<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED September 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________ TO __________
Commission file number 001-11769
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KEY PRODUCTION COMPANY, INC.
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(Exact name of registrant as specified in its charter)
Delaware 84-1089744
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
707 Seventeenth Street, Suite 3300 Denver, Colorado 80202-3404
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code 303/295-3995.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
----- -----
The number of shares of Key Production Company, Inc. common stock, $.25 par
value, outstanding as of September 30, 2000, is 12,418,322.
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PART 1 - FINANCIAL INFORMATION
------------------------------
ITEM 1 - FINANCIAL STATEMENTS
-----------------------------
KEY PRODUCTION COMPANY, INC.
CONSOLIDATED STATEMENT OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
For the Quarter For the Nine Months
Ended September 30, Ended September 30,
------------------- ------------------
(In thousands, except per share data) 2000 1999 2000 1999
--------- --------- --------- --------
<S> <C> <C> <C> <C>
Revenues:
Gas sales $ 15,005 $ 8,628 $ 34,749 $ 21,439
Oil sales 11,925 6,904 32,211 15,448
Plant product sales 356 203 1,194 512
Other 68 93 277 318
--------- --------- --------- --------
27,354 15,828 68,431 37,717
--------- --------- --------- --------
Operating Expenses:
Depreciation, depletion and
amortization 8,917 8,277 25,181 20,209
Lease operating 2,524 2,419 8,238 6,392
Production taxes 1,058 1,010 2,302 2,411
General and administrative 758 607 2,179 1,825
Financing costs:
Interest expense 1,099 1,093 3,338 3,011
Capitalized interest (459) (361) (1,194) (1,008)
Interest income (53) (75) (134) (144)
--------- --------- --------- --------
13,844 12,970 39,910 32,696
--------- --------- --------- --------
Income Before Income Taxes 13,510 2,858 28,521 5,021
Provision for Income Taxes 4,999 1,086 10,553 1,908
--------- --------- --------- --------
Net Income $ 8,511 $ 1,772 $ 17,968 $ 3,113
========= ========= ========= ========
Basic Earnings Per Share $ .69 $ .15 $ 1.51 $ .27
========= ========= ========= ========
Diluted Earnings Per Share $ .67 $ .15 $ 1.45 $ .26
========= ========= ========= ========
Weighted Average Basic Shares 12,302 11,535 11,934 11,526
========= ========= ========= ========
Weighted Average Diluted Shares 12,725 12,189 12,384 12,106
========= ========= ========= ========
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of this statement.
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KEY PRODUCTION COMPANY, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
For the Nine Months
September 30,
-------------------
(In thousands) 2000 1999
-------- --------
Cash Flows from Operating Activities:
Net income $ 17,968 $ 3,113
Adjustment to reconcile net income to net
cash provided by operating activities:
Depreciation, depletion and amortization 25,181 20,209
Deferred income taxes 5,526 1,707
Income tax benefit related to stock
options exercised 3,886 -
Changes in operating assets and liabilities:
Increase in receivables (5,807) (2,696)
(Increase) decrease in prepaid expenses
and other 332 (99)
Increase(decrease) in accounts payable
and accrued expenses 1,398 (2,687)
Increase in long-term property
liabilities and other 28 99
-------- --------
Net cash provided by operating activities 48,512 19,646
-------- --------
Cash Flows from Investing Activities:
Oil and gas exploration and development
expenditures (38,964) (24,611)
Acquisition of proved oil and gas reserves (121) (2,684)
Proceeds from sale of oil and gas properties 265 1,947
Other capital expenditures (330) (110)
-------- --------
Net cash used by investing activities (39,150) (25,458)
-------- --------
Cash Flows From Financing Activities:
Long-term borrowings - 5,000
Payments on long-term debt (11,000) -
Payments to acquire treasury stock (8) (2)
Proceeds from issuance of common stock 3,972 -
-------- --------
Net cash provided (used) by financing
activities (7,036) 4,998
-------- --------
Net Increase (Decrease) in Cash and Cash
Equivalents 2,326 (814)
Cash and Cash Equivalents at Beginning of Year 6,087 4,720
-------- --------
Cash and Cash Equivalents at End of Period $ 8,413 $ 3,906
======== ========
The accompanying notes to consolidated financial statements
are an integral part of this statement.
