corp. (also known as "TCO") for natural gas delivered into
Columbia Gas Transmission's pipeline system, plus a premium based on the higher
Btu content, less gathering, compression and processing fees. Eastern States is
responsible for all taxes attributable to the natural gas before the delivery
point. Statoil Energy Services is responsible for all taxes attributable to the
natural gas after the delivery point. Payment from Statoil Energy Services is
due by the 55th day following delivery.
Each confirmation with Statoil Energy Services sets forth the quantity of
natural gas to be delivered by Eastern States to the delivery point. Title and
risk of loss pass to Statoil Energy Services at the delivery point.
Each confirmation also sets forth the period of time that the terms of the
confirmation are effective. The effective period of a confirmation with Statoil
Energy Services has historically been for 12 months.
Third Party Services. Our 3,500 miles of Appalachian Basin gathering lines
provide us with the opportunity to purchase or transport third party gas
supplies for delivery into major interstate pipelines. We generally make these
purchases along our gathering pipeline systems, but also make purchases
off-system. Frequently, we market gas for joint venture partners. Our gathering
systems have enabled us to generate gross margins approximating $0.25 per MMBtu
over the past three years on third party volumes. Providing gathering services
to third parties allows Eastern States to obtain reimbursement for compressor
fuel and line loss amounts.
Domestic Customers. We also serve domestic customers at rates established
by state regulatory authorities. Revenues from these sales represent less than
1% of total revenues.
Hedging and Risk Management. We utilize forward sales of our production in
order to lock-in prices that we determine to be attractive and to achieve a
certain return on investment. In fiscal years 1996, 1997 and 1998, we hedged
approximately 70%, 70% and 60%, respectively, of our natural gas production.
This strategy has been successful in achieving our income goals. However, it has
limited our potential gains from increases in market prices. At June 30, 1999,
we had the following open natural gas hedges:
<TABLE>
<CAPTION>
MMBTU PER DAY DATE AVERAGE NYMEX PRICE PER MCF
- ------------- ---- ---------------------------
<C> <S> <C>
105 July 1999 to December 1999 $ 2.24
80 Year 2000 2.36
20 Year 2001 2.36
10 Years 2002 to 2008 2.35 to 2.45
30 Seven hedged Summer months in years 2000 to 2.10 to 2.30
2003
</TABLE>
In addition to our natural gas hedges, we have hedged a small amount of our
oil production and Appalachian Basin premium. We plan to continue to hedge our
natural gas production (excluding the production attributable to the trust) in
the future in order to reduce our exposure to significant declines in the market
price to ensure minimum levels of cash flow from our sales of oil and gas. At
the time we divest of any of our oil and gas properties, including the sale of
oil and gas properties to the trust as
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<PAGE> 102
contemplated herein, we would close out our hedging positions and include the
gain or loss, resulting from the hedges as a part of the property sale for
financial reporting purposes. At no time does the Company enter into speculative
positions.
SECTION 29 TAX CREDITS
The Crude Oil Windfall Profits Tax Act of 1980 amended the Internal Revenue
Code to provide an incentive for certain natural gas production from
unconventional sources such as the Devonian Shale and tight sandstone formations
of the Appalachian Basin. Pursuant to Section 29 of the Internal Revenue Code,
an owner of an economic interest in certain natural gas production can qualify
for certain tax credits on qualified production that is produced through
December 31, 2002.
As part of our acquisition of Blazer Energy, we acquired Blazer Energy's
working interests in approximately 1,450 gross wells that qualified for Section
29 tax credits under the Internal Revenue Code. In December 1997, we conveyed
substantially all the wells that qualified for Section 29 tax credits to our
subsidiary Eastern Seven, LLC. Eastern Seven then entered into an agreement
under which it monetized the value of its future Section 29 tax credits. Under
the terms of the agreement, Eastern Seven transferred title to these wells to a
trust, but retained a production payment and a note that entitle Eastern Seven
to all of the cash flow from the properties until approximately 95% of the
pre-tax net present value of the presently projected future production from the
properties has been received, which is expected to occur in the year 2018. In
addition to the note and production payment, Eastern Seven received a fixed cash
payment of $7.9 million at closing and will receive quarterly payments through
2002 equal to a specified percentage of the Section 29 tax credits generated
from the properties. These quarterly payments are expected to decline from
approximately $2.3 million per quarter in 1998 to approximately $1.9 million per
quarter in 2002.
In April 1999, we conveyed approximately 120 wells qualifying for Section
29 tax credits to Eastern Seven, LLC. Eastern Seven then entered into a
monetization agreement under similar terms and received a fixed cash payment of
$0.5 million at closing and will receive quarterly payments through 2002 equal
to a specified percentage of the Section 29 tax credits generated from the
properties. These quarterly payments are expected to decline from approximately
$117,000 per quarter in 1999 to approximately $107,000 per quarter in 2002.
Based on current law, Devonian Shale and tight sand tax credits will be
available until December 31, 2002. Eastern Seven has the option to repurchase
the properties after December 31, 2002 at the fair market value of the
properties at the time of repurchase less the value of the outstanding note and
production payment. Eastern States also entered into a management services
agreement with the trust pursuant to which Eastern States manages and operates
the properties on behalf of the trust.
RELATIONSHIP WITH STATOIL ENERGY
In August 1999, Statoil Energy Holdings agreed to combine and extend to
December 31, 2001 the final repayment dates of various notes payable to Statoil
Energy Holdings aggregating approximately $505 million of indebtedness at
December 31, 1998. This note has an 8% annual rate of interest, payable
semi-annually on January 1 and July 1 each year. At July 31, 1999, the total
amount of outstanding indebtedness under the note payable to Statoil Energy
Holdings was approximately $505 million and our intercompany indebtedness owed
to affiliates of Statoil Energy was approximately $45 million.
Since 1997, Eastern States, along with Statoil Energy and Statoil Energy
Holdings, has participated in a tax allocation agreement whereby all required
federal income tax returns for 1997 and thereafter are filed on a consolidated
basis. For each tax period, each subsidiary computes its separate tax liability
or receivable on a separate company basis. Any subsidiary tax liability is paid
to Statoil Energy by the subsidiary or, if there is a subsidiary tax benefit,
Statoil Energy will reimburse the subsidiary.
A-15
<PAGE> 103
In 1997, Eastern States sold the Gulf of Mexico properties acquired in the
Blazer acquisition in July 1997 to Eastern States' affiliate Statoil Exploration
U.S., Inc., an indirect wholly owned subsidiary of The Statoil Group, for
approximately $82 million.
Substantially all full-time employees of Eastern States participate in a
profit-sharing plan sponsored by Statoil Energy that includes an employee
savings feature under Section 401(k) of the Internal Revenue Code. Participants
in the plan may elect to defer up to 15% of their total compensation through
contributions to the plan and Statoil Energy matches 50% of employee
contributions up to 6% of an employee's total compensation. Statoil Energy's
matching vests within five years.
COMPETITION
Competition in our primary producing areas is intense. We actively compete,
in some cases against companies with substantially larger financial and other
resources, in the:
- acquisition of producing properties and natural gas and oil leases;
- marketing of natural gas and oil; and
- obtaining goods, services and labor.
To the extent that our gas supply, gathering systems, organization or
development budget are smaller than those of some of our competitors, we may be
disadvantaged in our competitive activities. We believe that our competitive gas
marketing position is based on location, price, contract terms, quality of
service and reliable delivery record. We believe that our extensive acreage
position, substantial ongoing development program and existing gas gathering
systems give us a competitive advantage over other producers in the Appalachian
Basin that do not have similar systems or facilities in place.
TITLE TO PROPERTIES
As is customary in the natural gas and oil industry, we make only a cursory
review of title to farm-out acreage and to undeveloped natural gas and oil
leases upon execution of the contracts. Prior to the commencement of drilling
operations, a thorough title examination may be conducted and curative work may
be performed with respect to significant defects. To the extent title opinions
or other investigations reflect title defects, we, rather than the seller of the
undeveloped property, are typically responsible to cure any such title defects
at our expense. If we were unable to remedy or cure any title defect of a nature
such that it would not be prudent to commence drilling operations on the
property, we could suffer a loss of our entire investment in the property. We
believe that we have satisfactory title to the properties in accordance with
standards generally accepted in the oil and gas industry. Our natural gas and
oil properties are subject to customary royalty interests, liens for current
taxes and other burdens that we believe do not materially interfere with the use
of or affect the value of such properties.
GOVERNMENT REGULATION
Regulation of Natural Gas and Oil Exploration and Production
Our exploration and production operations are subject to various types of
regulation at the federal, state and local levels. This regulation includes:
- requiring permits for the drilling of wells;
- maintaining bonding requirements in order to drill or operate wells; and
- regulating the location of wells, the method of drilling and casing
wells, the surface use and restoration of properties upon which wells are
drilled and the plugging and abandonment of wells.
A-16
<PAGE> 104
Our operations are also subject to various conservation laws and
regulations. These laws and regulations may include:
- the density or spacing of wells that may be drilled;
- the unitization or pooling of oil and gas properties; and
- the regulation of the maximum rate of production from natural gas and oil
wells.
The effect of these regulations may limit the amounts of natural gas and
oil that we can produce from our wells, and limit the number of wells or the
locations at which we can drill. Legislation affecting the oil and gas industry
also is under constant review for amendment or expansion. In addition, numerous
departments and agencies, both federal and state, are authorized by statute to
issue rules and regulations binding on the natural gas and oil industry and its
individual members, some of which carry substantial penalties for failure to
comply. The regulatory burden on the natural gas and oil industry increases our
cost of doing business and, as a result, affects our profitability. Because laws
and regulations are frequently expanded, amended and reinterpreted, we are
unable to predict the future cost or impact of complying with any laws and
regulations.
Federal Regulation of Gas.
Under the Natural Gas Act of 1938, the Federal Energy Regulatory Commission
regulates the interstate transportation and the sale in interstate commerce for
resale of natural gas. The FERC's jurisdiction over interstate natural gas sales
was substantially modified by the Natural Gas Policy Act, under which the FERC
continued to regulate the maximum selling prices of certain categories of gas
sold in "first sales" in interstate and intrastate commerce. Effective January
1, 1993, however, the Natural Gas Wellhead Decontrol Act deregulated natural gas
prices for all "first sales" of natural gas. Because "first sales" include
typical wellhead sales by producers, all natural gas produced from Eastern
States' natural gas properties is being sold at market prices, subject to the
terms of any private contracts which may be in effect. The FERC's jurisdiction
over natural gas transportation was not affected by the Decontrol Act.
Eastern States' sales of natural gas are affected by intrastate and
interstate gas transportation regulation. Beginning in 1985, the FERC adopted
regulatory changes that have significantly altered the transportation and
marketing of natural gas. These changes were intended by the FERC to foster
competition by, among other things, transforming the role of interstate pipeline
companies from wholesale marketers of gas to the primary role of gas
transporters. All gas marketing by the pipelines was required to be divested to
a marketing affiliate, which operates separately from the transporter and in
direct competition with all other merchants. As a result of the various omnibus
rulemaking proceedings in the late 1980s and the individual pipeline
restructuring proceedings of the early to mid-1990s, the interstate pipelines
are now required to provide open and nondiscriminatory transportation and
transportation-related services to all producers, gas marketing companies, local
distribution companies, industrial end users and other customers seeking
service. Through similar orders affecting intrastate pipelines that provide
similar interstate services, the FERC expanded the impact of open access
regulations to intrastate commerce.
More recently, the FERC has pursued other policy initiatives that have
affected natural gas marketing, including:
- the large-scale divestiture of interstate pipeline-owned gas gathering
facilities to affiliated or non-affiliated companies;
- further development of rules governing the relationship of the pipelines
with their marketing affiliates;
- the publication of standards relating to the use of electronic bulletin
boards and electronic data exchange by the pipelines to make available
transportation information on a timely basis and to enable transactions
to occur on a purely electronic basis;
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- further review of the role of the secondary market for released pipeline
capacity and its relationship to open access service in the primary
market; and
- development of policy and promulgation of orders pertaining to its
authorization of market-based rates (rather than traditional
cost-of-service based rates) for transportation or transportation-related
services upon the pipeline's demonstration of lack of market control in
the relevant service market. We cannot predict what effect the FERC's
other activities will have on the access to markets, the fostering of
competition and the cost of doing business.
As a result of these changes, sellers and buyers of gas have gained direct
access to the particular pipeline services they need and are better able to
conduct business with a larger number of counterparties. Eastern States believes
these changes generally have improved the access to markets for its natural gas
while, at the same time, substantially increasing competition in the natural gas
marketplace. We cannot predict what new or different regulations the FERC and
other regulatory agencies may adopt, or what effect subsequent regulations may
have on production and marketing of gas from our properties.
In the past, Congress has been very active in the area of gas regulation.
However, as discussed above, the more recent trend has been in favor of
deregulation and the promotion of competition in the gas industry. Thus, in
addition to "first sale" deregulation, Congress also repealed incremental
pricing requirements and gas use restraints previously applicable. There are
other legislative proposals pending in the Federal and state legislatures which,
if enacted, would significantly affect the petroleum industry. At the present
time, we cannot predict what proposals, if any, Congress or the various state
legislatures might actually enact and what effect, if any, these proposals might
have on our production and marketing of gas. Similarly, and despite the trend
toward federal deregulation of the natural gas industry, we cannot predict
whether or to what extent that trend will continue, or what the ultimate effect
will be on our production and marketing of gas.
Federal Regulation of Petroleum.
Eastern States' sales of oil are not regulated and are at market based
prices. The price received from the sale of these products is affected by the
cost of transporting the products to market. Much of that transportation is
through interstate common carrier pipelines. Effective as of January 1, 1995,
the FERC implemented regulations generally grandfathering all previously
approved interstate transportation rates and establishing an indexing system for
those rates by which adjustments are made annually based on the rate of
inflation, subject to certain conditions and limitations. These regulations may
tend to increase the cost of transporting oil and natural gas liquids by
interstate pipeline, although the annual adjustments may result in decreased
rates in a given year. These regulations have generally been approved on
judicial review. Every five years, the FERC will examine the relationship
between the annual change in the applicable index and the actual cost changes
experienced by the oil pipeline industry. The first such review is scheduled for
the year 2000. We are not able to predict with certainty what effect, if any
these relatively new federal regulations nor the periodic review of the index by
FERC will have on it.
Safety and Health Regulation
Our gathering operations are subject to occupational safety, health and
operational regulations relating to the design, installation, testing,
construction, operation, replacement and management of facilities. Pipeline
safety issues have recently been the subject of increasing focus in various
political and administrative arenas at both the state and federal levels. We
believe our operations, to the extent they may be subject to current natural gas
pipeline safety or other health and safety requirements, comply in all material
respects with these requirements. We cannot predict what effect, if any, the
adoption of additional pipeline safety or other safety and health legislation
might have on our operations, but the industry could be required to incur
additional capital expenditures and increased costs depending upon future
legislative and regulatory changes.
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ENVIRONMENTAL MATTERS
Our operations are subject to federal, state and local laws and regulations
governing the discharge of materials into the environment or otherwise relating
to environmental protection. Numerous governmental agencies issue rules and
regulations to implement and enforce these laws, which may be costly to comply
with and carry substantial penalties for failure to comply. These laws and
regulations may:
- require the acquisition of one or more permits before drilling commences;
- restrict the types, quantities and concentration of various substances
that can be released into the environment in connection with drilling and
production activities;
- limit or prohibit drilling activities on certain lands lying within
wilderness, wetlands and other protected areas;
- require measures to prevent the release of contaminants into the
environment from former operations, such as the remediation of former or
current well sites, including pit closure and plugging abandoned wells;
and
- impose substantial liabilities and penalties if any contaminants are
released into the environment as a result of our operations.
In addition, these laws, rules and regulations may restrict the rate of oil
and natural gas production below the rate that would otherwise exist or may
require that certain wells be shut-in. The regulatory burden on the natural gas
and oil industry increases the cost of doing business and consequently affects
our profitability and the profitability of others in the industry. Our
expenditures in the near future for regulatory and environmental compliance are
not expected to be material in relation to our total capital expenditure
program; however, we cannot predict the ultimate cost of compliance because
costs are highly dependent on the facts and circumstances of a particular
situation and environmental laws and regulations frequently change. Although we
believe that our operations and facilities are in compliance in all material
respects with current applicable environmental regulations, risks of substantial
costs and liabilities are inherent in gas and oil operations, and we cannot
assure you that we will not incur significant costs and liabilities in the
future. A change in current environmental laws and regulations could have an
adverse effect on our financial condition and results of operations.
CERCLA
The Comprehensive Environmental Response, Compensation and Liability Act,
which is commonly known as CERCLA and also as the Superfund law, imposes
liability, without regard to fault or the legality of the original conduct, on
persons who are considered to be responsible for the release of a "hazardous
substance" into the environment. While most oil and gas exploration and
production wastes are not considered hazardous substances, there may be some
materials present at an oil and gas well or used in oil and gas exploration and
production operations that are considered hazardous substances. Persons who may
be liable under CERCLA, usually referred to as potentially responsible parties,
include the current or former owner or operator of the disposal site or sites
where the release occurred and companies that disposed or arranged for the
disposal of the hazardous substances found at a site and companies that
transported the hazardous substance for disposal. Under CERCLA, potentially
responsible parties may be subject to joint and several liability for the costs
of cleaning up hazardous substances that have been released into the
environment, for damages to natural resources and for the costs of some health
studies. In addition, where a release of a hazardous substance has occurred, it
is not uncommon for neighboring landowners and other third parties to file
lawsuits claiming for personal injury and property damage allegedly caused by
hazardous substances or other pollutants released into the environment.
Stricter standards in environmental legislation may be imposed on the oil
and gas industry in the future. For instance, from time to time legislation has
been proposed in Congress that would reclassify certain oil and natural gas
exploration and production wastes as "hazardous wastes" subject to more
stringent handling, disposal and cleanup requirements. If such legislation were
enacted, it could have a
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significant impact on our operating costs, as well as the oil and gas industry
in general. Furthermore, although petroleum, including oil and natural gas, is
exempt from CERCLA, at least two courts have ruled that certain wastes
associated with the production of oil may be classified as "hazardous
substances" under CERCLA. State initiatives to regulate further the disposal of
oil and natural gas wastes are pending in several states, and these initiatives
could have a similar impact on us. Although future changes in federal and state
law related to discharge into navigable waters or state waters could have a
significant impact on our operating costs, the entire industry will experience a
similar impact and we believe that the increased costs will not have a material
adverse impact on our financial conditions and operations.
Solid and Hazardous Waste
The Federal Solid Waste Disposal Act, as amended by the Resource
Conservation and Recovery Act of 1976, which is commonly known as RCRA,
regulates the generation, transportation, storage, treatment and disposal of
hazardous wastes, and can require cleanup of hazardous waste disposal sites.
RCRA currently excludes drilling fluids, produced waters and other wastes
associated with the exploration, development or production of natural gas and
oil from the definition of "hazardous waste." Disposal of non-hazardous oil and
gas exploration, development and production wastes may be regulated by state
law. In addition, we occasionally handle material that may be classified as
hazardous waste under RCRA. RCRA and state laws impose certain operational
requirements upon the storage, handling and disposal of these materials.
LITIGATION
Various legal actions that have arisen in the ordinary course of business
are pending with respect to Eastern States and its affiliates. We do not expect
any of these proceedings to have a material adverse impact on our results of
operations or financial position.
OPERATING HAZARDS AND UNINSURED RISKS
Our operations are subject to hazards and risks inherent in drilling for
and production and transportation of oil and natural gas, such as:
- fires;
- natural disasters;
- explosions;
- encountering formations with abnormal pressures;
- blowouts;
- cratering;
- pipeline ruptures; and
- spills,
any of which can result in loss of hydrocarbons, environmental pollution,
personal injury claims, and other damage to our properties and properties of
others. As protection against operating hazards, we maintain insurance coverage
against some, but not all, potential losses. We believe that our insurance is
adequate and customary for companies of a similar size engaged in operations
similar to ours, but losses could occur for uninsurable or uninsured risks or in
amounts in excess of existing insurance coverage. The occurrence of an event
that is not fully covered by insurance could have an adverse impact on our
financial condition and results of operations.
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EMPLOYEES
As of June 30, 1999, we had 276 employees in eight offices. We believe that
our relations with our employees are satisfactory. We have not entered into any
collective bargaining agreements with any of our employees.
OFFICES
Statoil Energy maintains its corporate headquarters in Alexandria, Virginia
where it leases approximately 110,000 square feet of office space. Eastern
States maintains its corporate headquarters in the same building and subleases
approximately 17% or 19,000 square feet of the office space from Statoil Energy.
We also have a regional office in Charleston, West Virginia, with field offices
in Weston, West Virginia; Madison, West Virginia; Brenton, West Virginia;
Pikeville, Kentucky; Ravenna, Ohio; and Cambridge, Ohio.
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SELECTED FINANCIAL INFORMATION
The following table shows selected historical financial information for
Eastern States Oil & Gas, Inc. and reflects the acquisition of the domestic
natural gas and oil producing properties of Blazer Energy Corp. in July of 1997.
The selected historical financial information as of and for the three years
ended December 31, 1998 have been derived from our audited consolidated
financial statements. The summary historical financial information for the two
years ended December 31, 1995 and for the six months ended June 30, 1998 and
1999 has been derived from our unaudited financial statements. The results for
the six months ended June 30, 1999 are not necessarily indicative of the results
that may be expected for any other period or for the full year. The following
information should be read in conjunction with our financial statements and the
notes thereto and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" contained elsewhere in this appendix.
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, YEAR ENDED DECEMBER 31, ENDED JUNE 30,
------------------ -------------------------------- --------------------
1994 1995 1996 1997 1998 1998 1999
------- ------- -------- -------- -------- -------- --------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Total revenues........... $1,772.. $ 4,852 $ 18,247 $ 65,368 $104,670 $ 54,677 $ 57,723
------- ------- -------- -------- -------- -------- --------
Operating expenses....... 623 1,244 2,655 13,454 15,950 7,927 8,043
Depreciation, depletion
and amortization....... 550 1,429 4,783 19,073 31,517 16,520 16,129
General and
administrative
expenses............... -- -- 1,630 3,254 5,462 2,249 2,868
------- ------- -------- -------- -------- -------- --------
Total costs and
expenses............... 1,173 2,673 9,068 35,781 52,929 26,696 27,040
------- ------- -------- -------- -------- -------- --------
Operating income......... 599.... 2,179 9,179 29,587 51,741 27,981 30,683
Interest expense, net of
interest income........ 518 2,061 4,338 21,608 38,952 19,513 21,265
------- ------- -------- -------- -------- -------- --------
Income before income
taxes.................. 81 118 4,841 7,979 12,789 8,468 9,418
Income tax expense
(benefit).............. -- -- 956 (1,171) 4,443 3,112 3,372
------- ------- -------- -------- -------- -------- --------
Net income............... $ 81 $ 118 $ 3,885 $ 9,150 $ 8,346 $ 5,356 $ 6,046
======= ======= ======== ======== ======== ======== ========
OTHER FINANCIAL DATA:
EBITDA(1)................ $ 1,149 $ 3,608 $ 13,962 $ 48,660 $ 83,258 $ 44,501 $ 46,812
Net cash provided by
(used for) operating
activities............. (177) 40,341 10,301 12,244 40,511 22,081 24,818
Capital expenditures..... 19,173 28,641 56,789 597,007 82,525 24,818 21,830
BALANCE SHEET DATA (AT
END OF PERIOD):
Working capital.......... 638 (1,979) (2,133) 10,057 13,215 12,709 13,412
Oil and gas properties,
net.................... 18,623 45,835 97,484 593,385 619,807 578,038 625,301
Total assets............. 19,945 45,564 100,469 626,339 658,333 602,472 651,867
Total long-term debt..... 19,500 41,366 69,633 503,588 505,488 505,488 505,488
Stockholder's equity..... 81 1,700 5,585 64,735 73,081 70,090 79,127
</TABLE>
- ---------------
(1) EBITDA, as presented herein, is defined as the sum of income before
provision for income taxes, interest, depreciation, depletion and
amortization. EBITDA does not represent funds available for discretionary
use. EBITDA should not be considered in isolation or as a substitute for net
income, net cash flow provided by operating activities or other income or
cash flow data prepared in accordance with generally accepted accounting
principles or as a measure of a company's profitability or liquidity.
Further, EBITDA as presented herein, may not be comparable to similarly
titled measures reported by other companies.
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SUMMARY RESERVE AND OPERATING DATA
The following shows summary reserve and operating information as of and for
the periods indicated. For additional information regarding our proved reserves
as reviewed by Ryder Scott Company, L.P. and other information regarding our gas
and oil reserves, see "Business and Properties -- Reserves" and the
"Supplemental Disclosures About Oil and Gas Producing Activities" in Note 13 to
our consolidated financial statements presented elsewhere in this appendix.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1994 1995 1996 1997 1998
------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
NET PROVED RESERVES (AT END OF PERIOD):
Natural gas (Bcf)......................... 38 82 170 990 1,050
Oil (MMBbls).............................. -- -- 1 2 2
Total proved reserves (Bcfe).............. 38 83 177 1,025 1,062
Percent proved developed reserves......... 68% 75% 73% 69% 67%
Standardized measure before future income
taxes(1) (in thousands)................. $27,539 $66,170 $192,584 $680,432 $700,196
Standardized measure after future income
taxes(1) (in thousands)................. $21,145 $52,071 $136,175 $519,709 $538,401
Reserve to production ratio(2)............ 51 40 27 45 29
AVERAGE DAILY PRODUCTION:
Natural gas (MMcf per day)................ 2 6 17 61 98
Oil (MBbls per day)....................... -- -- -- -- --
Total production (MMcfe per day).......... 2 6 18 63 100
YEAR END COMMODITY PRICES:
Natural gas ($/Mcf)....................... $ 2.55 $ 3.06 $ 3.68 $ 2.57 $ 2.71
Oil ($/Bbl)............................... $ 15.50 $ 16.50 $ 22.50 $ 15.00 $ 9.00
</TABLE>
- ---------------
(1) Calculation of the standardized measure is made using a 10% discount rate in
accordance with the rules and regulations of the SEC. Includes the value of
Section 29 tax credits and future plugging and abandonment liabilities.
(2) Represents year-end reserves divided by that year's production.
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<PAGE> 111
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following information should be read in conjunction with the
information contained in our financial statements and the notes thereto included
elsewhere in this appendix.
OVERVIEW
As an independent energy producer, we are engaged in the exploration for
and the development, production, gathering, transportation, acquisition and
marketing of natural gas and oil primarily in the Appalachian Basin. We are
principally a natural gas producer, with natural gas making up over 98% of our
net revenue for the year ended December 31, 1998 and the six months ended June
30, 1999. Our average natural gas production increased from 2 MMcfe per day at
year-end 1994 to 104 MMcfe per day in the six-month period ended June 30, 1999.
Our results of operations are determined in large part by the differences
between the prices received for the natural gas produced and the cost to find,
develop, produce, transport and market such natural gas. Changes in sales price
received for our production directly affect our determination to proceed with
the development of natural gas and our quantity of proved reserves. Natural gas
and oil prices are influenced by seasonal factors, natural gas transportation
and storage infrastructure, imports, political and regulatory developments and
competition from other sources of energy and have been volatile over the last
three years. Final prices for prompt month natural gas contracts traded on the
NYMEX for delivery of gas at Henry Hub, Louisiana, have ranged from a low of
approximately $1.67 per MMBtu to a high of approximately $4 per MMBtu during the
period from January 1, 1996 to December 31, 1998. Our production volume growth
in recent years has occurred through exploration and development of our core
holdings, as well as from producing property acquisitions, the most significant
of which was the acquisition of Blazer Energy in July 1997 for $567.1 million.
Based upon the results of operations for the year ended December 31, 1998,
and excluding the effect of our hedging program, a change of $0.10 per Mcf in
the average price of natural gas throughout such period would result in
corresponding changes in operating and net income of $3.8 million and $2.5
million, respectively. We intend to continue to utilize hedging to limit our
exposure to significant declines in market prices and to ensure minimum levels
of cash flow from our sales of natural gas and oil. See "Business and
Properties -- Marketing and Contracts -- Risk Management."
We follow the full cost method of accounting for our natural gas and oil
exploration and production activities. Under this method, we capitalize all
productive and non-productive costs associated with acquisition, exploration and
development activities. The capitalized costs of producing natural gas and oil
properties are depreciated, depleted and amortized by the units-of-production
method based on estimated proved reserves.
We periodically review our proved properties in accordance with Rule
4-10(c)(4) of Regulation S-X to determine whether the unamortized capitalized
costs of such properties less related deferred income taxes, as reflected in our
accounting records, exceeds the estimated discounted future net revenues
attributable to such properties, adjusted for certain items.
We periodically review our other properties to determine whether the
carrying value of such properties as reflected in our accounting records exceeds
the estimated undiscounted future net revenues attributable to such properties.
Based on this review and the continuing evaluation of development plans,
economics and other factors, if appropriate, we would record impairments
(additional depletion and depreciation) pursuant to Statement of Financial
Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed of," to the extent
that the net book values of its other properties exceed the expected discounted
future net revenues. Such impairments would constitute a charge to earnings
which does not impact our cash flow from operating activities. However, such
potential write-downs impact the amount of stockholders' equity and, therefore,
the ratio of debt to equity. We have not incurred impairment charges for the
periods presented. No assurance can be given that we will not experience
impairments in the future.
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RESULTS OF OPERATIONS
Operating results for Eastern States are presented in the tables and
analyses that follow.
OPERATING INCOME
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
----------------------------- -------------------
1996 1997 1998 1998 1999
------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Revenues......................... $18,247 $ 65,368 $104,670 $ 54,677 $ 57,723
Operating expenses............... 2,655 13,454 15,950 7,927 8,043
Depreciation, depletion and
amortization................... 4,783 19,073 31,517 16,520 16,129
General and administrative
expenses....................... 1,630 3,254 5,462 2,249 2,868
Operating income................. $ 9,179 $ 29,587 $ 51,741 $ 27,981 $ 30,683
</TABLE>
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1999
Revenue for the six months ended June 30, 1999 was $57.7 million, or 5.6%
higher than the six months ended June 30, 1998. Natural gas and oil revenues
increased 6.2% to $53.1 million for the six months ended June 30, 1998, compared
to $50.0 million for the six months ended June 30, 1999. This increase was
principally due to higher produced volumes, which increased from 101.7 MMcfe per
day to 103.8 MMcfe per day, and higher average realized selling prices, which
increased from $2.72 per Mcfe to $2.83 per Mcfe.
Operating expenses increased 1.3% from $7.9 million for the six months
ended June 30, 1998 to $8.0 million for the six months ended June 30, 1999. This
increase was due principally to volume increases as operating expenses per Mcfe
for each period approximated $0.43 per Mcfe.
Depreciation, depletion and amortization (DD&A) decreased by 2.4% from
$16.5 million for the six months ended June 30, 1998 to $16.1 million for the
six months ended June 30, 1999. This favorable change in the DD&A rate per Mcfe,
from $0.90 to $0.86, reflects favorable drilling results for the period July
1998 to June 1999, which resulted in increased proved developed and proved
undeveloped gas reserves. The 4.5% decrease in the DD&A rate was partially
offset by additional costs resulting from a 2.1% increase in volumes.
Selling, general and administrative expenses increased 27% from $2.2
million for the six months ended June 30, 1998 to $2.8 million for the six
months ended June 30, 1999. This increase was attributable to increased
investments in information technology.
Interest expense increased from $19.5 million for the six months ended June
30, 1998 to $21.3 million for the six months ended June 30, 1999. This increase
is directly attributable to higher spending in support of development efforts.
Eastern States has a credit facility with Statoil Energy Holdings which provides
for borrowings at a 8% annual fixed interest rate. Outstanding borrowings at
December 31, 1998 were $505.5 million.
Pre-tax income was $9.4 million and $8.5 million for the six months ended
June 30, 1999 and 1998, respectively. The effective income tax rate approximated
36% in each period.
FISCAL YEAR ENDED DECEMBER 31, 1998 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
1997
Revenues for 1998 were $104.7 million, or 60% higher than 1997 revenues of
$65.4 million. The increase in revenues is attributable to the Blazer Energy
acquisition as of July 1, 1997, which increased daily production from 22.6
MMcfe/day to 100.0 MMcfe/day. Production approximated 23 Bcfe in 1997 based on
one-half year of Blazer Energy volumes as compared to approximately 37 Bcfe in
1998. Section 29 tax credits monetized in December 1997, provided $0.8 million
and $9.4 million in additional
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<PAGE> 113
revenues in 1997 and 1998, respectively. Partially offsetting the above revenue
increases was a decrease in the realized gas price from $2.81 per Mcfe in 1997
to $2.61 per Mcfe in 1998.
Operating expenses increased nearly 18% from $13.5 million in 1997 to $15.9
million in 1998. This increase is principally due to a full year of Blazer
Energy operations in 1998. The Company successfully assimilated Blazer Energy
into its operations as operating costs per Mcfe were reduced significantly to
$0.44 per Mcfe in 1998 versus $0.54 per Mcfe in 1997.
Depletion, depreciation and amortization expenses were $0.86 per Mcfe or
$31.5 million in 1998 and $0.83 per Mcfe or $19.1 million in 1997. The higher
rate reflects investments in pipeline infrastructure, approximately $10 million
in total over the two-year period.
Selling, general and administrative expenses increased by 67% to $5.5
million in 1998 from $3.3 million in 1997, reflecting a full year of Blazer
Energy operations and higher development activity.
Interest expense increased from $21.6 million in 1997 to $38.9 million in
1998 as a result of the Blazer Energy acquisition which was funded principally
by additional borrowings from Statoil Energy Holdings. Borrowings from Statoil
Energy Holdings were subject to 8% annual rate of interest.
Income before taxes increased from $8.0 million in 1997 to $12.8 million in
1998. Eastern States was able to use approximately $2.2 million of tax credits
in 1997 to reduce income taxes. This as well as other available credits allowed
Eastern States to realize an income tax benefit of $1.2 million in 1997, while
it had a tax expense of $4.4 million in 1998.
FISCAL YEAR ENDED DECEMBER 31, 1997 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
1996
Revenue increased from $18.2 million in 1996 to $65.4 million in 1997,
which is directly attributable to the July 1, 1997 Blazer Energy acquisition.
Production increased from 17.8 MMcfe/day to 100.0 MMcfe/day and accordingly,
total volume increased from 6.5 Bcfe produced in 1996 to 22.9 Bcfe produced in
1997. The realized selling price was approximately $2.81 per Mcfe in both
periods.
Operating expenses increased from $2.7 million in 1996 to $13.5 million in
1997. This increase was the direct result of the Blazer Energy acquisition and
generally higher development activity.
Depletion, depreciation and amortization expenses were $0.83 per Mcfe, or
$19.1 million, in 1997 and $0.73 per Mcfe, or $4.8 million, in 1996. This dollar
increase is directly related to the increased production volumes resulting from
the Blazer Energy acquisition.
Selling, general and administrative expenses increased from $1.6 million in
1996 to $3.3 million in 1997, due to the additional office personnel and related
expenses associated with the Blazer Energy acquisition.
Interest expense increased from $4.3 million to $21.6 million as a result
of increased borrowings from Statoil Energy Holdings to fund the Blazer Energy
acquisition. Borrowings from Statoil Energy Holdings were based on a fixed
interest rate of 8% per annum.
Income before income taxes increased from $4.8 million in 1996 to $8.0
million in 1997. In 1997, Eastern States realized $2.2 million of tax credits.
This, along with other available credits, resulted in a tax benefit of $1.2
million in 1997, compared to tax expense of $1.0 million in 1996.
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<PAGE> 114
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $40.5 million, $12.2 million, and
$10.3 million in 1998, 1997, and 1996, respectively. The increase from 1997 to
1998 was primarily due to increased revenues and production associated with the
Blazer Energy acquisition. Before changes in working capital, cash flow from
operations was $43.7 million, $24.4 million, and $9.6 million in 1998, 1997, and
1996, respectively.
Generally, Eastern States expects to finance property additions through
borrowings from Statoil Energy Holdings. Development expenditures have generally
been funded by cash flows from operations.
FINANCIAL CONDITION
Total assets increased 5.1% from $626 million at December 31, 1997 to $658
million at December 31, 1998, primarily because of development drilling. As of
December 31, 1998, total capitalization of Eastern States was $631 million, of
which 80% was long-term debt. This compares with capitalization of $606 million
at December 31, 1997, of which 83% was long-term debt.
In August 1999, Statoil Energy Holdings agreed to combine and extend to
December 31, 2001, the final repayment dates of various notes payable to Statoil
Energy Holdings aggregating approximately $505 million at December 31, 1998.
This note has an 8% annual rate of interest, payable semi-annually on January 1
and July 1 each year. At August 24, 1999, the total amount of outstanding
indebtedness under the note payable to Statoil Energy Holdings was approximately
$505 million.
WORKING CAPITAL
Eastern States generally uses available cash to minimize intercompany
indebtedness and, therefore, maintains minimal cash and cash equivalent
balances. Short-term liquidity needs are satisfied by either advances from
Statoil Energy or Statoil Energy Holdings. Working capital of $13.2 million at
December 31, 1998 is primarily attributable to the excess of accounts receivable
over accounts payable.
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<PAGE> 115
CAPITAL EXPENDITURES
The table below sets forth the components of our historical capital
expenditures for the two-years ended December 31, 1997 and 1998 and the
six-month periods ended June 30, 1998 and 1999.
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
------------------ -----------------
1997 1998 1998 1999
-------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Exploration................................... $ 2,531 $ 2,427 $ 1,063 $ 1,000
Development................................... 22,742 69,667 20,696 22,219
Lease acquisition............................. 1,401 345 (225) 205
Proved property acquisition................... 567,136 8,403 2,368 (1,826)
-------- ------- ------- -------
Total............................... $593,810 $80,842 $23,902 $21,598
======== ======= ======= =======
</TABLE>
Our ability to maintain and increase our operating income and cash flow is
dependent upon continued capital spending. We expect that our capital
expenditures in each of 1999 and 2000 will be approximately $44 million to $55
million. We currently expect to drill 200 to 250 net development wells in the
Appalachian Basin during 1999. Our level of capital expenditures may vary in the
future depending on a number of factors, including energy market conditions and
other related economic factors. We have no material long-term commitments
associated with expenditure plans.
Management believes that expected cash flow from operations supplemented by
borrowings, as needed, from Statoil Energy Holdings will be sufficient to fund
its capital expansion plans and working capital requirements. Future cash flows,
however, are subject to a number of variables, such as the level of production
of natural gas and oil and the sales price of natural gas and oil. Accordingly,
management cannot guarantee that future operations will provide cash in
sufficient amounts to maintain current levels of capital expenditures or to meet
our debt service requirements.
To date, we have not spent significant amounts to comply with environmental
or safety regulations, and we currently do not expect to do so during 1999.
However, developments such as new regulations, enforcement policies or claims
for damages could result in significant future costs.
YEAR 2000
The "Year 2000 Problem," or the ability of computer systems to process
dates with years beyond 1999, affects almost all companies and organizations.
Computer systems that are not Year 2000 compliant by January 1, 2000 may cause
material adverse effects to companies and organizations that rely upon those
systems. Continuity of our operations in January 2000 will depend not only on
the performance of our computer systems and computer-controlled equipment, but
also on the compliance of computer systems and computer-controlled equipment of
third parties. These third parties include oil and natural gas purchasers and
significant service providers such as electric utility companies and natural gas
plant, pipeline and gathering system operators.
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<PAGE> 116
Eastern States has reviewed its computer systems and computer-controlled
field equipment and is making the necessary modifications for Year 2000
compliance. Eastern States is completing modifications and testing of its
primary accounting, geography and land computer programs. The remaining computer
systems have been assessed and are compliant. Eastern States expects to complete
remediation and testing of significant remaining systems by the end of September
1999.
Some of Eastern States' critical field equipment, such as natural gas
compressors, are partially controlled or regulated by embedded computer chips.
Based on a preliminary review of all operating areas, Eastern States has
identified no significant compliance exceptions. Eastern States has completed
remediation and testing of identified exceptions for significant
computer-controlled field equipment. Based on its review, remediation efforts
and the results of testing to date, Eastern States does not believe that timely
modification of its computer systems and computer-controlled equipment for Year
2000 compliance represents a material risk. Eastern States estimates that total
costs related to Year 2000 compliance efforts will be less than $200,000 of
which approximately $100,000 has been incurred and expensed through June 30,
1999.
Eastern States has identified significant third parties whose Year 2000
compliance could affect Eastern States and is in the process of formally
inquiring about their Year 2000 status. Eastern States has received responses to
approximately 98% of its inquiries. To date, all respondents, except one, have
indicated that they will be Year 2000 compliant by January 1, 2000. Despite its
efforts to assure that the third parties are Year 2000 compliant, Eastern States
cannot provide assurance that all significant third parties will achieve
compliance in a timely manner. A third party's failure to achieve Year 2000
compliance could have a material adverse effect on Eastern States' operations
and cash flow. For example, a third party might fail to deliver revenue to
Eastern States. The potential effect of Year 2000 non-compliance by third
parties is currently unknown.
Eastern States is currently identifying appropriate contingency plans in
the event of potential problems resulting from failure of Eastern States' or
significant third party computer systems on January 1, 2000. Eastern States has
not completed any contingency plans to date. Specific contingency plans will be
developed by September 30, 1999 in response to the results of scheduled testing,
as well as the assessed probability and risk of system or equipment failure.
NEW ACCOUNTING STANDARDS
We will be required to comply with the provisions of SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" which must be
adopted for fiscal years beginning after June 15, 2000. SFAS No. 133 requires
that derivatives be reported on the balance sheet at fair value and, if the
derivative is not designated as a hedging instrument, changes in fair value must
be recognized in earnings in the period of change. If the derivative is
designated as a hedge and to the extent such hedge is determined to be
effective, changes in fair value are either offset by the change in fair value
of the hedged asset or liability (if applicable) or reported as a component of
other comprehensive income in the period of change, and subsequently recognized
in earnings when the offsetting hedged transaction occurs. The definition of
derivatives has also been expanded to include contracts that require physical
delivery of oil and gas if the contract allows for net cash settlement. We
primarily use derivatives to hedge product price and interest rate risks. These
derivatives are recorded at cost, and gains and losses on such derivatives are
reported when the hedged transaction occurs. Accordingly, adoption of SFAS No.
133 will have an impact on our reported financial position, and although such
impact has not been determined, it is currently not believed to be material.
Adoption of SFAS No. 133 should have no significant impact on reported earnings,
but could materially affect comprehensive income.
PRODUCTION IMBALANCES
We have only immaterial gas production imbalance positions which result
from the balancing of accounts relating to natural gas volumes on our gathering
systems and third party gathering systems that we utilize.
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<PAGE> 117
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We use derivative financial instruments for hedging purposes, including
swap agreements and commodity futures, swaps, and option agreements. These
financial and commodity-based derivative contracts are used to limit the risks
of natural gas price changes. Gains and losses on these derivatives are entirely
offset by losses and gains on the respective hedged exposures.
The Board of Directors has adopted a policy governing the use of derivative
instruments, which requires that all derivatives we use relate to an underlying,
offsetting position, anticipated transaction or firm commitment. The policy
prohibits the use of speculative, highly complex or leveraged derivatives. The
policy also requires review and approval by our President of all risk management
programs using derivatives and all derivative transactions. These programs are
also periodically reviewed by our Board of Directors.
Hypothetical changes in natural gas prices chosen for the estimated
sensitivity effects are considered to be reasonably possible near-term changes
generally based on consideration of past fluctuations for each risk category. It
is not possible to accurately predict future changes in natural gas prices.
Accordingly, these hypothetical changes may not necessarily be an indicator of
probable future fluctuations.
COMMODITY PRICE RISK
Currently, Eastern States hedges a portion of the market risks associated
with its natural gas sales. During 1998, we entered into gas futures contracts
and gas basis swap agreements to reduce exposure to price volatility in the
physical markets. As of December 31, 1998, outstanding futures contracts had a
fair value gain of $8.4 million and outstanding basis swap agreements had a fair
value gain of $2.8 million. These futures contracts and basis swap agreements
are not recorded on our balance sheet at year end, but are recorded in the month
to which the contracts relate. As of December 31, 1997, outstanding futures
contracts had a fair value loss of $2.0 million and outstanding basis swap
agreements had a fair value gain of $1.2 million.
For commodity derivatives that are permitted to be settled in cash or
another financial instrument, sensitivity effects are as follows. At year-end
1998, the aggregate effect of a hypothetical 10% change in natural gas prices
and basis would result in a $1.1 million change in the fair value of these
financial instruments. This sensitivity does not include the effects of gas
contracts that cannot be settled in cash or with another financial instrument.
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<PAGE> 118
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Our Board of Directors consists of five members. Their terms expire at
Eastern States' next annual meeting.
The Board of Directors elects our executive officers annually and those
executive officers serve at the discretion of the Board of Directors.
Information concerning our current directors and executive officers is
provided below.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Johan Nic Vold............................ 52 Chairman of the Board and Director
David A. Dresner.......................... 51 Director
Kristian B. Hausken....................... 47 Director
Jon A. Jacobsen........................... 41 Director
Thor Otto Lohne........................... 42 Director
Clifton A. Brown.......................... 50 President and Chief Executive Officer
Stevens V. Gillespie...................... 42 Senior Vice President and Chief Financial
Officer
James E. Cochran.......................... 38 Senior Vice President -- Operations
Jeffrey E. Fulmer......................... 38 Vice President -- Exploration, Development
and Land
James S. Caballero........................ 45 Vice President -- Engineering,
Acquisitions and Divestitures
Kerry W. Eckstein......................... 43 Vice President, General Counsel and
Secretary
David L. Matz............................. 51 Vice President -- Drilling and Completion
</TABLE>
BACKGROUND OF DIRECTORS AND EXECUTIVE OFFICERS
Johan Nic Vold has served as Executive Vice President of The Statoil Group
since 1988, and has served as Chairman of Statoil Energy's and Eastern States'
Boards of Directors since April 1999.
David A. Dresner has served as President and Chief Executive Officer of
Statoil Energy since June 1996, and as President of Eastern States from 1994
until July 1999. He served as President and Chief Operating Officer for Statoil
Energy and its predecessor from August 1991 through May 1996. Mr. Dresner has
served as a director of Statoil Energy since August 1991 and Eastern States
since 1994.
Kristian B. Hausken has served as Senior Vice President of Strategic
Projects and Restructuring for The Statoil Group since January 1999. From 1993
to 1998, Mr. Hausken served as Senior Vice President of Natural Gas Business
Development of Statoil Energy. He has served as an employee of The Statoil Group
since 1981, and as a Vice President since 1989. He was elected to the Boards of
Directors of Statoil Energy and Eastern States in June 1996.
Jon A. Jacobsen has served as a Senior Vice President of Finance for The
Statoil Group since June 1998 and has served on the Boards of Directors of
Statoil Energy and Eastern States since May 1998. From January 1992 to June
1998, he served with Den Norske Bank (DnB) in positions relating to the energy
and international finance industry, including management of the Asian group
activities for DnB in Singapore.
Thor Otto Lohne has served as the General Manager of the Gas Division of
Statoil (UK) Gas and Chairman of Alliance Gas Limited since August 1996.
