<PAGE> 1
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UNITED STATES
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, 1998
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File No. 0-19136 (Common Stock)
and 333-9045 (Series B Senior Notes)
and 333-38075 (Series D Senior Notes)
NATIONAL ENERGY GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 58-1922764
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
1400 ONE ENERGY SQUARE
4925 GREENVILLE AVENUE
DALLAS, TEXAS 75206
(Address of principal executive offices)
(214) 692-9211
(Registrant's telephone number, including area code)
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[ ]
-------------------------
40,707,222 shares of the registrant's Common Stock, $0.01 par value,
were outstanding on November 10, 1998.
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<PAGE> 2
NATIONAL ENERGY GROUP, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at December 31, 1997 and September 30, 1998
(Unaudited)..................................................................... 1
Consolidated Statements of Operations for the three and nine months ended
September 30, 1997 and 1998 (Unaudited)......................................... 2
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1997 and 1998 (Unaudited)................................... 3
Consolidated Statement of Stockholders' Equity (Deficit) for the nine months ended
September 30, 1998 (Unaudited).................................................. 4
Notes to Consolidated Financial Statements (Unaudited)............................. 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................................... 10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................................. 16
Item 5. Other Information.................................................................. 16
Item 6. Exhibits and Reports on Form 8-K................................................... 16
</TABLE>
<PAGE> 3
NATIONAL ENERGY GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
-------------- --------------
<S> <C> <C>
Current assets:
Cash and cash equivalents ............................................... $ 25,954,479 $ 5,465,695
Marketable securities ................................................... 486,750 324,500
Accounts receivable--oil and natural gas sales .......................... 10,145,739 4,515,982
Accounts receivable--joint interest and other ........................... 7,278,436 4,436,369
Other ................................................................... 2,678,029 1,632,687
-------------- --------------
Total current assets ................................................. 46,543,433 16,375,233
Oil and natural gas properties, at cost (full cost method):
Proved oil and natural gas properties ................................... 245,228,081 290,433,128
Unproved oil and natural gas properties ................................. 35,698,549 27,043,465
-------------- --------------
280,926,630 317,476,593
Accumulated depreciation, depletion, and amortization ................... (83,478,971) (188,933,128)
-------------- --------------
Net oil and natural gas properties ................................... 197,447,659 128,543,465
Other property and equipment ................................................ 4,797,737 5,497,286
Accumulated depreciation ................................................ (799,136) (1,233,272)
-------------- --------------
Net other property and equipment ..................................... 3,998,601 4,264,014
Other assets and deferred charges, net ...................................... 6,371,714 6,074,531
-------------- --------------
Total assets ............................................................ $ 254,361,407 $ 155,257,243
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable-trade .................................................. $ 21,725,575 $ 2,772,615
Accounts payable-revenue ................................................ 7,393,127 5,417,933
Drilling advances ....................................................... 5,282,467 275,511
Credit facility ......................................................... -- 25,000,000
Accrued interest ........................................................ 2,956,250 7,390,625
Other ................................................................... 798,983 732,483
-------------- --------------
Total current liabilities ............................................ 38,156,402 41,589,167
Long-term liabilities ....................................................... 1,915,305 1,426,642
10 3/4% Senior Notes due 2006, including unamortized issuance
premium ................................................................. 166,396,622 166,278,040
Stockholders' equity (deficit): Convertible preferred stock, $1.00 par:
Authorized shares--1,000,000
Issued and outstanding shares--171,187
Aggregate liquidation preference--$17,118,700 ........................ 171,187 171,187
Common stock, $.01 par value:
Authorized shares--100,000,000
Issued and outstanding shares--40,456,320 and 40,527,482 at
December 31, 1997 and September 30, 1998, respectively ............. 404,563 405,275
Additional paid-in capital .............................................. 112,940,414 113,089,872
Unrealized loss on marketable securities, net ........................... (28,594) (190,844)
Deficit ................................................................. (65,594,492) (167,512,096)
-------------- --------------
Total stockholders' equity (deficit) ................................. 47,893,078 (54,036,606)
-------------- --------------
Total liabilities and stockholders' equity .............................. $ 254,361,407 $ 155,257,243
============== ==============
</TABLE>
See accompanying notes.