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KEY PRODUCTION COMPANY, INC.
CONSOLIDATED BALANCE SHEET
(Unaudited)
September 30, December 31,
(In thousands) 2000 1999
------------- ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 8,413 $ 6,087
Receivables 18,013 12,206
Prepaid expenses and other 891 1,223
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27,317 19,516
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Oil and Gas Properties, on the basis of
full cost accounting:
Proved properties 258,432 223,285
Unproved properties and properties
under development, not being amortized 23,306 18,104
------------- ------------
281,738 241,389
Less - accumulated depreciation,
depletion and amortization (110,523) (85,990)
------------- ------------
171,215 155,399
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Other Assets, net 1,624 1,942
------------- ------------
$ 200,156 $ 176,857
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 14,863 $ 13,189
Accrued exploration and development 3,917 2,388
Accrued lease operating expense and other 2,685 1,901
------------- ------------
21,465 17,478
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Long-Term Debt 49,000 60,000
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Non-current Liabilities:
Deferred income taxes 28,518 21,855
Long-term property liabilities and other 679 651
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29,197 22,506
------------- ------------
Stockholders' Equity:
Common stock, $.25 par value, 50,000,000
shares authorized, 12,721,849 and
11,820,190 shares issued, respectively 3,180 2,955
Paid-in capital 43,920 37,557
Retained earnings 56,486 38,518
Treasury stock at cost, 303,527, and
232,887 shares, respectively (3,092) (2,157)
------------- ------------
100,494 76,873
------------- ------------
$ 200,156 $ 176,857
============= ============
The accompanying notes to consolidated financial statements
are an integral part of this statement.
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KEY PRODUCTION COMPANY, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
Total
Stock-
Common Paid-in Retained Treasury holders'
Stock Capital Earnings Stock Equity
------ ------- -------- -------- --------
(In thousands, except per share data)
Balance, December 31, 1999 $2,955 $37,557 $ 38,518 $ (2,157) $ 76,873
Net income - - 17,968 - 17,968
Common stock issued for
option exercises 225 2,436 - - 2,661
Income tax benefit from
stock options exercised - 3,886 - - 3,886
Treasury stock issued - 41 - 101 142
Treasury stock purchased - - - (1,036) (1,036)
------ ------- -------- -------- --------
Balance, September 30, 2000 $3,180 $43,920 $ 56,486 $ (3,092) $100,494
====== ======= ======== ======== ========
The accompanying notes to consolidated financial statements
are an integral part of this statement.
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KEY PRODUCTION COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Introduction
------------
The accompanying financial statements are unaudited and were prepared from
our records. Our management believes these financial statements include all
adjustments necessary for a fair presentation of our financial position and
results of operations. All adjustments are of a normal and recurring nature
unless specifically noted. We prepared these statements on a basis consistent
with our annual audited statements and Regulation S-X. Regulation S-X allows us
to omit some of the footnote and policy disclosures required by accounting
principles generally accepted in the United States and normally included in
annual reports on Form 10-K. You should read these interim financial statements
together with the financial statements, summary of significant accounting
policies and notes in our most recent annual report on Form 10-K.
Basis of Presentation
---------------------
We included the accounts of Key and its subsidiaries in the accompanying
consolidated financial statements. All intercompany accounts and transactions
were eliminated in consolidation.
Use of Estimates
----------------
We rely on estimates and assumptions made by our management to prepare
financial statements in conformity with generally accepted accounting
principles. Those estimates and assumptions affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Income Taxes
Income tax expense consisted of the following:
Nine Months Ended September 30,
---------------------------------
2000 1999
---------- ---------
Current Taxes:
Federal $ 3,886
State 1,141 201
Deferred Taxes 5,526 1,707
---------- ---------
$ 10,553 $ 1,908
========== =========
As of September 30, 2000, we believe that we have fully utilized all of our
net operating loss carryforwards (NOLs). We had approximately $8.2 million of
NOLs at December 31, 1999. In addition, our tax liability at September 30,
2000, has been reduced by a $3.9 million compensation expense deduction related
to the exercise of non-qualified stock options.