Alliance Gas Limited is a marketing subsidiary of The Statoil Group in the
United Kingdom. He joined The Statoil Group in 1983. He was elected to the
Boards of Directors of Statoil Energy and Eastern States in April 1999.
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<PAGE> 119
Clifton A. Brown has been President and Chief Executive Officer of Eastern
States since July 1999. From June 1996 to July 1999, he served as Executive Vice
President of Statoil Energy and Statoil Energy's subsidiaries engaged in natural
gas production and development operations, including Eastern States. He also
served as Senior Vice President of Statoil Energy from January 1994 to June
1996.
Stevens V. Gillespie has served as Senior Vice President and Chief
Financial Officer of Eastern States since July 1999, and from April 1996 to July
1999 as Senior Vice President with Statoil Energy and Eastern States,
responsible for management of the company's Producer Services division. From
1984 to 1996, he served as Chief Financial Officer for Statoil Energy and its
predecessor companies.
James E. Cochran has served as Senior Vice President -- Operations of
Statoil Energy and Eastern States since January 1999 and previously served as
Vice President of Eastern States from July 1997 to January 1999. From January
1988 to June 1997, he performed consulting services for various oil and gas
industry clients, including Eastern States. Since June 1994, he has also owned
and operated Big Sandy Oil Company, which conducts natural gas exploration and
production in the Western Pennsylvania region of Appalachian Basin.
Jeffrey E. Fulmer has served as Vice President -- Exploration, Development
and Land of Statoil Energy and Eastern States since July 1996. From 1989 to July
1996, he held the positions of Director -- Exploration, Manager Exploration
Special Projects, and Project Geologist with Statoil Energy and its predecessor
companies.
James S. Caballero has served as Vice President -- Engineering,
Acquisitions and Divestitures of Statoil Energy and Eastern States since 1994.
From 1990 to 1994, he served as Vice President -- of Engineering, Acquisitions
and Divestitures of Statoil Energy's predecessor companies.
Kerry W. Eckstein has served as Vice President, General Counsel and
Secretary to Eastern States since July 1999 and as Counsel to Statoil Energy
since June 1997. From June 1995 to June 1997, he was the owner and operator of
the Thames Group, which conducted investments in oil and gas and other projects.
From 1990 to 1995, he served as Senior Attorney for the international
exploration and production division of the Atlantic Richfield Company.
David L. Matz has served as a Vice President -- Drilling and Production
since joining Eastern States' predecessor in 1990.
DIRECTORS' COMPENSATION
All directors are also employees of our affiliates and receive no
additional compensation for service on the Board of Directors.
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<PAGE> 120
EXECUTIVE COMPENSATION
The table below provides compensation information for our Chief Executive
Officer and the four other most highly compensated executive officers for the
year ended December 31, 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
-------------------------------
SECURITIES
ANNUAL COMPENSATION OTHER UNDERLYING
---------------------- ANNUAL OPTIONS/ ALL OTHER
SALARY($) BONUS($) COMPENSATION($)(2) SARS(#) COMPENSATION($)(3)
---------- --------- ------------------ ---------- ------------------
<S> <C> <C> <C> <C> <C>
Clifton A. Brown(1)........... 251,667 67,953 -- 15,000 6,200
President and Chief
Executive Officer
Stevens V. Gillespie.......... 185,000 36,920 -- 6,200 5,408
Senior Vice President, Chief
Financial Officer and
Treasurer
James Cochran................. 125,000 19,526 -- 5,000 253
Senior Vice President --
Operations
James S. Caballero............ 119,792 20,776 -- 3,300 3,985
Vice
President -- Engineering,
Acquisitions and
Divestitures
Jeffrey E. Fulmer............. 125,000 23,901 -- 3,300 4,015
Vice
President -- Exploration,
Development and Land
</TABLE>
- ---------------
(1) Mr. Dresner served as President of Eastern States at December 31, 1998. He
also serves as President of Statoil Energy and most other U.S. subsidiaries
of The Statoil Group. Effective July 1999, Mr. Dresner resigned as Eastern
States' President. At such date, Clifton A. Brown, who served as Eastern
States' Executive Vice President, was appointed President. During 1998, none
of Mr. Dresner's compensation was paid for by Eastern States.
(2) Amounts do not include perquisites and other personal benefits, securities
or property, because the total amount of such compensation did not exceed
the lesser of $50,000 or 10% of the total of annual salary and bonus
reported for the named executive.
(3) In the case of Messrs. Brown, Gillespie, Caballero and Fulmer, includes a
$5,000, $5,000, $3,594 and $3,751 employee match for Statoil Energy's 401(k)
plan and a $1,200, $408, $391 and $264 yearly life insurance premium. In the
case of Mr. Cochran, includes a $253 life insurance premium.
The following table shows certain information concerning grants of stock
options and stock appreciation rights, or SARs, during 1998 for officers named
in the Summary Compensation Table.
<TABLE>
<CAPTION>
POTENTIAL REALIZED
PERCENTAGE VALUE AT
NUMBER OF OF TOTAL ASSUMED
SECURITIES OPTIONS/ ANNUAL RATE OF
UNDERLYING SARS STOCK PRICE APPRECIATION
OPTIONS/ GRANTED TO EXERCISE FOR OPTION TERM(1)
SARS EMPLOYEES PRICE EXPIRATION -------------------------
NAME GRANTED IN 1998 ($/SHARE) DATE 5%($) 10%($)
- ---- ---------- ---------- --------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Clifton A. Brown........... 15,000 7.88% $15.06 8/6/2008 $11,295.00 $22,590.00
Stevens V. Gillespie....... 6,200 3.26% 15.06 8/6/2008 $ 4,668.60 $ 9,337.20
James Cochran.............. 5,000 2.63% 15.06 8/6/2008 $ 3,765.00 $ 7,530.00
James S. Caballero......... 3,300 1.73% 15.06 8/6/2008 $ 2,484.90 $ 4,969.80
Jeffrey E. Fulmer.......... 3,300 1.73% 15.06 8/6/2008 $ 2,484.90 $ 4,969.80
</TABLE>
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<PAGE> 121
- ---------------
(1) Based on the fair market value at the date of grant and the stated annual
appreciation rate, compounded annually, for the option term of ten years.
The assumed annual appreciation rates of 5% and 10% were established by the
SEC and therefore are not intended to forecast possible future appreciation,
if any, of the common stock. However, the total potential realized value
shown for the above named executives represents less than 1.5% of the total
appreciation all stockholders would realize.
OPTION/SAR GRANTS IN 1998
INDIVIDUAL GRANTS
Options granted under the Statoil Energy Amended and Restated Incentive
Compensation Plan are granted at fair market value at the date of grant and
generally vest over five years and expire five years after the date of grant.
Shares issued pursuant to option exercise are transfer restricted. See
"-- Employee Shareholders Agreement".
The following table shows information regarding stock options and SARs
exercised during 1998 by the officers named in the Summary Compensation Table
and 1998 year-end values.
AGGREGATED OPTION/SAR EXERCISES IN 1998 AND DECEMBER 31, 1998 OPTION/SAR VALUES
<TABLE>
<CAPTION>
NUMBER OF SHARES VALUE OF
UNDERLYING UNEXERCISED UNEXERCISED IN-THE-MONEY
SHARES OPTIONS/SARS AT OPTIONS/SARS AT
ACQUIRED 12/31/98(#) 12/31/98 ($)
ON VALUE --------------------------- ---------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Clifton A. Brown....... -- $ -- 32,500 37,500 $112,190 $48,810
Stevens V. Gillespie... -- -- 42,950 13,440 216,942 8,970
James E. Cochran....... -- -- -- 5,000 -- --
James S. Caballero..... 4,000 20,400 4,640 8,610 15,010 11,896
Jeffrey E. Fulmer...... -- -- 3,380 7,820 10,609 9,797
</TABLE>
EMPLOYMENT AND CHANGE IN CONTROL AGREEMENTS
Effective February 1, 1999, Messrs. Brown and Gillespie entered into
individual employment agreements with Statoil Energy pursuant to which they
serve as executive officers responsible for Statoil Energy's natural gas
production and development operations, including Eastern States. Mr. Brown's
agreement has a term of 30 months, which is automatically extended so that at
all times the term is 30 months from the current date. Mr. Gillespie's agreement
has a term of 24 months, which is automatically extended so that at all times
the term is 24 months from the current date. The employment agreements contain
customary non-compete and non-solicitation provisions which terminate at the
later of (1) one year after termination of employment or (2) the end of the
period after which the executive continues to receive severance payments after a
change in control.
Mr. Brown's agreement provides for an annual base salary of not less than
$260,000, and Mr. Gillespie's agreement provides for an annual base salary of
not less than $190,000, both of which may be increased at the discretion of the
Board of Directors of Statoil Energy. In addition, Messrs. Brown and Gillespie
are eligible to receive:
- an incentive bonus based on the financial performance of Eastern States
and the evaluation of each of Mr. Brown's and Mr. Gillespie's performance
by the Board of Directors of Statoil Energy;
- stock options awarded at the discretion of Statoil Energy's Board of
Directors consistent with historical practices;
- reimbursement of all reasonable expenses; and
- other benefits including, but not limited to, any retirement benefit
plan, disability, group life, sickness, accident and health insurance
programs provided by Statoil Energy to executives.
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<PAGE> 122
Eastern States may terminate either employment agreement at any time
without cause. Messrs. Brown and Gillespie are then entitled to receive "base
compensation" for the longer of (1) one year, or (2) the time period remaining
under the term of the agreement. "Base compensation" is defined as the
executive's annual base salary plus the average of all incentive bonuses paid to
the executive during the past three years. Each employment agreement further
states that if, within two years following a "change in control" the executive
(a) is terminated without cause or (b) terminates his employment for good
reason, then the executive will be entitled to a severance payment in an amount
equal to
- two and one-half times Mr. Brown's base compensation or two times Mr.
Gillespie's base compensation, respectively, and
- the lesser of
-- 10% of the base compensation or
-- $20,000 adjusted for inflation.
All non-vested stock options will vest automatically upon such termination
and be exercisable until the first anniversary of the executive's termination of
employment with Statoil Energy.
In the event of termination for cause, the executive will be entitled to no
further compensation or payment.
Messrs. Brown and Gillespie may terminate their employment for good reason.
If the executive resigns for good reason, he is entitled to his base
compensation for the longer of (1) one year or (2) the remainder of the term of
the agreement.
Ninety percent of the compensation owed to Mr. Brown and Mr. Gillespie
under these employment agreements is paid for and allocated to Eastern States.
The remaining 10% is allocated to Eastern States Exploration Company.
AMENDED AND RESTATED INCENTIVE COMPENSATION PLAN
Statoil Energy has an Amended and Restated Incentive Compensation Plan
designed to reward and incentivize employees of Statoil Energy and its
subsidiaries based on the financial performance of Statoil Energy and its
subsidiaries and the personal performance of the employee. Incentives offered
under this plan include: (1) incentive stock options, (2) non-qualified stock
options, (3) stock awards, (4) restricted stock awards and (5) performance stock
awards.
The Incentive Plan is administered by a committee appointed by Statoil
Energy's board of directors. Only officers and employees of Statoil Energy and
its subsidiaries, including Eastern States, are eligible for such awards. The
maximum aggregate number of shares of common stock which may be issued under the
Incentive Plan is 500,000 shares. The Incentive Plan will terminate on January
6, 2002.
Incentive Stock Options. Incentive stock options must satisfy the
requirements of Section 422(b) of the Internal Revenue Code of 1986, as amended.
All incentive stock options must be granted by January 6, 2002 and expire no
later than ten (10) years after the date of grant. The exercise price for each
incentive stock option may not be less than the fair market value of the
underlying common stock. No incentive stock options may be granted to any
employee who, at the time the option is granted, would own more than 10% of the
total combined voting power of all classes of stock unless: (1) the exercise
price is equal to at least 110% of the fair market value of the underlying stock
and (2) the option is not exercisable after the expiration of five years from
the grant date.
Non-qualified Stock Options. The exercise price of non-qualified stock
options may be determined by the committee, provided that such price is not less
than 33% of the fair market value of the underlying stock on the grant date. The
term of each non-qualified stock option cannot be longer than ten (10) years
from the date of the grant. Each non-qualified stock option will vest and become
exercisable in accordance with the provisions set forth in each stock option
agreement. Notwithstanding any such vesting provisions,
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<PAGE> 123
any option (whether incentive or non-qualified) will become fully vested and
exercisable: (1) when the employee dies, becomes disabled or attains age 65
while employed by Statoil Energy or one of its subsidiaries or (2) when the
employee's employment is terminated within two (2) years following a
change-in-control.
Stock Awards and Restricted Stock Awards. A stock award of common stock is
issued by Statoil Energy to an employee, without other payment therefor, as
additional compensation for his service to Statoil Energy or one of its
subsidiaries. A restricted stock award is common stock issued, without other
payment, but subject to certain restrictions on sale or transfer as determined
by the committee. All employees receiving a restricted stock award must enter
into an escrow agreement with Statoil Energy outlining the conditions of such
award.
Performance Stock Awards. Performance stock awards are contingent rights to
receive shares dependent upon the achievement of certain performance objectives.
Each performance stock award is evidenced by a written agreement outlining the
specific objectives to be achieved. If the employee attains such objectives,
Statoil Energy will issue shares of common stock equal to the number of
performance stock awards granted by the committee to the employee.
Termination of Employment. Any stock option (whether incentive or
non-qualified) held by an employee and not exercised will be immediately
cancelled upon termination of employment by Statoil Energy or one of its
subsidiaries for cause or as a result of voluntary termination by the employee.
If the employee is terminated for any reason other than for cause, any vested
and unexercised option (whether incentive or non-qualified) will continue to be
exercisable in accordance with the terms of its stock option agreement for a
period of ninety days.
If the employee is terminated for any reason, any restricted stock award or
performance stock award not already issued and vested will be cancelled
immediately.
EMPLOYEE SHAREHOLDER AGREEMENT
Each employee who receives an incentive under the Incentive Plan is
required to enter into a Shareholders Agreement with Statoil Energy which:
- prohibits the transfer of shares received pursuant to option exercises
and other incentive grants to any person other than the holder's
immediate family or to a Statoil Energy affiliate;
- grants a put option to the holder during April and October of each year
at fair market value established according to a formula provided in the
agreement; and
- provides for the mandatory repurchase at fair market value upon
termination or death of the employee of all shares owned by the employee
as a result of awards under the Incentive Plan.
If, within one year from the repurchase of common stock as a result of an
employee's termination without cause or resignation for good reason there is:
(1) an underwritten public offering; (2) a merger, consolidation or sale of all
or substantially all assets; or (3) a transfer of at least 25% of Statoil's
capital stock of Statoil Energy, any of which results in a change in control,
Statoil Energy will pay to the employee the difference between the value of a
share sold in such transaction and the price at which Statoil Energy repurchased
the employee's shares.
SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL OWNERS
Eastern States is a privately held company. All of the outstanding shares
of common stock of Eastern States are owned by Statoil Energy Holdings, Inc., a
wholly owned subsidiary of Statoil Energy.
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<PAGE> 124
INDEX TO FINANCIAL STATEMENTS
EASTERN STATES OIL & GAS, INC.
<TABLE>
<S> <C>
EASTERN STATES OIL & GAS, INC.
Consolidated Financial Statements
Report of Independent Auditors......................... AF-2
Consolidated Balance Sheets as of December 31, 1997 and
1998.................................................. AF-3
Consolidated Statements of Operations for the years
ended December 31, 1996, 1997 and 1998................ AF-4
Consolidated Statements of Stockholder's Equity........ AF-5
Consolidated Statements of Cash Flows for the years
ended December 31, 1996, 1997 and 1998................ AF-6
Notes to Consolidated Financial Statements............. AF-7
Unaudited Consolidated Financial Statements
Unaudited Consolidated Balance Sheets as of December
31, 1998 and June 30, 1999............................ AF-18
Unaudited Consolidated Statements of Operations for the
six month periods ended June 30, 1998 and 1999........ AF-19
Unaudited Consolidated Statements of Cash Flows for the
six month periods ended June 30, 1998 and 1999........ AF-20
Note to Unaudited Consolidated Financial Statements.... AF-21
Unaudited Pro Forma Consolidated Financial Statements
Unaudited Pro Forma Consolidated Balance Sheet as of
June 30, 1999......................................... AF-23
Unaudited Pro Forma Consolidated Statement of
Operations for the year ended December 31, 1998....... AF-24
Unaudited Pro Forma Consolidated Statement of
Operations for the six months ended June 30, 1999..... AF-25
Notes to Unaudited Pro Forma Consolidated Financial
Statements............................................ AF-26
DOMESTIC OPERATIONS OF BLAZER ENERGY CORP. AND SUBSIDIARY
Report of Independent Auditors............................ AF-27
Consolidated Income Statement for the fiscal year ended
September 30, 1996..................................... AF-28
Consolidated Statement of Cash Flows for the year ended
September 30, 1996..................................... AF-29
Notes to Consolidated Financial Statements................ AF-30
Unaudited Domestic Operations of Blazer Energy Corp. and
Subsidiary
Unaudited Consolidated Income Statement for the nine
months ended June 30, 1997............................ AF-38
Unaudited Consolidated Statement of Cash Flows for the
nine months ended June 30, 1997....................... AF-39
Notes to Unaudited Consolidated Financial Statements... AF-40
</TABLE>
AF-1
<PAGE> 125
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholder
Eastern States Oil & Gas, Inc.
We have audited the accompanying consolidated balance sheets of Eastern
States Oil & Gas, Inc. as of December 31, 1997 and 1998, and the related
consolidated statements of operations, stockholder's equity and cash flows for
each of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Eastern States
Oil & Gas, Inc. at December 31, 1997 and 1998, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Vienna, Virginia
August 23, 1999
AF-2
<PAGE> 126
EASTERN STATES OIL & GAS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1998
-------- --------
<S> <C> <C>
Current assets
Accounts receivable -- related party...................... $ 21,795 $ 28,787
Accounts receivable -- trade, net......................... 3,928 7,732
Inventories............................................... 4,112 1,600
Prepaid expenses and other................................ 41 159
-------- --------
Total current assets.............................. 29,876 38,278
-------- --------
Property and equipment, net
Natural gas and oil properties (full cost method)......... 543,777 559,523
Gathering systems......................................... 46,112 56,088
Other property and equipment.............................. 3,496 4,196
-------- --------
Total property and equipment...................... 593,385 619,807
-------- --------
Deferred income taxes....................................... 2,880 --
Other assets................................................ 198 248
-------- --------
Total assets...................................... $626,339 $658,333
======== ========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Accounts payable.......................................... $ 17,389 $ 21,214
Accrued expenses.......................................... 1,691 1,136
Accrued severance and property taxes...................... 739 2,713
-------- --------
Total current liabilities......................... 19,819 25,063
-------- --------
Deferred income taxes....................................... -- 926
Long-term debt.............................................. 503,588 505,488
Intercompany liabilities.................................... 37,834 51,974
Other liabilities........................................... 363 1,801
Stockholder's equity
Common stock ($1 par value, 1,000 shares authorized,
issued and outstanding)................................ 1 1
Additional paid-in capital................................ 51,500 51,500
Retained earnings......................................... 13,234 21,580
-------- --------
Total stockholder's equity........................ 64,735 73,081
-------- --------
Total liabilities and stockholder's equity........ $626,339 $658,333
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
AF-3
<PAGE> 127
EASTERN STATES OIL & GAS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1996 1997 1998
------- ------- --------
<S> <C> <C> <C>
Revenue
Natural gas and oil....................................... $18,247 $64,604 $ 95,315
Tax credit monetization................................... -- 764 9,355
------- ------- --------
18,247 65,368 104,670
------- ------- --------
Costs and expenses
Direct operating costs.................................... 2,655 13,454 15,950
Selling, general and administrative....................... 1,630 3,254 5,462
Depreciation, depletion and amortization.................. 4,783 19,073 31,517
------- ------- --------
9,068 35,781 52,929
------- ------- --------
Income from operations...................................... 9,179 29,587 51,741
Interest expense............................................ 4,338 21,608 38,952
------- ------- --------
Income before income taxes.................................. 4,841 7,979 12,789
Income tax expense (benefit)................................ 956 (1,171) 4,443
------- ------- --------
Net income.................................................. $ 3,885 $ 9,150 $ 8,346
======= ======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
AF-4
<PAGE> 128
EASTERN STATES OIL & GAS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONAL
COMMON PAID-IN RETAINED
STOCK CAPITAL EARNINGS TOTAL
------ ---------- -------- -------
<S> <C> <C> <C> <C>
Balance, December 31, 1995............................ $1 $ 1,500 $ 199 $ 1,700
Net income -- 1996.................................... 3,885 3,885
-- ------- ------- -------
Balance, December 31, 1996............................ 1 1,500 4,084 5,585
Net income -- 1997.................................... 9,150 9,150
Contribution of capital............................... 50,000 50,000
-- ------- ------- -------
Balance, December 31, 1997............................ 1 51,500 13,234 64,735
Net income -- 1998.................................... 8,346 8,346
-- ------- ------- -------
Balance, December 31, 1998............................ $1 $51,500 $21,580 $73,081
== ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
AF-5
<PAGE> 129
EASTERN STATES OIL & GAS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1997 1998
-------- --------- --------
<S> <C> <C> <C>
Cash flows from operating activities
Net income................................................ $ 3,885 $ 9,150 $ 8,346
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation, depletion and amortization............... 4,783 19,073 31,517
Deferred income tax expense (benefit).................. 909 (3,788) 3,806
Net changes in working capital
Accounts receivable.................................... (2,398) (22,960) (10,796)
Inventories............................................ (52) (3,920) 2,512
Prepaid expenses and other............................. (18) (12) (118)
Accounts payable and accrued expenses.................. 3,192 14,701 5,244
-------- --------- --------
Net cash provided by operating activities................... 10,301 12,244 40,511
-------- --------- --------
Cash flows from investing activities
Acquisition of natural gas and oil properties............. (31,760) (450,214) (6,812)
Other additions to natural gas and oil properties......... (24,511) (143,596) (74,030)
Disposition of natural gas and oil properties............. -- 82,300 23,957
Other property additions.................................. (518) (3,197) (1,683)
Other..................................................... 218 (102) 2,017
-------- --------- --------
Net cash used in investing activities....................... (56,571) (514,809) (56,551)
-------- --------- --------
Cash flows from financing activities
Contribution of capital................................... -- 50,000 --
Issuance of long-term debt................................ 28,267 433,955 1,900
Intercompany activity..................................... 18,003 18,610 14,140
-------- --------- --------
Net cash provided by financing activities................... 46,270 502,565 16,040
-------- --------- --------
Net change in cash and cash equivalents..................... -- -- --
Cash and cash equivalents
Beginning of year......................................... -- -- --
-------- --------- --------
End of the year........................................... $ -- $ -- $ --
======== ========= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
AF-6
<PAGE> 130
EASTERN STATES OIL & GAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company
Eastern States Oil & Gas, Inc. ("Company") is a wholly-owned subsidiary of
Statoil Energy Holdings, Inc. ("SEH") and is engaged in natural gas and oil
exploration and production in the states of Ohio, West Virginia and Kentucky.
SEH is a wholly-owned subsidiary of Statoil Energy, Inc. ("STEN") and holds
STEN's interests in various operating entities engaged in energy related
activities.
Principles of consolidation
The consolidated financial statements include the accounts of the Company,
its wholly-owned subsidiaries and its proportionate share of the assets,
liabilities, revenue and expenses of various oil and gas development ventures.
All intercompany accounts and transactions have been eliminated.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts of assets and liabilities and
disclosure of contingent liabilities at the date of the financial statements.
These estimates and assumptions also affect certain amounts of reported revenues
and expenses. Actual results could differ from those estimates.
Derivatives
The Company uses derivatives to hedge product price risks, as opposed to
their use for trading purposes. Gains and losses on commodity futures contracts
and other price risk management instruments are recognized in oil and gas
revenues when the hedged transaction occurs. Cash flows related to derivative
transactions are included in operating activities. In order to qualify for hedge
accounting, the derivative instrument must be designated and effective as a
hedge. If the derivative does not meet these requirements, the derivative
instrument is marked-to-market in income. In the event the hedged item matures,
is sold, or is terminated, the realized and unrealized gains and losses are
recognized in income coincidental with the transaction.
Accounts receivable
Accounts receivable arises primarily from the sale of natural gas. The
Company performs ongoing credit evaluations of its customers to minimize its
exposure to credit risk. The Company's allowance for doubtful accounts, which is
reflected in the consolidated balance sheets as a reduction in accounts
receivable, was $1.0 million and $0.2 million at December 31, 1997 and 1998,
respectively.
Concentration of credit risk
In 1996, 1997 and 1998, sales to Statoil Energy Services, Inc. ("SES"), an
affiliated company, were 85%, 83% and 59%, respectively, of total revenues.
Sales to an unaffiliated purchaser were 23% in 1998. There were no other
customers with purchases of greater than 10% of total revenues for 1996, 1997
and 1998.
Inventories
Inventories, consisting primarily of operating supplies and other materials
used in well drilling, are stated at the lower of cost or market using the
first-in, first-out method.
AF-7
<PAGE> 131
EASTERN STATES OIL & GAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Property and equipment
In accounting for natural gas and oil exploration and development costs,
the Company follows the full cost method of accounting, under which all
productive and nonproductive costs associated with acquisition, exploration and
development activities are capitalized. Depreciation, depletion and amortization
of evaluated costs is provided using the units-of-production method based on
proved natural gas and oil reserves. Estimated restoration and abandonment
costs, net of salvage credits, are taken into account in determining
depreciation and depletion. Capitalized costs may not exceed the present value
of future net revenues from production of proved natural gas and oil reserves,
determined in accordance with procedures prescribed by the Securities and
Exchange Commission.
Gathering systems are depreciated using the straight-line method over the
useful lives of assets (20 to 25 years).
Other property and equipment is stated at original cost and long-lived
assets are reviewed annually in accordance with current accounting standards.
Depreciation of other property and equipment is provided on a straight-line
basis over the useful lives of the assets (5 to 10 years for equipment). Repairs
of property and equipment are charged to expense as incurred.
Accounts payable
Accounts payable includes credit balances to the extent that checks issued
have not been presented to the Company's bank for payment. These credit balances
included in accounts payable were approximately $2.9 million and $5.2 million at
December 31, 1997 and 1998, respectively.
Revenue recognition
The Company records its natural gas and oil revenues on the entitlement
method whereby the Company recognizes revenues based upon its entitled share of
production. As of December 31, 1996, 1997, and 1998, the Company's natural gas
and oil imbalances were not material.
Natural gas measurement
The Company records estimated amounts for natural gas revenues and natural
gas purchase costs based on volumetric calculations under its natural gas sales
and purchase contracts. Variances resulting from such calculations are inherent
in natural gas sales, production, operation, measurement and administration.
Management does not believe that differences between actual and estimated
natural gas revenues are material.
Income taxes
The Company follows the asset and liability method of accounting for income
taxes. Deferred tax assets and liabilities are determined using the tax rate for
the period in which those amounts are expected to be received or paid, based on
temporary differences between the tax bases of assets and liabilities and their
reported amounts. Under this method, the effect of a change in income tax rates
on deferred tax assets and liabilities is recognized as an element of income in
the period the rate change is enacted.
Since 1997, the Company and all Statoil affiliated companies located in the
United States, participate in a tax sharing arrangement, whereby all required
federal income tax returns for 1997 and future years will be filed on a
consolidated basis. For financial reporting purposes, each company accounts for
its income taxes on a separate company basis. Any benefits or detriments
resulting from the consolidation of federal income tax returns will remain with
or be incurred by the holding company, Statoil North America, Inc. ("SNA").
AF-8
<PAGE> 132
EASTERN STATES OIL & GAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Segment reporting
In accordance with Statement of Financial Accounting Standards No. 131
("SFAS 131"), Disclosures about Segments of an Enterprise and Related
Information, the Company has identified only one operating segment, which is the
exploration and production of oil and gas. All the Company's assets are located
in the United States and all of its revenues are attributable to United States
customers.
2. ACQUISITIONS AND DISPOSALS
The following acquisitions have been accounted for using the purchase
method. The results of the acquired operations are included in the accompanying
consolidated financial statements from their respective dates of acquisition:
Purchases of natural gas and oil properties from unaffiliated parties,
recorded at cost exclusive of internal cost capitalization, are as follows (in
millions):
<TABLE>
<CAPTION>
PROVED UNPROVED GATHERING OTHER
RESERVES PROPERTIES SYSTEMS PROPERTY TOTAL
-------- ---------- --------- -------- ------
<S> <C> <C> <C> <C> <C>
1996................................... $ 31.6 $ 0.2 $ 5.8 $ 0.3 $ 37.9
1997................................... 409.9 40.3 31.7 8.4 490.3
1998................................... 0.8 6.0 -- -- 6.8
</TABLE>
In 1997, the Company acquired the stock of Blazer Energy Corporation
(Blazer), a wholly-owned subsidiary of Ashland Inc. for a purchase price of
$567.1 million. Blazer is engaged in the exploration, development, production,
acquisition and marketing of natural gas and oil. Subsequent to the closing of
the transaction, Blazer properties located in the Gulf of Mexico region were
sold to an affiliated company, Statoil Exploration, Inc. ("SEUS"), a
wholly-owned subsidiary of SNA for $82.3 million. In addition, in 1998, the
Company sold certain proved developed reserves along with undeveloped acreage in
approximately 400 non-producing properties for $24.0 million.
AF-9
<PAGE> 133
EASTERN STATES OIL & GAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. PROPERTY AND EQUIPMENT
Investments in property and equipment are comprised of the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1998
-------- --------
<S> <C> <C>
Natural gas and oil properties
Proved.................................................... $523,506 $567,741
Unproved.................................................. 44,066 42,444
-------- --------
Total cost............................................. 567,572 610,185
Accumulated depletion.................................. (23,795) (50,662)
-------- --------
Net book value of natural gas and oil properties............ 543,777 559,523
-------- --------
Gathering systems
Cost...................................................... 47,931 60,507
Accumulated depletion..................................... (1,819) (4,419)
-------- --------
Net book value of gathering systems......................... 46,112 56,088
-------- --------
Other property and equipment
Cost...................................................... 4,036 5,718
Accumulated depreciation and amortization................. (540) (1,522)
-------- --------
Net book value of other property and equipment.............. 3,496 4,196
-------- --------
Net book value of property and equipment.................... $593,385 $619,807
======== ========
</TABLE>
4. PRICE RISK MANAGEMENT AND FINANCIAL INSTRUMENTS
It is the Company's general practice to hedge commodity price risk arising
from its unmatched firm physical commitments to purchase or sell hydrocarbon
products at fixed prices by taking offsetting positions in futures, options and
swaps (collectively, "derivative commodity instruments"). The maturity of these
derivative commodity instruments is matched closely with the underlying physical
commitment. The Company does not hold or issue derivative financial instruments
for speculative or trading purposes.
The Company is exposed to credit risk in the event of non-performance by
counterparts on natural gas forwards, options and swaps. The Company does not
anticipate non-performance by any of these counterparts. The amount of such
exposure is generally the unrealized gain on such contracts.
At December 31, the estimated pre-tax fair values determined by market
quotes, of the Company's derivative commodity instruments were as follows (in
millions):
<TABLE>
<CAPTION>
1997 1998
---------------- -----------------
NOTIONAL FAIR NOTIONAL FAIR
VALUE VALUE VALUE VALUE
-------- ----- -------- ------
<S> <C> <C> <C> <C>
Futures............................................ $36.7 $38.2 $ 8.2 $ 10.0
Swaps.............................................. 58.1 57.2 130.3 137.7
Basis.............................................. 4.4 5.6 10.6 13.4
Options............................................ 71.6 69.0 51.4 50.6
</TABLE>
The Company recognized a $1.2 million loss, a $4.5 million loss and a $7.1
million gain in 1996, 1997 and 1998, respectively, related to its derivative
commodity instruments. Such amounts are reflected as a component of natural gas
and oil revenue.
The carrying value of the Company's accounts receivable, accounts payable
and long-term debt approximate fair value.
AF-10
<PAGE> 134
EASTERN STATES OIL & GAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities". SFAS 133 establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded on the
balance sheet as either an asset or liability measured at its fair value. SFAS
133 requires that changes in the derivative's fair value be recognized currently
in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the income statement. SFAS 133 is
effective for fiscal years beginning after June 15, 2000. The Company has not
determined the method or quantified the effects of adopting SFAS 133 on its
financial statements; however, the Company will adopt SFAS 133 effective January
1, 2001.
In November 1998, the Financial Accounting Standards Board Emerging Issues
Task Force (EITF) issued "Accounting for Contracts Involved in Energy Trading
and Risk Management Activities" (EITF No. 98-10). The EITF provides guidance
regarding the accounting for energy trading contracts which should be applied to
financial statements issued for fiscal years beginning after December 15, 1998.
The application of EITF 98-10 will not have a significant impact on the
Company's financial statements.
5. LONG-TERM DEBT
In August 1999, the Company and SEH agreed to aggregate and extend to
December 31, 2001 the final repayment dates of various notes payable to SEH
aggregating $505.5 million. This note has an 8% annual rate of interest, payable
semi-annually on January 1 and July 1 each year.
During the years ended December 31, 1996, 1997 and 1998, the Company
recorded interest expense due to SEH of $4.8 million, $23.2 million and $40.9
million. All amounts were settled as of the respective year end dates. Interest
expense, in the amount of $0.5 million, $1.5 million and $1.9 million, relating
to unevaluated natural gas and oil properties, has been capitalized as part of
natural gas and oil properties in 1996, 1997 and 1998, respectively.
6. INCOME TAXES
The provision for income taxes is as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1997 1998
---- ------- ------
<S> <C> <C> <C>
Current tax expense
Federal................................................... $ -- $ 1,570 $ --
State..................................................... 47 1,047 637
---- ------- ------
Total current tax expense................................... 47 2,617 637
---- ------- ------
Deferred tax expense (benefit)
Federal................................................... 779 (3,246) 3,261
State..................................................... 130 (542) 545
---- ------- ------
Total deferred tax expense (benefit)........................ 909 (3,788) 3,806
---- ------- ------
Total income tax expense (benefit).......................... $956 $(1,171) $4,443
==== ======= ======
</TABLE>
AF-11
<PAGE> 135
EASTERN STATES OIL & GAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred tax liabilities (assets) are comprised of the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1998
------- --------
<S> <C> <C>
Deferred tax liabilities
Excess of book basis over tax basis:
Natural gas and oil properties......................... $ 4,317 $ 12,709
------- --------
Total deferred tax liabilities.............................. 4,317 12,709
------- --------
Deferred tax assets
Net operating loss carryforwards.......................... -- (10,181)
Minimum tax credit carryforwards.......................... (1,570) (1,570)
Other..................................................... (5,627) (32)
------- --------
Total deferred tax assets................................... (7,197) (11,783)
------- --------
Net deferred income tax liability (asset)................... $(2,880) $ 926
======= ========
</TABLE>
The provision for income taxes differs from the amount of income tax
determined by applying the applicable statutory federal income tax rate to
pre-tax income as a result of the following (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1996 1997 1998
------ ------- -------
<S> <C> <C> <C>
Federal income tax....................................... $1,694 $ 2,793 $ 4,476
Change in valuation allowance............................ (47) -- --
Permanent items.......................................... 1 13 17
Transfer pricing adjustment.............................. (870) (2,249) (1,232)
State and local income taxes............................. 178 505 1,182
Nonconventional fuel source tax credits.................. -- (2,233) --
------ ------- -------
Total income tax expense (benefit)....................... $ 956 $(1,171) $ 4,443
====== ======= =======
</TABLE>
As of December 31, 1998, the Company has available, for income tax
purposes, minimum tax credit carryforwards of approximately $1.5 million, which
do not expire, and net operating loss carryforwards of approximately $25.0
million, which expire in 2006 through 2018. For the years ended December 31,
1996, 1997 and 1998, the Company made income tax payments of $0.1 million, $2.6
million and $0.6 million, respectively.
7. STOCK OPTIONS
Key employees of the Company participate in a STEN sponsored incentive
compensation plan under which stock options may be granted. Each option granted
to an employee entitles the grantee to purchase one share of STEN common stock
at a price equal to its fair market value at the date of the grant. All options
generally vest over five years and expire ten years after the date of grant or
90 days after
AF-12
<PAGE> 136
EASTERN STATES OIL & GAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
termination of employment, whichever is earlier. Transactions involving stock
options under the plan are summarized below:
<TABLE>
<CAPTION>
INCENTIVE NON-
STOCK QUALIFIED OPTION PRICE
OPTIONS OPTIONS TOTAL PER SHARE
--------- --------- ------- ----------------
<S> <C> <C> <C> <C>
Outstanding at December 31, 1995................ 86,500 -- 86,500 $9.15 to $13.80
Granted....................................... 29,500 -- 29,500 $10.75
Canceled...................................... -- -- --
Exercised..................................... -- -- --
------- ------ -------
Outstanding at December 31, 1996................ 116,000 -- 116,000 $9.15 to $13.80
Granted....................................... -- 33,500 33,500 $14.92
Canceled...................................... -- -- --
Exercised..................................... (5,110) -- (5,110) $9.15
------- ------ -------
Outstanding at December 31, 1997................ 110,890 33,500 144,390 $9.15 to $14.92
Granted....................................... -- 44,350 44,350 $15.06
Canceled...................................... -- -- --
Exercised..................................... (4,000) -- (4,000) $9.15 to $10.05
------- ------ -------
Outstanding at December 31, 1998................ 106,890 77,850 184,740 $9.15 to $15.06
======= ====== =======
</TABLE>
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
PRICE PER SHARE
----------------
<S> <C> <C> <C> <C>
Exercisable at December 31, 1996................ 64,600 -- 64,600 $10.33
======= =======
Exercisable at December 31, 1997................ 75,090 -- 75,090 $10.49
======= =======
Exercisable at December 31, 1998................ 86,690 6,700 93,390 $10.87
======= ====== =======
</TABLE>
Management has reviewed SFAS 123, "Accounting for Stock-Based
Compensation", which outlines a fair value based method of accounting for stock
options or similar equity instruments and has elected to continue using the
intrinsic value based method of accounting, as prescribed by Accounting
Principles Board Opinion No. 25. Accordingly, no compensation expense has been
recorded in the accompanying financial statements.
Net income would be $3.8 million in 1996, $9.1 million in 1997 and $8.3
million in 1998 had the Company adopted the fair value based accounting model
set forth in SFAS 123. Under the fair value based method, the weighted average
fair values of options granted during 1996, 1997 and 1998 were $2.88, $4.00 and
$4.04, respectively. The fair value of stock options were calculated using the
minimum value method with the following weighted average assumptions for grants
in 1996, 1997 and 1998: risk free interest rate of 6.25%; no expected dividend
yield; and an expected option life of five years. The fair value of stock
options included in the pro forma results for 1996, 1997 and 1998 are not
necessarily indicative of future effects on net income.
8. RELATED PARTY TRANSACTIONS
Accounts receivable with related party consists of accrued natural gas
sales to SES.
AF-13
<PAGE> 137
EASTERN STATES OIL & GAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Intercompany liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1998
-------- --------
<S> <C> <C>
STEN........................................................ $(14,858) $(81,773)
SES, receivable in 1998..................................... (7,502) 39,580
ESEC........................................................ (15,474) (9,781)
-------- --------
$(37,834) $(51,974)
======== ========
</TABLE>
The intercompany activity with STEN consists of amounts due for
payroll-related costs, fixed asset additions, corporate taxes, interest payments
to SEH on behalf of the Company and other cash transactions to and from STEN.
The intercompany activity with SES relates to marketing of natural gas to SES
and fees for risk management services provided to the Company. Eastern States
Exploration Company ("ESEC") is a wholly-owned subsidiary of SEH engaged in
natural gas and oil exploration and production in Pennsylvania. The intercompany
payable to ESEC consists primarily of amounts due for drilling expenditures,
certain operating costs and other transactions related to cash management
activities.
See Note 5 for debt and interest transactions between the Company and SEH.
9. PROFIT SHARING PLAN
Substantially all full-time employees of the Company participate in a STEN
sponsored profit sharing plan that includes an employee savings feature under
Section 401(k) of the Internal Revenue Code. Participants can elect to defer up
to 15% of their total compensation through contributions to the plan and STEN
matches 50% of employee contributions up to 6% of an employee's total
compensation. Effective January 1, 1997, the vesting schedule for STEN's
contributions was shortened from seven to five years.
For the years ended December 31, 1996, 1997 and 1998, charges to income for
the Company's share of contributions to the plan aggregated $0.02 million, $0.10
million, and $0.20 million, respectively. STEN also made supplemental
contributions, a portion of which benefited Company participants, for the years
ended December 31, 1996 and 1997 in the amounts of $0.15 million and $0.30
million, respectively.
10. COMMITMENTS AND CONTINGENT LIABILITIES
The Company leases facilities and operating equipment from third parties
under operating lease arrangements, certain of which contain renewal or purchase
options. Total charges to income for rent expense aggregated $0.4 million in
1996, $0.9 million in 1997 and $1.8 million in 1998.
Future minimum lease commitments under operating leases in each of the five
years subsequent to December 31, 1998 are $1.1 million in 1999, $1.0 million in
2000, $0.9 million in 2001, $0.8 million in 2002, $0.8 million in 2003 and $3.0
million thereafter.
The Company has employment agreements with two of its executive officers
that provide for severance payments and accelerated vesting of options upon
termination of employment under certain circumstances. The Company's maximum
contingent obligation for severance payments under these agreements in such
event was approximately $1.4 million at December 31, 1998.
The Company is involved in various legal actions and claims arising in the
normal course of business. Based upon its current assessment of the facts, and
the law, management does not believe that the outcome of any such action or
claim will have a material adverse effect upon the consolidated financial
position or results of operations of the Company. However, these actions against
the Company are subject to the uncertainties inherent in any litigation.
AF-14
<PAGE> 138
EASTERN STATES OIL & GAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. MONETIZATION OF SECTION 29 TAX CREDITS
In 1997, the Company entered into a transaction with a financial
institution under which it monetized $43 million of future Section 29 credits
related to its working interests in approximately 1,500 gross wells. In
consideration, the Company received a production payment and a note which
entitles it to all of the cash flow from the properties until approximately 95%
of the expected, pre-tax net present value of the presently projected future
production from the properties has been received, which is expected to occur in
the year 2018. In addition to the note and production payment, the Company
received a fixed cash payment at closing of $7.9 million (recorded as a
reduction to the book value of oil and gas properties) and will receive
quarterly payments equal to a specified percentage of the Section 29 tax credits
generated from the properties through 2002. The Company also retained a
reversionary interest in the properties pursuant to which 100% of the interests
in the properties transferred will revert to the Company when 100% of currently
projected future production from the properties has been realized.
Based on current law, Section 29 tax credits will be available until
December 31, 2002. The Company has the option to repurchase the properties after
December 31, 2002 at the fair market value of the properties at the time of
repurchase less the value of the outstanding note and production payment and the
value of the reversionary interest. The Company has also entered into a
management services agreement with the buyer pursuant to which the Company will
manage and operate the properties on behalf of the buyer.
12. SUBSEQUENT EVENT
SNA's parent company, Statoil Group -- Norway ("Statoil") is seeking a
strategic partner with which to join forces in the U.S. energy market, whereby
its assets and business would be combined with the complementary assets and
business activities of a strategic partner. The combined entity will pursue
business opportunities in the unregulated sector of the U.S. energy market.
13. RESERVE INFORMATION (UNAUDITED)
Costs incurred in the Company's natural gas and oil operations, including
internal capitalization allocations, were as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1996 1997 1998
------- -------- -------
<S> <C> <C> <C>
Exploration............................................ $ 1,956 $ 3,932 $ 2,772
Development............................................ 13,535 22,743 69,667
Acquisitions
Natural gas and oil properties....................... 33,115 534,198 8,403
Gathering systems.................................... 7,665 32,937 --
Production costs, net of service fees.................. 2,414 6,866 10,089
------- -------- -------
$58,685 $600,676 $90,931
======= ======== =======
</TABLE>
Depreciation, depletion and amortization relating to natural gas and oil
operations for the years ended December 31, 1996, 1997, and 1998 was $4.7
million, $18.9 million, and $30.6 million, respectively.
The following tables set forth information with respect to the Company's
estimated proved natural gas and oil reserves, all of which are located in the
continental United States. The information has been reviewed by Ryder Scott
Company, L.P., an independent petroleum engineering firm, as of December 31,
1998.
The table of proved natural gas and oil reserves represents estimated
quantities of natural gas, oil and natural gas liquids which geological and
engineering data demonstrate to be recoverable in future years
AF-15
<PAGE> 139
EASTERN STATES OIL & GAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
from known reservoirs under existing economic and operating conditions. The
proved reserves are further classified as developed and undeveloped. The
reserves described below and the related standardized measures of discounted net
cash flows are estimates only and do not purport to reflect realizable values or
fair market values of the Company's reserves. The Company emphasizes that
reserve estimates are inherently imprecise. Substantial revisions to existing
reserve estimates occur periodically due to additional production history from
each well, current-year drilling activity and other new geologic or reserve
characteristic information that may be discovered each year.
The Company's estimates of proved developed and undeveloped reserves of
natural gas (99% in 1998) and oil (1% in 1998) expressed in millions of cubic
feet equivalents (MMcfe) as of December 31, 1996, 1997, 1998, and the change in
its proved reserves are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1997 1998
------- --------- ---------
<S> <C> <C> <C>
Proved developed and undeveloped reserves
Beginning of year.................................. 82,656 176,673 1,025,315
Production......................................... (6,825) (24,192) (38,514)
Revisions of previous estimates.................... 5,801 (5,521) 150
Acquisitions of reserves in place.................. 64,732 913,104 1,293
Disposition of reserves in place................... (5,336) (51,144) (22,356)
Extensions, discoveries and other revisions........ 35,645 16,395 95,850
------- --------- ---------
End of year........................................ 176,673 1,025,315 1,061,738
======= ========= =========
Proved developed reserves at end of year............. 129,749 715,664 709,305
======= ========= =========
</TABLE>
Standardized Measure of Discounted Future Net Cash Flows (in thousands)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1996 1997 1998
--------- ---------- ----------
<S> <C> <C> <C>
Future cash flows................................ $ 649,856 $2,670,246 $2,901,515
Future development costs......................... (28,428) (175,215) (195,499)
Future production costs.......................... (125,680) (554,171) (548,361)
Future income tax expense........................ (155,599) (547,697) (632,829)
--------- ---------- ----------
Future net cash flows............................ 340,149 1,393,163 1,524,826
Discount at 10% per annum for timing of cash
flows.......................................... (203,974) (873,454) (986,425)
--------- ---------- ----------
Discounted future net cash flows................. $ 136,175 $ 519,709 $ 538,401
========= ========== ==========
</TABLE>
AF-16
<PAGE> 140
EASTERN STATES OIL & GAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1997 1998
-------- --------- --------
<S> <C> <C> <C>
Balance, beginning of year.......................... $ 52,071 $ 136,175 $519,709
Sales, net of production costs...................... (16,337) (60,528) (77,983)
Extensions and discoveries, net of production
costs............................................. 47,708 13,162 72,593
Acquisitions of developed reserves in place......... 56,958 466,177 928
Acquisitions of undeveloped reserves in place....... -- 157,903 --
Disposition of reserves in place.................... (5,672) (32,184) (24,826)
Change in sales prices, net of production costs..... 27,458 (68,043) 14,319
Changes in estimated future development costs....... (27) 3,731 (11,761)
Previously estimated development cost incurred
during the year................................... 4,500 7,410 17,617
Revisions of quantity estimates..................... (3,318) (3,376) 4,923
Accretion of discount............................... 6,331 18,333 64,406
Change in income taxes.............................. (36,975) (109,351) 6,388
Changes in production rates and other............... 3,478 (9,700) (47,912)
-------- --------- --------
Balance, end of year................................ $136,175 $ 519,709 $538,401
======== ========= ========
</TABLE>
The standardized measure of discounted future net cash flows (discounted at
10%) relating to proved natural gas and oil reserves is prescribed by SFAS
Statement No. 69, "Disclosures About Oil and Gas Producing Activities." The
statement requires measurement of future net cash flows through assignment of a
monetary value to proved reserve quantities and changes therein using a
standardized formula. The amounts shown above were developed as follows:
1. An estimate was made of the quantity of proved reserves and the
future periods in which they are expected to be produced based on
year-end economic conditions.