1
<PAGE> 4
NATIONAL ENERGY GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ---------------------------------
1997 1998 1997 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Oil and natural gas sales .............................. $ 13,122,114 $ 8,573,214 $ 37,607,790 $ 29,646,157
Costs and expenses:
Operating costs ..................................... 2,325,902 2,918,327 7,094,080 8,262,653
Depreciation, depletion, and amortization ........... 6,366,154 5,050,793 17,226,265 16,983,673
Write-down of oil and natural gas properties ........ -- 38,650,000 -- 89,950,000
Restructuring ....................................... -- 274,725 -- 872,971
General and administrative .......................... 1,329,864 1,369,442 2,812,877 4,303,401
-------------- -------------- -------------- --------------
Total costs and expenses ........................... 10,021,920 48,263,287 27,133,222 120,372,698
-------------- -------------- -------------- --------------
Operating income (loss) ................................ 3,100,194 (39,690,073) 10,474,568 (90,726,541)
Other income (expense):
Interest expense .................................... (2,976,211) (3,971,558) (7,773,828) (11,231,026)
Interest income and other, net ...................... 268,672 69,552 506,806 354,148
-------------- -------------- -------------- --------------
Income (loss) before income taxes ...................... 392,655 (43,592,079) 3,207,546 (101,603,419)
Provision for income taxes ............................. 121,567 -- 1,078,579 --
-------------- -------------- -------------- --------------
Net income (loss) ...................................... 271,088 (43,592,079) 2,128,967 (101,603,419)
Preferred stock dividend requirements .................. (236,250) (157,095) (708,750) (471,285)
-------------- -------------- -------------- --------------
Net income (loss) applicable to common shareholders .... $ 34,838 $ (43,749,174) $ 1,420,217 $ (102,074,704)
============== ============== ============== ==============
Net income (loss) per common share, basic and diluted .. $ .00 $ (1.08) $ .03 $ (2.52)
============== ============== ============== ==============
Weighted average number of common shares outstanding ... $ 36,172,159 $ 40,509,419 $ 36,151,259 $ 40,490,585
============== ============== ============== ==============
</TABLE>
See accompanying notes.
2
<PAGE> 5
NATIONAL ENERGY GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------
1997 1998
-------------- --------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) ..................................................... $ 2,128,967 $ (101,603,419)
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation, depletion, and amortization .......................... 17,226,265 16,983,673
Write-down of oil and natural gas properties ...................... -- 89,950,000
Amortization of issuance premium ................................... (26,351) (118,582)
Amortization of deferred compensation .............................. 28,894 31,457
Provision for deferred income taxes ................................ 1,090,513 --
Common stock, options, and warrants issued for services ............ 117,812 32,811
Other .............................................................. -- 256,242
Changes in operating assets and liabilities:
Accounts receivable.............................................. (8,439,133) 8,225,627
Other current assets ............................................ (1,049,388) 696,294
Accounts payable and accrued liabilities ........................ 3,948,491 (11,779,193)
-------------- --------------
Net cash provided by operating activities ..................... 15,026,070 2,674,910
-------------- --------------
INVESTING ACTIVITIES
Purchases of other property and equipment ............................. (1,341,557) (511,954)
Purchases of marketable securities .................................... (515,344) --
Oil and gas acquisition, exploration, and development expenditures .... (54,792,088) (46,881,351)
Purchases of other long-term assets ................................... (2,630,958) (594,476)
Other ................................................................. 4,884 15,020
-------------- --------------
Net cash used in investing activities ......................... (59,275,063) (47,972,761)
-------------- --------------
FINANCING ACTIVITIES
Proceeds from credit facility ......................................... 32,978,502 30,000,000
Repayments of credit facility ......................................... (33,000,000) (5,000,000)
Proceeds from issuance of 103/4% Notes due 2006, net .................. 66,462,500 --
Repayments of other long-term liabilities ............................. (776,947) (26,918)
Proceeds from exercise of stock options and warrants .................. 570,813 93,750
Proceeds from employee stock purchase plan ............................ -- 56,420
Purchase of common stock .............................................. (80,372) --
Preferred stock dividends ............................................. (472,500) (314,185)
-------------- --------------
Net cash provided by financing activities ..................... 65,681,996 24,809,067
-------------- --------------
Decrease in cash and cash equivalents ................................. 21,433,003 (20,488,784)
Cash and cash equivalents and beginning of period ..................... 14,182,246 25,954,479
-------------- --------------
Cash and cash equivalents at end of period ............................ $ 35,615,249 $ 5,465,695
============== ==============
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid in cash ................................................. $ 5,668,482 $ 9,534,005
============== ==============
</TABLE>
See accompanying notes.