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Earnings Per Share
The components of basic and diluted net income per common share for the
periods ended September 30, 2000 and 1999 are presented in the table below:
<TABLE>
<CAPTION>
For the Three For the Nine
Months Ended Months Ended
---------------- ----------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
(In thousands, except per share data)
Basic earnings per share:
Income available to common
stockholders $ 8,511 $ 1,772 $17,968 $ 3,113
Weighted average basic shares
outstanding 12,302 11,535 11,934 11,526
Basic earnings per share $ .69 $ .15 $ 1.51 $ .27
Diluted earnings per share:
Income available to common
stockholders $ 8,511 $ 1,772 $17,968 $ 3,113
Incremental shares assuming
the exercise of stock options 423 654 450 580
Weighted average diluted shares
outstanding 12,725 12,189 12,384 12,106
Diluted earnings per share $ .67 $ .15 $ 1.45 $ .26
</TABLE>
Cash and Cash Equivalents
We consider all highly liquid debt instruments purchased with an original
maturity of three months or less to be cash equivalents. These investments
earned 6.1 and 3.4 percent rates of interest at September 30, 2000 and December
31, 1999, respectively, with cost approximating market.
Supplemental Disclosure of Cash Flow Information
For the Nine Months
Ended September 30,
-------------------
2000 1999
-------- --------
(In thousands)
Cash paid during the period for:
Interest (net of amounts capitalized:
$1,194,000 and $1,008,000, respectively) $ 2,145 $ 1,987
Income taxes (net of refunds received) $ 32 $ (6)
Noncash Transactions
During the first nine months of 2000, officers and directors of Key
exercised 1.1 million non-qualified stock options. In connection with these
transactions, we received total proceeds of $4.9 million. Approximately $4.0
million of the proceeds was cash and the balance of the proceeds was noncash.
The noncash portion was in the form of mature (held longer than six months) Key
common stock, and subsequently added to treasury stock at market value.
Long Term Debt
In November of 1999, we signed a long-term credit agreement funded by a
group of banks led by Banc of America Securities LLC. It replaced our prior
credit arrangement with NationsBank of Texas. Our new agreement specifies a
maximum loan amount of $150
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million. We set our initial borrowing base at $85 million and our outstanding
balance was $49.0 million at September 30, 2000. The lenders may periodically
re-determine the borrowing base depending upon the value of our oil and gas
properties.
We may voluntarily select a borrowing base, less than the maximum value of
our properties would allow, to reduce fees for unused borrowing base capacity.
The agreement has a maturity date of January 1, 2006, including a revolving
period that ends on January 1, 2002. On the later date, if not amended before
then, the outstanding loan amount converts to a term loan and we must commence
quarterly principal payments.
We secured this debt with oil and gas assets owned by Key and our
subsidiaries. We are also subject to customary covenants and restrictions
including: 1) limitations on additional borrowings, 2) working capital
requirements, and 3) net worth maintenance. We are currently, and have been
since inception, in compliance with the covenants of the agreement.
Please see our annual report on Form 10-K if you would like more
information about the terms of the agreement.
Reclassification
We reclassified a few prior year amounts to conform with the current year
presentation.
Ratio of Earnings to Fixed Charges
For the respective nine-month periods ended September 30, 2000 and 1999,
our ratio of earnings to fixed charges was 8.59 and 2.35.
Other Events
On August 29, 2000, we announced our intentions to acquire all of the
outstanding common stock of Columbus Energy Corp. in exchange for 1.3 million
shares of Key common stock. On September 12, 2000, together with Columbus, we
filed an S-4 registration statement with the SEC. The SEC is currently
reviewing the filing. Once the SEC has declared the filing effective and
Columbus stockholders approve the terms of the transaction, we expect to
consummate the acquisition. Please see our S-4 registration statement filed
with the SEC on September 12, 2000 and any subsequent amendments, for additional
details about the proposed transaction.
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<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Financial Results
We generated net income of $8.5 million and earnings per diluted share of
$.67 per share for the third quarter of 2000. These results are nearly five
times the $1.8 million of net income and $.15 per diluted share reported in the
third quarter a year ago. Third quarter results derive from revenues of $27.4
and $15.8 million in 2000 and 1999, respectively.
Based on year-to-date revenues of $68.4 and $37.7 million, net income for
the first nine months of 2000 and 1999 was $18.0 and $3.1 million, respectively.