2. Year-end prices in effect for each respective year were applied to
the estimated quantities of year-end reserves. Prices remained
constant, except in instances where fixed and determinable gas
price escalations are provided by contracts. The average prices
used at December 31, 1996, 1997, and 1998 were $3.68, $2.57, and
$2.71 per Mcf of natural gas and $22.50, $15.00, and $9.00 per
barrel of oil, respectively.
3. The future gross cash inflows were reduced by estimated future
costs of developing and producing the proved reserves and the
estimated effect of future income taxes. The principal sources of
changes in the standardized measure of future net cash flows are
described above.
AF-17
<PAGE> 141
EASTERN STATES OIL & GAS, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1998 1999
------------ -----------
(AUDITED) (UNAUDITED)
<S> <C> <C>
Current assets
Accounts receivable -- related party...................... $ 28,787 $ 17,048
Accounts receivable -- trade, net......................... 7,732 7,298
Inventories............................................... 1,600 1,633
Prepaid expenses and other................................ 159 143
-------- --------
Total current assets.............................. 38,278 26,122
-------- --------
Property and equipment, net
Natural gas and oil properties (full cost method)......... 559,523 563,767
Gathering systems......................................... 56,088 57,106
Other property and equipment.............................. 4,196 4,428
-------- --------
Total property and equipment...................... 619,807 625,301
-------- --------
Other assets................................................ 248 444
-------- --------
Total assets...................................... $658,333 $651,867
======== ========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Accounts payable.......................................... $ 21,214 $ 9,579
Accrued expenses.......................................... 1,136 991
Accrued severance and property taxes...................... 2,713 2,140
-------- --------
Total current liabilities......................... 25,063 12,710
-------- --------
Deferred income taxes....................................... 926 3,766
Long-term debt.............................................. 505,488 505,488
Intercompany liabilities.................................... 51,974 48,217
Other liabilities........................................... 1,801 2,559
Stockholder's equity
Common stock ($1 par value, 1,000 shares authorized,
issued and outstanding)................................ 1 1
Additional paid-in capital................................ 51,500 51,500
Retained earnings......................................... 21,580 27,626
-------- --------
Total stockholder's equity........................ 73,081 79,127
-------- --------
Total liabilities and stockholder's equity........ $658,333 $651,867
======== ========
</TABLE>
The accompanying note is an integral part of these financial statements.
AF-18
<PAGE> 142
EASTERN STATES OIL & GAS, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-----------------
1998 1999
------- -------
<S> <C> <C>
Revenue
Natural gas and oil....................................... $50,034 $53,149
Tax credit monetization................................... 4,643 4,574
------- -------
54,677 57,723
------- -------
Costs and expenses
Direct operating costs.................................... 7,927 8,043
Selling, general and administrative....................... 2,249 2,868
Depreciation, depletion and amortization.................. 16,520 16,129
------- -------
26,696 27,040
------- -------
Income from operations...................................... 27,981 30,683
Interest expense............................................ 19,513 21,265
------- -------
Income before income taxes.................................. 8,468 9,418
Income tax expense.......................................... 3,112 3,372
------- -------
Net income.................................................. $ 5,356 $ 6,046
======= =======
</TABLE>
The accompanying note is an integral part of these financial statements.
AF-19
<PAGE> 143
EASTERN STATES OIL & GAS, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-------------------
1998 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities
Net income................................................ $ 5,356 $ 6,046
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation, depletion and amortization............... 16,520 16,129
Deferred income tax expense............................ 2,857 2,840
Net changes in working capital
Accounts receivable.................................... 4,943 12,173
Inventories............................................ 820 (33)
Prepaid expenses and other............................. (29) 16
Accounts payable and accrued expenses.................. (8,386) (12,353)
-------- --------
Net cash provided by operating activities................... 22,081 24,818
-------- --------
Cash flows from investing activities
Acquisition of natural gas and oil properties............. (1,695) (140)
Other additions to natural gas and oil properties......... (22,207) (21,458)
Disposition of natural gas and oil properties............. 23,673 --
Other..................................................... (277) 537
-------- --------
Net cash used in investing activities....................... (506) (21,061)
-------- --------
Cash flows from financing activities
Issuance of long-term debt................................ 1,900 --
Intercompany activity..................................... (23,475) (3,757)
-------- --------
Net cash used in financing activities....................... (21,575) (3,757)
-------- --------
Net change in cash and cash equivalents..................... -- --
Cash and cash equivalents
Beginning of year......................................... -- --
-------- --------
End of the year........................................... $ -- $ --
======== ========
</TABLE>
The accompanying note is an integral part of these financial statements.
AF-20
<PAGE> 144
EASTERN STATES OIL & GAS, INC.
NOTE TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. FINANCIAL STATEMENT PRESENTATION
Eastern States Oil & Gas, Inc ("Company") is a wholly-owned subsidiary of
Statoil Energy Holding, Inc. ("SEH") and is engaged in natural gas and oil
exploration and production in the states of Ohio, West Virginia and Kentucky.
SEH is a wholly-owned subsidiary of Statoil Energy, Inc. ("STEN") and holds
STEN's interests in various operating entities engaged in energy related
activities.
The accompanying condensed consolidated financial statements of the Company
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions for Article 10 of
Regulation S-X. The consolidated balance sheet as of June 30, 1999, the
consolidated statements of operations for the six months ended June 30, 1998 and
1999 and the consolidated statements of cash flows for the six month periods
ended June 30, 1998 and 1999 are unaudited but include all adjustments
(consisting of only normal recurring adjustments) which the Company considers
necessary for a fair presentation of the financial position at such dates and
the operating results and cash flows for those periods. Although the Company
believes that the disclosures in the accompanying consolidated financial
statements are adequate to make the information presented not misleading,
certain information normally included in financial statements and related
footnotes prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission. The December 31, 1998 consolidated balance
sheet data included herein were derived from audited consolidated financial
statements but do not include all disclosures required by generally accepted
accounting principles. The accompanying financial statements should be read in
conjunction with the consolidated financial statements for the year ended
December 31, 1998 and related footnotes as contained within this Form S-1.
The unaudited consolidated financial statements include the accounts of the
Company, its wholly-owned subsidiaries and its proportionate share of the
assets, liabilities, revenue and expenses of various oil and gas development
ventures. All intercompany accounts and transactions have been eliminated.
AF-21
<PAGE> 145
EASTERN STATES OIL & GAS, INC.
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
The accompanying Unaudited Pro Forma Consolidated Financial Statements of
Eastern States Oil & Gas, Inc. ("the Company") have been prepared by recording
pro forma adjustments to the historical consolidated financial statements of the
Company. The Unaudited Pro Forma Consolidated Balance Sheet as of June 30, 1999
has been prepared as if the Trust Offering, as described in Note 3, was
consummated on June 30, 1999. The Unaudited Pro Forma Consolidated Statements of
Operations for the year ended December 31, 1998 and for the six months ended
June 30, 1999 have been prepared as if the Trust Offering was consummated
immediately prior to January 1, 1998 and January 1, 1999, respectively.
The Unaudited Pro Forma Consolidated Financial Statements are not
necessarily indicative of the financial position or results of operations which
would have occurred had the transactions occurred on the assumed dates.
Additionally, future results may vary significantly from the results reflected
in the Unaudited Pro Forma Consolidated Statements of Operations due to normal
production declines, changes in prices, future transactions and other factors.
These statements should be read in conjunction with the Company's audited
consolidated financial statements and the related notes for the year ended
December 31, 1998, included in this prospectus.
AF-22
<PAGE> 146
EASTERN STATES OIL & GAS, INC.
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
JUNE 30, 1999
ASSETS
<TABLE>
<CAPTION>
PRO FORMA ADJUSTMENTS (NOTE 3)
-------------------------------------
TRUST TOTAL
HISTORICAL OFFERING (A) PRO FORMA
---------- ------------ ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Current assets
Accounts receivable -- related party...................... $ 17,048 $
Accounts receivable -- trade, net......................... 7,298
Inventories............................................... 1,633
Prepaid expenses and other................................ 143
-------- --------- --------
Total current assets.............................. 26,122
-------- --------- --------
Property and equipment, net
Natural gas & oil properties (full cost method)........... 563,767
Gathering systems......................................... 57,106
Other property and equipment.............................. 4,428
-------- --------- --------
Total property and equipment...................... 625,301
-------- --------- --------
Other assets................................................ 444
-------- --------- --------
Total assets...................................... $651,867 $ $
======== ========= ========
</TABLE>
LIABILITIES AND STOCKHOLDER'S EQUITY
<TABLE>
<S> <C> <C> <C>
Current liabilities
Accounts payable.......................................... $ 9,579
Accrued expenses.......................................... 991
Accrued severance & property taxes........................ 2,140
-------- --------- --------
Total current liabilities......................... 12,710
-------- --------- --------
Deferred income taxes....................................... 3,766 $
Long-term debt.............................................. 505,488
Intercompany liabilities.................................... 48,217
Other liabilities........................................... 2,559
Stockholder's equity
Common stock ($1 par value, 1,000 shares authorized, issued
and outstanding).......................................... 1
Additional paid-in capital.................................. 51,500
Retained earnings........................................... 27,626
-------- --------- --------
Total stockholder's equity........................ 79,127
-------- --------- --------
Total liabilities and stockholder's equity........ $651,867 $ $
======== ========= ========
</TABLE>
See accompanying notes to pro forma consolidated financial statements.
AF-23
<PAGE> 147
EASTERN STATES OIL & GAS, INC.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
PRO FORMA ADJUSTMENTS (NOTE 3)
-------------------------------------
TRUST TOTAL
HISTORICAL OFFERING (B) PRO FORMA
---------- ------------ ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Revenue
Natural gas and oil....................................... $ 95,315 $ $
Tax credit monetization................................... 9,355
-------- -------- -------
104,670
-------- -------- -------
Costs and expenses
Direct operating costs.................................... 15,950
Selling, general and administrative....................... 5,462
Depreciation, depletion and amortization.................. 31,517
-------- -------- -------
52,929
-------- -------- -------
Income from operations...................................... 51,741
Interest expense............................................ 38,952
-------- -------- -------
Income before income taxes.................................. 12,789
Income tax expense.......................................... 4,443
-------- -------- -------
Net income.................................................. $ 8,346 $ $
======== ======== =======
</TABLE>
See accompanying notes to pro forma consolidated financial statements.
AF-24
<PAGE> 148
EASTERN STATES OIL & GAS, INC.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1999
<TABLE>
<CAPTION>
PRO FORMA ADJUSTMENTS (NOTE 3)
-------------------------------------
TRUST TOTAL
HISTORICAL OFFERING (B) PRO FORMA
---------- ------------ ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Revenue
Natural gas and oil....................................... $53,149 $ $
Tax credit monetization................................... 4,574
------- -------- -------
57,723
------- -------- -------
Costs and expenses
Direct operating costs.................................... 8,043
Selling, general and administrative....................... 2,868
Depreciation, depletion and amortization.................. 16,129
------- -------- -------
27,040
------- -------- -------
Income from operations...................................... 30,683
Interest expense............................................ 21,265
------- -------- -------
Income before income taxes.................................. 9,418
Income tax expense.......................................... 3,372
------- -------- -------
Net income.................................................. $ 6,046 $ $
======= ======== =======
</TABLE>
See accompanying notes to pro forma consolidated financial statements.
AF-25
<PAGE> 149
EASTERN STATES OIL & GAS, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying Unaudited Pro Forma Consolidated Balance Sheet at June 30,
1999 has been prepared assuming Eastern States Oil & Gas, Inc. ("the Company")
consummated the sale of 75% of the Appalachian Basin Royalty Trust units to the
public ("Trust Offering") on June 30, 1999 (Note 3). The Unaudited Pro Forma
Consolidated Statements of Operations for the year ended December 31, 1998 and
the six months ended June 30, 1999 have been prepared assuming the Company
consummated the Trust Offering immediately prior to January 1, 1998 and January
1, 1999, respectively. The Unaudited Pro Forma Consolidated Statements of
Operations are not necessarily indicative of the results of operations had the
above-described transactions occurred on the assumed dates.
2. APPALACHIAN BASIN ROYALTY TRUST OFFERING
The Company formed the Appalachian Basin Royalty Trust in August 1999. The
Company plans to sell , or %, of the Appalachian Basin Royalty Trust
Units to the public in September or October 1999. An additional %, or
units, may be sold pursuant to exercise of the underwriters'
overallotment option. The offering price to the public will be $ per Trust
unit.
3. PRO FORMA ADJUSTMENTS
Pro Forma adjustments necessary to adjust the Consolidated Balance Sheet
and Statements of Operations are as follows:
(a) To record net proceeds of $ received by the Company upon
consummation of the Trust Offering, reflecting the sale of
Appalachian Basin Royalty Trust Units by the Company to the public at a
price of $ per unit, less underwriters' discount and estimated
expenses. This transaction has been reflected as a reduction of natural
gas and oil properties, as it has an immaterial impact on the Company's
depletion rate. All proceeds from the offering will be used to repay
debt to a related party. Income taxes have been adjusted using a
corporate rate of 34%.
(b) To record reduction of revenue and expenses related to the sale of
Appalachian Basin Royalty Trust units, assuming the underwriters'
overallotment option is not exercised (Note 2), a $2.3 million loss on
the termination of natural gas hedged contracts, the reduction in
interest expense attributable to a decrease in long-term debt upon
application of net proceeds of $ from the Trust Offering (Note
3(a)) and the related decrease in federal income tax at the Company's
effective tax rate. Interest expense was determined using the interest
rate of 8% incurred by the Company under its long-term note payable.
AF-26
<PAGE> 150
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholder
Eastern States Oil & Gas, Inc.
We have audited the accompanying consolidated income statement and cash
flows for the domestic operations of Blazer Energy Corp. and subsidiary
(formerly Ashland Exploration, Inc.) for the year ended September 30, 1996.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated results of domestic operations and
cash flows for Blazer Energy Corp. and subsidiary for the year ended September
30, 1996, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Vienna, Virginia
August 23, 1999
AF-27
<PAGE> 151
DOMESTIC OPERATIONS OF BLAZER ENERGY CORP. AND SUBSIDIARY
CONSOLIDATED INCOME STATEMENT
YEAR ENDED SEPTEMBER 30, 1996
(IN THOUSANDS)
<TABLE>
<S> <C>
Revenues:
Sales and operating revenues:
Natural gas............................................ $ 94,750
Crude oil.............................................. 3,759
Columbia Gas settlement (Note 5).......................... 73,139
Other (Note 6)............................................ 1,671
--------
173,319
--------
Cost and expenses:
Operating expenses........................................ 32,642
NORM reclamation/litigation (Note 3)...................... 3,049
Depreciation, depletion and amortization (Note 1)......... 28,921
General and administrative expenses (Note 7).............. 15,658
Exploration costs, including dry holes.................... 11,204
--------
91,474
--------
Operating income............................................ 81,845
Interest expense............................................ 195
--------
Income before income taxes.................................. 81,650
Income tax expense (Note 2)................................. 19,132
--------
Net income.................................................. $ 62,518
========
</TABLE>
The accompanying notes are an integral part of these financial statements.
AF-28
<PAGE> 152
DOMESTIC OPERATIONS OF BLAZER ENERGY CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
YEAR ENDED SEPTEMBER 30, 1996
(IN THOUSANDS)
<TABLE>
<S> <C>
Cash flows from operating activities
Net income................................................ $ 62,518
Adjustments to reconcile income to net cash provided by
operating activities:
Depreciation, depletion and amortization............... 28,921
Impairment of undeveloped leaseholds................... 2,128
Deferred income taxes.................................. 4,438
Changes in operating assets and liabilities:
Accounts receivable.................................... (4,288)
Inventories............................................ 300
Prepaids and other current assets...................... (766)
Trade accounts payable................................. 25,840
Accrued liabilities.................................... 2,438
Other.................................................. (1,961)
--------
Net cash provided by operating activities................... 119,568
--------
Cash flows from investing activities
Property, plant and equipment:
Additions.............................................. (45,091)
Property disposals..................................... 2,149
--------
Net cash used in investing activities....................... (42,942)
--------
Increase in net obligations with affiliated Companies....... $ 76,626
========
</TABLE>
The accompanying notes are an integral part of these financial statements.
AF-29
<PAGE> 153
DOMESTIC OPERATIONS OF BLAZER ENERGY CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1996
1. SIGNIFICANT ACCOUNTING POLICIES
Background
Blazer Energy Corp. and subsidiary (formerly Ashland Exploration, Inc.)
("Company") operated both domestic and international exploration and production
activities. Immediately prior to the acquisition of the Company by a subsidiary
of Statoil Energy, Inc. (see Note 10), Ashland Inc. (parent company of Blazer
Energy Corp.) removed all international exploration and production operations of
the Company. The accompanying financial statements reflect all domestic
exploration and production operations. The Company is engaged in the exploration
for and the development, production, acquisition and marketing of natural gas
and oil in the United States.
Consolidation
The financial statements include the domestic accounts of Blazer Energy
Corp. and subsidiary. Significant intercompany accounts and transactions have
been eliminated in consolidation. Consistent with industry practice, the Company
utilizes pro rata consolidation to account for its investment in oil and gas
ventures.
Risk and uncertainties
The preparation of the Company's consolidated financial statements in
conformity with generally accepted accounting principles requires the Company's
management to make estimates and assumptions that affect the reported amounts of
revenues and expenses. Actual results could differ from the estimates and
assumptions used.
Inventories
Crude oil inventories are stated at current market value. Materials and
supplies inventories are stated at the lower of cost or market.
Property, plant and equipment
The successful efforts method of accounting is followed for costs incurred
in oil and gas exploration and development activities. Property acquisition
costs and exploratory drilling costs for oil and gas properties are initially
capitalized. If and when exploratory wells are determined to be nonproductive,
the related costs are charged to expense. Other exploration costs, including
geological, geophysical and lease rentals, are charged to expense as incurred.
When a property is determined to contain proved reserves, property
acquisition costs and related exploratory drilling costs are transferred to
producing properties. Depreciation, depletion and amortization of producing
properties are computed separately on a field basis using the
units-of-production method.
Significant unproved properties are periodically evaluated and provision
made for impairment individually. Insignificant properties are amortized to
provide for estimated impairment.
AF-30
<PAGE> 154
DOMESTIC OPERATIONS OF BLAZER ENERGY CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Environmental Costs
Accruals for environmental costs are recognized when it is probable that a
liability has been incurred and the amount of that liability can be reasonably
estimated. Such costs are charged to expense if they are related to the
remediation of conditions caused by past operations, or are not expected to
mitigate or prevent contamination from future operations. Accruals are recorded
at undiscounted amounts based on experience, assessments and current technology
and are regularly adjusted as environmental assessments and remediation efforts
proceed.
Natural Gas Revenues
Natural gas revenues generally are recorded using the sales method, whereby
the Company recognizes natural gas revenues based on the amount of gas sold to
purchasers on its behalf. As of September 30, 1996, the Company did not have any
material gas imbalances.
Crude Oil Revenues
Crude oil revenue is recognized as produced.
Dismantlement, Removal and Restoration Costs
The estimated costs, net of salvage values, of dismantling and removing
major facilities, including necessary site restoration, are accrued using the
units-of-production method. In the case of facilities where such costs are not
expected to be significant, the net cost is accrued when operations cease.
Income Taxes
The consolidated domestic provision was computed on the basis of a separate
return.
Hedging Activities
The Company selectively uses futures contracts and swaps to reduce price
volatility and lock in favorable sales prices for future production of natural
gas and crude oil. Gains and losses on futures contracts and swaps are deferred
until the related gas or oil production has been produced or delivered. As a
result, gains and losses are generally offset by similar changes in the price of
natural gas and crude oil. While these instruments are intended to reduce the
Company's exposure to declines in the market price of natural gas and crude oil,
they may also limit the Company's gain from increases in the market price of
natural gas and crude oil.
The futures contracts have settlement guaranteed by the New York Mercantile
Exchange ("NYMEX") and have nominal credit risk. The swap agreements are with
third parties and expose the Company to credit risk to the extent the third
parties are unable to meet their monthly settlement commitment to the Company.
AF-31
<PAGE> 155
DOMESTIC OPERATIONS OF BLAZER ENERGY CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. INCOME TAXES
A summary of the provision for income tax expense follows:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
1996
--------------
(IN THOUSANDS)
<S> <C>
Current tax expense.................................... $14,694
Deferred tax expense................................... 4,438
-------
$19,132
=======
</TABLE>
The difference between the statutory rate and the Company's effective
income tax rate is reconciled as follows:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
1996
--------------
(IN THOUSANDS)
<S> <C>
Income tax computed at statutory rates................. $28,578
Section 29 tax credits................................. (10,509)
Adjustment to prior year's tax......................... 537
State tax, net of federal tax.......................... 137
Other.................................................. 389
-------
$19,132
=======
</TABLE>
3. COMMITMENTS AND CONTINGENCIES
The Company is subject to various federal, state and local environmental
laws and regulations, which require remediation efforts at multiple locations,
including operating facilities and previously owned or operated facilities.
Environmental reserves are subject to considerable uncertainties that affect the
Company's ability to estimate its share of the ultimate costs of required
remediation efforts. Such uncertainties involve the nature and extent of
contamination at each site, the extent of required cleanup efforts under
existing environmental regulations, widely varying costs of alternate cleanup
methods, changes in environmental regulations, the potential effect of
continuing improvements in remediation technology and the number and financial
strength of other potentially responsible parties at multiparty sites. As a
result, charges to income for environmental liabilities could have a material
effect on results of operations in a particular quarter or fiscal year as
assessments and remediation efforts proceed, revised estimates are made based on
current information or as new remediation sites are identified.
During 1996, the U.S. Environmental Protection Agency and the state of
Kentucky approved the Company's plan of reclamation (including disposal off
site) of naturally occurring radioactive material ("NORM") from the Martha oil
field in Kentucky. The Company's independent contractor began implementing the
NORM reclamation work in September 1996.
In addition to environmental matters, the Company is party to numerous
claims and lawsuits. While these actions are being contested, the outcome of
individual matters is not predictable with assurance. Although any actual
liability is not determinable as of September 30, 1996, the Company believes
that any liability resulting from these matters, after taking into consideration
Ashland's insurance coverages should not have a material adverse effect on the
Company's consolidated financial position.
AF-32
<PAGE> 156
DOMESTIC OPERATIONS OF BLAZER ENERGY CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. EMPLOYEES' PENSION AND RETIREMENT BENEFITS
Ashland sponsors pension plans that cover substantially all employees,
other than union employees covered by multiemployer pension plans under
collective bargaining agreements. Benefits under Ashland's plans generally are
based on employees' years of service and compensation during the years
immediately preceding their retirement. For certain plans, such benefits are
expected to come in part from one-half of employees' leveraged employee stock
ownership plan ("LESOP") accounts. Ashland determines the level of contributions
to the pension plans annually and contributes amounts within allowable
limitations imposed by Internal Revenue Service regulations. Ashland contributed
the maximum tax-deductible contributions to its pension plans during the last
three years. A discount rate of 8% and an assumed rate of salary increases of 5%
were used in determining the actuarial present value of projected benefit
obligations at September 30, 1996. The Company's expense related to pension and
the LESOP amounted to $1,512,000 in 1996.
5. COLUMBIA GAS SETTLEMENT
During 1995, the Company entered into a settlement agreement with Columbia
Gas Transmission ("Columbia") to resolve claims involving natural gas sales
contracts that were abrogated by Columbia in 1991. The agreement provided for a
$78,500,000 payment to the Company, of which 5% was withheld by Columbia to be
used to potentially satisfy the claims of nonsettling producers. The Company
received the proceeds net of expenses under this agreement in 1996, which
resulted in operating income of $73,139,000. In the event that any portion of
the amount withheld by Columbia is not used to satisfy such nonsettling claims,
the Company and Ashland have agreed that such amount will be paid to Ashland.
6. OTHER REVENUES
The Company purchases third-party natural gas for resale and delivery into
major interstate pipelines. Revenue from these purchases and resales were
$500,000 in 1996.
7. RELATED PARTY TRANSACTIONS
The Company sells natural gas production to Ashland Petroleum Company, a
wholly owned subsidiary of Ashland. Sales to Ashland Petroleum Company were
$2,700,000 for the fiscal year ending 1996.
Certain administrative services are provided to the Company by Ashland. For
these services, the Company receives an allocation of Ashland's general and
administrative expenses which amounted to $2,326,000 in 1996. These services
include, among others, insurance administration and certain tax and legal
administrative activities. It is Ashland's policy to charge these expenses and
all other central administrative costs on the basis of direct usage when
identifiable. Management of the Company has determined that this method is
reasonable.
8. LEASES AND OTHER COMMITMENTS
The Company is a lessee in noncancelable leasing agreements for office
buildings and other equipment and properties which expire at various dates.
Rental expense under operating leases was $5,900,000 in
AF-33
<PAGE> 157
DOMESTIC OPERATIONS OF BLAZER ENERGY CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1996. Future minimum rental payments (which escalate over time) at September 30,
1996 follow (in thousands):
<TABLE>
<S> <C>
1997....................................................... $1,004
1998....................................................... 950
1999....................................................... 944
2000....................................................... 1,072
2001....................................................... 1,048
Thereafter................................................. 3,104
</TABLE>
9. SUPPLEMENTAL DISCLOSURES ABOUT OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED)
Standardized Measure of Discounted Future Net Cash Flows Relating to Oil and
Gas Reserves
The following tables summarize discounted future net cash flows and changes
in such flows in accordance with Statement of Financial Accounting Standards
Board No. 69, ("SFAS 69"), Disclosures About Oil and Gas Producing Activities.
Under the guidelines of SFAS 69, estimated future cash flows are determined
based on current prices for crude oil and natural gas, estimated production of
proved crude oil and natural gas reserves, estimated future production and
development costs of those reserves based on current costs and economic
conditions and estimated future income taxes based on taxing arrangements in
effect at year-end which include allocation of the full tax benefit of Section
29 tax credits. Such cash flows are then discounted using the prescribed 10%
rate.
Many other assumptions could have been made which may have resulted in
significantly different estimates. The Company does not rely upon these
estimates in making investment and operating decisions. Furthermore, the Company
does not represent that such estimates are indicative of its expected future
cash flows or the current value of its reserves. Since gas prices utilized in
deriving these estimates are based on conditions that existed at September 30
and are usually different than prices that exist at December 31 due to seasonal
fluctuations in the natural gas market, the estimates may not be comparable to
those of other companies with different fiscal years. Prices can also vary
significantly at the same point in time from year to year due to a variety of
factors. The average gas price used in the discounted future net cash flows
calculations was based on $1.85 per MMBtu for 1996.
Discounted Future Net Cash Flows
<TABLE>
<CAPTION>
SEPTEMBER 30,
1996
-------------
(IN MILLIONS)
<S> <C>
Future cash inflows.................................... $1,273
Future production (lifting) costs...................... (509)
Future development costs............................... (55)
Future income taxes.................................... (116)
------
593
Annual 10% discount.................................... (304)
------
Standardized measure of discounted future net cash
flows................................................ $ 289
======
</TABLE>
AF-34
<PAGE> 158
DOMESTIC OPERATIONS OF BLAZER ENERGY CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
] Changes in Discounted Future Net Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
1996
-------------
(IN MILLIONS)
<S> <C>
Net change due to extensions and discoveries............ $ 27
Sales of oil and gas produced -- net of
production (lifting) costs............................ (85)
Changes in prices....................................... 60
Previously estimated development costs incurred......... 22
Net change due to revisions of previous estimates of
reserves.............................................. 4
Purchase (net of sales) of reserves in place............ 1
Accretion of 10% discount............................... 25
Other -- net(1)......................................... 10
Net change in income taxes.............................. (27)
----
37
Discounted future net cash flows at beginning of year... 252
----
Discounted future net cash flows at end of year......... $289
====
</TABLE>
- ---------------
(1) Includes changes in future production and development costs and changes in
the timing of future production.
Crude Oil and Natural Gas Reserves, Revenues and Costs
The following tables summarize the Company's crude oil and natural gas
reserves. Crude oil and natural gas reserves are reported net of royalties and
interests owned by others.
Reserves reported in the table are estimated and are subject to future
revisions. Since October 1, 1995, no estimates of the Company's total proved net
oil or gas reserves have been filed or included in reports to any federal
authority or agency other than the Securities and Exchange Commission (the
"Commission"). Crude oil reserves of 1.6 MMBbls at September 30, 1996 are as
estimated by Netherland Sewell.
Crude Oil and Natural Gas Reserves
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
1996
-------------
<S> <C>
Crude Oil Reserves (Mmbbls)
Proved developed and undeveloped reserves:
Beginning of year.................................... 1.3
Revisions of previous estimates...................... 0.4
Extensions and discoveries........................... --
Production........................................... (0.2)
Net purchases of reserves in place................... 0.1
----
End of year.......................................... 1.6
====
Proved developed reserves at beginning of year......... 1.3
Proved developed reserves at end of year............... 1.6
</TABLE>
AF-35
<PAGE> 159
DOMESTIC OPERATIONS OF BLAZER ENERGY CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
1996
-------------
<S> <C>
Natural Gas Reserves (BCF)
Proved developed and undeveloped reserves:
Beginning of year.................................... 507.4
Revisions of previous estimates...................... 37.6
Extensions and discoveries........................... 70.0
Production........................................... (39.7)
Purchase (net of sales) of reserves in place......... 1.6
-----
End of year.......................................... 576.9
=====
Proved developed reserves at beginning of year......... 427.3
Proved developed reserves at end of year............... 477.0
</TABLE>
Net Oil and Gas Production
The following table summarizes net oil and gas production (net after
royalty) for the fiscal year ended September 30, 1996.
<TABLE>
<CAPTION>
1996
----
<S> <C>
Net natural gas production (MMcf per day)................... 109
Net crude oil production (Bbls per day)..................... 564
</TABLE>
Average Sales Price and Production Cost
The Company's average sales price per unit and production cost per unit for
crude oil and natural gas for the fiscal year ended September 30, 1996 is set
forth in the table below.
<TABLE>
<CAPTION>
1996
------
<S> <C>
Average sales prices -- natural gas (per Mcf)............... $ 2.39
Average sales prices -- crude oil (per Bbl)................. $18.22
Average production cost (per Mcfe)(1)....................... $ 0.47
</TABLE>
- ---------------
(1) Equivalents computed on a six Mcf to one Bbl ratio.
Gross and Net Productive Wells
The following table sets forth the Company's gross and net productive
wells.
<TABLE>
<CAPTION>
SEPTEMBER 30,
1996
-------------
GROSS NET
----- -----
<S> <C> <C>
Productive wells -- Gas............................... 4,211 3,836
Productive wells -- Oil............................... 36 22
</TABLE>
These wells include 317 gross wells and 279 net wells at September 30,
1996, which have multiple completions.
Total Gross and Net Oil and Gas Producing and Undeveloped Acreage
The Company's major interests consist of producing and nonproducing working
interests located in the Appalachian and Gulf Coast areas, as well as royalty
interests located primarily in the Southwest and
AF-36
<PAGE> 160
DOMESTIC OPERATIONS OF BLAZER ENERGY CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Midcontinent areas of the United States. The following table sets forth the
Company's total gross and net oil and gas producing and undeveloped acreage:
<TABLE>
<CAPTION>
GROSS NET GROSS NET
PRODUCING PRODUCING UNDEVELOPED UNDEVELOPED
ACREAGE ACREAGE ACREAGE ACREAGE
- --------- --------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
1,263 936 748 410
</TABLE>
Net Productive and Dry Wells Drilled
The Company's net productive and dry wells drilled during the fiscal year
ended September 30, 1996 are set forth below.
<TABLE>
<CAPTION>
1996
----
<S> <C>
Net exploratory wells drilled
Net productive wells...................................... 1
Net dry wells............................................. 1
----
Total............................................. 2
====
Net development wells drilled:
Net productive wells...................................... 79
Net dry wells............................................. --
</TABLE>
10. SUBSEQUENT EVENT
On July 1, 1997, a subsidiary of Statoil Energy, Inc. ("STEN") entered into
a Stock Purchase Agreement to acquire the domestic operations of Blazer Energy
Corp. for a purchase price of $567.1 million. Items excluded from this
transaction include the Martha Oil Field in Kentucky, including related
environmental obligations, insurance policies, office facilities and leases,
certain fee interests in land and any potential additional recovery related to
the Columbia Gas settlement (See Note 5). Pursuant to this agreement, Ashland
agreed to indemnify STEN from and against losses resulting from certain other
environmental claims and litigation.
AF-37
<PAGE> 161
DOMESTIC OPERATIONS OF BLAZER ENERGY CORP. AND SUBSIDIARY
UNAUDITED CONSOLIDATED INCOME STATEMENT
NINE MONTHS ENDED JUNE 30, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
(UNAUDITED)
-----------
<S> <C>
Revenues:
Sales and operating revenues
Natural gas............................................ $90,850
Crude oil.............................................. 2,699
Other..................................................... 1,499
-------
95,048
-------
Cost and expenses:
Operating expenses........................................ 26,771
NORM reclamation/litigation (Note 2)...................... 7,525
Depreciation, depletion and amortization.................. 27,999
General and administrative expenses....................... 11,341
Exploration costs, including dry holes.................... 3,850
-------
77,486
-------
Operating income............................................ 17,562
Interest expense............................................ 139
-------
Income before income taxes.................................. 17,423
Income tax benefit (Note 3)................................. (413)
-------
Net income.................................................. $17,836
=======
</TABLE>
The accompanying notes are an integral part of these financial statements.
AF-38
<PAGE> 162
DOMESTIC OPERATIONS OF BLAZER ENERGY CORP. AND SUBSIDIARY
UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED JUNE 30, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
(UNAUDITED)
-----------
<S> <C>
Cash flows from operating activities
Net income................................................ $ 17,836
Adjustments to reconcile income to net cash provided by
operating activities:
Depreciation, depletion and amortization............... 27,999
Gain on sale of operations............................. (208)
Deferred income taxes.................................. 6,763
Other non-cash items................................... 633
Change in operating assets and liabilities:
Accounts receivable.................................. 965
Inventories.......................................... (1,516)
Prepaids and other current assets.................... (5,533)
Trade accounts payable............................... (21,088)
Other................................................ (5,348)
--------
Net cash provided by operating activities................... 20,503
--------
Cash flows from investing activities
Property, plant and equipment:
Additions.............................................. (23,713)
Proceeds from sale or restructuring of operations...... 1,166
Property disposals..................................... 214
--------
Net cash used in investing activities....................... (22,333)
--------
Cash flows from financing activities
Investment in subsidiary.................................. (11,142)
Intercompany dividends.................................... (56,138)
--------
Net cash used in financing activities....................... (67,280)
--------
Decrease in net obligations with affiliated Companies....... $(69,110)
========
</TABLE>
The accompanying notes are an integral part of these financial statements.
AF-39
<PAGE> 163
DOMESTIC OPERATIONS OF BLAZER ENERGY CORP. AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. FINANCIAL STATEMENT PRESENTATION
Blazer Energy Corp. and subsidiary (formerly Ashland Exploration, Inc.)
("Company") operated both domestic and international exploration and production
operations. Immediately prior to the acquisition of the Company by a subsidiary
of Statoil Energy, Inc. (See Note 4), Ashland Inc. (parent company of Blazer
Energy Corp.) removed all international exploration and production operations of
the Company. The accompanying financial statements reflect all domestic
exploration and production operations. The Company is engaged in the exploration
for and the development, production, acquisition and marketing of natural gas
and oil in the United States.
The financial statements include only the domestic accounts of the Company
and its subsidiary. Significant intercompany accounts and transactions have been
eliminated in consolidation. Consistent with industry practice, the Company
utilizes pro rata consolidation to account for its investment in oil and gas
ventures.
The accompanying condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions for Article 10 of Regulation
S-X. The consolidated income statement for the nine months ended June 30, 1997,
and the consolidated statement of cash flows for the nine month period ended
June 30, 1997, are unaudited but include all adjustments (consisting of only
normal recurring adjustments) which the Company considers necessary for a fair
presentation of the operating results and cash flows for this period. Although
the Company believes that the disclosure in the accompanying consolidated
financial statements is adequate to make the information presented not
misleading, certain information normally included in financial statements and
related footnotes prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission. The accompanying financial statements
should be read in conjunction with the consolidated financial statements for the
year ended September 30, 1996 and related footnotes as contained elsewhere
herein.
2. NORM RECLAMATION AND RELATED LIABILITIES
During 1996, the U.S. Environmental Protection Agency and the state of
Kentucky approved the Company's plan of reclamation (including disposal off
site) of naturally occurring radioactive material ("NORM") from the Martha oil
field in Kentucky. The Company's independent contractor began implementing the
NORM reclamation work in September 1996.
3. INCOME TAXES
Income tax benefit has been computed on an interim basis based on the
estimated effective rate for the entire year.
4. SUBSEQUENT EVENT
On July 1, 1997, a subsidiary of Statoil Energy, Inc. ("STEN") entered into
a Stock Purchase Agreement to acquire the domestic operations of Blazer Energy
Corp. for a purchase price of $567.1 million. Items excluded from this
transaction include the Martha Oil Field in Kentucky, including related
environmental obligations, insurance policies, office facilities and leases,
certain fee interests in land and any potential additional recovery related to
the Columbia Gas settlement. Pursuant to this agreement, Ashland agreed to
indemnify STEN from and against losses resulting from certain other
environmental claims and litigation.
AF-40
<PAGE> 164
[Ryder Scott Letterhead]
EXHIBIT A
[RYDER LOGO]
August 9, 1999
Eastern States Oil & Gas, Inc.
2800 Eisenhower Avenue, Suite 300
Alexandria, Virginia 22314
Gentlemen:
At your request, we have reviewed your estimate of the reserves, future
production and income attributable to certain leasehold and royalty interests of
the Underlying Properties Relating to the Appalachian Basin Royalty Trust, as of
June 30, 1999. The subject properties are located in the states of Kentucky and
West Virginia. The income data have been estimated using the Securities and
Exchange Commission (SEC) guidelines for future cost and price parameters. Your
estimates are summarized below.
SEC PARAMETERS
ESTIMATED NET RESERVE AND INCOME DATA
CERTAIN LEASEHOLD AND ROYALTY INTERESTS OF
THE UNDERLYING PROPERTIES RELATING TO THE
APPALACHIAN BASIN ROYALTY TRUST
AS OF JUNE 30, 1999
<TABLE>
<CAPTION>
PROVED
------------------------------------------------------------
DEVELOPED
---------------------------- TOTAL
PRODUCING NON-PRODUCING UNDEVELOPED PROVED
------------ ------------- ------------ --------------
<S> <C> <C> <C> <C>
NET REMAINING RESERVES
Gas -- MMCF....................... 337,958 511 398,978 737,447
Oil/Condensate -- Barrels......... 273,342 0 0 273,342
INCOME DATA
Future Gross Revenue.............. $810,931,549 $1,220,243 $971,211,015 $1,783,362,807
Deductions........................ 189,988,497 353,616 410,353,535 600,695,648
------------ ---------- ------------ --------------
Future Net Income (FNI)........... $620,943,052 $ 866,627 $560,857,480 $1,182,667,159
Discounted FNI @ 10%.............. $228,923,815 $ 238,717 $ 75,262,977 $ 304,425,509
</TABLE>
Liquid hydrocarbons are expressed in standard 42 gallon barrels. All gas
volumes are expressed in millions in cubic feet (MMCF) at the official
temperature and pressure bases of areas where they are located.
The discounted future net income shown above is based on a discount rate of
10 percent per annum compounded annually taken at mid-year.
The proved reserves presented in this report comply with the Securities and
Exchange Commission's Regulation S-X Part 210.4-10(a) as clarified by subsequent
Commission Staff Accounting Bulletins, and are based on the following
definitions and criteria:
Proved reserves of crude oil, condensate, natural gas, and natural gas
liquids are estimated quantities that geological and engineering data
demonstrate with reasonable certainty to be recoverable in the future
XA-1
<PAGE> 165
Eastern States Oil & Gas, Inc.
August 9, 1999
Page 2
from known reservoirs under existing operating conditions, i.e., prices and
costs as of the date the estimate is made. Prices include consideration of
changes in existing prices provided only by contractual arrangements, but not on
escalation based on future conditions. Reservoirs are considered proved if
economic producibility is supported by either actual production or conclusive
formation test. In certain instances, proved reserves are assigned on the basis
of a combination of core analysis and electrical and other type logs which
indicate the reservoirs are analogous to reservoirs in the same field which are
producing or have demonstrated the ability to produce on a formation test. The
area of a reservoir considered proved includes (1) that portion delineated by
drilling and defined by fluid contacts, if any, and (2) the adjoining portions
not yet drilled that can be reasonably judged as economically productive on the
basis of available geological and engineering data. In the absence of data on
fluid contacts, the lowest known structural occurrence of hydrocarbons controls
the lower proved limit of the reservoir. Reserves that can be produced
economically through the application of improved recovery techniques are
included in the proved classification when these qualifications are met: (1)
successful testing by a pilot project or the operation of an installed program
in the reservoir provides support for the engineering analysis on which the
project or program was based, and (2) it is reasonably certain the project will
proceed. Improved recovery includes all methods for supplementing natural
reservoir forces and energy, or otherwise increasing ultimate recovery from a
reservoir, including (1) pressure maintenance, (2) cycling, and (3) secondary
recovery in its original sense. Improved recovery also includes the enhanced
recovery methods of thermal, chemical flooding, and the use of miscible and
immiscible displacement fluids. Proved natural gas reserves are comprised of
non-associated, associated and dissolved gas. An appropriate reduction in gas
reserves has been made for the expected removal of natural gas liquids, for
lease and plant fuel, and for the exclusion of non-hydrocarbon gases if they
occur in significant quantities and are removed prior to sale. Estimates of
proved reserves do not include crude oil, natural gas, or natural gas liquids
being held in underground or surface storage. Proved reserves are estimates of
hydrocarbons to be recovered from a given date forward. They may be revised as
hydrocarbons are produced and additional data become available.
Proved developed oil and gas reserves are reserves that can be expected to
be recovered through existing wells with existing equipment and operating
methods. Additional oil and gas expected to be obtained through the
application of fluid injection or other improved recovery techniques for
supplementing the natural forces and mechanisms of primary recovery should
be included as "proved developed reserves" only after testing by a pilot
project or after the operation of an installed program has confirmed
through production response that increased recovery will be achieved.
Developed reserves may be subcategorized as producing or non-producing
using the SPE/WPC Definitions:
Producing Reserves sub-categorized as producing are expected to be
recovered from completion intervals which are open and are producing
at the time of the estimate. Improved recovery reserves are
considered producing only after the improved recovery project is in
operation.
Non-producing Reserves sub-categorized as non-producing include
shut-in and behind pipe reserves. Shut-in reserves are expected to
be recovered from (1) completion intervals which are open at the
time of the estimate but which have not started producing, (2) wells
which were shut-in for market conditions or pipeline connections, or
(3) wells not capable of production for mechanical reasons. Behind
pipe reserves are expected to be recovered from zones in existing
wells, which will require additional completion work or future
recompletion prior to the start of production.
Proved undeveloped oil and gas reserves are reserves that are expected to be
recovered from new wells on undrilled acreage, or from existing wells where
a relatively major expenditure is required for recompletion. Reserves on
undrilled acreage shall be limited to those drilling units offsetting
XA-2
<PAGE> 166
Eastern States Oil & Gas, Inc.
August 9, 1999
Page 3
productive units that are reasonably certain of production when drilled.
Proved reserves for other undrilled units can be claimed only where it can
be demonstrated with reasonable certainty that there is continuity of
production from the existing productive formation. Estimates for proved
undeveloped reserves are attributable to any acreage for which an
application of fluid injection or other improved technique is contemplated,
only when such techniques have been proved effective by actual tests in the
area and in the same reservoir.
REVIEW PROCEDURE AND OPINION
In performing our review, we have relied upon data furnished by Eastern
States Oil & Gas, Inc. (ESOG) with respect to property interests owned by ESOG,
and production from the examined wells. These data were accepted as authentic
and sufficient for determining the reserves unless, during the course of our
examination, a matter of question came to our attention in which case the data
were not accepted until all questions were satisfactorily resolved. Our review
included such tests and procedures as we considered necessary under the
circumstances to render the conclusions set forth herein.
In our opinion, ESOG's estimates of future reserves and production rates
for the properties were prepared in accordance with generally accepted
procedures for the estimation of future reserves and production rates, and we
found no bias in the utilization and analysis of data in ESOG's estimates for
the properties. In general, we were in reasonable agreement with ESOG's
estimates of remaining reserves for the properties which we reviewed; however,
in certain cases there was more than an acceptable variance in ESOG's estimates
and our estimates due to a difference in interpretation of data or due to our
having access to data which were not available to ESOG when its reserve
estimates were prepared. In these cases, ESOG revised its estimates to conform
to our estimates. As a consequence, it is our opinion that the data presented
herein for the properties fairly reflect the estimated net reserves based on the
prices and costs provided by ESOG.
Certain technical personnel of ESOG are responsible for the preparation of
reserve estimates on new properties and for the preparation of revised
estimates, when necessary, on old properties. These personnel assemble the
necessary data and maintain the data and work papers in an orderly manner. We
consulted with these technical personnel and had access to their work papers and
supporting data in the course of our review.
HYDROCARBON PRICING PARAMETERS
ESOG utilized oil and gas prices in effect at June 30, 1999. These prices
were held constant throughout the life of the properties except for known and
determinable escalations. Gas prices reflect adjustments due to fuel and
shrinkage in final sales volumes.
COSTS
Operating costs utilized by ESOG were held constant throughout the life of
the properties except where changes were known and determinable. These changes
include a two-tier cost structure in certain areas based upon ESOG's actual
operating experience and practices. ESOG's costs are directly proportional to
the level of monitoring provided by field personnel. Since high rate wells are
monitored more closely than low rate wells, high rate wells have been assigned a
higher proportion of the average operating cost in these areas. As a well's
production drops below a predetermined threshold limit, field personnel reduce
the level of monitoring provided to the well, reducing the well's operating
costs, and establishing the two-tier structure.