This equates to $1.45 and $.26 per diluted share for these same periods.
Throughout 2000, positive market conditions for oil and gas, along with
steady production increases, contributed to growth in our revenue, net income,
earnings per share, and cash flow. While the high prices we received for our oil
and gas sales this year largely mirror industry trends, our volume growth is
attributable to positive results from our drilling program.
Results of Operations
For the Quarter For the Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
2000 1999 2000 1999
-------- -------- -------- -------
Selected Oil and Gas
Operating Statistics
------------------------------
Gas Volume - Mcf per day 39,394 37,201 38,009 37,705
Gas Price - Per Mcf $ 4.14 $ 2.52 $ 3.34 $ 2.08
Oil Volume - Barrels per day 4,242 3,820 4,148 3,665
Oil Price - Per barrel $ 30.55 $ 19.65 $ 28.34 $ 15.44
Full Cost Amortization Rate 31.9% 51.9% 36.0% 53.2%
As generally used in the oil and gas business and in this Form 10-Q, the
following terms have the following meanings:
Mcf - Thousand cubic feet (of natural gas)
Mcfe - Thousand cubic feet equivalent
MMcfe - Million cubic feet equivalent
BBls - Barrels (of oil)
In calculating Mcf equivalents, we use a generally recognized standard in
which one BBl of oil is equal to six Mcf of gas.
Our oil and gas sales soared to $27.3 million in the third quarter of 2000,
from $15.7 million in the same quarter of 1999. Of the $11.6 million increase:
oil sales increased $5.0 million, gas sales increased $6.4 million, and plant
products rose $.2 million. During the third quarters, we produced combined oil
and gas volumes of 64.8 MMcfe per day in 2000 compared to 60.1 MMcfe per day in
1999.
On a year-to-date basis, our sales were $68.2 million or 82 percent more
than 1999 sales for the same period. Just like the quarterly sales variance,
the nine-month increase is spread between oil, gas, and plant product sales, and
can be linked to
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<PAGE>
price and volume increases. For the first nine months of 2000, production
averaged 62.9 MMcfe per day versus 59.7 MMcfe per day in the first nine months
of 1999.
The following paragraphs are going to quantify the impact of price and
volume changes. The biggest factor is the high prices that we realized for both
oil and gas in 2000 compared to 1999. We did not have anything to do with
driving the prices up, however, we did manage to take full advantage of them
while they were being offered. In simplest terms, the premium prices we are
receiving are being driven upwards by demand. Basic economics tell us that if
there is too much demand and too little supply, the price should go up. This
rule seems to be holding true whether the supply shortages are real or just
perceived to be so. Economists and market analysts point to price determining
factors such as: low inventories, predictions for a winter that is colder than
normal, tensions in the Middle East, political strategies to release crude from
the Strategic Petroleum Reserve, and many other variations on these themes. We
do not have exact explanations for this market phenomenon.
We have not entered into any derivative contracts or hedges with respect to
our production. As a result, the prices we receive reflect the full impact of
market forces. Our analysis indicates that the prices we receive tend to follow
changes in domestic natural gas prices and worldwide oil prices. A commonly used
benchmark for natural gas prices is the price at the Henry Hub as reported by
Natural Gas Week. When we track our gas price increases and decreases, there is
a direct correlation between our prices and the prices at the Henry Hub. A
similar relationship exists for our oil prices. One of the commonly used
benchmark prices for oil is West Texas Intermediate (WTI) as reported in the
Wall Street Journal. Our oil price tends to move in direct correlation with the
WTI price.
Our gas sales for the third quarter of 2000 jumped to $15.0 million from
$8.6 million in 1999, a 74 percent increase. Most of the quarter-over-quarter
gain is due to an increase in gas prices. Our average realized gas price was
$4.14 per Mcf in 2000 compared to $2.52 per Mcf in 1999. The $1.62 per Mcf
increment added approximately $5.9 million to sales. While not as dramatic as
the price increases, daily gas output for the third quarter rose six percent to
39,394 Mcf per day in 2000, from 37,201 Mcf per day in 1999, resulting in a $.5
million addition to gas sales. Most of the production increase is from several
new wells in Mississippi and Oklahoma.
Between the first nine months of 2000 and 1999, our gas sales increased by
62 percent to $34.7 million. Gas prices increased to $3.34 per Mcf in 2000 from
$2.08 per Mcf in 1999. Favorable pricing in 2000 added more than $13.1 million
to sales. Gas production for this timeframe increased to 38,009 from 37,705 Mcf
per day in 2000 and 1999, respectively.
Driven by significantly higher prices in the third quarter of 2000, our oil
sales increased by 73 percent between the third quarters of 2000 and 1999.
Sales climbed to $11.9 million in 2000 from $6.9 million in 1999. We realized
an average of $30.55 per barrel in 2000, compared to $19.65 per barrel in 1999.
The price difference between these two quarters added almost $4.2 million to oil
sales. At the same time prices were on the rise, our production increased by 11
percent. We produced an average of 4,242 barrels per day in 2000 compared to
3,820 barrels per day in 1999. The increase in production is responsible for
$.8 million of the positive sales variance. A major factor in the production
increase is new wells drilled in the Midcontinent region.
Oil sales for the first nine months of 2000 were more than double oil sales
for the same period of 1999. Fuelled by a combination of high prices and new
production, sales climbed to $32.2 million in 2000 from $15.4 million in 1999.
Our average price
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<PAGE>
for this period increased to $28.34 per barrel in 2000 from $15.44 per barrel in
1999. The price increase positively impacted sales by $14.7 million. At the same
time, daily production rose to 4,148 barrels per day in 2000 from 3,665 barrels
per day in 1999. The 11 percent production increase resulted in a $2.1 million
addition to gas sales. As mentioned above, much of the production increase is
from wells drilled in the Midcontinent region and six oil and gas wells drilled
in Mississippi and Louisiana.
Product sales from gas processing plants increased 75 percent between the
third quarters of 2000 and 1999, and increased 133 percent between the first
nine months of 2000 and 1999. Just like gas and oil, price was also the basis
for our improved plant product sales.
In the first nine months of 2000, our revenues came from the following
product mix: 47 percent oil, 51 percent gas and 2 percent plant products. This
compares to the following mix for the first nine months of 1999: 41 percent oil,
57 percent gas and 2 percent plant products. If you look at our total
production volumes for the first nine months of 2000, 40 percent of our output
is oil and 60 percent is gas. Production for the same period of 1999 was 37
percent oil and 63 percent gas.
Other revenues were approximately $277,000 and $318,000 for the first nine
months of 2000 and 1999, respectively. For all periods presented, the primary
source of other revenue was income from our two gathering systems in California.
Gathering income decreased between 2000 and 1999 as gas production from our
northwest Blosser and northwest Malton wells began to decline.
Costs and Expenses
Depreciation, depletion and amortization (DD&A) expense increased eight
percent between the third quarters of 2000 and 1999. Part of this increase can
be attributed to the 73 percent increase in oil and gas sales. The increase
resulting from higher sales was partially offset by a decrease in the depletion
rate. Our depletion rate as a percentage of oil and gas sales decreased to 31.9
percent from 51.9 percent between the third quarters of 2000 and 1999.
Similarly, DD&A for the first nine months increased 25 percent between 2000 and
1999, while oil and gas sales for the same period increased by 82 percent. The
depletion rate as a percentage of oil and gas sales was 36.0 percent and 53.2
percent for the first nine months of 2000 and 1999, respectively. We use the
future gross revenue method and rolling average prices to compute DD&A expense.
Higher product prices over the last year, for both oil and gas, are helping to
bring the depletion rate down. We also include a small amount of fixed asset
depreciation and amortization of financing costs associated with our credit
facility in this income statement line.
In the third quarters, our lease operating expense (LOE) increased by four
percent between 2000 and 1999. This is a relatively small increase considering
that our production increased by eight percent during this same period. On a
unit of production basis, third quarter LOE decreased to $.42 per Mcfe in 2000
from $.44 per Mcfe in 1999. For the nine months, LOE increased 29 percent
between 2000 and 1999. Compared on a unit of production basis, year to date
expenses increased 22 percent to $.48 per Mcfe. A few of the many things that
are pushing LOE upward in 2000 are: 1) production from drilling is growing and
we are paying expenses on more wells, 2) commodity prices are very good and it
is becoming economical to do more workovers to further increase production, and
3) higher prices are increasing property values and, as a result, ad valorem
taxes. During the third quarter of 2000, workover activity slowed down, but our
drilling activity accelerated.