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Eastern States Oil & Gas, Inc.
August 9, 1999
Page 4
Development costs utilized by ESOG are based upon authorizations for
expenditure for the proposed work or actual costs of similar projects. This
study does not consider the salvage value of the lease equipment or the
abandonment cost of the subject wells.
GENERAL
In the utilization of the reserve and income data presented herein,
consideration should be given to the following characteristics of estimates of
reserves and future production rates.
1. The reserves included in this report are estimates only and should
not be construed as being exact quantities. They may or may not be actually
recovered. Moreover, estimates of proved reserves may increase or decrease
as a result of future operations.
2. The future production rates from properties now on production may
be more or less than estimated because of changes in market demand or
allowables set by regulatory bodies. Properties which are not currently
producing may start producing earlier or later than anticipated in our
estimates of their future production rates.
3. The estimated reserves and future income amounts presented in this
report are related to hydrocarbon prices. June 1999 hydrocarbon prices were
used in the preparation of this report as required by SEC guidelines;
however, actual future prices may vary significantly from June 1999 prices.
Therefore, volumes of reserves actually recovered and amounts of income
actually received may differ significantly from the estimated quantities
presented in this report.
Neither we nor any of our employees have any interest in the subject
properties and neither the employment to make this study nor the compensation is
contingent on our estimates of reserves and future net income for the subject
properties.
Very truly yours,
RYDER SCOTT COMPANY, L.P.
[F.W. Emmerich signature]
Frederick W. Emmerich
Petroleum Engineer
FWE/sw
Approved:
[D.P. Griffin signature]
Don P. Griffin, P.E.
Vice President
XA-4
<PAGE> 168
[RYDER SCOTT LETTERHEAD]
EXHIBIT B
[RYDER LOGO]
August 11, 1999
Eastern States Oil & Gas, Inc.
2800 Eisenhower Avenue, Suite 300
Alexandria, Virginia 22314
Gentlemen:
At your request, we have reviewed your estimate of the reserves, future
production and income attributable to certain leasehold and royalty interests of
the Appalachian Basin Royalty Trust Net Profits Interest as of June 30, 1999.
The subject properties are located in the states of Kentucky and West Virginia.
The income data have been estimated using the Securities and Exchange Commission
(SEC) guidelines for future cost and price parameters. Your estimates are
summarized below.
SEC PARAMETERS
ESTIMATED NET RESERVE AND INCOME DATA
CERTAIN LEASEHOLD AND ROYALTY INTERESTS OF
APPALACHIAN BASIN ROYALTY TRUST NET PROFITS INTEREST
AS OF JUNE 30, 1999
<TABLE>
<CAPTION>
PROVED
---------------------------------------------------------
DEVELOPED
---------------------------- TOTAL
PRODUCING NON-PRODUCING UNDEVELOPED PROVED
------------ ------------- ----------- ------------
<S> <C> <C> <C> <C>
NET REMAINING RESERVES
Gas -- MMCF......................... 210,947 319 22,750 234,016
Oil/Condensate -- Barrels........... 170,000 0 0 170,000
INCOME DATA
Future Gross Revenue................ $476,368,000 $718,000 $51,027,000 $528,113,000
Deductions.......................... 48,724,000 76,000 7,242,000 56,042,000
------------ -------- ----------- ------------
Future Net Income (FNI)............. $427,644,000 $642,000 $43,785,000 $472,071,000
Discounted FNI @ 10%................ $163,417,000 $169,000 $ 4,580,000 $168,166,000
</TABLE>
Liquid hydrocarbons are expressed in standard 42 gallon barrels. All gas
volumes are expressed in millions of cubic feet (MMCF) at the official
temperature and pressure bases of areas where they are located.
The discounted future net income shown above is based on a discount rate of
10 percent per annum compounded annually taken at mid-year.
The proved reserves presented in this report comply with the Securities and
Exchange Commission's Regulation S-X Part 210.4-10(a) as clarified by subsequent
Commission Staff Accounting Bulletins, and are based on the following
definitions and criteria:
Proved reserves of crude oil, condensate, natural gas, and natural gas
liquids are estimated quantities that geological and engineering data
demonstrate with reasonable certainty to be recoverable in the future from known
reservoirs under existing operating conditions, i.e., prices and costs as of the
date the estimate is made. Prices include consideration of changes in existing
prices provided only by contractual arrangements, but not on escalation based on
future conditions. Reservoirs are considered proved if
XB-1
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Eastern States Oil & Gas, Inc.
August 11, 1999
Page 2
economic producibility is supported by either actual production or conclusive
formation test. In certain instances, proved reserves are assigned on the basis
of a combination of core analysis and electrical and other type logs which
indicate the reservoirs are analogous to reservoirs in the same field which are
producing or have demonstrated the ability to produce on a formation test. The
area of a reservoir considered proved includes (1) that portion delineated by
drilling and defined by fluid contacts, if any, and (2) the adjoining portions
not yet drilled that can be reasonably judged as economically productive on the
basis of available geological and engineering data. In the absence of data on
fluid contacts, the lowest known structural occurrence of hydrocarbons controls
the lower proved limit of the reservoir. Reserves that can be produced
economically through the application of improved recovery techniques are
included in the proved classification when these qualifications are met: (1)
successful testing by a pilot project or the operation of an installed program
in the reservoir provides support for the engineering analysis on which the
project or program was based, and (2) it is reasonably certain the project will
proceed. Improved recovery includes all methods for supplementing natural
reservoir forces and energy, or otherwise increasing ultimate recovery from a
reservoir, including (1) pressure maintenance, (2) cycling, and (3) secondary
recovery in its original sense. Improved recovery also includes the enhanced
recovery methods of thermal, chemical flooding, and the use of miscible and
immiscible displacement fluids. Proved natural gas reserves are comprised of
non-associated, associated and dissolved gas. An appropriate reduction in gas
reserves has been made for the expected removal of natural gas liquids, for
lease and plant fuel, and for the exclusion of non-hydrocarbon gases if they
occur in significant quantities and are removed prior to sale. Estimates of
proved reserves do not include crude oil, natural gas, or natural gas liquids
being held in underground or surface storage. Proved reserves are estimates of
hydrocarbons to be recovered from a given date forward. They may be revised as
hydrocarbons are produced and additional data become available.
Proved developed oil and gas reserves are reserves that can be expected to
be recovered through existing wells with existing equipment and operating
methods. Additional oil and gas expected to be obtained through the
application of fluid injection or other improved recovery techniques for
supplementing the natural forces and mechanisms of primary recovery should
be included as "proved developed reserves" only after testing by a pilot
project or after the operation of an installed program has confirmed
through production response that increased recovery will be achieved.
Developed reserves may be subcategorized as producing or non-producing
using the SPE/WPC Definitions:
Producing Reserves sub-categorized as producing are expected to be
recovered from completion intervals which are open and producing at the
time of the estimate. Improved recovery reserves are considered producing
only after the improved recovery project is in operation.
Non-Producing Reserves sub-categorized as non-producing include
shut-in and behind pipe reserves. Shut-in reserves are expected to be
recovered from (1) completion intervals which are open at the time of the
estimate but which have not started producing, (2) wells which were shut-in
for market conditions or pipeline connections, or (3) wells not capable of
production for mechanical reasons. Behind pipe reserves are expected to be
recovered from zones in existing wells, which will require additional
completion work or future recompletion prior to the start of production.
Proved undeveloped oil and gas reserves are reserves that are expected to
be recovered from new wells on undrilled acreage, or from existing wells
where a relatively major expenditure is required for recompletion. Reserves
on undrilled acreage shall be limited to those drilling units offsetting
productive units that are reasonably certain of production when drilled.
Proved reserves for other undrilled units can be claimed only where it can
be demonstrated with reasonable certainty that there is continuity of
production from the existing productive formation. Estimates for proved
undeveloped reserves are attributable to any acreage for which an
application of fluid injection or other improved
XB-2
<PAGE> 170
Eastern States Oil & Gas, Inc.
August 11, 1999
Page 3
technique is contemplated, only when such techniques have been proved
effective by actual tests in the area and in the same reservoir.
REVIEW PROCEDURE AND OPINION
In performing our review, we have relied upon data furnished by Eastern
States Oil and Gas, Inc. (ESOG) with respect to property interests owned by the
Trust, and production from the examined wells. These data were accepted as
authentic and sufficient for determining the reserves unless, during the course
of our examination, a matter of question came to our attention in which case the
data were not accepted until all questions were satisfactorily resolved. Our
review included such tests and procedures as we considered necessary under the
circumstances to render the conclusions set forth herein.
In our opinion, ESOG's estimates of future reserves and production rates
for the properties were prepared in accordance with generally accepted
procedures for the estimation of future reserves and production rates, and we
found no bias in the utilization and analysis of data in ESOG's estimates for
the properties. In general, we were in reasonable agreement with ESOG's
estimates of remaining reserves for the properties which we reviewed; however,
in certain cases there was more than an acceptable variance in ESOG's estimates
and our estimates due to a difference in interpretation of data or due to our
having access to data which were not available to ESOG when its reserve
estimates were prepared. In these cases, ESOG revised its estimates to conform
to our estimates. As a consequence, it is our opinion that the data presented
herein for the properties fairly reflect the estimated net reserves based on the
prices and costs provided by ESOG.
Certain technical personnel of ESOG are responsible for the preparation of
reserve estimates on new properties and for the preparation of revised
estimates, when necessary, on old properties. These personnel assemble the
necessary data and maintain the data and work papers in an orderly manner. We
consulted with these technical personnel and had access to their work papers and
supporting data in the course of our review.
RESERVE ADJUSTMENTS
The Appalachian Basin Royalty Trust interests evaluated herein are
comprised of an 80 percent net profits interest in 2,562 proved developed
producing wells and a 10 percent net profits interest in ESOG's proved
undeveloped reserves in West Virginia and Kentucky.
Proved reserves for the net profits interests attributable to the 2,562
producing wells were calculated by subtracting from 80 percent of the proved
reserves, reserve quantities of a sufficient value to pay 80 percent of the
future estimated operating and development costs exclusive of property and
severance taxes. Proved reserves for the net profits interests attributable to
the proved undeveloped reserves owned by ESOG in West Virginia and Kentucky were
calculated by subtracting from 10 percent of the proved undeveloped reserves,
reserve quantities of a sufficient value to pay 10 percent of the future
operating and development costs exclusive of property and severance taxes.
Accordingly, proved reserves for the net profits interests reflect quantities
that are calculated after reductions for future costs and expenses exclusive of
property and severance taxes based on price and cost assumptions used in the
reserve estimates. As a result of this procedure, a change in the future costs,
or prices different from those projected herein may result in a change in the
computed reserves to the net interests even if there are no revisions or
additions to the gross reserves attributable to the properties.
XB-3
<PAGE> 171
Eastern States Oil & Gas, Inc.
August 11, 1999
Page 4
HYDROCARBON PRICING PARAMETERS
ESOG utilized oil and gas prices in effect at June 30, 1999 for the net
profits interest. These prices were held constant throughout the life of the
properties except for known and determinable escalations. Gas prices reflect
adjustments due to fuel and shrinkage in final sales volumes.
COSTS
Operating costs were based upon a two tier fixed charge per well to the
Trust by ESOG. The higher tier fixed charge per well was used as the operating
cost until a well's production volumes drops below a predetermined threshold
limit in a given year, and then the lower tier fixed charge per well was used as
the operating cost. Except for the change from the higher to lower fixed
operating charge, the operating costs were held constant throughout the life of
the properties. As discussed under reserve adjustments above, the operating
costs were subtracted from revenues.
Property and severance tax deductions were based on rates and charges
provided by ESOG.
Development costs utilized by ESOG were based upon authorizations for
expenditure for the proposed work or actual costs of similar wells. This study
does not consider the salvage value of the lease equipment, abandonment cost of
the subject wells, or overhead costs. As discussed under reserve adjustments
above, the development costs were subtracted from revenues.
GENERAL
In the utilization of the reserve and income data presented herein,
consideration should be given to the following characteristics of estimates of
reserves and future production rates.
1. The reserves included in this report are estimates only and should
not be construed as being exact quantities. They may or may not be actually
recovered. Moreover, estimates of proved reserves may increase or decrease
as a result of future operations.
2. The future production rates from properties now on production may
be more or less than estimated because of changes in market demand or
allowables set by regulatory bodies. Properties which are not currently
producing may start producing earlier or later than anticipated in our
estimates of their future production rates.
3. The estimated reserves and future income amounts presented in this
report are related to hydrocarbon prices. June 1999 hydrocarbon prices were
used in the preparation of this report as required by SEC guidelines;
however, actual future prices may vary significantly from June 1999 prices.
Therefore, volumes of reserves actually recovered and amounts of income
actually received may differ significantly from the estimated quantities
presented in this report.
XB-4
<PAGE> 172
Eastern States Oil & Gas, Inc.
August 11, 1999
Page 5
Neither we nor any of our employees have any interest in the subject
properties and neither the employment to make this study nor the compensation is
contingent on our estimates of reserves and future net income for the subject
properties.
Very truly yours,
RYDER SCOTT COMPANY, L.P.
[E.W. EMMERICH SIGNATURE]
Frederick W. Emmerich
Petroleum Engineer
FWE/sw
Approved:
[D.P. GRIFFIN SIGNATURE]
Don P. Griffin, P.E.
Vice President
XB-5
<PAGE> 173
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
APPALACHIAN BASIN ROYALTY TRUST
TRUST UNITS
---------------------
PROSPECTUS
, 1999
---------------------
LEHMAN BROTHERS
SALOMON SMITH BARNEY
PAINEWEBBER INCORPORATED
CIBC WORLD MARKETS
CREDIT SUISSE FIRST BOSTON
DAIN RAUSCHER WESSELS
A DIVISION OF DAIN RAUSCHER INCORPORATED
DONALDSON, LUFKIN & JENRETTE
A.G. EDWARDS & SONS, INC.
MCDONALD INVESTMENTS INC.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 174
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
All capitalized terms used and not defined in Part II of this Registration
Statement shall have the meanings assigned to them in the Prospectus forming a
part of this Registration Statement.
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
Except for the Registration Fee and the NASD Filing Fee, the following
itemized table sets forth estimates of those expenses payable by Eastern States
in connection with the offer and sale of the securities offered hereby:
<TABLE>
<S> <C>
Registration Fee............................................ $50,040
NASD Filing Fee............................................. 18,500
NYSE Listing Fee............................................ *
Printing and Engraving Expenses............................. *
Legal Fees and Expenses..................................... *
Accountants' Fees and Expenses.............................. *
Trustee's Fees and Expenses................................. *
Blue Sky Fees............................................... *
Miscellaneous Fees and Expenses............................. *
-------
Total.............................................
=======
</TABLE>
- ---------------
* To be filed by amendment
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 7 of the Trust Agreement provides that the trustee will be
indemnified by Eastern States Oil & Gas, Inc., a Delaware corporation, against
any and all liability and expenses incurred by it individually or as trustee in
the administration of the trust and the trust estate, except for any liability
or expense resulting from willful misconduct, bad faith or gross negligence.
Subsection (a) of Section 145 of the General Corporation Law of the State
of Delaware ("DGCL") empowers a corporation to indemnify any person who was or
is a party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding, whether civil, criminal, administrative or
investigative (other than an action by or in the right of the corporation) by
reason of the fact that he is or was a director, officer, employee or agent of
the corporation, or is or was serving at the request of the corporation as a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust or other enterprise, against expenses (including attorneys'
fees), judgments, fines and amounts paid in settlement actually and reasonably
incurred by him in connection with such action, suit or proceeding if he acted
in good faith and in a manner he reasonably believed to be in or not opposed to
the best interests of the corporation, and, with respect to any criminal action
or proceeding, had no reasonable cause to believe his conduct was unlawful.
Subsection (b) of Section 145 empowers a corporation to indemnify any
person who was or is a party or is threatened to be made a party to any
threatened, pending or completed action or suit by or in the right of the
corporation to procure a judgment in its favor by reason of the fact that such
person acted in any of the capacities set forth above, against expenses
(including attorneys' fees) actually and reasonably incurred by him in
connection with the defense or settlement of such action or suit if he acted in
good faith and in a manner he reasonably believed to be in or not opposed to the
best interests of the corporation, except that no indemnification may be made in
respect of any claim, issue or matter as to which such person shall have been
adjudged to be liable to the corporation unless and only to the extent that the
Court of Chancery or the court in which such action or suit was brought shall
determine upon application that, despite the adjudication of liability but in
view of all the circumstances of the case, such person is fairly and reasonably
entitled to indemnity for such expenses which the Court of Chancery or such
other court shall deem proper.
II-1
<PAGE> 175
Section 145 further provides that to the extent a director or officer of a
corporation has been successful on the merits or otherwise in the defense of any
action, suit or proceeding referred to in subsections (a) and (b) of Section 145
or in the defense of any claim, issue or matter therein, he shall be indemnified
against expenses (including attorneys' fees) actually and reasonably incurred by
him in connection therewith; that indemnification provided for by Section 145
shall not be deemed exclusive of any other rights to which the indemnified party
may be entitled; that indemnification provided by Section 145 shall, unless
otherwise provided when authorized or ratified, continue as to a person who has
ceased to be a director, officer, employee or agent and shall inure to the
benefit of such person's heirs, executors and administrators; and empowers the
corporation to purchase and maintain insurance on behalf of a director or
officer of the corporation against any liability asserted against him and
incurred by him in any such capacity, or arising out of his status as such,
whether or not the corporation would have the power to indemnify him against
such liabilities under Section 145.
Section 102(b)(7) of the DGCL provides that a certificate of incorporation
may contain a provision eliminating or limiting the personal liability of a
director to the corporation or its stockholders for monetary damages for breach
of fiduciary duty as a director, provided that such provisions may not eliminate
or limit the liability of a director (1) for any breach of the director's duty
of loyalty to the corporation or its stockholders, (2) for acts or omissions not
in good faith or which involve intentional misconduct or a knowing violation of
law, (3) under Section 174 (relating to liability for unauthorized acquisitions
or redemptions of, or dividends on, capital stock) of the DGCL or (4) for any
transaction from which the director derived an improper personal benefit.
Article VII of Eastern States' Amended and Restated Certificate of Incorporation
contains such a provision.
Section 8.07 of Eastern States' Amended and Restated Bylaws further
provides that:
"(a) The Corporation shall indemnify a director or officer of the
Corporation who is or was a party to any proceeding by reason of the fact
that he is or was such a director or officer or is or was serving at the
request of the Corporation as a director, officer, employee or agent of
another corporation, partnership, joint venture, trust, employee benefit
plan or other profit or non-profit enterprise against all liabilities and
expenses incurred in the proceeding to the maximum extent permissible under
applicable law.
(b) To the maximum extent permissible under applicable law, the
Corporation shall make advances and reimbursements for expenses incurred by
a director or officer in a proceeding upon receipt of an undertaking from
him to repay the same if it is ultimately determined that he is not
entitled to indemnification. Such undertaking shall be an unlimited,
unsecured general obligation of the director or officer and shall be
accepted without reference to his ability to make repayment. The Executive
Committee is hereby designated as an appropriate committee to authorize
such advances/reimbursements.
(c) The Board of Directors is hereby empowered, by majority vote of a
quorum of disinterested directors, to cause the Corporation to indemnify or
contract in advance to indemnify any other employee or agent of the
Corporation not specified in subsection (a) of this Section 8.07 who was or
is a party to any proceeding, by reason of the fact that he is or was an
employee or agent of the Corporation, or is or was serving at the request
of the Corporation as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust, employee benefit plan or
other profit or non-profit enterprise, to the same extent as if such person
was specified as one to whom indemnification is granted in subsection (a).
(d) The Corporation may purchase and maintain insurance to indemnify
it against the whole or any portion of the liability assumed by it in
accordance with this Section 8.07 and may also procure insurance, in such
amounts as the Board of Directors may determine, on behalf of any person
who is or was a director, officer, employee or agent of another
corporation, partnership, joint venture, trust, employee benefit plan or
other enterprise, against any liability asserted against or incurred by
such person in any such capacity or arising from his status as such,
whether or not the Corporation would have power to indemnify him against
such liability under the provisions of this Section 8.07.
II-2
<PAGE> 176
(e) In the event there has been a change in the composition of a
majority of the Board of Directors after the date of an alleged act or
omission with respect to which indemnification is claimed, any
determination as to indemnification and advancement of expenses with
respect to any claim for indemnification made pursuant to subsection (a) of
this Section 8.07 shall be made by special legal counsel agreed upon by the
Board of Directors and the proposed indemnitee. If the Board of Directors
and the proposed indemnitee are unable to agree upon such special legal
counsel, the Board of Directors and the proposed indemnitee each shall
select a nominee, and the nominees shall select such special legal counsel.
(f) The provisions of this Section 8.07 shall be applicable to all
actions, claims, suits or proceedings commenced after the adoption hereof,
whether arising from any action taken or failure to act before or after
such adoption. No amendment, modification or repeal of this Section 8.07
shall diminish the rights provided hereby or diminish the right to
indemnification with respect to any claim, issue or matter in any then
pending or subsequent proceeding that is based in any material respect on
any alleged action or failure to act prior to such amendment, modification
or repeal.
(g) Reference herein to directors, officers, employees or agents shall
include former directors, officers, employees and agents and their
respective heirs, executors and administrators.
(h) If any provision or provisions of this Section 8.07 shall be held
to be invalid, illegal or unenforceable for any reason whatsoever: (i) the
validity, legality and enforceability of the remaining provisions of this
Section 8.07 (including, without limitation, all portions of Section 8.07
containing any such provision held to be invalid, illegal or unenforceable,
that are not themselves invalid, illegal or unenforceable) shall not in any
way be affected or impaired thereby; and (ii) to the fullest extent
possible, the provisions of this Section 8.07 (including, without
limitation, all portions of Section 8.07 containing any such provision held
to be invalid, illegal or unenforceable, that are not themselves invalid,
illegal or unenforceable) shall be construed so as to give effect to the
intent manifested by the provision held invalid, illegal or unenforceable."
In addition, Eastern States and certain other persons may be entitled under
agreements entered into with agents or underwriters to indemnification by such
agents or underwriters against certain liabilities, including liabilities under
the Securities Act of 1933, or to contribution with respect to payments which
Eastern States or such persons may be required to make in respect thereof.
The above discussion of Eastern States' Amended and Restated Certificate of
Incorporation, Amended and Restated Bylaws and Sections 145 and 102(b)(7) of the
DGCL is not intended to be exhaustive and is qualified in its entirety by such
Amended and Restated Certificate of Incorporation, Amended and Restated Bylaws
and statutes.
Additionally, Eastern States has acquired directors' and officers'
insurance in the amount of $[ ] million.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
None
ITEM 16. EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
** 1.1 -- Form of Underwriting Agreement.
* 3.1 -- Amended and Restated Certificate of Incorporation of
Eastern States Oil & Gas, Inc.
* 3.2 -- Amended and Restated Bylaws of Eastern States Oil & Gas,
Inc.
* 4.1 -- Certificate of Trust of Appalachian Basin Royalty Trust
</TABLE>
II-3
<PAGE> 177
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
* 4.2 -- Appalachian Basin Royalty Trust -- Trust Agreement, dated
as of August 18, 1999.
** 5.1 -- Opinion of Richards, Layton & Fingers, P.A. as to the
legality of the securities offered hereby.
** 8.1 -- Opinion of Andrews & Kurth L.L.P. regarding federal
income tax matters.
**10.1.1 -- Form of Net Overriding Royalty Conveyance -- Kentucky as
amended and restated.
**10.1.2 -- Form of Net Overriding Royalty Conveyance -- West
Virginia as amended and restated.
*10.2 -- Amended and Restated Incentive Compensation Plan of
Statoil Energy, Inc.
*10.3.1 -- Employee Shareholders Agreement dated May 31, 1995 by and
among Statoil Energy, Inc. and the signatories thereto
who hold Statoil Energy, Inc. common stock and/or options
to purchase common stock.
*10.3.2 -- First Amendment to Employee Shareholders Agreement dated
June 6, 1997 by and among Statoil Energy and the
signatories thereto who hold Statoil Energy common stock
and/or options to purchase common stock.
*10.3.3 -- Second Amendment to Employee Shareholders Agreement dated
May 19, 1998 by and among Statoil Energy and the
signatories thereto who hold Statoil common stock and/or
options to purchase common stock.
*10.4 -- Promissory Note dated August 10, 1999 made by Eastern
States Oil & Gas, Inc. to Statoil Energy Holdings, Inc.
for the principal sum of $505,488,085.
*10.5.1 -- Employment Agreement between Clifton A. Brown and Statoil
Energy effective February 1, 1999.
*10.5.2 -- Employment Agreement between Stevens V. Gillespie and
Statoil Energy effective February 1, 1999.
*21.1 -- Subsidiaries of Eastern States Oil & Gas, Inc.
*23.1 -- Consent of Ernst & Young LLP dated August 23, 1999.
**23.2 -- Consent of Richards, Layton & Fingers, P.A. (included in
the opinion filed as Exhibit 5.1).
**23.3 -- Consent of Andrews & Kurth L.L.P. (included in the
opinion filed as Exhibit 8.1).
*23.4 -- Consent of Ryder Scott Company, L.P. Petroleum Engineers
dated August 25, 1999.
*24.1 -- Power of attorney (included in the signature page).
*27.1 -- Financial Data Schedule relating to Appalachian Basin
Royalty Trust.
*27.2 -- Financial Data Schedule relating to Eastern States Oil &
Gas, Inc.
</TABLE>
- ---------------
* Filed herewith.
** To be filed by amendment.
ITEM 17. UNDERTAKINGS.
The registrants hereby undertake:
(a) To provide to the underwriters at the closing specified in the
underwriting agreement certificates in such denominations and registered in
such names as required by the underwriters to permit prompt delivery to
each purchaser.
(b) That, for purposes of determining any liability under the
Securities Act of 1933, the information omitted from the form of prospectus
filed as part of this Registration Statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the registrants pursuant to Rule
424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed a part
of this Registration Statement as of the time it was declared effective.
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<PAGE> 178
(c) That, for the purpose of determining any liability under the
Securities Act of 1933, each post-effective amendment that contains a form
of prospectus shall be deemed to be a new registration statement relating
to the securities offered therein, and the offering of such securities at
that time shall be deemed to be the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of each
of the registrants pursuant to the provisions described in Item 14 above or
otherwise, each registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In
the event that claim for indemnification against such liabilities (other than
the payment by Eastern States of expenses incurred or paid by a director,
officer or controlling person of each of the registrants in the successful
defense of any action, suit or proceeding) is asserted by such director, officer
or controlling person in connection with the securities being registered, each
registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in the Securities Act of 1933 and will be governed by the final
adjudication of such issue.
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<PAGE> 179
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Alexandria, State of
Virginia, on August 26, 1999.
EASTERN STATES OIL & GAS, INC.
By: /s/ CLIFTON A. BROWN
----------------------------------
Name: Clifton A. Brown
Title: President and Chief
Executive Officer
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Alexandria, State of
Virginia, on August 26, 1999.
APPALACHIAN BASIN ROYALTY TRUST
By: EASTERN STATES OIL & GAS, INC.,
as sponsor
By: /s/ CLIFTON A. BROWN
----------------------------------
Name: Clifton A. Brown
Title: President and Chief
Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes and appoints
Clifton A. Brown, Stevens V. Gillespie and Kerry W. Eckstein, and each of them,
any one of whom may act without the joinder of the other, as his true and lawful
attorneys-in-fact and agents, with full power of substitution and
resubstitution, for him, and in his name, place and stead, in any and all
capacities to sign any and all amendments (including post-effective amendments)
to this registration statement, and any related registration statement filed
pursuant to Rule 462(b) under the Securities Act of 1933 and all amendments and
post-effective amendments thereto, and to file the same, with all exhibits
thereto and all other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents full power
and authority to do and perform each and every act and thing requisite and
necessary to be done, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents or their substitute or substitutes may lawfully do or cause to be
done by virtue hereof.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ CLIFTON A. BROWN President and Chief Executive August 26, 1999
- ----------------------------------------------------- Officer (Principal Executive
Clifton A. Brown Officer)
/s/ STEVENS V. GILLESPIE Senior Vice President, Chief August 26, 1999
- ----------------------------------------------------- Financial Officer and
Stevens V. Gillespie Treasurer (Principal
Financial Officer and
Principal Accounting Officer)
</TABLE>
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<PAGE> 180
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ DAVID A. DRESNER Director August 26, 1999
- -----------------------------------------------------
David A. Dresner
/s/ KRISTIAN B. HAUSKEN Director August 26, 1999
- -----------------------------------------------------
Kristian B. Hausken
/s/ JON A. JACOBSEN Director August 26, 1999
- -----------------------------------------------------
Jon A. Jacobsen
/s/ THOR OTTO LOHNE Director August 26, 1999
- -----------------------------------------------------
Thor Otto Lohne
/s/ JOHAN NIC VOLD Director August 26, 1999
- -----------------------------------------------------
Johan Nic Vold
</TABLE>
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<PAGE> 181
EXHIBIT INDEX
ITEM 16. EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
** 1.1 -- Form of Underwriting Agreement.
* 3.1 -- Amended and Restated Certificate of Incorporation of
Eastern States Oil & Gas, Inc.
* 3.2 -- Amended and Restated Bylaws of Eastern States Oil & Gas,
Inc.
* 4.1 -- Certificate of Trust of Appalachian Basin Royalty Trust
* 4.2 -- Appalachian Basin Royalty Trust -- Trust Agreement, dated
as of August 18, 1999.
** 5.1 -- Opinion of Richards, Layton & Fingers, P.A. as to the
legality of the securities offered hereby.
** 8.1 -- Opinion of Andrews & Kurth L.L.P. regarding federal
income tax matters.
**10.1.1 -- Form of Net Overriding Royalty Conveyance -- Kentucky as
amended and restated.
**10.1.2 -- Form of Net Overriding Royalty Conveyance -- West
Virginia as amended and restated.
*10.2 -- Amended and Restated Incentive Compensation Plan of
Statoil Energy, Inc.
*10.3.1 -- Employee Shareholders Agreement dated May 31, 1995 by and
among Statoil Energy, Inc. and the signatories thereto
who hold Statoil Energy, Inc. common stock and/or options
to purchase common stock.
*10.3.2 -- First Amendment to Employee Shareholders Agreement dated
June 6, 1997 by and among Statoil Energy and the
signatories thereto who hold Statoil Energy common stock
and/or options to purchase common stock.
*10.3.3 -- Second Amendment to Employee Shareholders Agreement dated
May 19, 1998 by and among Statoil Energy and the
signatories thereto who hold Statoil common stock and/or
options to purchase common stock.
*10.4 -- Promissory Note dated August 10, 1999 made by Eastern
States Oil & Gas, Inc. to Statoil Energy Holdings, Inc.
for the principal sum of $505,488,085.
*10.5.1 -- Employment Agreement between Clifton A. Brown and Statoil
Energy effective February 1, 1999.
*10.5.2 -- Employment Agreement between Stevens V. Gillespie and
Statoil Energy effective February 1, 1999.
*21.1 -- Subsidiaries of Eastern States Oil & Gas, Inc.
*23.1 -- Consent of Ernst & Young LLP dated August 23, 1999.
**23.2 -- Consent of Richards, Layton & Fingers, P.A. (included in
the opinion filed as Exhibit 5.1).
**23.3 -- Consent of Andrews & Kurth L.L.P. (included in the
opinion filed as Exhibit 8.1).
*23.4 -- Consent of Ryder Scott Company, L.P. Petroleum Engineers
dated August 25, 1999.
*24.1 -- Power of attorney (included in the signature page).
*27.1 -- Financial Data Schedule relating to Appalachian Basin
Royalty Trust.
*27.2 -- Financial Data Schedule relating to Eastern States Oil &
Gas, Inc.
</TABLE>
- ---------------
* Filed herewith.
** To be filed by amendment.
II-8
<PAGE> 1
EXHIBIT 3.1
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF
EASTERN STATES OIL & GAS, INC.
EASTERN STATES OIL & GAS, INC. (the "Corporation"), a corporation
organized and existing under and by virtue of the General Corporation Law of the
State of Delaware ("DGCL"), hereby certifies as follows pursuant to Sections 242
and 245 of the DGCL:
FIRST: The name of the Corporation is "Eastern States Oil & Gas,
Inc."
SECOND: The Corporation was originally incorporated under the name of
"Pamco, Inc."
THIRD: The original Certificate of Incorporation of the Corporation
was filed in the Office of the Secretary of State of the
State 1f Delaware (the "Secretary of State") on November 14,
1985.
FOURTH: The Corporation filed amendments to its Certificate of
Incorporation with the Secretary of State on April 21, 1986,
June 29, 1987, June 20, 1996, October 30, 1996, December 4,
1996, March 4, 1997, October 21, 1997, December 3, 1998, and
August 19, 1999.
FIFTH: The sole stockholder of the Corporation is Statoil Energy
Holdings, Inc. (the "Sole Stockholder"), a Delaware
corporation.
SIXTH: The board of directors of the Corporation, in accordance with
Sections 242 and 245 of the DGCL, (i) adopted and approved
this Amended and Restated Certificate of Incorporation
(including the amendments to the Corporation's Certificate of
Incorporation effected hereby) and (ii) proposed that the
Sole Stockholder adopt and approve this Amended and Restated
Certificate of Incorporation (including the amendments to the
Corporation's Certificate of Incorporation effected hereby).
SEVENTH: The Sole Stockholder, in accordance with Sections 242 and 245
of the DGCL, approved and adopted on behalf of the Sole
Stockholder this Amended and Restated Certificate of
Incorporation (including the amendments to the Corporation's
Certificate of Incorporation effected hereby).
<PAGE> 2
EIGHTH: The Sole Stockholder, in accordance with Section 228 of the
DGCL, approved and adopted this Amended and Restated
Certificate of Incorporation (including the amendments to the
Corporation's Certificate of Incorporation effected hereby).
NINTH: This Amended and Restated Certificate of Incorporation shall
become effective upon its filing with the Secretary of State.
TENTH: Effective immediately upon the filing of this Amended and
Restated Certificate of Incorporation in the office of the
Secretary of State, each outstanding share of previously
existing Common Stock shall be and hereby is converted into
and reclassified as one-half of one share of Common Stock.
Certificates representing reclassified shares are hereby
canceled and upon presentation of the canceled certificates
to the Corporation, the holders thereof shall be entitled to
receive certificate(s) representing the new shares into which
such canceled shares have been converted.
ELEVENTH: The Certificate of Incorporation of the Corporation is hereby
amended and restated to read in its entirety as follows:
ARTICLE I
NAME
The name of the Corporation is Eastern States Oil & Gas, Inc.
ARTICLE II
REGISTERED OFFICE AND REGISTERED AGENT
The registered office of the Corporation in the State of Delaware is
located at 1013 Centre Road in the City of Wilmington 19805, County of New
Castle. The name of its registered agent at such address is Corporation Service
Company. The principal place of business of the Corporation is 2800 Eisenhower
Avenue, Alexandria, Virginia 22314.
ARTICLE III
PURPOSE
The purpose for which the Corporation is organized is to engage in any
lawful acts and activities for which corporations may be organized under the
DGCL, and the Corporation shall have the power to perform all lawful acts and
activities.
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<PAGE> 3
ARTICLE IV
CAPITALIZATION
The total number of shares of stock which the Corporation has authority
to issue is One Thousand (1,000) shares of common stock ("Common Stock") of the
par value of One Dollar ($1.00) per share.
ARTICLE V
STOCKHOLDERS' RIGHTS
(1) The holders of the Common Stock shall have the right, pro rata,
according to their total respective holdings of Common Stock and on such terms
and conditions as the board of directors may determine, to purchase or subscribe
for any of the authorized but unissued shares of Common Stock which the
Corporation may hereafter issue; provided, however, that any such right to
purchase or subscribe for any such shares of Common Stock or any such obligation
shall be nontransferable.
(2) The holders of the Common Stock shall be entitled to vote upon all
matters submitted to a vote of the stockholders of the Corporation and shall be
entitled to one vote for each share of Common Stock held.
(3) The right to cumulate votes for the election of directors as
provided in Section 214 of the DGCL shall not be granted and is hereby expressly
denied.
(4) The private property of the stockholders of the Corporation shall
not be subject to the payment of any of the debts or liabilities of the
Corporation.
ARTICLE VI
BOARD OF DIRECTORS
Subject to the restrictions that the number of directors shall not be
less than two (2) or, such larger number as from time to time may be required by
the laws of the State of Delaware the number of directors may be fixed from time
to time by the Bylaws of the Corporation.
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<PAGE> 4
ARTICLE VII
INDEMNIFICATION OF OFFICERS AND DIRECTORS
(1) To the full extent permitted by Section 102(b)(7) of the DGCL, the
personal liability for monetary damages for breach of fiduciary duty as a
director to the Corporation or its stockholders of any person who is or was a
director shall be eliminated; provided, however, that such personal liability
shall not be eliminated hereby (i) for any breach of the director's duty of
loyalty to the Corporation or its stockholders, (ii) for acts or omissions not
in good faith or which involve intentional misconduct or a knowing violation of
law, (iii) under Section 174 of the DGCL or (iv) for any transaction from which
the director derived an improper personal benefit.
(2) If the DGCL is hereafter amended to authorize corporate action
further limiting or eliminating the personal liability of directors, then the
personal liability of the directors to the Corporation or its stockholders shall
be limited or eliminated to the full extent permitted by the DGCL, as so amended
from time to time.
(3) In addition, subject to the approval of the board of directors, the
Corporation may indemnify each employee and agent of the Corporation and all
other persons whom the Corporation is authorized to indemnify under the
provisions of the DGCL.
ARTICLE VIII
MANAGEMENT
This article EIGHTH is inserted for the management of the business and
the conduct of the affairs of the Corporation, and for further definition,
limitation and regulation of the powers of the Corporation and of its directors
and stockholders.
The following powers shall not be vested in the directors but shall be
reserved in and exercised only by the stockholders of the Corporation:
(1) The power to declare dividends.
(2) The power to borrow money and/or to mortgage, pledge or otherwise
encumber assets of the Corporation.
(3) The power to amend the Bylaws of the Corporation.
(4) The power to sell all or substantially all of the assets of the
Corporation or to merge, consolidate or to liquidate the Corporation.
(5) The power to grant proxies to vote shares of stock owned or held by
the Corporation.
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<PAGE> 5
(5) The power to guarantee debts or obligations of any other person,
corporation or other entity.
ARTICLE IX
AMENDMENT OF CERTIFICATE OF
INCORPORATION
The Corporation reserves the right to amend or repeal any provision
contained in this Amended and Restated Certificate of Incorporation in the
manner prescribed by the laws of the State of Delaware. All rights herein
conferred are granted subject to this reservation.
IN WITNESS WHEREOF, this Amended and Restated Certificate of
Incorporation has been executed for and on behalf and in the name of the
Corporation by its officers thereunto duly authorized on August 26, 1999.
/s/ KERRY W. ECKSTEIN
-----------------------------
Kerry W. Eckstein
Secretary
-5-
<PAGE> 1
EXHIBIT 3.2
Amended and
Restated as of
April 30, 1999
EASTERN STATES OIL & GAS, INC.
AMENDED AND RESTATED BY-LAWS
ARTICLE I.
STOCKHOLDERS
SECTION 1.01. Annual Meeting. The Corporation shall hold an annual
meeting of its stockholders to elect directors and transact any other business
within its powers, either at 10:00 a.m. on the third Thursday of May in each
year if not a legal holiday, or at such other time on such other day falling on
or before the 30th day thereafter as shall be set by the Board of Directors.
Except as the Articles of Incorporation or statute provides otherwise, any
business may be considered at an annual meeting without the purpose of the
meeting having been specified in the notice. Failure to hold an annual meeting
does not invalidate the Corporation's existence or affect any otherwise valid
corporate acts.
SECTION 1.02. Special Meeting. At any time in the interval between
annual meetings, a special meeting of the stockholders may be called by the
Chairman of the Board or the President or by a majority of the Board of
Directors by vote at a meeting or in writing (addressed to the Secretary of the
Corporation) with or without a meeting. Special meetings of the stockholders
shall be called at the request of the stockholders only as may be required by
law.
SECTION 1.03. Place of Meetings. Meetings of stockholders shall be
held at the principal office of the Corporation or such other place in the
United States as is set from time to time by the Board of Directors.
SECTION 1.04. Notice of Meetings; Waiver of Notice. Not less than
ten nor more than 60 days before each stockholders' meeting, the Secretary
shall give written notice of the meeting to each stockholder entitled to vote
at the meeting, except that notice of a stockholders' meeting to act on an
amendment of the Articles of Incorporation, a plan of merger or share exchange,
a proposed sale of assets pursuant to Section 13.1-724 of the Virginia Stock
Corporation Act or the dissolution of the Corporation shall be given not less
than 25 nor more than 60 days before each stockholders' meeting. The notice
shall state the date, time and place of the meeting and, if the meeting is a
special meeting or notice of the purpose is required by statute, the purpose of
the meeting. Notice is given to a stockholder when it is personally delivered
to him, left at his residence or usual place of business, or sent by recognized
overnight delivery service to the address of such stockholder as it appears on
the records of the Corporation. Notwithstanding the foregoing provisions, each
person who is entitled
-1-
<PAGE> 2
to notice waives notice if he before or after the meeting signs a waiver of the
notice which is filed with the records of stockholders' meetings, or is present
at the meeting in person or by proxy, unless the shareholder at the beginning
of the meeting objects to holding the meeting or transacting business at the
meeting.
SECTION 1.05. Quorum; Voting. Unless statute or the Articles of
Incorporation provides otherwise, at a meeting of stockholders the presence in
person or by proxy of stockholders entitled to cast a majority of all the votes
entitled to be cast at the meeting constitutes a quorum, and a majority of all
the votes cast at a meeting at which a quorum is present is sufficient to
approve any matter which properly comes before the meeting, except as otherwise
provided by statute, the Articles of Incorporation or these By-Laws.
SECTION 1.06. Adjournments. Whether or not a quorum is present, a
meeting of stockholders convened on the date for which it was called may be
adjourned from time to time without further notice by a majority vote of the
stockholders present in person or by proxy to a date not more than 120 days
after the original record date. Any business which might have been transacted
at the meeting as originally notified may be deferred and transacted at any
such adjourned meeting at which a quorum shall be present. If a stockholders'
meeting is adjourned to a different date, time or place, notice need not be
given if the new date, time or place is announced at the meeting before
adjournment.
SECTION 1.07. General Right to Vote; Proxies. Unless the Articles of
Incorporation provides for a greater or lesser number of votes per share or
limits or denies voting rights, each outstanding share of stock, regardless of
class, is entitled to one vote on each matter submitted to a vote at a meeting
of stockholders. In all elections for directors, each share of stock may be
voted for as many individuals as there are directors to be elected and for
whose election the share is entitled to be voted. A stockholder may vote the
stock he owns of record either in person or by written proxy signed by the
stockholder or by his duly authorized attorney in fact. Unless a proxy provides
otherwise, it is not valid more than 11 months after its date.
SECTION 1.08. List of Stockholders. The officer or agent having
charge of the share transfer books of the Corporation shall make, at least ten
(10) days before each meeting of stockholders, a complete list of the
stockholders entitled to vote at such meeting or any adjournment thereof, with
the address of and the number of shares held by each, arranged by class of
shares. For the ten day period prior to the meeting, the list of stockholders
shall be kept on file at the registered office of the Corporation or at its
principal office or at the office of its transfer agent or registrar and shall
be subject to inspection by any stockholder at any time during usual business
hours. Such list shall also be produced and kept open at the time and place of
the meeting and shall be subject to the inspection of any stockholder during
the meeting for the purposes thereof.
SECTION 1.09. Conduct of Business and Voting. At all meetings of
stockholders, unless the voting is conducted by inspectors, the proxies and
ballots shall be received, and all questions touching the qualification of
voters and the validity of proxies, the acceptance or rejection of votes and
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<PAGE> 3
procedures for the conduct of business not otherwise specified by these
By-Laws, the Articles of Incorporation or law, shall be decided or determined
by the chairman of the meeting. If demanded by stockholders, present in person
or by proxy, entitled to cast 10% in number of votes entitled to be cast, or if
ordered by the chairman, the vote upon any election or question shall be taken
by ballot and, upon like demand or order, the voting shall be conducted by two
inspectors, in which event the proxies and ballots shall be received, and all
questions touching the qualification of voters and the validity of proxies and
the acceptance or rejection of votes shall be decided, by such inspectors.
Unless so demanded or ordered, no vote need be by ballot and voting need not be
conducted by inspectors. The stockholders at any meeting may choose an
inspector or inspectors to act at such meeting, and in default of such election
the chairman of the meeting may appoint an inspector or inspectors. No
candidate for election as a director at a meeting shall serve as an inspector
thereat.
SECTION 1.10. Informal Action by Stockholders. Any action required
or permitted to be taken at a meeting of stockholders may be taken without a
meeting if there is filed with the records of stockholders' meetings an
unanimous written consent which sets forth the action and is signed by each
stockholder entitled to vote on the matter and a written waiver of any right to
dissent signed by each stockholder entitled to notice of the meeting but not
entitled to vote at it.
ARTICLE II.
BOARD OF DIRECTORS
SECTION 2.01. Function of Directors. The business and affairs of the
Corporation shall be managed under the direction of its Board of Directors.
All powers of the Corporation may be exercised by or under authority of the
Board of Directors, except as conferred on or reserved to the stockholders by
statute or by the Articles of Incorporation or these By-Laws.
SECTION 2.02. Number of Directors. The number of directors shall be
six (6) or such other number, but not less than two (2) nor more than nine (9),
as may be designated from time to time by a resolution of a majority of the
entire Board of Directors.
SECTION 2.03. Election and Tenure of Directors. At each annual
meeting, the stockholders shall elect directors to hold office until the next
annual meeting and until their successors are elected and qualify.
SECTION 2.04. Removal of Director. Unless statute or the Articles
of Incorporation provides otherwise, the stockholders may remove any director,
with or without cause, by the affirmative vote of a majority of all the votes
entitled to be cast for the election of directors.
SECTION 2.05. Vacancy on Board. In the case of any vacancy in the
Board of Directors from any cause except an increase in the number of
directors, the stockholders will call a special meeting and elect a successor
to hold office for the unexpired portion of the term of the director, and until
the election of his successor, or until he shall be removed, prior thereto,
pursuant to these By-Laws. In
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<PAGE> 4
the event the number of directors is increased, as provided in these By-Laws,
the additional directors so provided for shall be elected by a majority of the
entire Board of Directors already in office, and shall hold office until the
next annual meeting of stockholders and thereafter until his or their
successors shall be elected.
SECTION 2.06. Regular Meetings. After each meeting of stockholders
at which directors shall have been elected, the Board of Directors shall meet
as soon as practicable for the purpose of organization and the transaction of
other business. In the event that no other time and place are specified by
resolution of the Board, the President or the Chairman, with notice in
accordance with Section 2.08, the Board of Directors shall meet immediately
following the close of, and at the place of, such stockholders' meeting. Any
other regular meeting of the Board of Directors shall be held on such date and
at any place as may be designated from time to time by the Board of Directors.