Production taxes for the third quarter and nine months are down by five
percent. On a unit basis, both the third quarters of 2000 and 1999 equated to a
$.18 per Mcfe.
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<PAGE>
For the nine-month periods, production tax decreased to $.13 per Mcfe in 2000
from $.15 per Mcfe in 1999. In the fourth quarter of 1999, we realized that we
had over estimated production tax expense for the entire year. At that time, we
made a downward adjustment reflecting a decrease in our overall production tax
rate and a change in our procedure for accruing unpaid production taxes. You are
seeing a difference between periods because the first nine months of 2000 are
calculated using updated rates and procedures, and production taxes reported for
the first nine months of 1999 were overstated.
General and administrative expense (G&A) increased 25 percent between the
third quarters and 19 percent between the first nine months of 2000 and 1999.
Most of the G&A variance is due to higher employee compensation and benefit
expense. For the quarter and nine-month timeframes, G&A increased to $.13 per
Mcfe in 2000 from $.11 per Mcfe in 1999. As prescribed by full cost accounting
rules, we capitalize direct overhead related to exploration and development
activities.
Interest expense before capitalization was $3,338,000 and $3,011,000 for
the first nine months of 2000 and 1999, respectively. Even though our long-term
debt balance is $16.0 million less than it was a year ago and $11.0 million less
than it was at yearend 1999, our interest expense is higher due to an increase
in interest rates. Our average interest rate was 7.9 percent on September 30,
2000. On the same day a year earlier, our average interest rate was only 6.1
percent. We capitalized interest of $1,194,000 and $1,008,000 in 2000 and 1999,
respectively. These capitalized amounts are for borrowings associated with
undeveloped leasehold.
We calculated our provision for income taxes using effective rates of 37
percent and 38 percent for 2000 and 1999, respectively. The effective tax rate
for the year 2000 considers the impact of NOLs and deductions related to
compensation expense from the exercise of non-qualified stock options.
Cash Flow and Liquidity
We primarily need cash to fund oil and gas exploration, development, and
acquisition activities and to pay existing obligations and trade commitments
related to oil and gas operations. Our primary sources of liquidity are cash
flows from operating activities and proceeds from financing activities.
We generated cash from operating activities of $48.5 million in the first
nine months of 2000. This was a 28.9 million increase, or more than two and one
half times, the $19.6 million reported for the same period a year ago. Most of
the increase was a consequence of higher oil and gas prices in 2000, and the
resulting increases in oil and gas sales and net income.
In the first nine months of 2000, we made cash expenditures for exploration
and development (E&D) of $39.0 million, or 80 percent of cash from operating
activities. This was $14.4 million more than the $24.6 million we spent in the
first nine months of 1999. Year to date, we participated in drilling 75 wells,
with an overall success rate of 81 percent. Twenty-four of the 31 wells drilled
during the third quarter were successful. Our drilling efforts remain
concentrated in the Mid-Continent and Gulf Coast regions. Of the 33 wells we
drilled in the Mid-Continent region thus far in 2000, 27 have been completed or
are in the process of being completed. Fifteen successful wells were drilled in
the Gulf Coast area, with only two dry holes. Year 2000 E&D projects were
funded with cash generated from operating activities.
Expenditures for E&D in the first nine months of 1999 totaled $24.6
million, or 125 percent of cash generated from operating activities. Projects
initiated in the
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first nine months of 1999 were funded with a combination of cash from
operations, long-term debt and property sales proceeds. Through the first nine
months of 1999, we had participated in drilling 76 wells, with an overall
success rate of 80 percent. Twenty-seven of the 31 wells drilled during the
third quarter of 1999 were successful.
In the first nine months of 1999, we acquired additional interests in
producing properties we already operated in the Hardeman Basin of north-central
Texas and properties in the Gulf Coast region.
We received proceeds from various purchasers totaling $.3 million and $1.9
million in 2000 and 1999, respectively, for the sale of miscellaneous producing
properties and non-producing acreage.