SECTION 2.07. Special Meetings. Special meetings of the Board of
Directors may be called at any time by the Chairman of the Board or the
President or by a majority of the Board of Directors by vote at a meeting, or
in writing with or without a meeting. A special meeting of the Board of
Directors shall be held on such date and at any place as may be designated from
time to time by the Board of Directors. In the absence of designation such
meeting shall be held at such place as may be designated in the call.
SECTION 2.08. Notice of Meeting. Except as Provided in Section 2.06,
the Secretary shall give notice to each director of each regular and special
meeting of the Board of Directors. The notice shall state the time and place
of the meeting. Notice is given to a director when it is delivered personally
to him, or left at his residence or usual place of business at least 24 hours
before the time of the meeting or sent by recognized overnight delivery service
to his address as it shall appear on the records of the Corporation, at least
96 hours before the time of the meeting. Unless a resolution of the Board of
Directors provides otherwise, the notice need not state the business to be
transacted at or the purposes of any regular or special meeting of the Board of
Directors. No notice of any meeting of the Board of Directors need be given to
any director who attends except where a director attends a meeting for the
express purpose of objecting to the transaction of any business because the
meeting is not lawfully called or convened, or to any director who, in writing
executed and filed with the records of the meeting either before or after the
holding thereof, waives such notice. Any meeting of the Board of Directors,
regular or special, may adjourn from time to time to reconvene at the same or
some other place, and no notice need be given of any such adjourned meeting
other than by announcement.
SECTION 2.09. Action by Directors. Unless statute or the Articles of
Incorporation or By-Laws requires a greater proportion, the action of a
majority of the directors present at a meeting at which a quorum is present is
action of the Board of Directors. A majority of the entire Board of Directors
shall constitute a quorum for the transaction of business. In the absence of a
quorum, the directors present by majority vote and without notice other than by
announcement may adjourn the meeting from time to time until a quorum shall
attend. At any such adjourned meeting at which a quorum shall be present, any
business may be transacted which might have been transacted at the
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<PAGE> 5
meeting as originally notified. Any action required or permitted to be taken
at a meeting of the Board of Directors may be taken without a meeting, if an
unanimous written consent which sets forth the action is signed by each member
of the Board and filed with the minutes of proceedings of the Board.
SECTION 2.10. Meeting by Conference Telephone Or Other Means.
Members of the Board of Directors may participate in a meeting by means of a
conference telephone or similar communications equipment if all persons
participating in the meeting can hear each other at the same time.
Participation in a meeting by these means constitutes presence in person at a
meeting.
SECTION 2.11. Compensation. By resolution of the Board of Directors,
a fixed sum and expenses, if any, for attendance at each regular or special
meeting of the Board of Directors or of committees thereof, and other
compensation for their services as such or on committees of the Board of
Directors, may be paid to directors. Directors who are full-time employees of
the Corporation need not be paid for attendance at meetings of the board or
committees thereof for which fees are paid to other directors. A director who
serves the Corporation in any other capacity also may receive compensation for
such other services, pursuant to a resolution of the directors.
ARTICLE III.
COMMITTEES
SECTION 3.01. Committees. The Board of Directors may appoint from
among its members an audit committee, a compensation committee, a dividend
review committee, an executive committee, and one or more other committees
composed of two or more directors and delegate to these committees any of the
powers of the Board of Directors, except the power to:
(1) approve or recommend to shareholders action that the Virginia
Stock Corporation Act requires to be approved by stockholders;
(2) fill vacancies on the Board of Directors or any of its
committees;
(3) amend the Corporation's Articles of Incorporation;
(4) adopt, amend, or repeal the By-Laws;
(5) approve a plan of merger not requiring shareholder approval;
(6) authorize or approve a distribution, except according to a
general formula or method prescribed by the Board of
Directors; and
(7) authorize or approve the issuance or sale or contract for sale
of shares, or determine the designation and relative rights,
preferences, and limitations of a class or series of
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shares, except that the Board of Directors may authorize a
committee to do so within limits prescribed by the Board of
Directors of the Corporation.
SECTION 3.02. Audit Committee. The function of the Audit Committee
shall be to review the establishment of the Corporation's accounting policies,
the adequacy of its financial controls, and the reliability of its financial
accountants. The Audit Committee shall: (i) review the Corporation's
financial information and controls; (ii) maintain a direct line of
communications between the Board of Directors and the Corporation's independent
certified public accountants; (iii) recommend the appointment of independent
auditors from year to year; (iv) approve the scope of the annual audit; and (v)
review the annual audit report and any management letters or similar reports
provided by the accountants.
SECTION 3.03. Compensation Committee. The function of the
Compensation Committee shall be to review and recommend to the Board of
Directors general levels of salary, bonus, and incentive compensation
arrangements for senior officers and other key employees and to review the
Corporation's general compensation and benefit policies.
SECTION 3.04. Dividend Review Committee. The Dividend Review
Committee shall function exclusively in an advisory capacity to the Board of
Directors in circumstances where the Board of Directors has declined to declare
a dividend that has been requested by the Corporation's stockholders. The
functions of the Dividend Review Committee shall be to (i) review the
determination by the Corporation's management that the Corporation has
insufficient legally available funds to effect the payment of a dividend, (ii)
review contractual restrictions that may prevent the payment of the dividend,
and (iii) review determinations by the Board of Directors or the Corporation's
management that a redeployment of cash that would have otherwise been available
for distribution to stockholders will enhance the long- term value of an
investment in the Corporation. In making such reviews and determinations, the
Dividend Review Committee shall have access to all internal memoranda,
projections, financial models, and other supporting material, including copies
of any advice provided to the Corporation by its financial advisors or counsel,
that supported the Corporation's decision to refrain from payment of a dividend
that had been so requested. In the case of a review of a decision outlined in
clause (iii), the Dividend Review Committee shall have the right to present a
written statement to the Board of Directors outlining whether or not the
Committee concurs with the determination of the Corporation, although such
statement shall not be binding on the Board of Directors.
SECTION 3.05. Executive Committee. The Executive Committee, when the
Board of Directors is not in session, shall have and may exercise all of the
authority and power of the Board of Directors except for (1) the powers
excluded in Section 3.01, (2) the power to elect or remove members of any
committee or appoint another member in the absence of an Executive Committee
member, (3) any restrictions or limitations that may from time to time be
specified by the Board of Directors. Time and place of Executive Committee
meetings shall be determined by the Executive Committee. The designation of an
Executive Committee and the delegation of authority to it shall not
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operate to relieve the Board of Directors, or any member thereof, of any
responsibility imposed upon it or him by law.
SECTION 3.06. Committee Procedure. Each committee, except the
Executive Committee, may fix rules of procedure for its business. A majority
of the members of a committee, except the Executive Committee which must act
unanimously, shall constitute a quorum for the transaction of business and the
act of a majority of those present at a meeting at which a quorum is present
shall be the act of the committee. The members of a committee, except the
Executive Committee, present at any meeting, whether or not they constitute a
quorum, may appoint a director to act in the place of an absent member. Any
action required or permitted to be taken at a meeting of a committee may be
taken without a meeting, if a unanimous consent which sets forth the action is
signed by each member of the committee and filed with the minutes of the
committee. The members of a committee may conduct any meeting thereof by
conference telephone in accordance with the provisions of applicable law.
SECTION 3.07. Emergency. In the event of a state of disaster of
sufficient severity to prevent the conduct and management of the affairs and
business of the Corporation by its directors and officers as contemplated by
the Articles of Incorporation and these By-Laws, any two or more available
members of the then incumbent Executive Committee shall constitute a quorum of
that Committee for the full conduct and management of the affairs and business
of the Corporation in accordance with the provisions of Section 3.01. In the
event of the unavailability, at such time, of a minimum of two members of the
then incumbent Executive Committee, the available directors shall elect an
Executive Committee consisting of any two members of the Board of Directors,
whether or not they be officers of the Corporation, which two members shall
constitute the Executive Committee for the full conduct and management of the
affairs of the Corporation in accordance with the foregoing provisions of this
Section. This Section shall be subject to implementation by resolution of the
Board of Directors passed from time to time for that purpose, and any
provisions of the By-Laws (other than this Section) and any resolutions which
are contrary to the provisions of this Section or to the provisions of any such
implementary resolutions shall be suspended until it shall be determined by any
interim Executive Committee acting under this Section that it shall be to the
advantage of the Corporation to resume the conduct and management of its
affairs and business under all the other provisions of these By-Laws.
ARTICLE IV.
OFFICERS
SECTION 4.01. Executive and Other Officers. The Corporation shall
have a President, a Secretary, and a Treasurer. It may also have a Chairman of
the Board, who shall be an officer of the Corporation if he is so designated by
the Board of Directors. The Board of Directors may designate who shall serve
as chief executive officer, having general supervision of the business and
affairs of the Corporation, or as chief operating officer, having supervision
of the operations of the Corporation. In the absence of any designation the
Chairman of the Board, if there be one, shall serve as chief
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<PAGE> 8
executive officer and the President shall serve as chief operating officer. In
the absence of the Chairman of the Board, or if there be none, the President
shall be the chief executive officer. The same person may hold both offices.
The Corporation may also have one or more Vice-Presidents, assistant officers,
and subordinate officers as may be established by the Board of Directors and
may provide additional descriptive titles, such as chief financial officer, as
the Board shall deem appropriate. A person may hold more than one office in
the Corporation except that no person may serve concurrently as both President
and Vice-President of the Corporation. The Chairman of the Board shall be a
director; the other officers may be directors.
SECTION 4.02. Chairman of the Board, The Chairman of the Board, if
one be elected, shall preside at all meetings of the Board of Directors and of
the stockholders at which he shall be present. In general, he shall perform
all such duties as are from time to time assigned to him by the Board of
Directors.
SECTION 4.03. President. Unless otherwise provided by resolution of
the Board of Directors, the President, in the absence of the Chairman of the
Board, shall preside at all meetings of the Board of Directors and of the
stockholders at which he shall be present. He may sign and execute, in the
name of the Corporation, all authorized deeds, mortgages, bonds, contracts or
other instruments, except in cases in which the signing and execution thereof
shall have been expressly delegated to some other officer or agent of the
Corporation. In general, he shall perform such other duties usually performed
by a president of a corporation and such other duties as are from time to time
assigned to him by the Board of Directors or the chief executive officer of the
Corporation.
SECTION 4.04. Vice-Presidents. The Vice-President or
Vice-Presidents, at the request of the chief executive officer or the
President, or in the President's absence or during his inability to act, shall
perform the duties and exercise the functions of the President, and when so
acting shall have the powers of the President. If there be more than one
Vice-President, the Board of Directors may determine which one or more of the
Vice-Presidents shall perform any of such duties or exercise any of such
functions, or if such determination is not made by the Board of Directors, the
chief executive officer, or the President may make such determination;
otherwise any of the Vice-Presidents may perform any of such duties or exercise
any of such functions. The Vice-President or Vice-Presidents shall have such
other powers and perform such other duties, and have such additional
descriptive designations in their titles (if any), as are from time to time
assigned to them by the Board of Directors, the chief executive officer, or the
President.
SECTION 4.05. Secretary. The Secretary shall keep the minutes of the
meetings of the stockholders, of the Board of Directors and of any committees,
in books provided for the purpose; he shall see that all notices are duly given
in accordance with the provisions of the By-Laws or as required by law; he
shall be custodian of the records of the Corporation; he may witness any
document on behalf of the Corporation, the execution of which is duly
authorized, see that the corporate seal is affixed where such document is
required or desired to be under its seal, and, when so affixed, may attest the
same; and, in general, he shall perform all duties incident to the office of a
secretary of a
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corporation, and such other duties as are from time to time assigned to him by
the Board of Directors, the chief executive officer, or the President.
SECTION 4.06. Treasurer. The Treasurer shall have charge of and be
responsible for all funds, securities, receipts and disbursements of the
Corporation, and shall deposit, or cause to be deposited, in the name of the
Corporation, all moneys or other valuable effects in such banks, trust
companies or other depositories as shall, from time to time, be selected by the
Board of Directors; he shall render to the President and to the Board of
Directors, whenever requested, an account of the financial condition of the
Corporation; and, in general, he shall perform all the duties incident to the
office of a treasurer of a corporation, and such other duties as are from time
to time assigned to him by the Board of Directors, the chief executive officer,
or the President.
SECTION 4.07. Assistant and Subordinate Officers. The assistant and
subordinate officers of the Corporation are all officers below the office of
Vice-President, Secretary, or Treasurer. The assistant or subordinate officers
shall have such duties as are from time to time assigned to them by the Board
of Directors, the chief executive officer, or the President.
SECTION 4.08. Election, Tenure and Removal of Officers. The Board of
Directors shall elect the officers. The Board of Directors may from time to
time authorize any committee or officer to appoint assistant and subordinate
officers. Election or appointment of an officer, employee or agent shall not
of itself create contract rights. All officers shall be appointed to hold
their offices, respectively, during the pleasure of the Board. The Board of
Directors (or, as to any assistant or subordinate officer, any committee or
officer authorized by the Board) may remove an officer at any time, with or
without cause. The removal of an officer does not prejudice any of his
contract rights. The Board of Directors (or, as to any assistant or
subordinate officer, any committee or officer authorized by the Board) may fill
a vacancy which occurs in any office for the unexpired portion of the term.
SECTION 4.09. Compensation. The Board of Directors shall have power
to fix the salaries and other compensation and remuneration, of whatever kind,
of all officers of the Corporation. No officer shall be prevented from
receiving such salary by reason of the fact that he is also a director of the
Corporation. The Board of Directors may authorize any committee or officer to
fix the salaries, compensation and remuneration of other officers and assistant
and subordinate officers.
ARTICLE V.
DIVISIONAL TITLES
SECTION 5.01. Conferring Divisional Titles. The Board of Directors
may from time to time confer upon any employee of a division of the Corporation
the title of President, Vice President, Treasurer or Controller of such
division or any other title or titles deemed appropriate, or may authorize the
Chairman of the Board or the President to do so. Any such titles so conferred
may be discontinued and withdrawn at any time by the Board of Directors, or by
the Chairman of the Board
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or the President if so authorized by the Board of Directors. Any employee of a
division designated by such divisional title shall have the powers and duties
with respect to such division as shall be prescribed by the Board of Directors,
the Chairman of the Board or the President.
SECTION 5.02. Effect of Divisional Titles. The conferring of
divisional titles shall not create an office of the Corporation under Article
IV unless specifically designated as such by the Board of Directors; but any
person who is an officer of the Corporation may also have a divisional title.
ARTICLE VI.
STOCK
SECTION 6.01. Certificates for Stock. Each stockholder is entitled
to certificates which represent and certify the shares of stock he holds in the
Corporation. Each stock certificate shall include on its face the name of the
Corporation and the fact that it is organized under the laws of the
Commonwealth of Virginia, the name of the stockholder or other person to whom
it is issued, and the class of stock and number of shares it represents. It
shall be in such form, not inconsistent with law or with the Articles of
Incorporation, as shall be approved by the Board of Directors or any officer or
officers designated for such purpose by resolution of the Board of Directors.
Each stock certificate shall be signed by the Chairman of the Board, the
President, or a Vice-President, and countersigned by the Secretary, an
Assistant Secretary, the Treasurer, or an Assistant Treasurer. Each
certificate may be sealed with the actual corporate seal or a facsimile of it
or in any other form and the signatures may be either manual or facsimile
signatures. A certificate is valid and may be issued whether or not an officer
who signed it is still an officer when it is issued.
SECTION 6.02. Transfers. The Board of Directors shall have power and
authority to make such rules and regulations as it may deem expedient
concerning the issue, transfer and registration of certificates of stock; and
may appoint transfer agents and registrars thereof. The duties of transfer
agent and registrar may be combined.
SECTION 6.03. Record Dates and Closing of Transfer Books. The Board
of Directors may set a record date or direct that the stock transfer books be
closed for a stated period for the purpose of making any proper determination
with respect to stockholders, including which stockholders are entitled to
notice of a meeting, vote at a meeting, receive a dividend, or be allotted
other rights. The record date may not be prior to the close of business on the
day the record date is fixed nor, subject to Section 1.06, more than 60 days
before the date on which the action requiring the determination will be taken;
the transfer books may not be closed for a period longer than 20 days; and, in
the case of a meeting of stockholders, the record date or the closing of the
transfer books shall be at least ten days before the date of the meeting.
SECTION 6.04. Stock Ledger. The Corporation shall maintain a stock
ledger which contains the name and address of each stockholder and the number
of shares of stock of each class which the stockholder holds. The stock ledger
may be in written form or in any other form which can be
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converted within a reasonable time into written form for visual inspection.
The original or a duplicate of the stock ledger shall be kept at the offices of
a transfer agent for the particular class of stock, or, if none, at the
principal office in the Commonwealth of Virginia or the principal executive
offices of the Corporation.
SECTION 6.05. Certification of Beneficial Owners. The Board of
Directors may adopt by resolution a procedure by which a stockholder of the
Corporation may certify in writing to the Corporation that any shares of stock
registered in the name of the stockholder are held for the account of a
specified person other than the stockholder. The resolution shall set forth
the class of stockholders who may certify; the purpose for which the
certification may be made; the form of certification and the information to be
contained in it; if the certification is with respect to a record date or
closing of the stock transfer books, the time after the record date or closing
of the stock transfer books within which the certification must be received by
the Corporation; and any other provisions with respect to the procedure which
the Board considers necessary or desirable. On receipt of a certification
which complies with the procedure adopted by the Board in accordance with this
Section, the person specified in the certification is, for the purpose set
forth in the certification, the holder of record of the specified stock in
place of the stockholder who makes the certification.
SECTION 6.06. Lost Stock Certificates. The Board of Directors of the
Corporation may determine the conditions for issuing a new stock certificate in
place of one which is alleged to have been lost, stolen, or destroyed, or the
Board of Directors may delegate such power to any officer or officers of the
Corporation. In their discretion, the Board of Directors or such officer or
officers may refuse to issue such new certificate save upon the order of some
court having jurisdiction in the premises.
ARTICLE VII.
FINANCE
SECTION 7.01. Checks, Drafts, Etc. All checks, drafts and orders for
the payment of money, notes and other evidences of indebtedness, issued in the
name of the Corporation, shall, unless otherwise provided by resolution of the
Board of Directors, be signed by the President, a Vice-President or an
Assistant Vice-President and countersigned by the Treasurer, an Assistant
Treasurer, the Secretary or an Assistant Secretary.
SECTION 7.02. Annual Statement of Affairs. The President or chief
accounting officer shall prepare annually a full and correct statement of the
affairs of the Corporation, to include a balance sheet and a financial
statement of operations for the preceding fiscal year. The statement of
affairs shall be submitted at the annual meeting of the stockholders and,
within 20 days after the meeting, placed on file at the Corporation's principal
office.
SECTION 7.03. Fiscal Year. The fiscal year of the Corporation shall
be the twelve calendar months period ending December 31 in each year, unless
otherwise provided by the Board of Directors.
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SECTION 7.04. Dividends. If declared by the Board of Directors at
any meeting thereof, the Corporation may pay dividends on its shares in cash,
property, or in shares of the capital stock of the Corporation, unless such
dividend is contrary to law or to a restriction contained in the Articles of
Incorporation.
ARTICLE VIII.
SUNDRY PROVISIONS
SECTION 8.01. Books and Records. The Corporation shall keep correct
and complete books and records of its accounts and transactions and minutes of
the proceedings of its stockholders and Board of Directors and of any executive
or other committee when exercising any of the powers of the Board of Directors.
The books and records of a Corporation may be in written form or in any other
form which can be converted within a reasonable time into written form for
visual inspection. Minutes shall be recorded in written form but may be
maintained in the form of a reproduction. The original or a certified copy of
the By-Laws shall be kept at the principal office of the Corporation.
SECTION 8.02. Corporate Seal. The Board of Directors shall provide a
suitable seal, bearing the name of the Corporation, which shall be in the
charge of the Secretary. The Board of Directors may authorize one or more
duplicate seals and provide for the custody thereof. If the Corporation is
required to place its corporate seal to a document, it is sufficient to meet
the requirement of any law, rule, or regulation relating to a corporate seal to
place the word "Seal" adjacent to the signature of the person authorized to
sign the document on behalf of the Corporation.
SECTION 8.03. Bonds. The Board of Directors may require any officer,
agent or employee of the Corporation to give a bond to the Corporation,
conditioned upon the faithful discharge of his duties, with one or more
sureties and in such amount as may be satisfactory to the Board of Directors.
SECTION 8.04. Voting Upon Shares in Other Corporations. Stock of
other corporations or associations, registered in the name of the Corporation,
may be voted by the President, a Vice-President, or a proxy appointed by either
of them. The Board of Directors, however, may by resolution appoint some other
person to vote such shares, in which case such person shall be entitled to vote
such shares upon the production of a certified copy of such resolution.
SECTION 8.05. Mail. Any notice or other document which is required
by these By-Laws to be mailed shall be deposited in the United States mails,
postage prepaid.
SECTION 8.06. Execution of Documents. A person who holds more than
one office in the Corporation may not act in more than one capacity to execute,
acknowledge, or verify an instrument required by law to be executed,
acknowledged, or verified by more than one officer.
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SECTION 8.07. Indemnification.
(a) The Corporation shall indemnify a director or officer of the
Corporation who is or was a party to any proceeding by reason of the fact that
he is or was such a director or officer or is or was serving at the request of
the Corporation as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust, employee benefit plan or other
profit or non-profit enterprise against all liabilities and expenses incurred
in the proceeding to the maximum extent permissible under applicable law.
(b) To the maximum extent permissible under applicable law, the
Corporation shall make advances and reimbursements for expenses incurred by a
director or officer in a proceeding upon receipt of an undertaking from him to
repay the same if it is ultimately determined that he is not entitled to
indemnification. Such undertaking shall be an unlimited, unsecured general
obligation of the director or officer and shall be accepted without reference
to his ability to make repayment. The Executive Committee is hereby designated
as an appropriate committee to authorize such advances/reimbursements.
(c) The Board of Directors is hereby empowered, by majority vote
of a quorum of disinterested directors, to cause the Corporation to indemnify
or contract in advance to indemnify any other employee or agent of the
Corporation not specified in subsection (a) of this Section 8.07 who was or is
a party to any proceeding, by reason of the fact that he is or was an employee
or agent of the Corporation, or is or was serving at the request of the
Corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust, employee benefit plan or other profit or
non-profit enterprise, to the same extent as if such person was specified as
one to whom indemnification is granted in subsection (a).
(d) The Corporation may purchase and maintain insurance to
indemnify it against the whole or any portion of the liability assumed by it in
accordance with this Section 8.07 and may also procure insurance, in such
amounts as the Board of Directors may determine, on behalf of any person who is
or was a director, officer, employee or agent of another corporation,
partnership, joint venture, trust, employee benefit plan or other enterprise,
against any liability asserted against or incurred by such person in any such
capacity or arising from his status as such, whether or not the Corporation
would have power to indemnify him against such liability under the provisions
of this Section 8.07.
(e) In the event there has been a change in the composition of a
majority of the Board of Directors after the date of an alleged act or omission
with respect to which indemnification is claimed, any determination as to
indemnification and advancement of expenses with respect to any claim for
indemnification made pursuant to subsection (a) of this Section 8.07 shall be
made by special legal counsel agreed upon by the Board of Directors and the
proposed indemnitee. If the Board of Directors and the proposed indemnitee are
unable to agree upon such special legal counsel, the Board of Directors and the
proposed indemnitee each shall select a nominee, and the nominees shall select
such special legal counsel.
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(f) The provisions of this Section 8.07 shall be applicable to all
actions, claims, suits or proceedings commenced after the adoption hereof,
whether arising from any action taken or failure to act before or after such
adoption. No amendment, modification or repeal of this Section 8.07 shall
diminish the rights provided hereby or diminish the right to indemnification
with respect to any claim, issue or matter in any then pending or subsequent
proceeding that is based in any material respect on any alleged action or
failure to act prior to such amendment, modification or repeal.
(g) Reference herein to directors, officers, employees or agents
shall include former directors, officers, employees and agents and their
respective heirs, executors and administrators.
(h) If any provision or provisions of this Section 8.07 shall be
held to be invalid, illegal or unenforceable for any reason whatsoever: (i) the
validity, legality and enforceability of the remaining provisions of this
Section 8.07 (including, without limitation, all portions of Section 8.07
containing any such provision held to be invalid, illegal or unenforceable,
that are not themselves invalid, illegal or unenforceable) shall not in any way
be affected or impaired thereby; and (ii) to the fullest extent possible, the
provisions of this Section 8.07 (including, without limitation, all portions of
Section 8.07 containing any such provision held to be invalid, illegal or
unenforceable, that are not themselves invalid, illegal or unenforceable) shall
be construed so as to give effect to the intent manifested by the provision
held invalid, illegal or unenforceable.
SECTION 8.08. Amendments. (a) Any and all provisions of these
By-Laws may be altered or repealed and the new by-laws may be adopted at any
annual meeting of the stockholders, or at any special meeting called for that
purpose, and (b) the Board of Directors shall have the power, at any regular or
special meeting thereof, to make and adopt new by- laws, or to amend, alter or
repeal any of the By-Laws of the Corporation.
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EXHIBIT 4.1
CERTIFICATE OF TRUST
OF
APPALACHIAN BASIN ROYALTY TRUST
THIS Certificate of Trust of Appalachian Basin Royalty Trust (the
"Trust"), dated as of August 18, 1999, is being duly executed and filed by the
undersigned, as trustees, to form a business trust under the Delaware Business
Trust Act (12 Del. C. Section 3801, et seq.).
1. Name. The name of the business trust formed hereby is Appalachian
Basin Royalty Trust.
2. Delaware Trustee. The name and business address of the trustee of
the Trust with a principal place of business in the State of Delaware are Bank
One Delaware, Inc., Three Christina Center, 201 North Walnut Street, Wilmington,
DE 19801.
3. Effective Date. This Certificate of Trust shall be effective upon
filing with the Secretary of the State of the State of Delaware.
IN WITNESS WHEREOF, the undersigned, being the sole trustees of the
Trust, have executed this Certificate of Trust as of the date first-above
written.
Bank One Delaware, Inc., as trustee
By: /s/ SANDRA L. CARUBA
--------------------------------
Name: Sandra L. Caruba
Title: Vice President
/s/ KERRY W. ECKSTEIN
--------------------------------
Kerry W. Eckstein, as trustee
<PAGE> 1
EXHIBIT 4.2
TRUST AGREEMENT
OF
APPALACHIAN BASIN ROYALTY TRUST
THIS TRUST AGREEMENT OF APPALACHIAN BASIN ROYALTY TRUST is
made as of August 18, 1999 (this "Trust Agreement"), by and among Eastern
States Oil & Gas, Inc., a Virginia corporation, as sponsor (the "Sponsor"), and
Bank One Delaware, Inc., a Delaware corporation, as trustee, and Kerry W.
Eckstein, as trustee (jointly, the "Trustees"). The Sponsor and the Trustees
hereby agree as follows:
1. The trust created hereby shall be known as "Appalachian Basin
Royalty Trust" (the "Trust"), in which name the Trustees or the Sponsor, to the
extent provided herein, may conduct the business of the Trust, make and execute
contracts, and sue and be sued.
2. The Sponsor hereby assigns, transfer, conveys and sets over to
the Trust the sum of $1000.00. Such amount shall constitute the initial trust
estate. It is the intention of the parties hereto that the Trust created
hereby constitute a business trust under Chapter 38 of Title 12 of the Delaware
Code, 12 Del. C. Section 3801, et seq. (the "Business Trust Act"), and that
this document constitute the governing instrument of the Trust. The Trustees
are hereby authorized and directed to execute and file a certificate of trust
with the Secretary of State of the State of Delaware in such form as the
Trustees may approve.
3. The Sponsor and the Trustees will enter into an amended and
restated Trust Agreement satisfactory to each such party to provide for the
contemplated operation of the Trust created hereby and the issuance of the
trust securities referred to therein. Prior to the execution and delivery of
such amended and restated Trust Agreement, the Trustees shall not have any duty
or obligation hereunder or with respect of the trust estate, except as
otherwise contemplated by this Trust Agreement, required by applicable law or
as may be necessary to obtain prior to such execution and delivery any
licenses, consents or approvals required by applicable law or otherwise.
Notwithstanding the foregoing, the Trustees may take all actions deemed proper
as are necessary to effect the transactions contemplated herein.
4. The Sponsor, as sponsor of the Trust, is hereby authorized, in
its sole discretion, (i) to prepare and file with the Securities and Exchange
Commission (the "SEC") and to execute, in the case of the 1933 Act Registration
Statement and 1934 Act Registration Statement (as herein defined), on behalf of
the Trust, (a) a Registration Statement (the "1933 Act Registration
Statement"), including all pre-effective and post-effective amendments thereto,
relating to the registration under the Securities Act of 1933, as amended (the
"1933 Act"), of the trust securities of the Trust, (b) any preliminary
prospectus or prospectus or supplement thereto relating to the trust securities
of the Trust required to be filed pursuant to the 1933 Act, and (c) a
Registration Statement on Form 8-A or other appropriate form (the "1934 Act
Registration Statement"), including all pre-effective and post-effective
amendments thereto, relating to the registration of the trust securities of the
Trust under the Securities Exchange Act of 1934, as amended; (ii) if and at
such time as determined by the Sponsor, to file with the New York Stock
Exchange Inc.
<PAGE> 2
("NYSE"), or other exchange, or the National Association of Securities Dealers
("NASD"), and execute on behalf of the Trust a listing application and all
other applications, statements, certificates, agreements and other instruments
as shall be necessary or desirable to cause the trust securities of the Trust
to be listed on the NYSE or such other exchange, or the NASD's Nasdaq National
Market; (iii) to file and execute on behalf of the Trust, such applications,
reports, surety bonds, irrevocable consents, appointments of attorney for
service of process and other papers and documents that shall be necessary or
desirable to register the trust securities of the Trust under the securities or
"blue sky" laws of such jurisdictions as the Sponsor, on behalf of the Trust,
may deem necessary or desirable; (iv) to execute and deliver letters or
documents to, or instruments for filing with, a depository relating to the
trust securities of the Trust; (v) to execute, deliver and perform on behalf of
the Trust one or more conveyances pursuant to which the Sponsor, or one or more
of its subsidiaries, conveys to the Trust a net profits interest in certain oil
and gas properties located in Kentucky and West Virginia; and (vi) to execute,
deliver and perform on behalf of the Trust an underwriting agreement with one
or more underwriters relating to the offering of the trust securities of the
Trust.
In the event that any filing referred to in this Section 4 is
required by the rules and regulations of the SEC, the NYSE or other exchange,
NASD, or state securities or "blue sky" laws to be executed on behalf of the
Trust by the Trustees, the Trustees, in their capacity as trustees of the
Trust, are hereby authorized to join in any such filing and to execute on
behalf of the Trust any and all of the foregoing, it being understood that the
Trustees, in their capacity as trustees of the Trust, shall not be required to
join in any such filing or execute on behalf of the Trust any such document
unless required by the rules and regulations of the Commission, the NYSE or
other exchange, NASD, or state securities or "blue sky" laws.
5. This Trust Agreement may be executed in one or more
counterparts.
6. The number of trustees of the Trust initially shall be two and
thereafter the number of trustees of the Trust shall be such number as shall be
fixed from time to time by a written instrument signed by the Sponsor which may
increase or decrease the number of trustees of the Trust; provided, however,
that to the extent required by the Business Trust Act, one trustee of the Trust
shall either be a natural person who is a resident of the State of Delaware or,
if not a natural person, an entity that has its principal place of business in
the State of Delaware and otherwise meets the requirements of applicable law.
Subject to the foregoing, the Sponsor is entitled to appoint or remove without
cause any trustee of the Trust at any time. Any trustee of the Trust may
resign upon 30 days' prior notice to the Sponsor.
7. The Sponsor hereby agrees to (i) reimburse the Trustees for
all reasonable expenses (including reasonable fees and expenses of counsel and
other experts) and (ii) indemnify, defend and hold harmless the Trustees and
any of the officers, directors, employees and agents of the trustees (the
"Indemnified Persons") from and against any and all losses, damages,
liabilities, claims, actions, suits, costs, expenses, disbursements (including
the reasonable fees and expenses of counsel), taxes and penalties of any kind
and nature whatsoever (collectively, "Expenses"), to the extent that such
Expenses arise out of or are imposed upon or
<PAGE> 3
asserted at any time against such Indemnified Persons with respect to the
performance of this Trust Agreement, the creation, operation or termination of
the Trust or the transactions contemplated hereby; provided, however, that the
Sponsor shall not be required to indemnify any Indemnified Person for any
Expenses that are a result of the willful misconduct, bad faith or gross
negligence of such Indemnified Person.
8. The Trust may be dissolved and terminated before the issuance
of the trust securities of the Trust at the election of the Sponsor.
9. This Trust Agreement shall be governed by, and construed in
accordance with, the laws of the State of Delaware (without regard to conflict
of laws principles).
10. Bank One Delaware, Inc., in its capacity as Trustee hereunder,
shall not have any of the powers or duties of the trustees set forth herein,
except as required under the Business Trust Act, and shall be a Trustee
hereunder for the sole and limited purpose of fulfilling the requirements of
Section 3807(a) of the Business Trust Act.
IN WITNESS WHEREOF, the parties hereto have caused this Trust
Agreement to be duly executed as of the day and year first above written.
EASTERN STATES OIL & GAS, INC.,
as Sponsor
By: /s/ STEVENS V. GILLESPIE
---------------------------------------
Name: Stevens V. Gillespie
Title: Senior Vice President and Chief
Financial Officer
BANK ONE DELAWARE, INC.,
as Trustee
By: /s/ SANDRA L. CARUBA
---------------------------------------
Name: Sandra L. Caruba
Title: Vice President
/s/ KERRY W. ECKSTEIN
--------------------------------------------
Kerry W. Eckstein, as Trustee
<PAGE> 1
EXHIBIT 10.2
AMENDED AND RESTATED INCENTIVE COMPENSATION PLAN
OF
STATOIL ENERGY, INC.
SECTION 1. PURPOSE. The purpose of the Amended and Restated Incentive
Compensation Plan of Statoil Energy, Inc. (the "Plan") is to increase
stockholder values and to advance the interests of Statoil Energy, Inc. (the
"Company") by providing certain key employees of the Company and its
subsidiaries with additional incentives to promote the success of the Company;
to provide such employees with an equity interest in the Company; and to
encourage such employees to remain with the Company or a subsidiary of the
Company.
SECTION 2. DEFINITIONS. The following words and phrases shall have the
meanings set forth below whenever they are used in this Plan:
(a) "BOARD OF DIRECTORS" shall mean the Board of Directors of the Company.
(b) "CHANGE OF CONTROL" shall mean:
(i) the acquisition (other than by Ralph L. Bradley) by any
person, entity or "group" within the meaning of Section
13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934
(the "Exchange Act") (excluding, for this purpose, the Company
or its Subsidiaries or any employee benefit plan of the
Company or its Subsidiaries which acquires beneficial
ownership of voting securities of the Company) of beneficial
ownership (within the meaning of Rule 13d-3 promulgated under
the Exchange Act), of fifty percent (50%) or more of either
the then outstanding shares of Common Stock or the combined
voting power of the Company's then outstanding capital stock
entitled to vote generally in the election of directors; or
(ii) individuals who, as of the date hereof, constitute the Board
of Directors (as of the date hereof, the "Incumbent Board")
cease for any reason to constitute at least a majority of the
Board, provided that any person becoming a director subsequent
to the date hereof whose election, or nomination for election
by the Company's shareholders, was approved by a vote of at
least a majority of the directors then comprising the
Incumbent Board (other than an election or nomination of an
individual whose initial assumption of office is in connection
with an actual or threatened election contest relating to the
election of the directors of the Company) shall, for purposes
of this Agreement, be considered as though such person were a
member of the Incumbent Board; or
(iii) approval by the Board of Directors of a reorganization,
merger, consolidation or share exchange, in each case, with
respect to which persons who were the shareholders of the
Company immediately prior to such reorganization, merger,
consolidation or share exchange will not, immediately after
the effective date of the
<PAGE> 2
transaction, own more than fifty percent (50%) of the combined
voting power entitled to vote generally in the election of
directors of the reorganized, merged, consolidated or other
surviving company's then outstanding voting securities, or a
liquidation or dissolution of the Company or the sale of all
or substantially all of the assets of the Company.
(c) "CODE" shall mean the Internal Revenue Code of 1986, as amended.
(d) "COMMITTEE" shall mean the individual or individuals appointed by the
Board of Directors to administer the Plan.
(e) "COMMON STOCK" shall mean the common stock of the Company.
(f) "COMPANY" shall mean Statoil Energy, Inc.
(g) "EFFECTIVE DATE" shall mean the date the Plan was adopted by the Board
of Directors (i.e., January 6, 1992).
(h) "ELIGIBLE EMPLOYEE" shall mean any officer or other employee of the
Company or any of its Subsidiaries.
(i) "EXERCISE PRICE" shall mean the purchase price per share of Common
Stock that a Grantee must pay to purchase a share of Common Stock
pursuant to an Option granted under the Plan, as established by the
Committee.
(j) "FAIR MARKET VALUE" shall mean the value of a share of Common Stock
determined as follows:
(i) in the event the Common Stock is then publicly traded (i.e.,
on the New York Stock Exchange, the American Stock Exchange or
the National Association of Securities Dealers Automated
Quotation System), the average of the closing prices of the
Common Stock for the twenty (20) days immediately preceding
the Grant Date; or
(ii) in the event the Common Stock is not so publicly traded, the
determination shall be made in good faith by the Committee
based on an independent appraisal of the Company or such other
factors as may be determined in the reasonable discretion of
the Committee; for the purposes hereof, Fair Market Value
shall be based upon the fair market value of the Company
determined without any discount for minority interests or lack
of marketability of the Common Stock, based upon what a
willing buyer would pay and a willing seller would accept for
the Company as a whole.
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<PAGE> 3
(k) "FISCAL YEAR" shall mean the annual period on the basis of which the
Company regularly computes its income in keeping its books for
purposes of issuing audited financial statements and filing its
federal income tax returns.
(l) "FOR CAUSE" shall mean (i) the failure of the Grantee to faithfully
perform any of the duties of his employment, (ii) dishonesty in the
course of or related to employment by the Company or (iii) conviction
of a felony committed in the course of or related to the Grantee's
employment by the Company.
(m) "GRANT DATE" shall mean the date on which an Option or other Incentive
is granted under the Plan.
(n) "GRANTEE" shall mean any Eligible Employee of the Company or any of
its Subsidiaries to whom an Incentive is granted hereunder.
(o) "INCENTIVE" shall mean any of the incentives which may be issued under
the Plan as set forth in Section 3 hereof.
(p) "INCENTIVE STOCK OPTION" shall mean an Option that satisfies the
qualification requirements of Section 422(b) of the Code.
(q) "NON-QUALIFIED STOCK OPTION" shall mean an Option that is not an
Incentive Stock Option.
(r) "OPTION" shall mean the right, but not the obligation, of a Grantee to
purchase shares of Common Stock within the Option Period at the
Exercise Price (which Option may be either an Incentive Stock Option
or a Non-Qualified Stock Option).
(s) "OPTION PERIOD" shall mean a period in which the Grantee may elect to
purchase shares of Common Stock at the Exercise Price.
(t) "PERFORMANCE STOCK AWARD" shall mean an award of shares of Common
Stock to any Eligible Employee contingent upon the achievement of a
specified personal or Company performance objective.
(u) "PLAN" shall mean the Amended and Restated Incentive Compensation Plan
of Statoil Energy, Inc.
(v) "RESTRICTED STOCK AWARD" shall mean the award of shares of Common
Stock to any Eligible Employee which shares are subject to certain
restrictions to be established on a case-by-case basis by the Committee
which may include a requirement that the Eligible Employee forfeit
such shares to the Company in the event the employment of the Eligible
Employee is terminated prior to a certain date.
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<PAGE> 4
(w) "STOCK AWARD" shall mean the award of shares of Common Stock to any
Eligible Employee which shares would be without restriction except for
the provisions of the Stockholders Agreement.
(x) "STOCKHOLDERS AGREEMENT" shall mean the agreement to be entered into
by the Company and each Eligible Employee who receives an Incentive
hereunder.
(y) "STOCK OPTION AGREEMENT" shall mean an irrevocable, written agreement,
executed by both the Grantee and a duly authorized officer of the
Company, that shall set forth the number of shares of Common Stock,
the Exercise Price and the dates such shares of Common Stock may be
purchased by the Grantee under the Plan.
(z) "SUBSIDIARIES" shall mean any corporation of which the Company owns,
directly or indirectly, within the meaning of Section 425(f) of the
Code, fifty percent (50%) or more of the total combined voting power
of all classes of stock.
SECTION 3. SCOPE OF THE PLAN. The Incentives that may be offered under
the Plan are: (i) Incentive Stock Options; (ii) Non-Qualified Stock Options;
(iii) Stock Awards; (iv) Restricted Stock Awards; and (v) Performance Stock
Awards. The terms of the Plan shall be interpreted in accordance with this
intention.
SECTION 4. STOCK SUBJECT TO THE PLAN. The maximum aggregate number of
shares of Common Stock which may be issued under the Plan is 500,000 shares of
authorized but unissued shares of Common Stock, subject to adjustment as
provided in Section 14. If an Option shall expire or terminate for any reason
without having been exercised in full, the shares represented by the portion
thereof not so exercised shall (unless the Plan shall have been terminated)
become available for other issuance under the Plan. The Company shall at all
times reserve authorized but unissued shares of its Common Stock at least equal
to the number of shares of Common Stock which may be issued under the Plan.
SECTION 5. ADMINISTRATION OF THE PLAN. The Plan shall be administered by
the Committee. Subject to the provisions of the Plan and the laws of the
Commonwealth of Virginia, the Committee shall have full authority and sole
discretion to administer, interpret and construe the Plan, including setting
rules and regulations related to the Plan, making determinations and taking any
action necessary for the implementation and administration of the Plan. All
determinations of the Committee shall be final, conclusive and binding on the
Company, the stockholders of the Company and upon all Grantees under the Plan
and anyone claiming under or through any of them.
SECTION 6. ELIGIBILITY. Incentives may be granted only to Eligible
Employees. An Eligible Employee who has been granted an Incentive hereunder
may, if he or she is otherwise eligible, be granted an additional Incentive
under the Plan. The designation of an individual to receive an Incentive at
any time shall not require the Committee to designate such person to receive an
Incentive at any other time. The Committee may consider such factors as it
deems pertinent in
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<PAGE> 5
selecting Eligible Employees to receive Incentives hereunder and in determining
the type and amount of their respective Incentives, including without
limitation: (i) the financial condition of the Company; (ii) the anticipated
profits of the Company for the current or future years, including return on
invested capital; (iii) the contribution by the Eligible Employee to the
profitability and development of the Company through achievement of established
strategic objectives; and (iv) the amounts of other compensation provided to
such Eligible Employee.
SECTION 7. TERMS AND CONDITIONS OF OPTIONS. Each Option granted under
the Plan shall be subject to the following terms and conditions:
(a) EXERCISE PRICE. The Exercise Price shall be determined by the
Committee, subject to adjustment under Section 14; provided, however,
that the Exercise Price shall not be less than thirty-three percent
(33%) of the Fair Market Value on the Grant Date.
(b) NUMBER. The number of shares of Common Stock subject to the Option
shall be determined by the Committee, subject to adjustment under
Section 14.
(c) DURATION. The term of each Option shall be determined by the
Committee but shall not exceed ten (10) years from the Grant Date.
(d) EXERCISE. Each Option will vest and become exercisable in accordance
with the provisions set forth in each Stock Option Agreement which
provisions may differ among Options. Notwithstanding any such vesting
provisions, an Option will become fully vested and exercisable: (i)
when the Grantee dies, becomes disabled or attains age 65 while in the
service of the Company or one of its Subsidiaries; or (ii) when the
Company or one of its Subsidiaries terminates the employment of the
Grantee within two (2) years following a Change in Control. The
Committee may, in its discretion, accelerate the exercisability of any
Option.
(e) MANNER OF EXERCISE. An Option may be exercised, in whole or in part,
by giving written notice to the Secretary of the Company specifying
the number of shares of Common Stock to be purchased and accompanied
by the full Exercise Price for such shares. The Exercise Price shall
be payable in United States dollars and at the election of the Grantee
may be paid by cash, certified or uncertified check, bank draft, by
delivery of shares of mature Common Stock (stock held at least 6
months) in payment of all or any part of the Exercise Price (which
shares shall be valued for this purpose at their Fair Market Value on
the date such Option is exercised), or in such other manner permitted
by law as may be authorized from time to time by the Committee.
(f) REPURCHASE AND REPLACEMENT. Upon approval of the Committee, the
Company may repurchase a previously granted Option from a Grantee by
mutual agreement before such Option has been exercised upon such terms
and conditions as the Company and the Grantee shall agree, provided
that the per share repurchase price shall not exceed the amount by
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<PAGE> 6
which the Fair Market Value of the Common Stock subject to the Option
on the date of purchase exceeds the Exercise Price. The Committee may
agree to the cancellation of an Option in order to make a Grantee
eligible for the grant of a replacement Option.
(g) INCENTIVE STOCK OPTIONS. Notwithstanding anything in the Plan to the
contrary, the following additional provisions shall apply to the grant
of Options which are intended to qualify as Incentive Stock Options:
(i) Any Incentive Stock Option granted under the Plan shall
contain such other provisions as the Committee shall deem
advisable, but shall in all events be consistent with and
contain or be deemed to contain all provisions required in
order to qualify the Option as an Incentive Stock Option.
(ii) All Incentive Stock Options must be granted within ten (10)
years from the Effective Date.
(iii) Unless sooner exercised, all Incentive Stock Options shall
expire no later than ten (10) years after the Grant Date.
(iv) The Exercise Price for each Incentive Stock Option shall not
be less than the Fair Market Value of the Common Stock subject
to the Option on the Grant Date.
(v) No Incentive Stock Option shall be granted to any Eligible
Employee who, at the time such Option is granted, would own
(within the meaning of Section 422 of the Code) stock
possessing more than ten percent (10%) of the total combined
voting power of all classes of stock of the Company (or of any
Subsidiary) unless the Exercise Price is at least equal to one
hundred ten percent (110%) of the Fair Market Value of the
Common Stock subject to the Option on the Grant Date and the
Option is not exercisable after the expiration of five (5)
years from the Grant Date.
(vi) The aggregate Fair Market Value (determined as of the Grant
Date) of the shares of Common Stock with respect to which
Incentive Stock Options are exercisable for the first time by
any Eligible Employee during any calendar year (under all
plans of the Company and its parent corporation, if any, and
any Subsidiary) shall not exceed $100,000.
SECTION 8. STOCK AWARDS AND RESTRICTED STOCK AWARDS. A Stock Award
consists of the issuance by the Company to an Eligible Employee of shares of
Common Stock, without other payment therefor, as additional compensation for
his or her services to the Company. A Restricted Stock Award consists of the
issuance by the Company to an Eligible Employee of shares of Common Stock,
without other payment, but subject to restrictions on sale or other transfer.