Using cash from operating activities and proceeds from the issuance of
common stock associated with the exercise of stock options, we paid down $11.0
million of our long-term debt balance in the first nine months of 2000. During
the first nine months of 1999 we borrowed $5.0 million to help fund our
exploration and development projects. Please refer to the section titled "Long
Term Debt" for more information about our long-term credit arrangements.
We received cash proceeds of $4.0 million from the issuance of common stock
in the first nine months of 2000. New shares of Key common stock were issued in
connection with the exercise of stock options granted to officers and directors
between 1992 and 1994. The options exercised had exercise prices ranging from
$2.50 to $12.00 per share.
Included in the $2.3 million mentioned above and pursuant to the
registration statement we filed on May 5, 2000, our chief executive officer (Mr.
Merelli) exercised options for 500,000 shares of our common stock. The options
were granted in 1992 in accordance with his employment contract. These options
had an exercise price of $3.00. We received proceeds valued at $1.5 million from
Mr. Merelli for the exercise price of the options. The proceeds were a
combination of cash and 70,000 mature shares of Key common stock. We issued
370,000 new shares of stock to him after withholding 130,000 shares to cover his
tax liability.
We believe that cash on hand, net cash generated from operations and
amounts available under our existing line of credit will be adequate to meet
future liquidity needs, including satisfying our financial obligations and
funding operations, exploration and development. On September 30, 2000, we had
material commitments of approximately $5.4 million. All of the commitments were
routine and made in the normal course of our business.
Year 2000 Compliance
We assessed the effects of Year 2000 computer issues and determined that
there was no material adverse impact on our business. We do not expect to
record any losses related to this event. Our computer systems for accounting,
land and lease records, and reservoir engineering did not have any interruption
in the transition between 1999 and 2000 and continue to operate normally in
2000. Further, we are not aware of any material problems experienced by the
various entities we do business with that would materially impact us.
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Future Trends
Our primary goal is to profitably increase shareholder value. Just as we
have done in the past, we will try to position ourselves to weather all market
conditions. Our strategy is to increase our oil and gas reserves and production
through our exploration and development efforts and to supplement this growth
with an acquisition or merger when we find a target that meets our strict
criteria.
As we get ready to close out the year 2000 and move on to new opportunities
in 2001, we need to stop and evaluate the year we have had. We feel it is
important to be realistic about the success we have had and make decisions
accordingly. We understand that we don't have any control over oil and gas
prices, nor do we know what those prices are going to be. However, there are
things that we can do to maximize the benefits we receive when prices are good
and minimize the effects of lower prices.
Since the second quarter, we have been planning to devote $55 million to
exploration and development projects. It looks as though we are on track to
spend at least that much for the year 2000. The $55 million will be a
substantial increase over the $32.8 million we spent in 1999 and the $42-48
million we initially budgeted for 2000. If oil and gas prices stay high, our
2001 drilling budget should be at least as high as 2000 actual expenditures.
The decision to increase capital expenditures was made in the current price
environment and may change. The amount and allocation of our future capital
expenditures will always depend on a number of factors, including the impact of
oil and gas prices on investment opportunities and available cash flow, the
availability of debt and equity capital, and the number and size of attractive
acquisition opportunities. We will fund these expenditures with cash provided
by operating activities, supplemented, if necessary, by borrowings under our
bank line of credit.
If oil and gas prices remain as strong as they have been in recent months,
we will pay down additional debt in the fourth quarter of 2000 and in the year
2001. In fact, since September 30th, we paid down an additional $2 million on
our long-term debt with cash generated by operating activities. The current
debt balance is $47 million.
As mentioned in our "Income Tax" disclosure, we believe that we have fully
utilized our NOLs as of September 30, 2000. As a result, we expect that we will
have to pay taxes for the years 2000 and 2001. The amount of taxes that we have
to pay will depend on the level of prices we receive for oil and gas, the amount
of intangible drilling costs we incur and many other factors. If payments are
required for tax obligations, we expect to fund those payments with cash
provided by operating activities.
At the end of the year 2000 or in the early part of 2001, we expect to
complete the acquisition of Columbus Energy Corp. At present, the SEC is
reviewing the registration statement we filed in connection with the proposed
transaction. Once the SEC declares the registration statement effective, we will
seek the approval of Columbus' stockholders. We are making every attempt to
close this transaction at the earliest possible date.
As part of our on-going business strategy, we will continue to evaluate
other merger and acquisition opportunities. Acquisition or merger candidates
with the economic and strategic attributes needed to facilitate profitable
growth will be actively pursued.
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ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We use financial instruments, which inherently have some degree of market
risk. Our primary sources of market risk include fluctuations in commodity
prices and interest rates.
Price Fluctuations
Our results of operations are highly dependent upon the prices we receive
for natural gas and crude oil production, and those prices are constantly
changing in response to market forces. Nearly all of our revenue is from the
sale of gas and oil, so these fluctuations, positive and negative, can have a
significant impact.
If we wanted to attempt to smooth out the effect of commodity price
fluctuations, we could enter into: non-speculative hedge arrangements, commodity
swap agreements, forward sale contracts, commodity futures, options and other
similar agreements relating to natural gas and crude oil. To date, we have not
used any of these financial instruments to mitigate commodity price changes.
Changes in product prices also affect the limitation on capitalized costs
under the full cost accounting rules. To apply this rule, we determine a
"ceiling" by pricing future revenues at the unescalated prices in effect at the
end of the fiscal quarter. If the value of our capitalized costs exceeds the
ceiling, we would be required to do a write-down. We have never taken a full-
cost ceiling write-down.
Interest Rate Risk
Our reported earnings are impacted by changes in interest rates. Any
fluctuation in the rate will directly affect the amount of interest expense we
report. At September 30, 2000, we had $49 million of long-term debt outstanding
at an average interest rate of 7.9 percent. At our election, our interest
charges are based on either the prime rate or the LIBOR rate plus a margin
predetermined by our debt agreement. Assuming there is no change in the balance
outstanding during 2000, a ten percent change in the average interest rate would
impact annual interest expense by approximately $387,000. As the interest rate
is variable and is reflective of current market conditions, the carrying value
approximates the fair value.
CAUTIONARY STATEMENT PURSUANT TO SAFE HARBOR PROVISION OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995
This report contains "forward-looking statements" within the meaning of the
federal securities laws. These forward-looking statements include, among
others, statements concerning Key's outlook for the remainder of 2000 with
regard to production levels, price realizations, expenditures for exploration
and development, plans for funding operations and capital expenditures, and
other statements of expectations, beliefs, future plans and strategies,
anticipated events or trends and similar expressions concerning matters that are
not historical facts. The forward-looking statements in this report are subject
to risks and uncertainties that could cause actual results to differ materially
from those expressed or implied by the statements.
These risks and uncertainties include, but are not limited to, fluctuations
in the price we receive for oil and gas production, reductions in the quantity
of oil and gas sold due to decreased industry-wide demand and/or curtailments in
production from specific properties due to mechanical, marketing or other
problems, operating and capital expenditures that are either significantly
higher or lower than anticipated because the actual cost of identified projects
varied from original estimates and/or from the number of exploration and
development opportunities being greater or fewer
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<PAGE>
than currently anticipated and increased financing costs due to a significant
increase in interest rates. These and other risks and uncertainties affecting
Key are discussed in greater detail in this report and the Form S-8 Registration
Statement we filed with the Securities and Exchange Commission on May 5, 2000.
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PART II - OTHER INFORMATION
---------------------------
ITEM 1. LEGAL PROCEEDINGS
--------------------------
None.
ITEM 2. CHANGES IN SECURITIES
------------------------------
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
----------------------------------------
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS
----------------------------------------------------------------
None.
ITEM 5. OTHER INFORMATION
--------------------------
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
-----------------------------------------
(a) Exhibits:
12.1 Statement RE: Computation of Ratio of Earnings to Fixed Charges.
27.1 Financial Data Schedule for Commercial and Industrial Companies
per Article 5 of Regulation S-X for the quarter ended September
30, 2000.
(b) Reports on Form 8-K:
On November 3, 2000, we filed a report dated November 2, 2000, on Form
8-K. The Form 8-K announced our third quarter earnings.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized:
Dated November 14, 2000
KEY PRODUCTION COMPANY, INC.
/s/ Paul Korus
----------------------------
Paul Korus
Vice President and Chief Financial Officer
(Principal Financial Officer)
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