The issuance of Common Stock pursuant to Stock Awards and the issuance of
Restricted Stock Awards shall be subject to the following terms and conditions:
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<PAGE> 7
(a) NUMBER OF SHARES. The number of shares of Common Stock to be issued
by the Company to an Eligible Employee pursuant to a Stock Award or a
Restricted Stock Award shall be determined by the Committee.
(b) RESTRICTIONS. All Restricted Stock Awards issued hereunder shall be
subject to such restrictions as the Committee may determine,
including, without limitation, any or all of the following:
(i) a prohibition against the sale, transfer, pledge or other
encumbrance of the shares, such prohibition to lapse at such
time or times as the Committee shall determine (whether in
annual or more frequent installments);
(ii) a requirement that the Eligible Employee forfeit all or a part
of such shares in the event of termination of his or her
employment during any period in which such shares are subject
to restrictions.
(c) ESCROW. In order to enforce the restrictions imposed by the Committee
pursuant to Section 8(b), the Eligible Employee receiving a Restricted
Stock Award shall be required to enter into an agreement with the
Company setting forth the conditions of the award. Restricted Stock
Awards shall be registered in the name of the Eligible Employee and
deposited, together with a stock power endorsed in blank, with the
Company. Each such certificate shall bear a legend in substantially
the following form:
The transferability of this certificate and the shares of
Common Stock represented by it are subject to the terms and
conditions (including conditions of forfeiture) contained in
the Amended and Restated Incentive Compensation Plan of
Statoil Energy, Inc. ("Statoil Energy") and the agreement
entered into between the registered owner and Statoil Energy.
Copies of the Plan and the agreement are on file in the office
of the Secretary of Statoil Energy.
(d) END OF RESTRICTIONS. At the end of any time period during which the
Restricted Stock Award is subject to forfeiture and restrictions on
transfer, certificates evidencing such shares will be delivered free
of all restrictions to the Eligible Employee.
(e) STOCKHOLDER. Subject to the terms and conditions of the Plan and any
other restrictions determined by the Committee and set forth in the
agreement evidencing the Restricted Stock Award, each Eligible
Employee receiving a Restricted Stock Award shall have all of the
rights of a stockholder with respect to shares of stock during any
period in which such shares are subject to forfeiture and restrictions
on transfer, including without limitation, the right to vote such
shares. Dividends paid in cash or property other than Common Stock or
other Company stock with respect to the Restricted Stock Award shall
be paid to the Eligible
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<PAGE> 8
Employee. Dividends payable in shares of Common Stock or other
Company stock shall be treated as a Restricted Stock Award and shall
be held pursuant to the provisions of the Plan.
SECTION 9. PERFORMANCE STOCK AWARDS. Performance Stock Awards are
contingent rights to receive shares of Common Stock upon the achievement of
certain performance objectives. The award of a Performance Stock Award shall
be subject to such terms and conditions as the Committee deems appropriate.
Each Performance Stock Award will be evidenced by a written agreement which
will include the performance objectives to be achieved. The number of shares
included in a Performance Stock Award shall be determined by the Committee and
may be subject to such terms and conditions as the Committee shall determine.
If the performance objectives are achieved, the Eligible Employee will be
issued shares of Common Stock equal to the number of Performance Stock Awards
granted to the Eligible Employee.
SECTION 10. ELECTION TO RECEIVE DISCOUNTED OPTIONS. At the sole
discretion of the Committee, an Eligible Employee may elect to receive all or
a portion of the Eligible Employee's annual bonus in the form of a discounted
Non-Qualified Stock Option instead of cash.
(a) TIME AND MANNER OF ELECTION. An election to receive a discounted
Option in lieu of cash must be made before the first day of the
calendar year for which the bonus would otherwise be paid. The
election shall be made in writing on a form provided by the Committee.
An Eligible Employee may specify the amount of annual bonus to be
received in the form of a discounted Option as:
(i) a percentage of the total annual bonus,
(ii) a fixed dollar amount, or
(iii) an amount in excess of a fixed dollar amount to be received in
cash.
(b) ELECTION IRREVOCABLE. The election to receive a discounted Option in
lieu of cash shall be irrevocable.
(c) EXERCISE PRICE. The Exercise Price of a discounted Option shall be
determined by the Committee in accordance with Section 7(a).
(d) NUMBER OF SHARES SUBJECT TO DISCOUNTED OPTION. The number of shares of
Common Stock subject to each discounted Option shall be the quotient
determined by dividing:
(i) the amount of the bonus payment payable in the form of a
discounted Option, by
(ii) an amount equal to the Fair Market Value on the Grant Date of
a share of Common Stock, reduced by the Exercise Price of the
discounted Option.
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<PAGE> 9
(e) EXERCISE OF DISCOUNTED OPTION. A discounted Option granted under this
Section 10 shall vest and become exercisable in accordance with the
rules described in Section 7(d).
(f) EFFECT OF TERMINATION OF ELIGIBLE EMPLOYEE. Notwithstanding the
provisions of Section 12, if a Grantee ceases to be an Eligible
Employee (except as set forth in Section 13), the Company will
repurchase from the Grantee any discounted Option granted under this
Section 10 which has not become vested and exercisable at such time
the Grantee ceases to be an Eligible Employee at a repurchase price
equal to the Fair Market Value on the Grant Date reduced by the
Exercise Price of the discounted Option.
SECTION 11. NON-TRANSFERABILITY. No Option, Restricted Stock Award or
Performance Stock Award granted under the Plan shall be transferable other than
by will or by the laws of descent and distribution. An Option, Restricted
Stock Award or Performance Stock Award may be exercised during the lifetime of
the Grantee only by the Grantee.
SECTION 12. TERMINATION OF RELATIONSHIP.
(a) EFFECT ON OPTIONS OF VOLUNTARY TERMINATION OF ELIGIBLE EMPLOYEE OR
TERMINATION FOR CAUSE. If a Grantee ceases to be an Eligible Employee
as a result of a termination of such employment relationship by the
Company For Cause or as a result of a voluntary termination of such
employment relationship by the Grantee, any Option held by the
Grantee, to the extent not theretofore exercised, shall be cancelled
immediately upon such termination of service as an Eligible Employee.
(b) EFFECT ON OPTIONS OF TERMINATION OF ELIGIBLE EMPLOYEE WITHOUT CAUSE.
If a Grantee ceases to be an Eligible Employee as a result of a
termination of such employment relationship by the Company for any
reason other than For Cause, any vested Option held by the Grantee, to
the extent not theretofore exercised, shall continue to be exercisable
in accordance with its terms for a period of ninety (90) days after
the Company provides notice to the Grantee of the termination of the
employment of the Grantee and thereafter such Option, to the extent
not theretofore exercised, shall be deemed cancelled.
(c) EFFECT ON OTHER INCENTIVES OF TERMINATION OF ELIGIBLE EMPLOYEES. If a
Grantee ceases to be an Eligible Employee for any reason, any
Restricted Stock Award or Performance Stock Award not theretofore
issued and vested shall be cancelled immediately upon such termination
of service as an Eligible Employee (whether or not caused by death or
disability).
(d) CHANGE OF DUTIES OR POSITION OF GRANTEE. An Incentive granted under
the Plan shall not be affected by any change of duties or position of
a Grantee so long as the Grantee remains an Eligible Employee.
SECTION 13. DEATH OR DISABILITY OF GRANTEE. If a Grantee shall (a) die
while serving as an Eligible Employee, or (b) becomes permanently and totally
disabled within the meaning of
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<PAGE> 10
Section 22(e)(3) of the Code while serving as an Eligible Employee and at such
time there does not exist grounds for the termination of the Eligible Employee
For Cause, then any outstanding Option may be exercised as set forth herein by
the Grantee or, in the event of death, by the person or persons to whom the
Grantee's rights under the Option pass by will or by the laws of descent and
distribution, or if no such person has such right, by his executors or
administrators, and the period for exercise to the extent provided in Section 7
shall be extended for sixty (60) days in the case of the permanent and total
disability or death of the Grantee, but not more than ten (10) years after the
Grant Date.
SECTION 14. ADJUSTMENTS UPON CHANGES IN COMMON STOCK. Each Stock Option
Agreement and any other agreement entered into pursuant to the Plan may contain
such provisions as the Committee shall determine to be appropriate for the
adjustment of the number and class of shares of Common Stock covered by such
Incentive, the Exercise Prices and the number of shares of Common Stock which
shall be issuable at any time, in the event of changes in the outstanding
Common Stock of the Company by reason of stock dividends, split-ups,
split-downs, reverse splits, recapitalizations, mergers, consolidations,
combinations or exchanges of shares, spin-offs, reorganizations, liquidations,
and the like. In the event of any such change in the outstanding Common Stock
of the Company, the aggregate number of shares of Common Stock which may be
granted under the Plan and to any Eligible Employee shall be appropriately
adjusted by the Committee, whose determination shall be conclusive.
SECTION 15. MISCELLANEOUS.
(a) EFFECTIVE DATE. The Plan became effective as of the Effective Date.
(b) TERMINATION OF THE PLAN. Unless the Plan shall have been previously
terminated as hereinafter provided, the Plan shall terminate on the
tenth (10th) anniversary of the Effective Date, and no Incentive or
other rights under it shall be granted thereafter. The Board of
Directors, without further approval of the stockholders of the
Company, may at any time prior to that date terminate the Plan and
thereafter no further Incentives may be granted under the Plan.
However, Options and other Incentives granted prior to any termination
shall continue to be exercisable in accordance with the terms thereof.
(c) GOVERNING LAW. This Agreement shall be construed and interpreted in
accordance with the laws of the Commonwealth of Virginia.
(d) NO RIGHTS AS STOCKHOLDER. The Grantee shall have no rights as a
stockholder of the Company with respect to the shares of Common Stock
to be issued under this Plan prior to the issuance by the Company of
Common Stock hereunder.
(e) NO RIGHT TO CONTINUED SERVICE. The Plan shall not confer upon any
Eligible Employee any right with respect to continuation of service
for or with the Company, or its Subsidiaries, nor
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<PAGE> 11
shall it interfere in any way with his or her right or the Company's
right to terminate his or her service at any time, which right is
hereby reserved.
(f) AMENDMENT OF THE PLAN. The Board of Directors may at any time and from
time to time modify and amend the Plan in any respect; provided,
however, that no amendment shall be made without the affirmative vote
of a majority of the shares of Common Stock of the Company if such
stockholder vote is required in the opinion of legal counsel to the
Company.
(g) SEVERABILITY. In the event that any one or more provisions of the
Plan or any agreement, or any action taken pursuant to the Plan or
such agreement, should, for any reason, be unenforceable or invalid in
any respect under the laws of the United States, any state of the
United States or any other government, such enforceability or
invalidity shall not affect any other provision of the Plan or of such
other agreement but in such particular jurisdiction and instance the
Plan and the affected agreement shall be construed as if such
enforceable or invalid provision had not been contained therein or if
the action in question had not been taken thereunder.
(h) WITHHOLDING. The Company and its Subsidiaries shall have the right to
withhold and collect any taxes required by law to be withheld upon the
exercise of an Option granted under the Plan or upon the grant of any
shares hereunder. The withholding obligation may be satisfied by:
(i) withholding from other amounts payable to the Grantee; (ii)
payment of the necessary withholding amount by the Grantee to the
Company; or (iii) the Company, subject to the approval of the
Committee in its sole discretion, accepting shares of issued Common
Stock.
(i) STOCKHOLDERS' AGREEMENT. Each Eligible Employee will be required to
become a party to the Stockholders' Agreement upon the grant of any
Incentive hereunder.
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EXHIBIT 10.3.1
EMPLOYEE SHAREHOLDERS AGREEMENT
THIS EMPLOYEE SHAREHOLDERS AGREEMENT is made as of this 31st day of
May, 1995 by and among Statoil Energy, Inc., a Virginia corporation (the
"Corporation"), and the persons who have executed this agreement who are owners
of Common Stock of the Corporation ("Shareholders") and/or holders of options
to purchase Common Stock ("Option Holders").
EXPLANATORY STATEMENT
The parties believe that it is desirable and in their best interests
to provide a means for Holders to achieve liquidity for shares of the
Corporation's Common Stock owned or to be acquired by employees of the
Corporation and to restrict the ownership of the Common Stock, in each case
until such time as the Corporation completes an initial public offering of its
Common Stock.
NOW, THEREFORE, in consideration of the matters set forth in the
Explanatory Statement and the mutual covenants, promises, agreements,
representations and warranties of the parties hereto, the parties hereto do
hereby covenant, promise, agree, represent and warrant as follows:
1. Definitions. Capitalized words and phrases used in this Agreement
shall have the following meanings:
"Act" means the Securities Act of 1933, as amended.
"Agreement" means this Employee Shareholders Agreement, as amended
from time to time.
"Appraiser" shall be the appraiser that shall initially determine
the Established Value Per Share for any year, as contemplated by Section 3
hereof.
"Bradley" means Ralph L. Bradley, an individual residing in
Alexandria, Virginia.
"Cause", when used with respect to a Holder, means the Termination
of a Holder's employment by the Corporation by reason of (i) the material
breach by the Holder of any of his employment duties, as reasonably determined
by the Corporation following notice to the Holder of the details of such breach
and a period of at least thirty (30) days during which the Holder shall be
given an opportunity to cure such breach, (ii) conviction of the Holder of the
commission of any felony, (iii) alcoholism or drug addiction of the Holder
(other than addiction caused by medical treatment for illness or injury), but
only if the Holder has refused to submit to rehabilitation for such condition
upon the request of the Corporation, or (iv) violation of agreements and.
policies of the Corporation regarding non-disclosure of confidential
information, confidentiality, and anti-competitive behavior, whether pursuant
to an employment agreement or otherwise.
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"Closing" and "Closing Date" each means the date and time at
which a Closing of the purchase of Shares by the Corporation under this
Agreement occurs.
"Code" means the Internal Revenue Code of 1986, as amended
from time to time (or any corresponding provisions of any succeeding law).
"Committee" means the Compensation Committee of the Board of
Directors of Statoil Energy, Inc.
"Common Stock" means the Corporation's authorized shares of
Common Stock, $0.01 par value per share.
"Consensus Appraisers" has the meaning set forth in Section
7.2 of this Agreement.
"Corporation" means Statoil Energy, Inc., a Virginia
corporation.
"Days" means all calendar days, inclusive of Saturdays,
Sundays and days which are legal holidays under the laws of the United States
or the State.
"Decedent" means a deceased Holder, the personal
representative or estate of which shall have certain rights pursuant to Section
6 of this Agreement.
"Established Value Per Share" means the fair market value per
share of Common Stock of the Corporation on a fully diluted basis as determined
under the provisions of Section 3 of this Agreement, or in the case of an
eligible Holder or Decedent electing to utilize the provisions of Section 7 of
this Agreement the price determined under Section 7.
"Holder" means an Option Holder or a Shareholder.
"Incentive Compensation Plan" means the Amended and Restated
Incentive Compensation Plan of Statoil Energy, Inc. as currently in effect or
as amended from time to time.
"Justification", when used with respect to a Holder, means
the resignation of a Holder from employment with the Corporation upon (i) a
substantial diminution in responsibilities, position, or salary, or (ii) the
involuntary transfer to an office or business location, in the case of a Holder
then assigned to the Corporation's headquarters offices, outside of the
Washington/Baltimore metroplex and in the case of any other Holder, by more
than 75 miles from the location of the Holder's immediately preceding office or
work location.
"LIBOR" means the London Inter-Bank Offered Rate as published
from time to time in The Wall Street Journal.
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"Note" means the Corporation's unsecured non-negotiable
promissory note issued by the Corporation in partial payment for Stock
purchased from a Holder in certain circumstances where the dollar amount of
Stock being repurchased exceeds $100,000. Sections 4.5 and 6.3 of this
Agreement describe the procedures for issuance of Notes, a form of which is
attached hereto as Exhibit A. The Note bears interest at the greatest of ten
percent (10%) per annum, 3% above the three month LIBOR or the minimum rate of
interest required by the Internal Revenue Code of 1986, as amended, to preclude
the imputation of interest.
"Option Holder" means an employee of the Corporation who
holds an option to purchase Common Stock pursuant to the Incentive Compensation
Plan. All Option Holders shall be subject to this Agreement as a condition of
the grant of Options.
"Own" when used with respect to shares of Common Stock of the
Corporation includes beneficial and record ownership of Shares.
"Person" means any individual, partnership, corporation,
trust or other entity.
"Plans" means the Incentive Compensation Plan and the Stock
Purchase Plan.
"Protected Termination" means either termination of the
Holder's employment by the Corporation without Cause or resignation of the
Holder from employment with the Corporation with Justification.
"Put Option Notice" shall be the notice, required to be given
during April or October in any year, in which a Holder commits, subject to
withdrawal in certain circumstances, to tender Put Option Shares to the
Corporation for repurchase.
"Put Option Shares" means Shares owned by a Holder for at
least six months that the Holder may tender to the Corporation (commencing in
October, 1996) for repurchase commencing January 1, 1997.
"Put Option Share Price" shall mean the price at which a
Holder's Put Option Shares are required to be purchased under Section 4.1 of
this Agreement.
"Security" has the meaning set forth in the Act.
"Shareholder" means those Persons who own shares of the
Common Stock acquired pursuant to the Incentive Compensation Plan, the Stock
Purchase Plan, or otherwise and who have entered into this Agreement.
"Shares" means all shares of Common Stock which a Holder may
own or may in the future own, whether of record or beneficially.
"State" means the Commonwealth of Virginia.
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"State Acts" means the securities laws of any state or the
District of Columbia.
"Statoil" means Den norske stats oljeselskap, a.s, a
corporation organized under the laws of the Kingdom of Norway.
"Stock Purchase Plan" means Statoil Energy, Inc. 1995 Stock
Purchase Plan, pursuant to which the Corporation has initially made available
150,000 shares of Common Stock for purchase by eligible employees.
"Terminated Shareholder" means a Holder whose employment with
the Corporation has terminated.
"Termination" means the termination of a Shareholder's
employment.
"Transfer" means the sale, hypothecation pledge, assignment
or other transfer, be it voluntary or involuntary to a Shareholder or third
person, inter vivos, testamentary, by operation of the laws of devise and
descent or any other laws; PROVIDED, HOWEVER) that the pledge of Shares by a
Holder to the Corporation pursuant to the Stock Purchase Plan in order to
secure the Holder's installment purchase obligations thereunder shall not be
deemed to be a Transfer for any purpose under this Agreement.
2. GENERAL.
2.1. Termination of Prior Agreement. The parties hereto that
are parties to the Incentive Compensation Plan Stockholders Agreement dated as
of December 29, 1993 hereby agree to supersede that agreement with this
Agreement and hereby agree that agreement has been terminated as of the date of
this Agreement.
2.2. Transfer Restrictions. Each Holder covenants, promises
and agrees that he or she shall not Transfer all, any portion of, or any
interest or rights in, the Shares Owned or which in the future may become Owned
by such Holder, except pursuant to the terms and provisions of this Agreement.
Each Holder hereby acknowledges the reasonableness of the restrictions on
Transfers imposed by this Agreement in view of the purposes of the Corporation
and the relationships of the Holders. Unless the Transfer is made in
conformance with and pursuant to the terms of this Agreement, the Transfer of
any Shares by any Holder shall be deemed invalid, null and void, and of no
force or effect, and the transferee of any such shares shall not be entitled to
vote such shares receive dividends on such shares or have any other rights in
and with respect to such shares.
2.3 Permitted Transfers. A Holder may freely and without
restriction transfer Shares to another Holder who at the time of the transfer
is an employee of the Corporation, to the Corporation, to Statoil, to Bradley
or to a member of Holder's immediate family, including a trust for the benefit
of family members, provided that in the case of intra-family Transfers, all
transferees shall have executed an instrument, in form and content satisfactory
to the Corporation, undertaking to become a party to this Agreement and to be
bound by all of its
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provisions, a form of which undertaking is attached hereto as Exhibit B.
2.4 Applicability of Agreement to Bradley Shares. With
respect to Shares Owned by Bradley, this Agreement shall apply only to Shares
Bradley may acquire in the future pursuant to the Incentive Compensation Plan
or from a Holder pursuant to Section 2.3 of this Agreement.
3. COMPUTATION OF ESTABLISHED VALUE PER SHARE
3.1 Determination of Established Value Per Share. Each year
the Committee shall cause the Established Value Per Share to be determined
pursuant to the provisions of this Section 3 and the Established Value Per
Share shall be applicable for transactions occurring during such year, except
as otherwise provided in this Agreement.
3.2 Selection of Appraiser. The Committee shall select an
Appraiser who shall be directed to determine the Established Value Per Share
applicable to Common Stock which may be repurchased by the Corporation during
calendar year 1996 and each succeeding calendar year. In all instances, the
Appraiser shall be selected in good faith by the Committee and shall be
experienced in valuing energy related business enterprises.
3.3. Method of Determination of Established Value Per Share.
The Appraiser shall make a determination of the Established Value Per Share
based on its determination of the fair market value of the Corporation as of
January 1 of each calendar year, commencing January 1, 1996, determined without
any discount for minority interests or lack of liquidity of the Shares, based
upon its assessment of the most likely price to which a willing buyer and
willing seller would agree for the Corporation as a whole and its judgment as
to whether such fair market value should be based upon a going concern value
approach, a liquidation value approach, another valuation approach, or a
combination of one or more valuation approaches. The Appraiser shall also
consider in good faith such factors as may be suggested in the reasonable
discretion of the Committee with the input of management of the Corporation and
such other factors as the Appraiser, in the independent exercise of its
professional judgment, determines to be customary and appropriate under the
circumstances.
3.4 Effect of Committee Determinations of Established Value
Per Share. The Committee may waive the requirement that an Appraiser determine
the Established Value Per Share for any particular year or may override the
Appraiser's determination of the Established Value Per Share then in effect in
the event that the Committee determines, in its sole and conclusive discretion,
that another transaction in shares of the Corporation's capital stock (other
than a repurchase by the Corporation of Shares pursuant to this Agreement or a
repurchase of shares of Common Stock owned by Bradley or transferees of Bradley
pursuant to the Shareholders Agreement dated February 10, 1994, as amended)
occurring since the last computation of Established Value Per Share is fairly
representative of the current fair market value per share of the Corporation's
Common Stock. In such event, the transaction price per share of Common Stock
for such transaction shall become the Established Value Per Share for purposes
of subsequent repurchases pursuant to this Agreement occurring during the
remainder
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of the calendar year in which the Committee makes its determination and such
Established Value Per Share shall be binding unless challenged by a Holder
pursuant to Section 7 of this Agreement.
3.5 Timing of Delivery of Appraiser's Report. Unless the
Committee waives the requirement that the Appraiser determine the Established
Value Per Share as permitted pursuant to Section 3.4 of this Agreement the
Corporation shall require the Appraiser to deliver to the Corporation a written
report indicating its determination of the Established Value Per Share on or
before March 31 of each year commencing March 31, 1996 (or as soon thereafter
as audited financial statements are available).
3.6 Committee Determination for 1995 Calendar Year. With
respect to Common Stock repurchases occurring during calendar year 1995, the
Committee has conclusively determined that the Established Value Per Share
shall be $10.00 and that the Appraiser shall not be required to compute the
Established Value Per Share for any repurchases of Common Stock that may occur
during calendar year 1995 pursuant to this Agreement.
4. MANDATORY REPURCHASES BY THE CORPORATION FROM ACTIVE EMPLOYEES.
4.1 Exercise of Put Option. Commencing October 1, 1996, a
Holder who is an active employee of the Corporation may provide a Put Option
Notice to the Corporation by which the Holder exercises the rights provided
under this Section 4.1 to require the Corporation to purchase all or a portion
of his Shares. A Put Option Notice may be given only as to any Shares owned by
a Shareholder for at least six (6) months at the time the Put Option Notice is
given. A Put Option Notice may only be given during the months of April and
October in any year (though in no event earlier that October 1996), and the
Corporation shall not be obligated to purchase Shares as to which a timely Put
Option Notice has not been provided.
4.2 Mechanics of Exercising Put Option. Shares as to which a
timely Put Option Notice have been given shall be purchased, out of lawfully
available funds, at the Established Value Per Share determined for the calendar
year in which the Put Option Notice is given. The Corporation shall provide a
person who has timely given a Put Option Notice a written response by the May
15 or November 15 immediately following the tender of the Holder's Put
indicating whether the Corporation plans to purchase the Put Option Shares for
cash, to pay the purchase price for the Put Option Shares in installments as
permitted pursuant to Section 4.5 (only if the aggregate Established Value Per
Share for the Shares to be repurchased from the Holder in question in any
twelve month period exceeds $ 100,000), or to decline to purchase such Shares
because of a lack of lawfully available funds. (Section 9 of this Agreement
sets forth the criteria for determining that the Corporation lacks lawfully
available funds to effect a purchase.)
4.3 Right to Withdraw or Amend Put Option Notice. In the
event the Corporation elects to utilize installment payments as permitted
pursuant to Section 4.5 or the Corporation lacks lawfully available funds to
effect the repurchase of the Put Option Shares in full, the Holder shall have
the right to withdraw his Put Option Notice and terminate the
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Corporation's obligation to purchase the Put Option Shares at such time or to
amend the Put Option Notice to reduce the number of Put Option Shares to be
repurchased pursuant to the Put Option Notice, provided there is lawfully
available funds to effect the repurchase of the reduced number of Shares. Any
amendment to the Put Option Notice, as permitted by the preceding sentence,
shall be received by the Corporation no later than the May 25 or November 25
immediately following the Put Option Notice, as the case may be.
4.4 Closing of Put Option Share Purchase. Subject to the
Holder's right to withdraw the Put Option Notice pursuant to Section 4.3, the
Closing of purchases pursuant to Put Option Notices that have not been
withdrawn shall occur not later than the May 30 or November 30 immediately
following the Put Option Notice, as the case may be; provided, that the Closing
of the purchase of any Shares as to which the Put Option Notice is given in
October, 1996 shall occur on January 2, 1997 provided that the Corporation has
lawfully available funds to repurchase such shares. The Corporation shall
provide the Holder written notice as to the date of Closing under this Section
4.4.
4.5 Installment Payments. The Corporation shall have the
right to pay up to a portion, as specified herein, of the purchase price for
any shares to be repurchased pursuant to Section 4, in installments; provided,
however, that this installment payment method shall not be available if the
aggregate Established Value Per Share for the Shares to be repurchased from the
Holder in question in any twelve month period is less than or equal to
$100,000. The maximum amount of the purchase price that may be paid by the
Corporation under the installment payment method shall be seventy-five percent
(75%) of the excess of the aggregate purchase price for the Shares to be
repurchased over $100,000. Accordingly, if the aggregate purchase price for the
Put Option Shares of Holder is greater than $100,000, at least $ 100,000 and
twenty-five percent (25%) of the aggregate purchase price in excess of $100,000
shall be paid in cash on the Closing Date and the remaining portion may be paid
at Closing by the making, sealing and delivering of the Note to the Holder in a
principal amount equal to such remaining portion of the aggregate purchase
price. The Note shall be payable in 12 equal quarterly installments of
principal and interest.
4.6 Options in the Event of Lack of Lawfully Available Funds.
In the event that the Corporation lacks the lawfully available funds, as
determined pursuant to Section 9, to repurchase the shares pursuant to this
Section 4, the Holder may either (i) withdraw the Put Option Notice pursuant to
Section 4.3 and submit a new Put Option Notice pursuant to Section 4.2 when the
Corporation has lawfully available funds to repurchase the Shares or (ii) amend
the Put Option Notice to reduce the number of Put Option Shares to be
repurchased up to the amount of lawful available funds, if any, available to
repurchase such shares. If the Holder neither voluntarily withdraws nor amends
the Put Option Notice to reduce the number of Put Option Shares to be
repurchased the Put Option Notice shall be automatically terminated by the
Corporation.
4.7 Death to Affect Put Option Notice. In the event a
Shareholder dies after giving a Put Option Notice pursuant to Section 4.2 but
before the Closing for the Shares covered by such notice, the provisions of
Section 6 shall become operative as to the Shares beneficially owned by the
deceased Holder and the provisions of this Section 4 shall be inapplicable to
such Shares.
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5. MANDATORY REPURCHASES BY THE CORPORATION FROM TERMINATED
SHAREHOLDERS.
5.1 Purchases from Terminated Shareholders. Within 90 days of
a Holder's Termination, the Corporation shall purchase and the Terminated
Shareholder shall sell or cause to be sold all Shares beneficially owned by the
Terminated Employee, including Shares transferred in intra-family transfers, at
the Established Value Per Share in effect for the calendar year in which
Termination occurs, and in the case of a Protected Termination only, as of such
subsequent date as shall be provided in Section 5.5. Such purchase shall be
made only from lawfully available funds.
5.2 Form of Consideration for Terminated Shareholder's
Shares. The Corporation shall provide the Holder written notice as to the date
of Closing under this Section 5, which notice shall describe the form of
consideration to be paid. Subject to the Corporation having lawfully available
funds, the Corporation shall have the option to pay the Terminated
Shareholder's repurchase price entirely in cash, or partly in cash and partly
in installments as provided in Section 5.3 (only if the aggregate Established
Value Per Share for the Shares to be repurchased from the Holder in question in
any twelve month period exceeds $100,000).
5.3 Installment Payments. The Corporation shall have the
right to pay up to a portion, as specified herein, of the purchase price any
shares to be repurchased pursuant to this Section 5, in installments; provided,
however, that this installment payment method shall not be available if the
aggregate Established Value Per Share for the Shares to be repurchased from the
Terminated Shareholder in question is less than a or equal to $ 100,000. The
maximum amount of the purchase price that may be paid by the Corporation under
the installment payment method shall be seventy-five percent (75%) of the
excess of the aggregate purchase price for the Shares to be repurchased over
$100,000. Accordingly, if the aggregate purchase price for the Shares of a
Terminated Shareholder is greater than $100,000, at least $100,000 and
twenty-five percent (25%) of the aggregate purchase price in excess of $100,000
shall be paid in cash on the Closing Date and the remaining portion may be paid
at Closing by the making, sealing and delivering of the Note to the Holder in a
principal amount equal to such remaining portion of the aggregate purchase
price. The Note shall be payable in 12 equal quarterly installments of
principal and interest.
5.4 Purchase from a Terminated Shareholder in the Event of
Lack of Lawfully Available Funds. In the event that the Corporation lacks the
lawfully available funds, as determined pursuant to Section 9, to repurchase
the shares pursuant to this Section 5, the Terminated Shareholder shall have
the right to Transfer the Shares pursuant to Section 2.3 or to Transfer the
Shares to the Corporation at a price equal to the greater of the Established
Value Per Share either (i) at the time of the Termination or (ii) at the time
when the Corporation has lawfully available funds to effect such a repurchase.
5.5 Application of Next Year's Established Value in Certain
Circumstances; Delay in Closing in Certain Circumstances. In the case of a
Holder's Protected Termination during the last three months of any calendar
year, the Holder may elect to have the new
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Established Value Per Share to be determined as of January 1 of the year
commencing after the date of the Holder's Protected Termination apply to the
repurchase of such Holder's Shares. In order to have the Established Value Per
Share for the year subsequent to the Protected Termination apply, the Holder
must provide written notice of such election to the Corporation within 45 days
of the date of such Protected Termination. In such event the Closing shall be
delayed until such new Established Value Per Share is determined. In the case
of Termination during the first calendar quarter of any year, the intention of
this Agreement is that the Established Value Per Share to be determined for
that calendar year shall be applicable, and, in the event that determination of
such Established Value Per Share shall be delayed, the Closing of the
repurchase of the shares shall be delayed accordingly.
5.6 Shares Pledged to the Corporation. The provisions of this
Section 5 shall not apply to any Shares pledged to the Corporation to the
extent the Holder notifies the Corporation, in writing, that the pledged Shares
will be used to discharge any remaining unpaid indebtedness to the Corporation
arising out of the purchase of such Shares.
6. MANDATORY REPURCHASES BY THE CORPORATION FROM DECEASED
SHAREHOLDERS.
6.1 Purchases from Deceased Shareholders. Subject to Section
6.5, within 90 days of a Holder's death, the Corporation shall purchase and the
Decedent's personal representative shall sell or cause to be sold all of the
Shares beneficially owned by the Decedent, including, without limitation, all
Shares transferred in intra-family transfers, at the Established Value Per
Share in effect for the calendar year in which the death occurred or, in the
event of the Holder's death during the last calendar quarter, the Established
Value Per Share in effect for the calendar year following the death should the
personal representative so elect as provided in Section 6.5. Such purchase
shall be made only from lawfully available funds (which are described in
Section 9). The Corporation shall provide the Decedent's personal
representative written notice as to the date of Closing under this Section 6.1.
6.2 Form of Consideration for Decedent's Shares. The
Corporation shall be required to pay the repurchase price for a Decedent's
Shares entirely in cash. To the extent the Corporation has lawfully available
funds in such circumstances such payment shall be made against tender of the
certificates representing the Decedents Shares, duly endorsed for Transfer, at
such date within the 90 day period contemplated by Section 6.1 (subject to
extension as contemplated by Section 6.5) as determined by the Corporation and
indicated in a written notice to Decedent's personal representatives.
6.3 Purchase from a Deceased Shareholder in the Event of Lack
of Lawfully Available Funds. In the event that the Corporation lacks the
lawfully available funds, as determined pursuant to Section 91, to repurchase
the shares pursuant to this Section 6, the Decedent shall have the right to
Transfer the Shares pursuant to Section 2.3 or to Transfer the Shares to the
Corporation at a price equal to the greater of the Established Value Per Share
either (i) at the time of the death of the Holder or (ii) at the time when the
Corporation has lawfully available funds to effect such a repurchase.
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6.4 Death to Affect Put Option Notice. In the event a
Shareholder dies after giving a Put Option Notice but before the Closing for
the Shares covered by such notice, the provisions of this Section 6 shall
become operative as to the Shares beneficially owned by the Holder and the
provisions of Section 4 shall be inapplicable to such Shares.
6.5 Application of Next Year's Established Value in Certain
Circumstances; Delay in Closing in Certain Circumstances. In the case of a
Holder's death during the last three months of any calendar year, the personal
representative of a deceased Holder may elect to have the new Established Value
Per Share to be determined as of January 1 of the year commencing after the
date of the Holder's death apply to the repurchase of such Holder's Shares. In
order to make the election to have the Established Value Per Share for the year
subsequent to the date of the Holder's death apply, the personal representative
of the Decedent must provide written notice of such election to the Corporation
within 45 days of the date of death of the Holder. In such event the Closing
shall be delayed until such new Established Value Per Share is determined. In
the case of death of a Holder during the first calendar quarter of any year,
the intention of this Agreement is that the Established Value Per Share to be
determined for that calendar year shall be applicable, and, in the event that
determination of such Established Value Per Share shall be delayed, the Closing
of the repurchase of the Shares shall be delayed accordingly.
6.6 Shares Pledged to the Corporation. The provisions of this
Section 6 shall not apply to any Shares pledged to the Corporation to the
extent the personal representative of the deceased Holder notifies the
Corporation, in writing, that the pledged Shares will be used to discharge any
remaining unpaid indebtedness to the Corporation arising out of the purchase of
such Shares.
7. CERTAIN HOLDERS RIGHTS TO REVIEW PUT OPTION SHARE PRICE.
7.1 Limited Right to Initiate Review Process. Whenever a
Holder or a Decedent, as the case may be, elects to, or is required to, tender
shares to the Corporation for repurchase pursuant to this Agreement, the
purchase price for such shares shall be the Established Value Per Share, unless
the Holder or the Decedent, as the case may be, elects to utilize the
procedures specified in this Section 7 to seek to determine an alternate
Established Value Per Share. A Holder or a Decedent, as the case may be, may
utilize the provisions of this Section 7 only if the Shares to be repurchased
from the Holder or the Decedent as the case may be, has an aggregate value of
at least $250,000 based on the applicable Established Value Per Share. The
provisions of this Section 7 shall have no effect on persons who have not
affirmatively elected to be governed by its provisions.
7.2 Right to Utilize Alternate Procedures. A Holder or
Decedent, as the case may be, shall have the right to request a reconsideration
of the Established Value Per Share that would otherwise be the basis for the
purchase price of his Shares by the Corporation provided that notice to such
effect is provided to the Corporation either in the Put Option Notice or within
30 days in the case of the death or Termination of a Holder. The notice shall
include a designation of an appraiser (the "Second Appraiser") who shall review
the Established Value Per Share computed by the Appraiser or otherwise
determined pursuant to Section 3.2. The Second
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Appraiser shall be a qualified, independent appraiser selected in good faith by
the Holder or the Decedent as the case may be, and shall be experienced in
valuing energy-related business enterprises. The Appraiser and the Second
Appraiser shall select a third appraiser (the "Consensus Appraiser"), who shall
be similarly qualified, whereupon the Second Appraiser and the Consensus
Appraiser shall each independently redetermine the Established Value Per Share
using the valuation guidelines specified in Section 3.3 and submit to the
Corporation and the Shareholder or the Decedent, as the case may be, exercising
rights under this Section 7 written reports within 90 days on their respective
views on an alternate Established Value Per Share.
7.3 Recomputation of Established Value Per Share. Upon
receipt of the reports of the Second Appraiser and the Consensus Appraiser, the
Established Value Per Share shall be recomputed as follows, which Recomputation
shall govern determination of the purchase price applicable to the Holder or
the Decedent, as the case may be, who has elected to utilize the procedures of
this Section 7. First, the three determinations of the Established Value Per
Share shall be added together and divided by three to compute an initial
average Established Value Per Share; second, the Established Value Per Share
which deviates the greatest (either upward or downward) from the initial
average Established Value Per Share shall be disregarded; and, third, the
remaining two Established Value Per Shares shall be added together and divided
by two, and the result of this computation shall be the Established Value Per
Share which shall govern the transaction in question.
7.4 Effect of Determinations tinder Section 7. Any
determination of a revised Established Value Per Share based upon this Section
7 shall be binding on such Holder or Decedent, as the case may be with respect
to the Shares to be purchased by the Corporation at that time. In addition, the
determination of the revised Established Value Per Share based on this Section
7 shall be binding on a Holder as to any subsequent exercise of the Put Option
during the calendar year in which the Put Option Notice is first given, but
shall have no effect on the Established Value to be applicable to any other
Holders.
7.5 Use of Section 7 by Two or More Holders. In the event
that two or more Holders shall seek to exercise their rights under this Section
7, the provisions of Section 7 shall operate independently with respect to each
Holder, unless the Holders determine, in their sole discretion, to utilize the
same Second Appraiser and Consensus Appraiser, in which event each such Holder
shall be jointly and severally liable for all expenses required to be paid by
Holders pursuant to this Section.
7.6 Costs under Section 7. The cost of the Second Appraiser
shall be borne by the Holder exercising his rights under this Section 7. The
cost of the Consensus Appraiser shall be borne equally by the Corporation, as
to half the cost, and the Holder exercising his rights, as to the other half,
except that, in the case of Holder who is exercising his Put Option Rights
pursuant to Section 4, the full cost of the Second Appraiser and the Consensus
Appraiser shall be borne by the Option Shareholder if he subsequently withdraws
his tendering Put tender of Put Option Shares pursuant to his Put Option
Notice.
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<PAGE> 12
8. FINANCIAL REPORTING.
The Corporation shall provide Holders (including Decedents
until the Corporation has purchased the Shares from the Decedents) the
following reports at the times indicated: (i) within 90 days of year end,
audited annual financial statements, prepared in accordance with generally
accepted accounting principles and accompanied by a report of a "Big Six"
accounting firm; (ii) within 45 days of the end of each of the first three
calendar quarters, quarterly reports containing unaudited financial statements;
and (iii) within 15 days after each determination of Established Value Per
Share or any change therein, a written notice concerning the determination of
Established Value Per Share and any changes thereto and Holders shall have
access to the report of the Appraiser with respect to such determination. Such
reports or notices shall be furnished to each Holder as his or her name appears
on the Corporation's stock transfer records.
9. LACK OF LAWFULLY AVAILABLE FUNDS.
9.1 The Holders acknowledge (i) that Section 13.1-653 of the
Virginia General Stock Corporation Act restricts the Corporation's ability to
make distributions, including redemptions and repurchases of Common Stock, if
after giving effect thereto the Corporation would not be able to pay its debts
as they become due in the usual course of business or if the Corporation's
total assets would be less than the sum of its total liabilities and the
liquidation preference of its preferred stock (the latter being approximately
$39.9 million as of the date hereof), and that such computations may be done on
a book value or a fair market value approach; and (ii) the terms of the
Corporation's current bank credit agreement limit dividends and distributions,
including redemption and stock repurchase payments, to an aggregate of $2
million plus cumulative net income earned by the Corporation since December 31,
1994. To the extent that any of the foregoing prohibit the redemption of
Shares, the Corporation shall be deemed to not have lawfully available funds
available for the repurchase of Shares, in which event the Corporation shall
not be obligated to purchase the Shares pursuant to this Agreement. The lack of
lawfully available funds shall not prejudice a Holder's rights to cause his
Shares to be repurchased whenever lawfully available funds become available
(for purposes of transactions by Terminated Shareholders and on behalf of
Decedents pursuant to Sections 5 and 6, respectively) and when the Holder is
next permitted pursuant to Section 4 to tender a Put Option Notice. The Holders
also acknowledge that Statoil has no obligation to invest additional capital in
the Corporation for any purpose, including without limitation for the purpose
of providing the Corporation with lawfully available funds under this
Agreement.
9.2 Partial Lack of Lawfully Available Funds. The provisions
of Section 9.1 notwithstanding, if the Corporation has lawfully available funds
in an amount insufficient to complete an entire purchase pursuant to Sections
4, 5 and 6, the amount which may lawfully be paid shall be paid immediately to
the Decedents and the Terminated Shareholders based on when the repurchase
obligation arose. In the case of Decedents, the repurchase obligation is deemed
to have arisen on the date of death of the Holder and in the case of Terminated
Shareholders, the repurchase obligation is deemed to have arisen on the date of
Termination. Any remaining lawfully available funds will be paid to the Holders
who have amended their Put Option Notice pursuant to Section 4.3 and will be
paid to such Holders in order or priority based on when the
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<PAGE> 13
repurchase obligation arose (i.e., when Put Option Notices were received by the
Corporation). All other Put Option Notices will automatically be terminated due
to the lack of lawfully available funds.
9.3 Additional Reporting. In addition to its reporting
obligations under Section 8, whenever the Corporation is unable to purchase
Shares because lawfully available funds are not available, there affected
Holders quarterly updates Corporation shall send to the regarding the status of
any change in lawfully available funds together with any changes in the
Established Value Per Share.
9.4 Requirement to Give Effect to Insurance Proceeds. In
determining whether the Corporation has lawfully available funds with respect
to a Decedent's Shares required to be repurchased, the determination of
lawfully available funds shall include and give effect to any insurance
proceeds payable to the Corporation with respect to the life of the Decedent.
10. DELIVERY OF CERTIFICATES.
10.1 Closing Date. Any Closing shall take place at 10:00 A.M.
on the date identified in the Corporation's notice pursuant to Sections 4.4,
5.2 or 6.1, as applicable, at the offices of the Corporation. At the Closing,
the stock certificate or certificates representing the Shares shall be
delivered to the Corporation duly endorsed in blank or with stock powers
attached, and the Corporation shall pay the purchase price therefor in cash or,
if permitted by Section 4.5 or Section 5.3 of this Agreement, by paying the
applicable cash portion and making, sealing and delivering the Note for the
remaining portion of the purchase price.
10.2 Effect of Refusal to Close. If a tender of the purchase
price in cash or in cash together with the Note, if applicable, shall be
refused; or the stock certificate or certificates representing the Shares, duly
executed, as aforesaid, shall not be so delivered, the Corporation may deposit
the purchase price in escrow in a commercial bank with offices in Alexandria,
Virginia or Washington, D.C., and, upon such tender, the Shares represented by
such certificates shall thereupon be deemed to have been repurchased.
Thereafter, the Holder or his assigns shall have no rights with respect to such
Shares, other than the right to collect the purchase price from the escrow
contemplated by this Section 10.2.
11. SECURITIES LAWS; RESTRICTIVE TRANSFER LEGENDS.
11.1 Acknowledgment of Restrictions. The Holders severally
acknowledge that the Common Stock owned by them has not been registered under
the Act or any State Acts, The Holders severally represent and wan-ant that
they will acquire their shares of the Common Stock without a view to the offer,
offer for sale, or the sale in connection with the public distribution of such
shares of Common Stock and that they will hold such shares of Common Stock
indefinitely unless (i) the shares of Common Stock are transferred in
accordance with this Agreement, (ii) the shares of Common Stock are
subsequently registered under the Act and the State Acts, or (iii) an exemption
from such registration is available and an opinion of counsel for the
Corporation, in
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<PAGE> 14
form and substance satisfactory to the Corporation, is obtained to that effect.
11.2 Legends. Due to the applicability of federal and state
securities laws and the restrictions imposed by this Agreement, all
certificates representing shares of Common Stock subject to this Agreement
shall be legended conspicuously in substantially the following form:
THE OFFERING AND SALE OF THE SECURITIES REPRESENTED BY THIS
CERTIFICATE HAVE NOT BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE
COMMISSION UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY
APPLICABLE STATE SECURITIES LAWS. ANY SALE, TRANSFER, PLEDGE OR OTHER
DISPOSITION OF THE SECURITIES REPRESENTED BY THIS CERTIFICATE MAY BE
MADE ONLY (I) IN A TRANSACTION REGISTERED UNDER SAID ACT AND ANY
APPLICABLE STATE SECURITIES LAWS, (II) IF AN EXEMPTION FROM
REGISTRATION UNDER SAID ACTS IS AVAILABLE AND THE CORPORATION HAS
RECEIVED AN OPINION OF COUNSEL TO SUCH EFFECT REASONABLY SATISFACTORY
TO IT OR (III) PURSUANT TO THAT CERTAIN EMPLOYEE SHAREHOLDERS
AGREEMENT DATED AS OF MAY 31,1995, AS AMENDED FROM TIME TO TIME.
THE COMPANY WILL FURNISH A FULL STATEMENT OF ALL OF THE
DESIGNATIONS, PREFERENCES, LIMITATIONS AND RELATIVE RIGHTS OF THE
SHARES OF EACH CLASS OF STOCK OR SERIES THEREOF OF THE COMPANY TO ANY
SHAREHOLDER UPON WRITTEN REQUEST TO THE CORPORATION AT ITS PRINCIPAL
PLACE OF BUSINESS OR REGISTERED OFFICE.
THE TRANSFER OF SHARES REPRESENTED BY THIS CERTIFICATE IS
ALSO RESTRICTED BY THE TERMS OF THAT CERTAIN EMPLOYEE SHAREHOLDERS
AGREEMENT DATED MAY 31, 1995, AS AMENDED, AMONG CERTAIN SHAREHOLDERS
OF THE CORPORATION, WHICH AGREEMENTS ALSO CONTAINS OTHER IMPORTANT
PROVISIONS RELATING TO SUCH SHARES, INCLUDING RIGHTS OF THE
CORPORATION TO REPURCHASE THE SHARES IN CERTAIN CIRCUMSTANCES. COPIES
OF THE AGREEMENT ARE ON FILE AT THE CORPORATIONS PRINCIPAL PLACE OF
BUSINESS AND REGISTERED OFFICE AND MAY BE OBTAINED WITHOUT CHARGE UPON
REQUEST TO THE CORPORATION AT ITS PRINCIPAL PLACE OF BUSINESS OR
REGISTERED OFFICE. BY ACCEPTANCE OF THIS CERTIFICATE, THE HOLDER
HEREOF AGREES TO BE BOUND BY THE TERMS OF SUCH AGREEMENT.
11.3 Acknowledgment Regarding Resales. Each Holder realizes
that the Corporation does not file, and does not in the foreseeable future
contemplate filing, periodic reports in accordance with the provisions of
Sections 13 and 15(d) of the Securities Exchange Act of 1934, as amended, or
making publicly available all of the information required by such
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<PAGE> 15
reports, and also understands that, except as contemplated by the Amended and
Restated Registration Rights Agreement dated as of May 2, 1995, the Corporation
has not agreed to register any of its securities for distribution in accordance
with the provisions of the Act or to take any actions respecting the obtaining
of an exemption from registration for such securities or any transaction with
respect thereto. Hence, by virtue of the applicable federal and state
securities laws, the Common Stock acquired by any Holder pursuant to this
Agreement or otherwise must be held indefinitely unless and until subsequently
registered under the Act and/or the State Acts, unless an exemption from such
registration is available, in which case the amount of the Common Stock that
may be sold may be limited or pursuant to this Agreement.
12. STOCK OR OPTIONS ISSUED IN THE FUTURE. Unless otherwise determined
by the Committee, this Agreement shall apply, automatically and without further
action on the part of any party hereto, to all Shares hereafter acquired by all
Holders. Whenever any Holder acquires any shares of Common Stock pursuant to
the Incentive Compensation Plan, the Stock Purchase Plan or otherwise (and
whether or not permitted under any applicable agreement or instrument), such
shares of Common Stock so acquired shall be subject to the terms of this
Agreement, and the certificates therefor shall be surrendered to the
Corporation for legended in accordance with Section 11 of this Agreement,
unless already so legended.
13. LOOK-BACK RIGHTS. If within one year from the date of repurchase
of the Common Stock hereunder upon a Protected Termination (a "Protected
Repurchase"), (i) the Corporation shall make an underwritten public offering of
newly-issued Common Stock or Common Stock owned by Statoil, (ii) Statoil shall
sell to a third party in one or a series of transactions at least 25% of the
capital stock of the Corporation owned by it or (iii) the Corporation shall
undertake any of the following transactions: merger, consolidation, share
exchange, sale, transfer, or other disposition of all or substantially all of
its assets, and as a result of such transactions the shareholders of the
Corporation before the transaction cease to own a majority of the capital stock
of the successor corporation (or the entity to which such assets have been sold
or transferred), the Corporation shall be obligated immediately to pay to any
Holder or former Holder who has participated in such a Protected Repurchase
cash in an amount equal to the number of shares of Common Stock repurchased
multiplied by the excess, if any, of (i) the value of a share of Common Stock
indicated by the terms of such transaction (net of applicable underwriting
discounts) over (ii) the repurchase price for said shares. The payment under
this Section 13 shall be made within five (5) days of the closing of the
transaction referred to in the foregoing sentence.
14. TERMINATION. This Agreement shall be perpetual until the happening
of any of the events listed below, upon the first to occur of which all rights,
duties and obligations, other than the duties and obligations relating to
registration under or exemption from the Act and the State Acts, as set forth
in Section 11 of this Agreement, and rights, duties and obligations respecting
payment under any outstanding Notes to any one or more of the Shareholders,
shall cease:
14.1 The agreement in writing of the Corporation and all
holders of the outstanding shares of Common Stock who are parties to, or who
are bound by, this Agreement to terminate this Agreement.
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<PAGE> 16
14.2 The dissolution of the Corporation.
14.3 The closing of an initial public offering of Common
Stock of the Corporation, whether of newly-issued shares or pursuant to a
secondary offering of shares,
14.4 In the event that there is a merger, consolidation, or
share exchange, or transfer or sale of all or substantially all of the assets
of the Corporation, if, as a result of such transaction, the shareholders of
the Corporation before the transaction cease to own a majority of the Capital
stock of the successor corporation (or the entity to which such assets have
been sold or transferred).
15. NOTICES. Any notice, payment, demand or communication required or
permitted to be given by any provision of this Agreement shall be in writing
and shall either be: (a) delivered personally to the party or to an officer of
the party to whom it is directed, in which case a signed receipt therefor shall
be received; or (b) sent by certified mail, return receipt requested, postage
prepaid, addressed as follows if to the Corporation or if to the Stock or
Option Holders, at the addresses set forth below their several signatures, or
to such other address or addresses as may be designated from time to time in
accordance with this Section 15. Any such notice shall be deemed to be
delivered, given and received for all purposes of this Agreement as of : (i)
the date noted on the signed receipt if delivered personally; or (ii) the date
deposited in a regularly maintained receptacle for the deposit of the United
States mail, if sent by certified mail.
16. ADDITIONAL ACTIONS AND DOCUMENTS. Each of the parties hereto
agrees to take or cause to be taken such further actions, to execute,
acknowledge, seal and deliver or cause to be executed, acknowledged, sealed and
delivered such further instruments and documents, including without limitation
a Registration Rights Agreement, and to use their reasonable efforts to obtain
such requisite consents as any other party may from time to time reasonably
request in order to fully effectuate the purposes and fulfill the intent of
this Agreement.
17. INTEGRATION. This instrument contains the entire integrated
agreement among the parties and supersedes all prior oral or written
agreements, commitments or understandings with respect to the matters provided
for herein (including but not limited to the Original Agreement), and no
modification shall be binding upon the party affected unless set forth in
writing and duly executed by each party affected.
18. SUCCESSORS AND ASSIGNS. Each of the covenants and agreements in
this Agreement by or on behalf of any of the parties hereto shall bind and
inure to the benefit of their respective heirs, guardians, personal and legal
representatives, successors and permitted assigns.
19. GOVERNING LAW. This Agreement shall be construed and enforced in
accordance with, and the rights of the parties shall be governed by, the laws
of the Commonwealth of Virginia.
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<PAGE> 17
20. SPECIFIC PERFORMANCE. In the event of a breach of this Agreement,
any non-breaching party hereto may maintain an action for specific performance
against the party or parties hereto who are alleged specific performance
against the party or parties hereto have breached any of the terms, conditions,
representations, warranties, provisions, covenants or agreements herein
contained, and it is hereby further agreed that no objection to the form of
action in any proceeding for specific performance of this Agreement shall be
raised by any party hereto so that such specific performance of this Agreement
may not be obtained by the aggrieved party. Anything contained herein to the
contrary notwithstanding, this Section 20 shall not be construed to limit in
any manner whatsoever any other rights and remedies that an aggrieved party may
have by virtue of any breach of this Agreement.
21. HEADINGS. The descriptive headings of the several sections and
subsections of this Agreement are inserted for convenience only, do not
constitute a substantive part of this Agreement, and are not intending to
describe, interpret, define, or limit the scope, extent or intent of this
Agreement as a whole, or any provision hereof. All schedules and exhibits
referred to in this Agreement are hereby deemed a substantive part of this
Agreement.
22. WORD USAGE. Unless the context otherwise requires, whenever used
in this Agreement, the singular shall include the plural, the plural shall
include the singular, and the masculine gender shall include the neuter and
feminine gender, and vice versa. Whenever used in this Agreement, words such as
"herein," "hereinafter," "hereof," "hereto, and "hereunder" refer to this
Agreement as a whole, unless the context otherwise requires.
23. COUNTERPARTS. This Agreement may be executed in counterparts, each
of which shall be an original, but all of which shall together constitute one
document.
24. SEVERABILITY. Each and every term and provision of this Agreement
is intending to be severable. If any term or provision hereof is illegal or
invalid for any reason whatsoever, such illegality or invalidity shall not
affect the legality or validity of the remainder of this Agreement.
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<PAGE> 18
IN WITNESS WHEREOF, the parties hereunto have executed,
sealed and delivered this Agreement or caused this Agreement to be executed,
sealed and delivered on this 6th day August, 1998.
ATTEST/WITNESS: STATOIL ENERGY, INC.
/s/ KYLA DEAN /s/ DAVID A. DRESNER
David A. Dresner
President and
Chief Executive Officer
ATTEST/WITNESS:
Name:
Shareholder/Option Holder
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<PAGE> 19
Exhibit A
NON-NEGOTIABLE PROMISSORY NOTE
Alexandria, Virginia
, 199
-------------- --
$
-----------------
FOR VALUE RECEIVED, Statoil Energy, Inc., a corporation organized
under the laws of the Commonwealth of Virginia (the "Corporation"), promises to
pay to ________________ (the "Holder") at ______________ or at such other place
as the Holder may from time to time designate in writing, the principal sum of
_______________ Dollars ($ ____________ ), with interest payable thereon as
hereinafter set forth. Interest and principal shall be payable in lawful money
of the United States of America, which shall be legal tender in payment of all
debts, public and private, at the time of payment as follows:
The Corporation shall repay the principal sum, together with interest
at the greatest of ten percent (10%) per annum, 3% above the three month London
Inter-Bank Offered Rate (LIBOR), as published from time to time in the Wall
Street Journal, or the minimum rate of interest required by the Internal
Revenue Code of 1986, as amended, to preclude the imputation of interest, in
twelve (12) equal quarterly installments of $ ______________ beginning on the
first day of the first calendar month following the expiration of sixty (60)
days from the date hereof, and continuing until 19__ , when the unpaid balance
of the principal sum and all unpaid interest thereon shall be paid in full.
All payments received shall be applied first to the payment of accrued
and unpaid interest and any balance to the payment of principal. Interest shall
be computed on the basis of a 360-day per year factor applied to actual days
elapsed.
The Corporation may prepay the principal sum in whole or in part at
any time without premium or penalty, by paying, in addition to the amount
prepaid, interest accrued to the date of prepayment.
Upon default in any payment of interest or of principal and interest,
such unpaid amount shall bear interest thereafter at a rate which is at all
times equal to two percent (2%) per annum in excess of the then current rate of
interest under this Note until the default is cured.
The Corporation shall also pay (i) a late charge of one twentieth
(1/20) of any payment of interest or principal and interest provided above if
such payment is made more than fifteen (15) calendar days after the due date
thereof and (ii) prior to judgment, costs of collection, including a reasonable
attorney's fee, if this Note is referred to an attorney for collection after
default, whether suit be brought or not.
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<PAGE> 20
The rights and remedies of the Holder provided herein shall
be cumulative and concurrent and may be pursued singularly, successively or
together at the sole discretion of the Holder, and may be exercised as often as
occasion therefor shall occur, and the failure to exercise any such right or
remedy shall in no event be construed as a waiver or release of the same.
In the event that any one or more of the provisions of this
Note shall for any reason be held to be invalid, illegal or unenforceable, in
whole or in part or in any respect, or in the event that any one or more of the
provisions of this Note operate or would prospectively operate to invalidate
this Note, then and in either of those events, such provision or provisions
only shall be deemed null and void and shall not affect any other provisions
(or remaining part of the affected provision) of this Note and the remaining
provisions (or remaining part of the affected provision) of this Note shall
remain operative and in full force and effect and shall in no way be affected,
prejudiced or disturbed thereby.
WITNESS the signature and seal of the Corporation by its duly
authorized officer as of the day and year first above written.
[SIGNATURE BLOCK TO COME]
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<PAGE> 21
Exhibit B
UNDERTAKING TO BE BOUND BY
EMPLOYEE SHAREHOLDER AGREEMENT
The undersigned, as the owner of an option to acquire shares
of Common Stock of the Corporation or as the owner of shares of such Common
Stock, hereby acknowledges and agrees that he or she has read and is familiar
with the Employee Shareholders Agreement dated as of May 31, 1995 of Statoil
Energy, Inc., (the "Agreement") that the undersigned agrees to be a Stock or
Option Holder under the Agreement, and that the undersigned or the
undersigned's heirs, executors, administrators, successors, and assigns shall
be bound by the provisions of the Agreement.
ATTEST/WITNESS:
Name
Shareholder/Option Holder
<PAGE> 1
EXHIBIT 10.3.2
FIRST AMENDMENT TO
EMPLOYEE SHAREHOLDERS AGREEMENT
THIS FIRST AMENDMENT TO EMPLOYEE SHAREHOLDERS AGREEMENT (this
"Amendment"), is made this 6th day of June, 1997, by and among Statoil Energy,
Inc., a Virginia corporation (the "Corporation"), and the individuals listed on
the signature page hereof who are owners of Common Stock of the Corporation
("Shareholders") and/or holders of options to purchase Common Stock of the
Corporation ("Option Holders").
EXPLANATORY STATEMENT
The Corporation, the Shareholders and the Option Holders are
parties to an Employee Shareholders Agreement dated as of May 31, 1995 (the
"Original Agreement"). The Original Agreement provides for the mandatory sale
by a Shareholder to the Corporation of all shares of Common Stock owned by such
Shareholder when such Shareholder ceases to be employed by the Corporation. The
parties hereto desire to amend the provisions of the Original Agreement to part
continued ownership of such shares of Common Stock in the event a Shareholder
leaves the employment of the Corporation but remains employed by an entity
owned and controlled by the principal stockholder of the Corporation. In
addition, the parties hereto desire to make other amendments to the Original
Agreement as set forth herein. Accordingly, the parties hereto desire to modify
the Original Agreement as set forth herein.
NOW, THEREFORE, in consideration of the matters set forth in
the Explanatory Statement and the mutual covenants, promises and agreements
contained herein, the parties hereto do hereby covenant, promise and agree as
follows:
1 . The provisions of the Explanatory Statement are
incorporated herein by reference. All undefined, capitalized terms contained
herein shall have the meanings set forth in the Original Agreement.
2. The following definition shall be added to Section I of
the Original Agreement:
"Statoil Entity" means an entity in which Statoil owns,
directly or indirectly, equity interests representing at least 50% of all such
equity interests.
3 . The definitions of each of the following terms as set
forth in Section I of the Original Agreement shall be deleted in their entirety
and the following shall be substituted in lieu thereof:
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<PAGE> 2
"Justification", when used with respect to a Holder, means
the resignation of a Holder from employment of au positions
with the Corporation and any Statoil Entity upon (i) a
substantial diminution in responsibilities, position, or
salary, or (ii) the involuntary transfer to an office or
business location, in the case of a Holder then assigned to
the Corporation's or Statoil Entity's headquarters offices,
outside of the relevant metropolitan area, and in the case of
any other Holder, by more than 75 miles from the location of
the Holder's immediately preceding office or work location.
"Termination" means when a Shareholder is no longer employed
by the Corporation or any Statoil Entity.
"Terminated Shareholder, means a Holder who is no longer
employed by the Corporation or any Statoil Entity.
4. The definitions of each of the following terms as set
forth in Section I of the Original Agreement shall be amended as follows:
"Cause" - all references in such definition to the term
"Corporation" shall be deleted and replaced by the term
"Statoil Entity".
"Option Holder" - all references in such definition to the
term "Corporation" shall be deleted and replaced by the term
"Statoil Entity".
"Protected Termination" - all references in such definition
to the term "Corporation" shall be deleted and replaced by
the term "Statoil Entity".
5. Section 2.3 of the Original Agreement is amended by
deleting the phrase "the Corporation" the first time it appears in the third
line of Section 2.3 and substituting in lieu thereof the phrase a Statoil
Entity".
6. Section 14.1 of the Original Agreement is deleted in its
entirety and the following is substituted in lieu thereof:
14.1 The agreement in writing of the Corporation and the
Stockholders Owning at least 80% of the Shares Owned by
Stockholders and governed by the provisions of this
Agreement to terminate this Agreement.
7. Section 17 of the Original Agreement is deleted in its
entirety and the following is substituted in lieu thereof:
17. Integration and Modification. This instrument contains
the entire integrated agreement among the parties and
supersedes all prior oral or written agreements, commitments
or understandings with respect to the matters provided for
herein. This Agreement may be modified or amended only by a
writing executed on behalf of the Corporation and by
Stockholders owning at least 80% of the Shares Owned by
Stockholders and governed by the provisions of this Agreement.
Notwithstanding the provisions of the foregoing sentence no
modification or amendment shall be binding upon any Holder,
absent the written consent of such Holder, which modification
or amendment would adversely affect such Holder's rights as a
Stockholder or Option Holder hereunder in a manner different
than other similarly situated Stockholders or Option Holders.
8. The Amendment may be executed in counterparts, each of
which shall constitute an original, but all of which when taken together shall
constitute a single contract.
9. In all other respects, the Original Agreement is ratified
and confirmed as of the date hereof.
IN WITNESS WHEREOF, the parties hereto have caused this
Amendment to be duly executed and sealed as of the date first above written.
ATTEST/WITNESS: THE EASTERN GROUP, INC.
By: /s/ DAVID A. DRESNER (SEAL)
- -------------------------------------- -------------------------
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<PAGE> 1
EXHIBIT 10.3.3
SECOND AMENDMENT TO
EMPLOYEE SHAREHOLDERS AGREEMENT
THIS SECOND AMENDMENT TO EMPLOYEE SHAREHOLDERS AGREEMENT (this
"Amendment") is made and entered into as of this 19th day of May, 1998, by and
among The Eastern Group, Inc., a Virginia corporation (the "Corporation"), and
the individuals listed on the signature page hereof who are owners of Common
Stock of the Corporation ("Shareholders") and/or holders of options to purchase
Common Stock of the Corporation ("Option Holders").
EXPLANATORY STATEMENT
The Corporation, the Shareholders and the Option Holders are parties
to an Employee Shareholders Agreement dated as of May 31, 1995, as amended by a
First Amendment To Employee Shareholders Agreement dated as June 6, 1997
(collectively, the "Original Agreement"). The parties hereto desire to amend
the Original Agreement to reflect (i) the transfer of all of the issued and
outstanding Common Stock of the Corporation from Den norske stats oljeselskap,
a.s to Statoil North America, Inc. and (ii) the sale by Ralph L. Bradley to the
Corporation of his Common Stock in the Corporation.
Section 17 of the Original Agreement provides that the Original
Agreement may be amended by a writing executed on behalf of the Corporation and
by Shareholders owning at least eighty percent (80%) of the shares of Common
Stock governed by the provisions of the Original Agreement.
NOW, THEREFORE, in consideration of the matters set forth in the
Explanatory Statement and the mutual covenants, promises and agreements
contained herein, the parties hereto do hereby covenant, promise and agree as
follows:
1. The provisions of the Explanatory Statement are incorporated herein
by reference. All undefined, capitalized terms contained herein shall have the
meanings set forth in the Original Agreement.
2. The following definition shall be added to Section 1 of the Original
Agreement:
"Parent Company" means Den norske stats oljeselskap, a.s, a
corporation organized under the laws of the Kingdom of Norway.
3. The definitions of each of the following terms as set forth in the
Original Agreement shall be deleted in their entirety and the following shall
be substituted in lieu thereof:
"Statoil" means Statoil North America, Inc. or any other entity which
acquires the issued and outstanding Common Stock now owned by Statoil as long
as the Parent Company owns, directly or indirectly, at least fifty percent
(50%) of the equity interests of such entity.
<PAGE> 2
"Statoil Entity" means an entity in which the Parent Company owns,
directly or indirectly, equity interests representing at least fifty percent
(50%) of all such equity interests.
4. Section 2.3 of the Original Agreement shall be deleted in its entirety
and the following shall be substituted in lieu thereof:
"2.3. Permitted Transfers. A Holder may freely and without restriction
transfer Shares to another Holder who at the time of the Transfer is an
employee of the Corporation, to the Corporation, to Statoil, or to a member of
the Holder's immediate family, including a trust for the benefit of family
members, provided that in the case of intra-family Transfers, all transferees
shall have executed an instrument, in form and content satisfactory to the
Corporation, undertaking to become a party to this Agreement and to be bound by
all of its provisions, a form of which undertaking is attached hereto as
Exhibit B."
5. Section 11.3 of the Original Agreement shall be amended by deleting the
reference therein to "Amended and Restated Registration Rights Agreement dated
as of May 2, 1995" and substituting in lieu thereof "1996 Amended and Restated
Registration Rights Agreement, as amended".
6. In all other respects, the Original Agreement is ratified and
confirmed as of the date hereof.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to
be duly executed and sealed as of the date first above written.
THE EASTERN GROUP, INC.
By: /s/ DAVID A. DRESNER
------------------------------
David A. Dresner
President and CEO
SHAREHOLDER
----------------------------------
Print Name:
2
<PAGE> 1
EXHIBIT 10.4
PROMISSORY NOTE
$505,488,085
Alexandria, Virginia
August 10, 1999
FOR VALUE RECEIVED, in the manner and in the amounts hereinafter provided for,
the undersigned, Eastern States Oil & Gas, Inc. a Virginia corporation
("Borrower") promises to pay to the order of Statoil Energy Holdings, Inc., a
Delaware corporation, its heirs and assigns ("Noteholder"), the principal sum
of Five Hundred Five Million Four Hundred Eighty Eight Thousand Eighty Five
Dollars ($505,488,085) or the actual principal amount due from the undersigned
(the "Principal Indebtedness"), at the time of payment provided for
hereinafter, and to pay interest on the unpaid Principal Indebtedness at the
times and at the rate per annum established in accordance with all the terms
and provisions of this Note until all the indebtedness evidenced by this Note
has been fully satisfied. Payment of principal and interest shall be made at
the place which the Noteholder from time to time shall direct in writing.
1. This Note shall bear interest at the annual rate of eight percent (8%)
payable semi-annually on January 1 and July 1 each year during the term of this
note.
2. Unless otherwise extended, the Borrower agrees to pay to the Noteholder
all outstanding principal and interest, not previously paid, on December 31,
2001.
3. THIS IS A BALLOON NOTE. Notwithstanding the principal amount of this
Note as stated on the face hereof, the actual principal amount due from the
undersigned to Statoil Energy Holdings, Inc., on account of this Note, as of
any date of computation shall be the sum of all advances made to the Borrower
less all payments of principal actually received by Statoil Energy Holdings,
Inc. in collected funds during the same period, but in any event shall not
exceed the face amount of this Note plus accrued and unpaid interest.
4. The Borrower reserves the right at any time to prepay, in whole or in
part, the Principal Indebtedness set forth above without premium or penalty.
Any such prepayment shall be applied first to interest accrued through the date
of prepayment, and then to the Principal Indebtedness.
5. Interest shall be calculated on the basis of a year of three hundred
sixty (360) days, and for the actual number of days elapsed, and shall, from
the date(s) of any partial prepayment(s), be computed on the outstanding unpaid
balance of Principal Indebtedness after application of such prepayment(s) in
accordance with Section 4 hereof. If any date for payment of any payment is
other than a business day, such payment shall be due on the next succeeding
business day.
6. Any payment due under this Note, whether of the Principal Indebtedness
or interest thereon, which is not paid in accordance with the terms hereof,
shall bear interest from the date due until paid at an annual interest rate
equal to eight percent (8%).
<PAGE> 2
7. The Borrower waives notice, presentment, demand or protest.
8. The Borrower hereby agrees to pay all expenses incurred, including all
reasonable attorneys' fees and court costs, all of which shall become a part of
the Principal Indebtedness, if this Note is placed in the hands of an attorney
for collection or is collected by suit or through any bankruptcy or any other
legal proceedings.
9. In the event one or more of the provisions contained in this Note shall
be for any reason be held to be invalid, illegal or unenforceable, such
invalidity, illegality or unenforceability shall not affect any other provision
of this Note, but this Note shall be construed as if such invalid, illegal or
unenforceable provision had never been contained herein.
10. It is the intention of the parties to comply with the usury laws of the
Commonwealth of Virginia and the United States federal government, and any
other applicable usury law. Accordingly, it is agreed that no provision in this
Note shall require the payment or permit the collection of interest or late
charges in excess of the maximum non-usurious interest permitted by applicable
law (the "Maximum Rate"). If any interest in excess of the Maximum Rate is
provided for, or shall be adjudicated to be so provided for, then in such event
(i) the provisions of this Section shall govern, (ii) neither the Borrower, nor
its legal representatives, successors or permitted assigns, nor any other party
liable for the payment thereof, shall be obligated to pay interest to the
extent that it is in excess of the Maximum Rate, (iii) any excess interest
which may have been collected shall, at the Borrower's election, be either
applied as a credit against the unpaid principal amount hereof, without
penalty, or refunded to the Borrower, and (iv) the effective rate of interest
shall be automatically reduced to the Maximum Rate.
11. The provisions of this Note shall bind and inure to the benefit of the
Borrower and the Noteholder, and their respective legal representatives,
legatees, heirs, successors and assigns; provided, however, that this Note may
be assigned by the Borrower.
12. This Note shall be governed by and construed in accordance with the
laws of the Commonwealth of Virginia.
2
<PAGE> 3
13. The rights and remedies of the Noteholder under this Note and
applicable law shall be cumulative and concurrent, and the exercise of any one
or more of said rights and remedies shall not preclude the simultaneous or
later exercise by the Noteholder of any or all such other rights or remedies.
No modification or waiver of any provision of this Note shall be effective
unless it is in writing and signed by the Noteholder, and any such waiver shall
be effective only in the specific instance for which it is given. The failure
of the Noteholder to exercise any option right or remedy in any on or more
instances, or the acceptance by the Noteholder of partial payments or partial
performance, shall not constitute a waiver of the right to exercise any option,
right or remedy at any time.
14. Any notice to Borrower provided for in this Note shall be given by
mailing such notice by certified mail to Borrower at 2800 Eisenhower Avenue,
Alexandria, Virginia 22314 or to such other address as Borrower may designate
by notice to the Noteholder. Any notice to the Noteholder shall be given by
mailing such notice by certified mail, return receipt requested, to the
Noteholder at 103 Foulk Road, Suite 202, Wilmington, Delaware 19803 or to such
other address as Noteholder may designate by notice to the Borrower.
15. This Promissory Note is not a negotiable instrument.
IN WITNESS HEREOF, the Borrower has caused this Note to be executed by its duly
authorized representative as of the date first above written.
EASTERN STATES OIL & GAS, INC.,
a Virginia corporation
By: /s/ STEVENS V. GILLESPIE
--------------------------------------
Stevens V. Gillespie
Senior Vice President and CFO
ATTEST:
By: /s/ KERRY W. ECKSTEIN
--------------------------------------
Kerry W. Eckstein
Secretary
3
<PAGE> 1
EXHIBIT 10.5.1
EMPLOYMENT AGREEMENT
This Employment Agreement (the "Agreement"), by and between
Statoil Energy, Inc., a Virginia corporation (the "Company"), and Clifton A.
Brown ("Employee"), is hereby entered into as of March 29, 1999 and is effective
as of February 1, 1999. This Agreement hereby supersedes any other employment
agreements or understandings; written or oral, between the Company and Employee.
RECITALS
WHEREAS Employee is employed hereunder by the Company in a
confidential relationship wherein Employee, in the course of his employment
with the Company, has and will continue to become familiar with and aware of
information as to the Company's customers, specific manner of doing business,
including the processes, techniques and trade secrets utilized by the Company,
and future plans with respect thereto, all of which has been and will be
established and maintained at great expense to the Company; this information is
a trade secret and constitutes the valuable good will of the Company; and
WHEREAS the Company wishes to employ Employee and Employee
wishes to be employed by the Company, each in accordance with the terms and
conditions of this Agreement.
NOW, THEREFORE, in consideration of the mutual promises,
terms, covenants and conditions set forth herein and the performance of each,
it is hereby agreed as follows:
ARTICLE 1
EMPLOYMENT & DUTIES
1.1 Position & Duties. Employee shall hold the office of Executive Vice
President and Employee shall have the powers and authority normally
associated with such position. Employee shall assume such other
responsibilities, consistent with his position as Executive Vice
President, as may be delegated to him from time to time by the
President and Chief Executive Officer of the Company. Such services
shall be provided at the Company's principal executive office located
at 2800 Eisenhower Avenue, Alexandria, Virginia, or such other
location of the Company's principal executive office as the Company
shall reasonably designate in accordance with the provisions of this
Agreement. Employee hereby accepts this employment upon the terms and
conditions herein contained and agrees to devote his time, skill,
labor, attention and efforts to promote and further the business of
the Company.
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<PAGE> 2
1.2 Company Policies. Employee shall faithfully adhere to, execute and
fulfill all policies established by the Company.
1.3 Other Activities. Employee shall not, during the Term of his
employment hereunder, be engaged in any other business activity
pursued for gain, profit or other pecuniary advantage if such activity
interferes with Employee's duties and responsibilities hereunder.
However, the foregoing limitations shall not be construed as
prohibiting Employee from (i) making personal investments in such form
or manner as will neither require his services in the operation or
affairs of the companies or enterprises in which such investments are
made nor violate the terms of Section 1.4 hereof; (ii) serving on the
board of directors of a reasonable number of other corporations, trade
associations or charitable organizations; or (iii) engaging in any
charitable activities or community affairs, so long as, in each case,
such other activities do not interfere with Employee's performance of
his obligations hereunder.
1.4 Investments. The foregoing covenant shall not be deemed to prohibit
Employee from acquiring as an investment not more than the lesser of
either (i) five percent (5%) of the outstanding capital stock of a
company in direct competition with the Company, or (ii) one million
dollars ($1,000,000) worth of the capital stock of a company in direct
competition with the Company; provided, however, that, notwithstanding
the foregoing, in the event that the Company shall adopt any policy
governing permissible investments by its employees and such policy is
applicable to Employee, any investment made by Employee in compliance
with such policy shall be deemed permissible under this Section 1.4
and any investment made by Employee that is not in compliance with
such policy shall be deemed to constitute a breach of this Agreement.
ARTICLE 2
COMPENSATION
2.1 Base Salary. Effective as of February 1, 1999, the base salary ("Base
Salary") payable to Employee shall be no less than $260,000 per year,
payable on a regular basis in accordance with the Company's standard
payroll procedures, but not less than monthly. On at least an annual
basis, the Board will review Employee's performance and may make
increases to such Base Salary if, in the Board's discretion, any such
increase is warranted. As used herein, "Base Compensation" shall mean
the Employee's Base Salary plus the Employee's Average Bonus (as
defined in Section 2.2 hereof).
2.2 Incentive Bonus Plan. The Company shall pay to the Employee such
bonuses based upon the financial performance of the Company and the
individual performance of the Employee in accordance with any bonus
plan established for senior management of the Company from time to
time by the Board or its designee or as otherwise granted in the
discretion of the Board or its designee; provided, however that any
future bonus plan established for senior management of the Company
shall be no less advantageous to the Employee than the bonus
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<PAGE> 3
plan of the Company in effect with respect to the Employee as of the
date hereof. As used herein, "Average Bonus" shall mean the average of
all bonuses paid to the Employee during the previous three years (or,
if applicable, such shorter time that Employee has been employed by
the Company); provided, however that if in one or more of such prior
years to be averaged the Employee was paid a bonus in excess of 50% of
Employee's Base Salary for any such year, then, in calculating the
average of bonuses paid to the Employee, a number equal to 50% of
Employee's Base Salary for any such year shall be substituted for the
actual amount of Employee's bonus in calculating the applicable
Average Bonus.
2.3 Executive Perquisites, Benefits and Other Compensation. Employee shall
be entitled to receive additional benefits and compensation from the
Company in such form and to such extent as specified below:
a. The Employee shall be entitled to receive any employee
benefits, including, without limitation, any retirement
benefit plan, disability, group life, sickness, accident and
health insurance programs and perquisites provided by the
Company to executives such as are the greater of (i) the
employee benefits and perquisites then provided by the
Company to executives with comparable authority or duties
(and in any event not less than those provided to executives
with junior authority or duties), or (ii) such employee
benefits and perquisites as in effect on the date hereof.
b. The Company shall reimburse the Employee for all reasonable
expenses incurred by the Executive in the performance of his
duties under this Agreement upon presentation of
documentation therefor in form and substance satisfactory to
the Company.
c. The Company may provide Employee with other executive
perquisites as may be available to or deemed appropriate for
Employee by the Board.
2.4 Stock Options. The Employee shall receive stock options ("Stock
Options") as shall be granted at the discretion of the Board of
Directors of the Company consistent with historical practices.
2.5 Vacation and Leave. The Employee shall be entitled to four (4) weeks
vacation and to leaves of absence for illness or temporary disability
in accordance with the policies of the Company in effect from time to
time. Any leave on account of illness or temporary disability which is
short of "Total Disability" (as defined below) shall not constitute a
breach by the Employee of his agreements hereunder and in no event
shall the Company be entitled to terminate the employment of the
Employee hereunder for cause due to such leave. "Total Disability"
shall mean the inability of the Employee due to physical or mental
illness or injury to perform his duties hereunder for any period of
more than ninety (90) consecutive days. Upon the Total Disability of
the Employee, the Employee shall be entitled to receive, until
Employee returns to work or, if Employee's employment terminates
pursuant to Section 4.2(b) hereof, the expiration of the Term of this
Agreement, (i) periodic monthly payments
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<PAGE> 4
from the Company equal to sixty-six and two-thirds percent (662/3%) of
the Base Compensation in effect at the commencement of such Total
Disability, and (ii) any health and other medical related benefits
provided by the Company to the same extent such health and medical
benefits were provided by the Company prior to Employee's Total
Disability; provided, however, that the periodic monthly payments set
forth in clause (i) hereof shall be reduced by the amount of any
disability insurance payment made to the Employee pursuant to any
disability insurance program funded by the Company.
ARTICLE 3
NON-COMPETITION/NON-SOLICITATION
3.1 Non-Competition and Non-Solicitation. During the period of employment
by or with the Company, and for a period following the termination of
his employment under this Agreement equal to the longer of (i) one (1)
year or (ii) the period during which Employee is entitled to receive
and is receiving any payment pursuant to Section 4.2(d), 4.2(e) or 4.3
hereof, Employee will not, for any reason whatsoever, directly or
indirectly, for himself or on behalf of or in conjunction with any
other person, persons, company, partnership, corporation or business
of whatever nature:
a. engage, as an officer, director, owner, partner, joint
venturer, employee, independent contractor, consultant or
advisor in any business selling any products or services in
direct competition with the Company, within one hundred (100)
miles of the principle executive office of the Company or
where any of the Company's affiliates or subsidiaries conduct
business, including any territory serviced by the Company or
any of such affiliates or subsidiaries (the "Territory");
b. call upon any person who is, at that time, within the
Territory, an employee of the Company (including the
affiliates and subsidiaries thereof) in a managerial capacity
for the purpose or with the intent of enticing such employee
away from or out of the employ of the Company (including the
affiliates and subsidiaries thereof), provided that Employee
shall be permitted to call upon and hire any member of his or
her immediate family;
c. call upon any person or entity which is, at that time, or
which has been, within one (1) year prior to that time, a
customer of the Company (including the affiliates and
subsidiaries thereof) within the Territory for the purpose of
soliciting or selling products or services in direct
competition with the Company within the Territory;
d. call upon any prospective acquisition candidate, on
Employee's own behalf or on behalf of any competitor, which
candidate was either called upon by the Company (including
the affiliates and subsidiaries thereof) or for which the
Company made an acquisition analysis, for the purpose of
acquiring such entity, in either case, during the last twelve
(12) months of the Employee's employment with the Company.
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<PAGE> 5
3.2 Remedies. Because of the difficulty of measuring economic losses to
the Company as a result of a breach of the foregoing covenant, and
because of the immediate and irreparable damage that could be caused
to the Company for which it would have no other adequate remedy,
Employee agrees that the foregoing covenant may be enforced by the
Company by seeking injunctions or restraining orders in the event of a
breach of the foregoing covenant by the Employee.
3.3 Reasonableness and Interpretation. It is agreed by the parties that
the foregoing covenants in this Article 3 impose a reasonable
restraint on Employee in light of the activities and business of the
Company and its affiliates on the date of the execution of this
Agreement and the current plans of the Company and its affiliates; but
it is also the intent of the Company and Employee that such covenants
be construed and enforced in accordance with the changing activities,
business and locations of the Company and its affiliates throughout
the term of this Article III.
3.4 Subsequent Conflicts. It is further agreed by the parties hereto that,
in the event that Employee shall cease to be employed hereunder, and
shall enter into a business or pursue other activities not in
competition with the Company or its affiliates, or similar activities
or business in locations the operation of which, under such
circumstances, does not violate Section 3.1 hereof, and in any event
such new business, activities or location is not in violation of
Section 3.1 hereof or of Employee's obligations under this Article 3,
Employee shall not be chargeable with a violation of this Article 3 if
the Company or its affiliates shall thereafter enter the same, similar
or a competitive (i) business, (ii) course of activities or (iii)
location, as applicable.
3.5 Reformation. The covenants in this Article 3 are severable and
separate, and the unenforceability of any specific covenant shall not
affect the provisions of any other covenant. Moreover, in the event
any court of competent jurisdiction shall determine that the scope,
time or territorial restrictions set forth are unreasonable, then it
is the intention of the parties that such restrictions be enforced to
the fullest extent which the court deems reasonable, and the Agreement
shall thereby be reformed.
3.6 No Defense. All of the covenants in this Article 3 shall be construed
as an agreement independent of any other provision in this Agreement,
and the existence of any claim or cause of action of Employee against
the Company, whether predicated on this Agreement or otherwise, shall
not constitute a defense to the enforcement by the Company of such
covenants; provided, however, that upon the failure of the Company to
make any payments required under this Agreement, the Employee may,
upon thirty (30) days prior written notice to the Company, waive his
right to receive any additional compensation pursuant to this
Agreement and engage in any activity prohibited by the covenants of
this Article 3. It is specifically agreed that the period stated in
Section 3.1, during which the agreements and covenants of Employee
made in this Article 3 shall be effective, shall be computed by
excluding from such computation any time during which Employee is in
violation of any provision of this Article 3.
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<PAGE> 6
3.7 Compensation Period. Notwithstanding any of the foregoing, if any
applicable law shall reduce the time period during which Employee
shall be prohibited from engaging in any competitive activity
described in Section 3.1 hereof, the period of time for which Employee
shall be prohibited pursuant to Section 3.1 hereof shall be the
maximum time permitted by law. However, in the event that the time
period specified by Section 3.1 shall be so reduced, then,
notwithstanding the provisions of Sections 4.2(d), 4.2(e) or 4.3
hereof, Employee shall be entitled to receive from the Company his
Base Compensation at the rate then in effect solely for the longer of
(i) the time period during which the provisions of Section 3.1 shall
be enforceable under the provisions of such applicable law, or (ii)
the time period during which Employee is not engaging in any
competitive activity, but in no event longer than the terms provided
in Sections 4.2 and 4.3.
ARTICLE 4
TERM & TERMINATION
4.1 Term. The term of this Agreement (the "Term") shall begin on the
effective date hereof and continue for 30 months. The Term shall be
automatically extended by one day for every day after the effective
date hereof that the Employee is employed by the Company. The Term
shall, at all times, be 30 months from the current date; provided,
however, that if the Board of Directors of the Company shall at any
time determine not to extend the Term, as of the date sixty (60) days
following notification of such decision to the Employee, the Term
shall not extend pursuant to this Section 4.1 and the 30 month Term
described herein shall begin to expire. If this Agreement and
Employee's employment hereunder is terminated in accordance with
Sections 4.2 or 4.3 of this Agreement, from that point forward, this
Agreement shall not be extended as set forth hereunder.
4.2 Termination Without Change in Control of the Company. This Agreement
and Employee's employment may be terminated prior to the expiration of
the Term in any one of the followings ways:
a. Death. The death of Employee shall immediately terminate the
Agreement with no further payments under this Agreement
(except as set forth in Section 4.4 hereof) due to Employee's
estate.
b. Disability. If, as a result of incapacity due to physical or
mental illness or injury, Employee shall have been absent
from his full-time duties hereunder for ninety (90)
consecutive days, then thirty (30) days after written notice
to the Employee (which notice may occur before or after the
end of such ninety (90) day period, but which shall not be
effective earlier than the last day of such ninety (90) day
period), the Company may terminate this Agreement and
Employee's employment hereunder provided Employee is unable
to resume his full-time duties at the conclusion of such
notice period. Also, Employee may terminate this Agreement
and his employment hereunder if his health should become
impaired to an extent that makes the continued
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<PAGE> 7
performance of his duties hereunder hazardous to his physical
or mental health or his life, provided that Employee shall
have furnished the Company with a written statement from a
qualified doctor to such effect and provided, further, that,
at the Company's request made within thirty (30) days of the
date of such written statement, Employee shall submit to an
examination by a doctor selected by the Company who is
reasonably acceptable to Employee or Employee's doctor and
such doctor shall have concurred in the conclusion of
Employee's doctor. Subject to Section 3.7 hereof, in the
event this Agreement is terminated as a result of Employee's
disability, until the expiration of the Term of this
Agreement, Employee shall receive from the Company periodic
monthly payments equal to sixty-six and two-thirds percent
(66 2/3%) of the Base Compensation in effect at the
commencement of such disability less the amount of any
insurance payment made to the Employee pursuant to any
disability insurance program funded by the Company.
c. For Cause. The Board of Directors of the Company may
terminate the Agreement ten (10) days after written notice to
Employee for good cause ("For Cause"), which shall mean: (i)
the willful failure or refusal of Employee to perform any
material obligation under this Agreement or to carry out the
reasonable directives of the Board or the repeated willful or
materially negligent failure to perform the Employee's duties
as determined by the Board in good faith, and the failure of
Employee to cure the same within a period of thirty (30) days
following notice thereof; (ii) Employee's failure to devote
full business time, skill, labor, attention and efforts to
promote and further the business of the Company; (iii)
Employee's conviction of a felony or other crime involving
moral turpitude, or willful misconduct or performance of an
illegal activity in connection with employment; or (iv) after
a request by the Company that the Employee obtain counseling
for any alcohol or illegal drug abuse by Employee, the
Employees' failure within a reasonable time to commence or
complete such counseling, or the Employee's continued alcohol
or drug abuse after the completion of such counseling;
provided, however, that an Employee shall only be considered
to abuse alcohol if the Employee fails to timely and
adequately fulfill his duties under this Agreement due to the
consumption of alcohol. In the event of a termination For
Cause, Employee shall have no right to any further payment
under this Agreement (except as set forth in Section 4.4
hereof).
d. Without Cause. At any time after the commencement of
employment, the Company may, without cause ("Without Cause"),
terminate this Agreement and Employee's employment, effective
thirty (30) days after written notice is provided to the
Employee. Should Employee be terminated by the Company
Without Cause, Employee shall receive from the Company the
Base Compensation at the rate then in effect for the longer
of (i) one year, or (ii) whatever time period is remaining
under the Term, in each case, payable in equal monthly
payments for the remainder of such time.
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<PAGE> 8
e. Termination by Employee for Good Reason. The Employee may
terminate his employment hereunder for "Good Reason" at any
time within sixty (60) days of any event or occurrence (or
earlier written notice to the Employee of an event or
occurrence) giving rise to Employee's right to terminate
under this Subsection 4.2(e). If Employee does not terminate
his or her employment within sixty (60) days of such event or
occurrence (or, where applicable, written notification by the
Company of such an event or occurrence), Employee shall be
deemed to have waived his right to terminate his or her
employment under this Subsection 4.2(e) with respect to such
event or occurrence. As used herein, "Good Reason" shall mean
the continuance of any of the following after ten (10) days'
prior written notice by Employee to the Company, specifying
the basis for such Employee's having Good Reason to terminate
this Agreement:
i. a material adverse change in Employee's compensation
package;
ii. the assignment to Employee of any duties materially
and adversely inconsistent with the position of an
executive vice president of the Company, including
status, offices, responsibilities, or any other
action by the Company which results in a material
and adverse change in such status, titles or
responsibilities;
iii. any other material breach of this Agreement by the
Company, including the failure to pay Employee on a
timely basis the amounts to which he is entitled
under this Agreement;
iv. the Company requires the Employee to change his
principal work site to a location fifty (50) or more
miles away from Employee's current principal work
site; or
v. the Board of Directors determines not to extend this
Agreement by providing the written notice referenced
in Section 4.1 hereof.
If Employee resigns or otherwise terminates his employment
for Good Reason, Employee shall receive from the Company the
Base Compensation at the rate then in effect for the longer
of (i) one year, or (ii) whatever time period is remaining
under the Term of this Agreement, in each case, payable in
equal monthly payments for the remainder of such Term. If
Employee resigns or otherwise terminates his employment for
any reason other than Good Reason, Employee shall have no
right to any further payment under this Agreement (except as
set forth in Section 4.4 hereof).
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<PAGE> 9
4.3 Termination With Change in Control of the Company.
a. Definition. For the purpose of the Agreement, "Change in
Control" shall be deemed to have occurred if:
i. any person, other than Den norske stats oljeselskap,
a.s. ("Statoil"), an affiliate of the Company or
Statoil, or an employee benefit plan of the Company,
or an affiliate of the Company, acquires directly or
indirectly the Beneficial Ownership (as defined in
Section 13(d) of the Securities Exchange Act of
1934, as amended) of any voting security of the
Company and immediately after such acquisition such
Person is, directly or indirectly, the Beneficial
Owner of voting securities representing more than
fifty percent (50%) or more of the total voting
power of all of the then-outstanding voting
securities of the Company;
ii. the stockholders of the Company approve a merger,
consolidation or reorganization of the Company
unless (A) such transaction would result in more
than fifty percent (50%) of the total voting power
represented by the voting securities of the
surviving entity outstanding immediately after such
transaction being Beneficially Owned by the holders
of outstanding voting securities of the Company
immediately prior to the transaction, with the
voting power of each such continuing holder relative
to other such continuing holders being substantially
the same as prior to the transaction, or (B) the
members constituting the Board of Directors of the
Company prior to such merger, consolidation,
recapitalization or reorganization constitute fifty
percent (50%) or more of the members of the Board of
Directors of the Company after the first vote to
elect members of the Board of Directors after such
merger, consolidation, recapitalization or
reorganization; or
iii. the stockholders of the Company approve a plan of
complete liquidation, dissolution or disposition of
all or substantially all of the assets or business
of the Company; or
iv. (A) the Company sells or otherwise transfers the
business unit or division for which Employee has
primary responsibility to any person, other than
Statoil, the Company or an entity controlled by the
Company or Statoil; and (B) the Company, Statoil or
an entity controlled by the Company or Statoil does
not offer Employee a position (x) substantially
similar, as to responsibilities and duties, to his
or her position with the Company as of the time of
such sale or transfer; and (y) where the Employee
will be entitled to the Base Compensation and all
other benefits provided to the Employee under this
Agreement.
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<PAGE> 10
b. Termination. If within two (2) years following a Change in
Control, Employee (i) is terminated Without Cause ("Change in
Control Termination"), or (ii) terminates his employment for
Good Reason after the occurrence of an event listed in
Section 4.2(e), (a "Change in Control Constructive
Termination"), Employee shall receive from the Company the
severance compensation package detailed in Exhibit A to this
Agreement in lieu of any compensation set forth in Section
4.2.
c. Cap on Parachute. Notwithstanding anything in this Agreement
to the contrary, if any amounts due to the Employee under
this Agreement and any other plan or program of the Company
constitute a "parachute payment," as such term is defined in
Code Section 280G(b)(2), and the amount of the parachute
payment, reduced by all federal, state and local taxes
applicable thereto, including the excise tax imposed pursuant
to Code Section 4999, is less than the amount the Employee
would receive if he were paid three times his "base amount,"
as defined in Code Section 280G(b)(3), less one dollar,
reduced by all federal, state and local taxes applicable
thereto, then the aggregate of the amounts constituting the
parachute payment shall be reduced to an amount that will
equal three times his base amount less one dollar. The
determinations to be made with respect to this Section shall
be made by an accounting firm jointly selected by the
Committee and the Employee and paid by the Company, and which
may be the Company's independent auditors.
4.4 Payment Through Termination. Upon termination of this Agreement for
any reason provided above, Employee shall be entitled to receive his
Base Salary earned and all benefits and reimbursements (including
payments for accrued vacation and sick leave) due through the
effective date of termination. In addition, upon termination of this
Agreement for any reason other than For Cause or by the Employee
without Good Reason, Employee shall be entitled to receive one-twelfth
(1/12th) of the Employee's Average Bonus for each complete month
served by the Employee during the year of the Employee's termination
through the effective date of termination. Additional compensation
subsequent to termination, if any, will be due and payable to Employee
only to the extent and in the manner expressly provided above. All
other rights and obligations of the Company and Employee under this
Agreement shall cease as of the effective date of termination, except
that the Company's obligations under Articles 4 and 6 herein and
Employee's obligations under Articles 3 and 5, and Section 7.1 herein
shall survive such termination in accordance with their terms.
4.5 Payment in Lieu of Employee Benefits.
a. If this Agreement is terminated by the Company Without Cause,
due to a Total Disability or as part of a Change in Control
Termination or if this Agreement is terminated by the
Employee with Good Reason, as part of a Change in Control
Constructive Termination or pursuant to Section 4.2(b)
hereof, Employee shall receive as severance compensation from
the Company payment of the Benefits Equivalent (as defined
below).
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<PAGE> 11
b. The Benefits Equivalent shall be paid in equal pro-rata
installments over the same time period that the Employee is
entitled to receive payment of his or her Base Compensation
as set forth elsewhere in this Article 4.
c. Employee's receipt of the Benefits Equivalent shall be in
lieu of any future employee benefits or perquisites that
might be made available to the Employee by the Company. By
executing this Agreement, Employee hereby waives his or her
rights to any such employee benefits or perquisites, other
than payment to the Employee of the Benefits Equivalent, as
of the effective date of the termination of this Agreement.
d. As used herein, "Benefits Equivalent" shall mean the lesser
of (i) ten percent (10%) of Employee's Base Compensation or
(ii) $20,000 (multiplied by a fraction whose denominator is
the Consumer Price Index as of the date of this Agreement,
and whose numerator is the Consumer Price Index as of the
effective date of the termination of this Agreement). In
either case, the Board of Directors may determine, in its
sole discretion from time to time, to increase the "Benefits
Equivalent" by an amount equal to the increase in value, on
an after tax basis, of any significant additional employee
benefit available to the Employee as of the effective date of
termination of this Agreement, but not available to the
Employee as of the date hereof. (e.g., a Supplemental
Employee Retirement Plan).
ARTICLE 5
PROPRIETARY INFORMATION
5.1 Return of Company Property. All records, designs, patents, business
plans, financial statements, manuals, memoranda, lists and other
property delivered to or compiled by Employee by or on behalf of the
Company, or their representatives, vendors or customers which pertain
to the business of the Company shall be and remain the property of the
Company, as the case may be, and be subject at all times to their
discretion and control. Likewise, all correspondence, reports,
records, charts, advertising materials and other similar data
pertaining to the business, activities or future plans of the Company
which is collected by Employee shall be delivered promptly to the
Company without request by it upon termination of Employee's
employment.
5.2 Inventions. Employee shall disclose promptly to the Company any and
all significant conceptions and ideas for inventions, improvements and
valuable discoveries, whether patentable or not, which are conceived
or made by Employee, solely or jointly with another, during the period
of employment or within one (1) year thereafter, and which are
directly related to the business or activities of the Company and
which Employee conceives as a result of his employment by the Company.
Employee hereby assigns and agrees to assign all his interests therein
to the Company or its nominee. Whenever requested to do so by the
Company, Employee shall execute any and all applications, assignments
or other instruments
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<PAGE> 12
that the Company shall deem necessary to apply for and obtain patents
in the United States or any foreign country or to otherwise protect
the Company's interest therein.
5.3 Trade Secrets. Employee agrees that he will not, during or after the
term of this Agreement with the Company, disclose the specific terms
of the Company's relationships or agreements with their respective
significant vendors or customers or any other significant and material
trade secret of the Company, whether in existence or proposed, to any
person, firm, partnership, corporation or business for any reason or
purpose whatsoever.
ARTICLE 6
INDEMNIFICATION & INSURANCE
6.1 Indemnification. In addition to any indemnification rights the
Executive may have by statute, by-law or otherwise, the Company to the
fullest extent permitted by, and in accordance with and subject to the
requirements of, the General Corporation Law of the Commonwealth of
Virginia (i) shall indemnify the Executive and hold him harmless for
all losses, costs, expenses or liabilities (whether or not arising
during the Executive's employment hereunder), based upon or relating
to acts, decisions or omissions made by him in good faith while
performing services for the Company, and (ii) shall advance to the
Executive and pay all expenses, including, but not limited to,
reasonable attorney's fees and court fees, actually and necessarily
incurred by the Executive in connection with the investigation or
defense of, or being a witness in, any action, suit or proceeding
arising therefrom and in connection with any appeal thereof.
6.2 Indemnity Insurance. The Company shall make coverage available to the
Executive at the Company's expense, under any insurance against
directors' and officers' liabilities otherwise made available to other
directors and officers of the Company.
6.3 Term of Indemnity and Insurance. The indemnification provision in
Section 6.1 hereof and the Executive's coverage under any insurance
provided under Section 6.2 hereof shall survive the termination of
employment hereunder; provided, however, that the obligation to
provide insurance coverage under Section 6.2 shall terminate on the
second anniversary of the termination of employment hereunder.
6.4 Life Insurance. The Executive agrees that the Company, in its
discretion, may apply for and procure in its own name and for its own
benefit, life insurance insuring the life of the Executive in any
amount or amounts considered advisable, and that the Executive shall
have no right, title or interest therein. Further, the Executive
agrees to submit to any medical or other examination and to execute
and deliver any application or other instrument in writing reasonably
necessary to effectuate such insurance.
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<PAGE> 13
ARTICLE 7
GENERAL PROVISIONS
7.1 No Prior Agreements. Employee hereby represents and warrants to the
Company that the execution of this Agreement by Employee and his
employment by the Company and the performance of his duties hereunder
will not violate or be a breach of any agreement with a former
employer, client or any other person or entity. Further, Employee
agrees to indemnify the Company for any claim, including, but not
limited to, attorneys' fees and expenses of investigation or
litigation, by any such third party that such third party may now have
or may hereafter come to have against the Company based upon or
arising out of any non-competition agreement, invention or secrecy
agreement between Employee and such third party which was in existence
as of the date of this Agreement.
7.2 Assignment; Binding Effect. Employee understands that he has been
selected for employment by the Company on the basis of his personal
qualifications, experience and skills. Employee agrees, therefore, he
cannot assign all or any portion of his performance under this
Agreement. This Agreement may not be assigned or transferred by the
Company without the prior written consent of Employee; provided,
however that the Company may assign this Agreement to a majority-owned
subsidiary or affiliate of the Company without Employee's consent if
the Company agrees in writing to guarantee any payments to be made to
the Employee under this Agreement for the remainder of the Term.
Subject to the preceding two (2) sentences, this Agreement shall be
binding upon, inure to the benefit of and be enforceable by the
parties hereto and their respective heirs, legal representatives,
successors and assigns.
7.3 Complete Agreement. This Agreement is not a promise of future
employment. Employee has no oral representations, understandings or
agreements with the Company or any of its officers, directors or
representatives covering the same subject matter of this Agreement.
This written Agreement is the final, complete and exclusive statement
and expression of the agreement between the Company and Employee and
of all the terms of this Agreement. This Agreement is intended to
amend and restate and replace any prior employment agreement or
arrangement between the Employee and the Company and this Agreement
cannot be varied, contradicted or supplemented by evidence of any
prior or contemporaneous oral or written agreements. This written
Agreement may not be later modified except by a further writing signed
by a duly authorized officer of the Company and Employee, and no term
of this Agreement may be waived except by writing signed by the party
waiving the benefit of such term.
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<PAGE> 14
7.4 Notice. Whenever any notice is required hereunder, it shall be given
in writing addressed as follows:
To the Company:
Statoil Energy, Inc.
2800 Eisenhower Avenue
Alexandria, Virginia 22314
Attention: David A. Dresner
To Employee:
Statoil Energy, Inc.
2800 Eisenhower Avenue
Alexandria, Virginia 22314
Attention: Clifton A. Brown
Notice shall be deemed given and effective three (3) days after the
deposit in the U.S. mail of a writing addressed as above and sent
first class mail, certified, return receipt requested, or when
actually received. Either party may change the address for notice by
notifying the other party of such change in accordance with this
Section 7.4.
7.5 Severability; Headings. If any portion of this Agreement is held
invalid or inoperative, the other portions of this Agreement shall be
deemed valid and operative and, so far as is reasonable and possible,
effect shall be given to the intent manifested by the portion held
invalid or inoperative. The Section headings herein are for reference
purposes only and are not intended in any way to describe, interpret,
define or limit the extent or intent of the Agreement or of any part
hereof.
7.6 Arbitration. Any unresolved dispute or controversy arising under or in
connection with this Agreement shall be settled exclusively by
arbitration, conducted in Washington, D.C. in accordance with the
rules of the American Arbitration Association then in effect. The
arbitrators shall not have the authority to add to, detract from, or
modify any provision hereof nor to award punitive damages to any
injured party. The arbitrators shall have the authority to order
back-pay, severance compensation, vesting of options (or cash
compensation in lieu of vesting of options), reimbursement of costs,
including those incurred to enforce this Agreement, and interest
thereon in the event the arbitrators determine that Employee was
terminated without disability or not For Cause, as defined in Sections
4.2(b) and 4.2(c), respectively, or that the Company has otherwise
materially breached this Agreement. A decision by a majority of the
arbitration panel shall be final and binding. Judgment may be entered
on the arbitrators' award in any court having jurisdiction. The direct
expense of any arbitration proceeding shall be borne by the party that
does not prevail in such arbitration.
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<PAGE> 15
7.7 Governing Law. This Agreement shall in all respects be construed
according to the laws of the Commonwealth of Virginia.
7.8 Counterparts. This Agreement may be executed in counterparts, each of
which shall be deemed an original, and all of which together shall
constitute one document.
7.9 Waiver. Except as otherwise specifically set forth herein, the failure
of either party to insist in any one or more instances upon
performance of any terms or conditions of this Agreement shall not be
construed as a waiver of future performance of any such term, covenant
or condition, and the obligations of either party with respect to such
term, covenant or condition shall continue in full force and effect.
7.10 No Duty to Mitigate. Employee has no obligation to seek or find other
employment or to otherwise mitigate his or her loss of income in order
to receive any amounts payable by the Company pursuant to this
Agreement upon Employee's termination. The Company's payment
obligations pursuant to this Agreement shall not be reduced because of
any compensation payable to Employee from other employment after
Employee's termination, or any claims that the Company may have
against the Employee at the time of or after Employee's termination.
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<PAGE> 16
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
day and year first above written.
Company: STATOIL ENERGY, INC.
a Virginia corporation,
By: /s/ DAVID A. DRESNER
------------------------------
Name: David A. Dresner
Title: President and Chief
Executive Officer
Employee: /s/ CLIFTON A. BROWN
----------------------------------
Clifton A. Brown
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<PAGE> 17
EXHIBIT A
Severance Compensation Package
In the event of a Change in Control Termination or Change in
Control Constructive Termination pursuant to Section 4.3 , the following shall
occur:
(i) Employee shall receive an amount equal to two and
one-half (2.5) times the sum of (i) such Employee's
Base Salary, at the time of termination and (ii) the
Employee's Average Bonus. Such amount to be paid in
equal monthly installments over the remainder of the
Term of this Agreement;
(ii) Employee shall receive the Benefits Equivalent as
set forth in Section 4.5 hereof; and
(iii) all non-vested Stock Options available to Employee
through the remainder of the Term of employment
shall automatically vest and such Stock Options
shall be exercisable by such Employee until the
first anniversary of Employee's termination.
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<PAGE> 1
EXHIBIT 10.5.2
EMPLOYMENT AGREEMENT
This Employment Agreement (the "Agreement"), by and between Statoil
Energy, Inc., a Virginia corporation (the "Company"), and Stevens V. Gillespie
("Employee"), is hereby entered into as of February 18, 1999 and is effective
as of February 1, 1999. This Agreement hereby supersedes any other employment
agreements or understandings; written or oral, between the Company and
Employee.
RECITALS
WHEREAS Employee is employed hereunder by the Company in a
confidential relationship wherein Employee, in the course of his employment
with the Company, has and will continue to become familiar with and aware of
information as to the Company's customers, specific manner of doing business,
including the processes, techniques and trade secrets utilized by the Company,
and future plans with respect thereto, all of which has been and will be
established and maintained at great expense to the Company; this information is
a trade secret and constitutes the valuable good will of the Company; and
WHEREAS the Company wishes to employ Employee and Employee wishes to
be employed by the Company, each in accordance with the terms and conditions of
this Agreement.
NOW, THEREFORE, in consideration of the mutual promises, terms,
covenants and conditions set forth herein and the performance of each, it is
hereby agreed as follows:
ARTICLE 1
EMPLOYMENT & DUTIES
1.1 Position & Duties. Employee shall hold the office of Senior Vice
President and Employee shall have the powers and authority normally
associated with such position. Employee shall assume such other
responsibilities, consistent with his position as Senior Vice
President, as may be delegated to him from time to time by the
President and Chief Executive Officer of the Company. Such services
shall be provided at the Company's principal executive office located
at 2800 Eisenhower Avenue, Alexandria, Virginia, or such other
location of the Company's principal executive office as the Company
shall reasonably designate in accordance with the provisions of this
Agreement. Employee hereby accepts this employment upon the terms and
conditions herein contained and agrees to devote his time, skill,
labor, attention and efforts to promote and further the business of
the Company.
<PAGE> 2
1.2 Company Policies. Employee shall faithfully adhere to, execute and
fulfill all policies established by the Company.
1.3 Other Activities. Employee shall not, during the Term of his
employment hereunder, be engaged in any other business activity
pursued for gain, profit or other pecuniary advantage if such activity
interferes with Employee's duties and responsibilities hereunder.
However, the foregoing limitations shall not be construed as
prohibiting Employee from (i) making personal investments in such form
or manner as will neither require his services in the operation or
affairs of the companies or enterprises in which such investments are
made nor violate the terms of Section 1.4 hereof; (ii) serving on the
board of directors of a reasonable number of other corporations, trade
associations or charitable organizations; or (iii) engaging in any
charitable activities or community affairs, so long as, in each case,
such other activities do not interfere with Employee's performance of
his obligations hereunder.
1.4 Investments. The foregoing covenant shall not be deemed to prohibit
Employee from acquiring as an investment not more than the lesser of
either (i) five percent (5%) of the outstanding capital stock of a
company in direct competition with the Company, or (ii) one million
dollars ($1,000,000) worth of the capital stock of a company in direct
competition with the Company; provided, however, that, notwithstanding
the foregoing, in the event that the Company shall adopt any policy
governing permissible investments by its employees and such policy is
applicable to Employee, any investment made by Employee in compliance
with such policy shall be deemed permissible under this Section 1.4
and any investment made by Employee that is not in compliance with
such policy shall be deemed to constitute a breach of this Agreement.
ARTICLE 2
COMPENSATION
2.1 Base Salary. Effective as of February 1, 1999, the base salary ("Base
Salary") payable to Employee shall be no less than $190,000 per year,
payable on a regular basis in accordance with the Company's standard
payroll procedures, but not less than monthly. On at least an annual
basis, the Board will review Employee's performance and may make
increases to such Base Salary if, in the Board's discretion, any such
increase is warranted. As used herein, "Base Compensation" shall mean
the Employee's Base Salary plus the Employee's Average Bonus (as
defined in Section 2.2 hereof).
2.2 Incentive Bonus Plan. The Company shall pay to the Employee such
bonuses based upon the financial performance of the Company and the
individual performance of the Employee in accordance with any bonus
plan established for senior management of the Company from time to
time by the Board or its designee or as otherwise granted in the
discretion of the Board or its designee; provided, however that any
future bonus plan established for senior management of the Company
shall be no less advantageous to the Employee than the bonus
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<PAGE> 3
plan of the Company in effect with respect to the Employee as of the
date hereof. As used herein, "Average Bonus" shall mean the average of
all bonuses paid to the Employee during the previous three years (or,
if applicable, such shorter time that Employee has been employed by
the Company); provided, however that if in one or more of such prior
years to be averaged the Employee was paid a bonus in excess of 50% of
Employee's Base Salary for any such year, then, in calculating the
average of bonuses paid to the Employee, a number equal to 50% of
Employee's Base Salary for any such year shall be substituted for the
actual amount of Employee's bonus in calculating the applicable
Average Bonus.
2.3 Executive Perquisites, Benefits and Other Compensation. Employee shall
be entitled to receive additional benefits and compensation from the
Company in such form and to such extent as specified below:
a. The Employee shall be entitled to receive any employee
benefits, including, without limitation, any retirement
benefit plan, disability, group life, sickness, accident and
health insurance programs and perquisites provided by the
Company to executives such as are the greater of (i) the
employee benefits and perquisites then provided by the
Company to executives with comparable authority or duties
(and in any event not less than those provided to executives
with junior authority or duties), or (ii) such employee
benefits and perquisites as in effect on the date hereof.
b. The Company shall reimburse the Employee for all reasonable
expenses incurred by the Executive in the performance of his
duties under this Agreement upon presentation of
documentation therefor in form and substance satisfactory to
the Company.
c. The Company may provide Employee with other executive
perquisites as may be available to or deemed appropriate for
Employee by the Board.
2.4 Stock Options. The Employee shall receive stock options ("Stock
Options") as shall be granted at the discretion of the Board of
Directors of the Company consistent with historical practices.
2.5 Vacation and Leave. The Employee shall be entitled to four (4) weeks
vacation and to leaves of absence for illness or temporary disability
in accordance with the policies of the Company in effect from time to
time. Any leave on account of illness or temporary disability which is
short of "Total Disability" (as defined below) shall not constitute a
breach by the Employee of his agreements hereunder and in no event
shall the Company be entitled to terminate the employment of the
Employee hereunder for cause due to such leave. "Total Disability"
shall mean the inability of the Employee due to physical or mental
illness or injury to perform his duties hereunder for any period of
more than ninety (90) consecutive days. Upon the Total Disability of
the Employee, the Employee shall be entitled to receive, until
Employee returns to work or, if Employee's employment terminates
pursuant to Section 4.2(b) hereof, the expiration of the Term of this
Agreement, (i) periodic monthly payments
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<PAGE> 4
from the Company equal to sixty-six and two-thirds percent (66 2/3%) of
the Base Compensation in effect at the commencement of such Total
Disability, and (ii) any health and other medical related benefits
provided by the Company to the same extent such health and medical
benefits were provided by the Company prior to Employee's Total
Disability; provided, however, that the periodic monthly payments set
forth in clause (i) hereof shall be reduced by the amount of any
disability insurance payment made to the Employee pursuant to any
disability insurance program funded by the Company.
ARTICLE 3
NON-COMPETITION/NON-SOLICITATION
3.1 Non-Competition and Non-Solicitation. During the period of employment
by or with the Company, and for a period following the termination of
his employment under this Agreement equal to the longer of (i) one (1)
year or (ii) the period during which Employee is entitled to receive
and is receiving any payment pursuant to Section 4.2(d), 4.2(e) or 4.3
hereof, Employee will not, for any reason whatsoever, directly or
indirectly, for himself or on behalf of or in conjunction with any
other person, persons, company, partnership, corporation or business
of whatever nature:
a. engage, as an officer, director, owner, partner, joint
venturer, employee, independent contractor, consultant or
advisor in any business selling any products or services in
direct competition with the Company, within one hundred (100)
miles of the principle executive office of the Company or
where any of the Company's affiliates or subsidiaries conduct
business, including any territory serviced by the Company or
any of such affiliates or subsidiaries (the "Territory");
b. call upon any person who is, at that time, within the
Territory, an employee of the Company (including the
affiliates and subsidiaries thereof) in a managerial capacity
for the purpose or with the intent of enticing such employee
away from or out of the employ of the Company (including the
affiliates and subsidiaries thereof), provided that Employee
shall be permitted to call upon and hire any member of his or
her immediate family;
c. call upon any person or entity which is, at that time, or
which has been, within one (1) year prior to that time, a
customer of the Company (including the affiliates and
subsidiaries thereof) within the Territory for the purpose of
soliciting or selling products or services in direct
competition with the Company within the Territory;
d. call upon any prospective acquisition candidate, on
Employee's own behalf or on behalf of any competitor, which
candidate was either called upon by the Company (including
the affiliates and subsidiaries thereof) or for which the
Company made an acquisition analysis, for the purpose of
acquiring such entity, in either case, during the last twelve
(12) months of the Employee's employment with the Company.
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<PAGE> 5
3.2 Remedies. Because of the difficulty of measuring economic losses to
the Company as a result of a breach of the foregoing covenant, and
because of the immediate and irreparable damage that could be caused
to the Company for which it would have no other adequate remedy,
Employee agrees that the foregoing covenant may be enforced by the
Company by seeking injunctions or restraining orders in the event of a
breach of the foregoing covenant by the Employee.
3.3 Reasonableness and Interpretation. It is agreed by the parties that
the foregoing covenants in this Article 3 impose a reasonable
restraint on Employee in light of the activities and business of the
Company and its affiliates on the date of the execution of this
Agreement and the current plans of the Company and its affiliates; but
it is also the intent of the Company and Employee that such covenants
be construed and enforced in accordance with the changing activities,
business and locations of the Company and its affiliates throughout
the term of this Article III.
3.4 Subsequent Conflicts. It is further agreed by the parties hereto that,
in the event that Employee shall cease to be employed hereunder, and
shall enter into a business or pursue other activities not in
competition with the Company or its affiliates, or similar activities
or business in locations the operation of which, under such
circumstances, does not violate Section 3.1 hereof, and in any event
such new business, activities or location is not in violation of
Section 3.1 hereof or of Employee's obligations under this Article 3,
Employee shall not be chargeable with a violation of this Article 3 if
the Company or its affiliates shall thereafter enter the same, similar
or a competitive (i) business, (ii) course of activities or (iii)
location, as applicable.
3.5 Reformation. The covenants in this Article 3 are severable and
separate, and the unenforceability of any specific covenant shall not
affect the provisions of any other covenant. Moreover, in the event
any court of competent jurisdiction shall determine that the scope,
time or territorial restrictions set forth are unreasonable, then it
is the intention of the parties that such restrictions be enforced to
the fullest extent which the court deems reasonable, and the Agreement
shall thereby be reformed.
3.6 No Defense. All of the covenants in this Article 3 shall be construed
as an agreement independent of any other provision in this Agreement,
and the existence of any claim or cause of action of Employee against
the Company, whether predicated on this Agreement or otherwise, shall
not constitute a defense to the enforcement by the Company of such
covenants; provided, however, that upon the failure of the Company to
make any payments required under this Agreement, the Employee may,
upon thirty (30) days prior written notice to the Company, waive his
right to receive any additional compensation pursuant to this
Agreement and engage in any activity prohibited by the covenants of
this Article 3. It is specifically agreed that the period stated in
Section 3.1, during which the agreements and covenants of Employee
made in this Article 3 shall be effective, shall be computed by
excluding from such computation any time during which Employee is in
violation of any provision of this Article 3.
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<PAGE> 6
3.7 Compensation Period. Notwithstanding any of the foregoing, if any
applicable law shall reduce the time period during which Employee
shall be prohibited from engaging in any competitive activity
described in Section 3.1 hereof, the period of time for which Employee
shall be prohibited pursuant to Section 3.1 hereof shall be the
maximum time permitted by law. However, in the event that the time
period specified by Section 3.1 shall be so reduced, then,
notwithstanding the provisions of Sections 4.2(d), 4.2(e) or 4.3
hereof, Employee shall be entitled to receive from the Company his
Base Compensation at the rate then in effect solely for the longer of
(i) the time period during which the provisions of Section 3.1 shall
be enforceable under the provisions of such applicable law, or (ii)
the time period during which Employee is not engaging in any
competitive activity, but in no event longer than the terms provided
in Sections 4.2 and 4.3.
ARTICLE 4
TERM & TERMINATION
4.1 Term. The term of this Agreement (the "Term") shall begin on the
effective date hereof and continue for 24 months. The Term shall be
automatically extended by one day for every day after the effective
date hereof that the Employee is employed by the Company. The Term
shall, at all times, be 24 months from the current date; provided,
however, that if the Board of Directors of the Company shall at any
time determine not to extend the Term, as of the date sixty (60) days
following notification of such decision to the Employee, the Term
shall not extend pursuant to this Section 4.1 and the 24 month Term
described herein shall begin to expire. If this Agreement and
Employee's employment hereunder is terminated in accordance with
Sections 4.2 or 4.3 of this Agreement, from that point forward, this
Agreement shall not be extended as set forth hereunder.
4.2 Termination Without Change in Control of the Company. This Agreement
and Employee's employment may be terminated prior to the expiration of
the Term in any one of the followings ways:
a. Death. The death of Employee shall immediately terminate the
Agreement with no further payments under this Agreement
(except as set forth in Section 4.4 hereof) due to Employee's
estate.
b. Disability. If, as a result of incapacity due to physical or
mental illness or injury, Employee shall have been absent
from his full-time duties hereunder for ninety (90)
consecutive days, then thirty (30) days after written notice
to the Employee (which notice may occur before or after the
end of such ninety (90) day period, but which shall not be
effective earlier than the last day of such ninety (90) day
period), the Company may terminate this Agreement and
Employee's employment hereunder provided Employee is unable
to resume his full-time duties at the conclusion of such
notice period. Also, Employee may terminate this Agreement
and his employment hereunder if his health should become
impaired to an extent that makes the continued
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<PAGE> 7
performance of his duties hereunder hazardous to his physical
or mental health or his life, provided that Employee shall
have furnished the Company with a written statement from a
qualified doctor to such effect and provided, further, that,
at the Company's request made within thirty (30) days of the
date of such written statement, Employee shall submit to an
examination by a doctor selected by the Company who is
reasonably acceptable to Employee or Employee's doctor and
such doctor shall have concurred in the conclusion of
Employee's doctor. Subject to Section 3.7 hereof, in the
event this Agreement is terminated as a result of Employee's
disability, until the expiration of the Term of this
Agreement, Employee shall receive from the Company periodic
monthly payments equal to sixty-six and two-thirds percent
(662/3%) of the Base Compensation in effect at the
commencement of such disability less the amount of any
insurance payment made to the Employee pursuant to any
disability insurance program funded by the Company.
c. For Cause. The Board of Directors of the Company may
terminate the Agreement ten (10) days after written notice to
Employee for good cause ("For Cause"), which shall mean: (i)
the willful failure or refusal of Employee to perform any
material obligation under this Agreement or to carry out the
reasonable directives of the Board or the repeated willful or
materially negligent failure to perform the Employee's duties
as determined by the Board in good faith, and the failure of
Employee to cure the same within a period of thirty (30) days
following notice thereof; (ii) Employee's failure to devote
full business time, skill, labor, attention and efforts to
promote and further the business of the Company; (iii)
Employee's conviction of a felony or other crime involving
moral turpitude, or willful misconduct or performance of an
illegal activity in connection with employment; or (iv) after
a request by the Company that the Employee obtain counseling
for any alcohol or illegal drug abuse by Employee, the
Employees' failure within a reasonable time to commence or
complete such counseling, or the Employee's continued alcohol
or drug abuse after the completion of such counseling;
provided, however, that an Employee shall only be considered
to abuse alcohol if the Employee fails to timely and
adequately fulfill his duties under this Agreement due to the
consumption of alcohol. In the event of a termination For
Cause, Employee shall have no right to any further payment
under this Agreement (except as set forth in Section 4.4
hereof).
d. Without Cause. At any time after the commencement of
employment, the Company may, without cause ("Without Cause"),
terminate this Agreement and Employee's employment, effective
thirty (30) days after written notice is provided to the
Employee. Should Employee be terminated by the Company
Without Cause, Employee shall receive from the Company the
Base Compensation at the rate then in effect for the longer
of (i) one year, or (ii) whatever time period is remaining
under the Term, in each case, payable in equal monthly
payments for the remainder of such time.
-7-
<PAGE> 8
e. Termination by Employee for Good Reason. The Employee may
terminate his employment hereunder for "Good Reason" at any
time within sixty (60) days of any event or occurrence (or
earlier written notice to the Employee of an event or
occurrence) giving rise to Employee's right to terminate
under this Subsection 4.2(e). If Employee does not terminate
his or her employment within sixty (60) days of such event or
occurrence (or, where applicable, written notification by the
Company of such an event or occurrence), Employee shall be
deemed to have waived his right to terminate his or her
employment under this Subsection 4.2(e) with respect to such
event or occurrence. As used herein, "Good Reason" shall mean
the continuance of any of the following after ten (10) days'
prior written notice by Employee to the Company, specifying
the basis for such Employee's having Good Reason to terminate
this Agreement:
i. a material adverse change in Employee's compensation
package;
ii. the assignment to Employee of any duties materially
and adversely inconsistent with a professional or
management position with the Company;
iii. any other material breach of this Agreement by the
Company, including the failure to pay Employee on a
timely basis the amounts to which he is entitled
under this Agreement;
iv. the Company requires the Employee to change his
principal work site to a location fifty (50) or more
miles away from Employee's current principal work
site; or
v. the Board of Directors determines not to extend this
Agreement by providing the written notice referenced
in Section 4.1 hereof.
If Employee resigns or otherwise terminates his employment
for Good Reason, Employee shall receive from the Company the
Base Compensation at the rate then in effect for the longer
of (i) one year, or (ii) whatever time period is remaining
under the Term of this Agreement, in each case, payable in
equal monthly payments for the remainder of such Term. If
Employee resigns or otherwise terminates his employment for
any reason other than Good Reason, Employee shall have no
right to any further payment under this Agreement (except as
set forth in Section 4.4 hereof).
-8-
<PAGE> 9
4.3 Termination With Change in Control of the Company.
a. Definition. For the purpose of the Agreement, "Change in
Control" shall be deemed to have occurred if:
i. any person, other than Den norske stats oljeselskap,
a.s. ("Statoil"), an affiliate of the Company or
Statoil, or an employee benefit plan of the Company,
or an affiliate of the Company, acquires directly or
indirectly the Beneficial Ownership (as defined in
Section 13(d) of the Securities Exchange Act of
1934, as amended) of any voting security of the
Company and immediately after such acquisition such
Person is, directly or indirectly, the Beneficial
Owner of voting securities representing more than
fifty percent (50%) or more of the total voting
power of all of the then-outstanding voting
securities of the Company;
ii. the stockholders of the Company approve a merger,
consolidation or reorganization of the Company
unless (A) such transaction would result in more
than fifty percent (50%) of the total voting power
represented by the voting securities of the
surviving entity outstanding immediately after such
transaction being Beneficially Owned by the holders
of outstanding voting securities of the Company
immediately prior to the transaction, with the
voting power of each such continuing holder relative
to other such continuing holders being substantially
the same as prior to the transaction, or (B) the
members constituting the Board of Directors of the
Company prior to such merger, consolidation,
recapitalization or reorganization constitute fifty
percent (50%) or more of the members of the Board of
Directors of the Company after the first vote to
elect members of the Board of Directors after such
merger, consolidation, recapitalization or
reorganization; or
iii. the stockholders of the Company approve a plan of
complete liquidation, dissolution or disposition of
all or substantially all of the assets or business
of the Company; or
iv. (A) the Company sells or otherwise transfers the
business unit or division for which Employee has
primary responsibility to any person, other than
Statoil, the Company or an entity controlled by the
Company or Statoil; and (B) the Company, Statoil or
an entity controlled by the Company or Statoil does
not offer Employee a position (x) substantially
similar, as to responsibilities and duties, to his
or her position with the Company as of the time of
such sale or transfer; and (y) where the Employee
will be entitled to the Base Compensation and all
other benefits provided to the Employee under this
Agreement.
-9-
<PAGE> 10
b. Termination. If within two (2) years following a Change in
Control, Employee (i) is terminated Without Cause ("Change in
Control Termination"), or (ii) terminates his employment for
Good Reason after the occurrence of an event listed in
Section 4.2(e), (a "Change in Control Constructive
Termination"), Employee shall receive from the Company the
severance compensation package detailed in Exhibit A to this
Agreement in lieu of any compensation set forth in Section
4.2.
c. Cap on Parachute. Notwithstanding anything in this Agreement
to the contrary, if any amounts due to the Employee under
this Agreement and any other plan or program of the Company
constitute a "parachute payment," as such term is defined in
Code Section 280G(b)(2), and the amount of the parachute
payment, reduced by all federal, state and local taxes
applicable thereto, including the excise tax imposed pursuant
to Code Section 4999, is less than the amount the Employee
would receive if he were paid three times his "base amount,"
as defined in Code Section 280G(b)(3), less one dollar,
reduced by all federal, state and local taxes applicable
thereto, then the aggregate of the amounts constituting the
parachute payment shall be reduced to an amount that will
equal three times his base amount less one dollar. The
determinations to be made with respect to this Section shall
be made by an accounting firm jointly selected by the
Committee and the Employee and paid by the Company, and which
may be the Company's independent auditors.
4.4 Payment Through Termination. Upon termination of this Agreement for
any reason provided above, Employee shall be entitled to receive his
Base Salary earned and all benefits and reimbursements (including
payments for accrued vacation and sick leave) due through the
effective date of termination. In addition, upon termination of this
Agreement for any reason other than For Cause or by the Employee
without Good Reason, Employee shall be entitled to receive one-twelfth
(1/12th) of Employee's Average Bonus for each complete month served by
the Employee during the year of the Employee's termination through the
effective date of termination. Additional compensation subsequent to
termination, if any, will be due and payable to Employee only to the
extent and in the manner expressly provided above. All other rights
and obligations of the Company and Employee under this Agreement shall
cease as of the effective date of termination, except that the
Company's obligations under Articles 4 and 6 herein and Employee's
obligations under Articles 3 and 5, and Section 7.1 herein shall
survive such termination in accordance with their terms.
4.5 Payment in Lieu of Employee Benefits.
a. If this Agreement is terminated by the Company Without Cause,
due to a Total Disability or as part of a Change in Control
Termination or if this Agreement is terminated by the
Employee with Good Reason, as part of a Change in Control
Constructive Termination or pursuant to Section 4.2(b)
hereof, Employee shall receive as severance compensation from
the Company payment of the Benefits Equivalent (as defined
below).
-10-
<PAGE> 11
b. The Benefits Equivalent shall be paid in equal pro-rata
installments over the same time period that the Employee is
entitled to receive payment of his or her Base Compensation
as set forth elsewhere in this Article 4.
c. Employee's receipt of the Benefits Equivalent shall be in
lieu of any future employee benefits or perquisites that
might be made available to the Employee by the Company. By
executing this Agreement, Employee hereby waives his or her
rights to any such employee benefits or perquisites, other
than payment to the Employee of the Benefits Equivalent, as
of the effective date of the termination of this Agreement.
d. As used herein, "Benefits Equivalent" shall mean the lesser
of (i) ten percent (10%) of Employee's Base Compensation or
(ii) $20,000 (multiplied by a fraction whose denominator is
the Consumer Price Index as of the date of this Agreement,
and whose numerator is the Consumer Price Index as of the
effective date of the termination of this Agreement). In
either case, the Board of Directors may determine, in its
sole discretion from time to time, to increase the "Benefits
Equivalent" by an amount equal to the increase in value, on
an after tax basis, of any significant additional employee
benefit available to the Employee as of the effective date of
termination of this Agreement, but not available to the
Employee as of the date hereof. (e.g., a Supplemental
Employee Retirement Plan).
ARTICLE 5
PROPRIETARY INFORMATION
5.1 Return of Company Property. All records, designs, patents, business
plans, financial statements, manuals, memoranda, lists and other
property delivered to or compiled by Employee by or on behalf of the
Company, or their representatives, vendors or customers which pertain
to the business of the Company shall be and remain the property of the
Company, as the case may be, and be subject at all times to their
discretion and control. Likewise, all correspondence, reports,
records, charts, advertising materials and other similar data
pertaining to the business, activities or future plans of the Company
which is collected by Employee shall be delivered promptly to the
Company without request by it upon termination of Employee's
employment.
5.2 Inventions. Employee shall disclose promptly to the Company any and
all significant conceptions and ideas for inventions, improvements and
valuable discoveries, whether patentable or not, which are conceived
or made by Employee, solely or jointly with another, during the period
of employment or within one (1) year thereafter, and which are
directly related to the business or activities of the Company and
which Employee conceives as a result of his employment by the Company.
Employee hereby assigns and agrees to assign all his interests therein
to the Company or its nominee. Whenever requested to do so by the
Company, Employee shall execute any and all applications, assignments
or other instruments
-11-
<PAGE> 12
that the Company shall deem necessary to apply for and obtain patents
in the United States or any foreign country or to otherwise protect
the Company's interest therein.
5.3 Trade Secrets. Employee agrees that he will not, during or after the
term of this Agreement with the Company, disclose the specific terms
of the Company's relationships or agreements with their respective
significant vendors or customers or any other significant and material
trade secret of the Company, whether in existence or proposed, to any
person, firm, partnership, corporation or business for any reason or
purpose whatsoever.
ARTICLE 6
INDEMNIFICATION & INSURANCE
6.1 Indemnification. In addition to any indemnification rights the
Executive may have by statute, by-law or otherwise, the Company to the
fullest extent permitted by, and in accordance with and subject to the
requirements of, the General Corporation Law of the Commonwealth of
Virginia (i) shall indemnify the Executive and hold him harmless for
all losses, costs, expenses or liabilities (whether or not arising
during the Executive's employment hereunder), based upon or relating
to acts, decisions or omissions made by him in good faith while
performing services for the Company, and (ii) shall advance to the
Executive and pay all expenses, including, but not limited to,
reasonable attorney's fees and court fees, actually and necessarily
incurred by the Executive in connection with the investigation or
defense of, or being a witness in, any action, suit or proceeding
arising therefrom and in connection with any appeal thereof.
6.2 Indemnity Insurance. The Company shall make coverage available to the
Executive at the Company's expense, under any insurance against
directors' and officers' liabilities otherwise made available to other
directors and officers of the Company.
6.3 Term of Indemnity and Insurance. The indemnification provision in
Section 6.1 hereof and the Executive's coverage under any insurance
provided under Section 6.2 hereof shall survive the termination of
employment hereunder; provided, however, that the obligation to
provide insurance coverage under Section 6.2 shall terminate on the
second anniversary of the termination of employment hereunder.
6.4 Life Insurance. The Executive agrees that the Company, in its
discretion, may apply for and procure in its own name and for its own
benefit, life insurance insuring the life of the Executive in any
amount or amounts considered advisable, and that the Executive shall
have no right, title or interest therein. Further, the Executive
agrees to submit to any medical or other examination and to execute
and deliver any application or other instrument in writing reasonably
necessary to effectuate such insurance.
-12-
<PAGE> 13
ARTICLE 7
GENERAL PROVISIONS
7.1 No Prior Agreements. Employee hereby represents and warrants to the
Company that the execution of this Agreement by Employee and his
employment by the Company and the performance of his duties hereunder
will not violate or be a breach of any agreement with a former
employer, client or any other person or entity. Further, Employee
agrees to indemnify the Company for any claim, including, but not
limited to, attorneys' fees and expenses of investigation or
litigation, by any such third party that such third party may now have
or may hereafter come to have against the Company based upon or
arising out of any non-competition agreement, invention or secrecy
agreement between Employee and such third party which was in existence
as of the date of this Agreement.
7.2 Assignment; Binding Effect. Employee understands that he has been
selected for employment by the Company on the basis of his personal
qualifications, experience and skills. Employee agrees, therefore, he
cannot assign all or any portion of his performance under this
Agreement. This Agreement may not be assigned or transferred by the
Company without the prior written consent of Employee; provided,
however that the Company may assign this Agreement to a majority-owned
subsidiary or affiliate of the Company without Employee's consent if
the Company agrees in writing to guarantee any payments to be made to
the Employee under this Agreement for the remainder of the Term.
Subject to the preceding two (2) sentences, this Agreement shall be
binding upon, inure to the benefit of and be enforceable by the
parties hereto and their respective heirs, legal representatives,
successors and assigns.
7.3 Complete Agreement. This Agreement is not a promise of future
employment. Employee has no oral representations, understandings or
agreements with the Company or any of its officers, directors or
representatives covering the same subject matter of this Agreement.
This written Agreement is the final, complete and exclusive statement
and expression of the agreement between the Company and Employee and
of all the terms of this Agreement. This Agreement is intended to
amend and restate and replace any prior employment agreement or
arrangement between the Employee and the Company and this Agreement
cannot be varied, contradicted or supplemented by evidence of any
prior or contemporaneous oral or written agreements. This written
Agreement may not be later modified except by a further writing signed
by a duly authorized officer of the Company and Employee, and no term
of this Agreement may be waived except by writing signed by the party
waiving the benefit of such term.
-13-
<PAGE> 14
7.4 Notice. Whenever any notice is required hereunder, it shall be given
in writing addressed as follows:
To the Company:
Statoil Energy, Inc.
2800 Eisenhower Avenue
Alexandria, Virginia 22314
Attention: David A. Dresner
To Employee:
Statoil Energy, Inc.
2800 Eisenhower Avenue
Alexandria, Virginia 22314
Attention: Stevens V. Gillespie
Notice shall be deemed given and effective three (3) days after the
deposit in the U.S. mail of a writing addressed as above and sent
first class mail, certified, return receipt requested, or when
actually received. Either party may change the address for notice by
notifying the other party of such change in accordance with this
Section 7.4.
7.5 Severability; Headings. If any portion of this Agreement is held
invalid or inoperative, the other portions of this Agreement shall be
deemed valid and operative and, so far as is reasonable and possible,
effect shall be given to the intent manifested by the portion held
invalid or inoperative. The Section headings herein are for reference
purposes only and are not intended in any way to describe, interpret,
define or limit the extent or intent of the Agreement or of any part
hereof.
7.6 Arbitration. Any unresolved dispute or controversy arising under or in
connection with this Agreement shall be settled exclusively by
arbitration, conducted in Washington, D.C. in accordance with the
rules of the American Arbitration Association then in effect. The
arbitrators shall not have the authority to add to, detract from, or
modify any provision hereof nor to award punitive damages to any
injured party. The arbitrators shall have the authority to order
back-pay, severance compensation, vesting of options (or cash
compensation in lieu of vesting of options), reimbursement of costs,
including those incurred to enforce this Agreement, and interest
thereon in the event the arbitrators determine that Employee was
terminated without disability or not For Cause, as defined in Sections
4.2(b) and 4.2(c), respectively, or that the Company has otherwise
materially breached this Agreement. A decision by a majority of the
arbitration panel shall be final and binding. Judgment may be entered
on the arbitrators' award in any court having jurisdiction. The direct
expense of any arbitration proceeding shall be borne by the party that
does not prevail in such arbitration.
-14-
<PAGE> 15
7.7 Governing Law. This Agreement shall in all respects be construed
according to the laws of the Commonwealth of Virginia.
7.8 Counterparts. This Agreement may be executed in counterparts, each of
which shall be deemed an original, and all of which together shall
constitute one document.
7.9 Waiver. Except as otherwise specifically set forth herein, the failure
of either party to insist in any one or more instances upon
performance of any terms or conditions of this Agreement shall not be
construed as a waiver of future performance of any such term, covenant
or condition, and the obligations of either party with respect to such
term, covenant or condition shall continue in full force and effect.
7.10
No Duty to Mitigate. Employee has no obligation to seek or find other
employment or to otherwise mitigate his or her loss of income in order
to receive any amounts payable by the Company pursuant to this
Agreement upon Employee's termination. The Company's payment
obligations pursuant to this Agreement shall not be reduced because of
any compensation payable to Employee from other employment after
Employee's termination, or any claims that the Company may have
against the Employee at the time of or after Employee's termination.
-15-
<PAGE> 16
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
day and year first above written.
Company: STATOIL ENERGY, INC.
a Virginia corporation,
By: /s/ DAVID A. DRESNER
------------------------------
Name: David A. Dresner
Title: President and Chief
Executive Officer
Employee: /s/ STEVENS V. GILLESPIE
----------------------------------
Stevens V. Gillespie
-16-
<PAGE> 17
EXHIBIT A
Severance Compensation Package
In the event of a Change in Control Termination or Change in
Control Constructive Termination pursuant to Section 4.3 , the following shall
occur:
(i) Employee shall receive an amount equal to two (2)
times the sum of (i) such Employee's Base Salary, at
the time of termination and (ii) the Employee's
Average Bonus. Such amount to be paid in equal
monthly installments over the remainder of the Term
of this Agreement;
(ii) Employee shall receive the Benefits Equivalent as
set forth in Section 4.5 hereof; and
(iii) all non-vested Stock Options available to Employee
through the remainder of the Term of employment
shall automatically vest and such Stock Options
shall be exercisable by such Employee until the
first anniversary of Employee's termination.
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF EASTERN STATES OIL & GAS, INC.
----------------------------------------------
Jurisdiction of Ownership
Subsidiary Incorporation Interest
---------- --------------- ---------
Eastern Seven, LLC Delaware 93.99%
Barns Transfer Company West Virginia 100.00%
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to the
use of our reports dated August 23, 1999, with respect to the consolidated
financial statements of Eastern States Oil & Gas, Inc.; the statements of
revenues and direct operating expenses of the Underlying Properties of Eastern
States Oil & Gas, Inc.; the consolidated income statement and cash flows of the
domestic operations of Blazer Energy Corp. and subsidiary (formerly Ashland
Exploration, Inc.); and the statement of assets and trust corpus of the
Appalachian Basin Royalty Trust included in the Registration Statement (Form
S-1/S-1) and related Prospectus of the Appalachian Basin Royalty Trust and
Eastern States Oil & Gas, Inc. for the registration of beneficial interests in
the Appalachian Basin Royalty Trust.
/s/ ERNST AND YOUNG LLP
Vienna, Virginia
August 23, 1999
<PAGE> 1
EXHIBIT 23.4
CONSENT OF INDEPENDENT PETROLEUM
ENGINEERS AND GEOLOGISTS
We hereby consent to the use of our Firm's name in the Registration
Statement on Form S-1/S-1 for the Appalachian Basin Royalty Trust and Eastern
States Oil & Gas, Inc. to which this consent is an exhibit. We further consent
to the reference to our Firm under the heading "Experts" in the Registration
Statement.
/s/ RYDER SCOTT COMPANY, L.P.
Houston, Texas
August 25, 1999
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