3
<PAGE> 6
NATIONAL ENERGY GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(UNAUDITED)
<TABLE>
<CAPTION>
UNREALIZED
CONVERTIBLE LOSS
PREFERRED STOCK COMMON STOCK ADDITIONAL ON
---------------------------- ---------------------------- PAID-IN MARKETABLE
SHARES AMOUNT SHARES AMOUNT CAPITAL SECURITIES
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1997 ..... 171,187 $ 171,187 40,456,320 $ 404,563 $112,940,414 $ (28,594)
Common stock issued upon
exercise of options ........ -- -- 25,000 250 93,500 --
Common stock issued under
employee stock purchase plan -- -- 46,162 462 55,958 --
Dividends on Series B
Preferred Stock ............ -- -- -- -- -- --
Dividends on Series C
Preferred Stock ............ -- -- -- -- -- --
Unrealized loss on marketable
securities ................. -- -- -- -- -- (162,250)
Net loss ...................... -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance at September 30, 1998 .... 171,187 $ 171,187 40,527,482 $ 405,275 $113,089,872 $ (190,844)
============ ============ ============ ============ ============ ============
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
DEFICIT (DEFICIT)
------------- -------------
<S> <C> <C>
Balance at December 31, 1997 ..... $ (65,594,492) $ 47,893,078
Common stock issued upon
exercise of options ........ -- 93,750
Common stock issued under
employee stock purchase plan -- 56,420
Dividends on Series B
Preferred Stock ............ (193,435) (193,435)
Dividends on Series C
Preferred Stock ............ (120,750) (120,750)
Unrealized loss on marketable
securities ................. -- (162,250)
Net loss ...................... (101,603,419) (101,603,419)
------------- -------------
Balance at September 30, 1998 .... $(167,512,096) $ (54,036,606)
============= =============
</TABLE>
See accompanying notes.
4
<PAGE> 7
NATIONAL ENERGY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1998
1. BASIS OF PRESENTATION
In management's opinion, the accompanying financial statements contain
all adjustments (consisting solely of normal recurring accruals) necessary to
present fairly the financial position of National Energy Group, Inc. (the
"Company") as of December 31, 1997 and September 30, 1998, the results of
operations for the three and nine month periods ended September 30, 1997 and
1998, and the cash flows for the nine month periods ended September 30, 1997 and
1998.
The accompanying unaudited financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and disclosures normally included in annual financial
statements prepared in accordance with generally accepted accounting principles
have been omitted pursuant to those rules and regulations, although the Company
believes that the disclosures made are adequate to make the information
presented not misleading. These financial statements should be read in
conjunction with the Company's financial statements and notes thereto included
in the Company's Annual Report on Form 10-K for the year ended December 31,
1997.
Certain previously reported amounts have been reclassified to conform
with the current presentation. See Note 7.
The results of operations for the nine months ended September 30, 1998,
are not necessarily indicative of the results expected for the full year.
The Company capitalizes internal general and administrative costs that
can be directly identified with acquisition, exploration, and development
activities. These costs totaled $336,465 and $1,006,280 for the three and nine
month periods ended September 30, 1997, respectively, and $581,964 and
$1,566,553 for the three and nine month periods ended September 30, 1998,
respectively. The Company capitalized interest costs of $813,000 and $1,539,000
for the three and nine month periods ended September 30, 1997, and $905,000 and
$2,824,000 for the three and nine month periods ended September 30, 1998,
related to its unproved oil and natural gas properties.
Lease overhead reimbursements included as a reduction of general and
administrative expense totaled $263,000 and $994,000 for the three and nine
month periods ended September 30, 1997, respectively, and $204,000 and $712,000
for the three and nine month periods ended September 30, 1998, respectively.
In 1997, the Financial Accounting Standards Board issued Statement No.
128, Earnings per Share ("SFAS 128") which replaced the previously reported
primary and fully diluted earnings per share with basic and diluted earnings per
share. Basic earnings per share data is computed by dividing income (loss)
applicable to common shareholders by the weighted average number of common
shares outstanding and excludes any dilutive effects of options, warrants, and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. Shares issuable upon
exercise of options and warrants are included in the computation of diluted
earnings per share to the extent that they are dilutive. Diluted earnings per
share computations also assume the conversion of the Company's preferred stock
if such conversion has a dilutive effect. For the three and nine month periods
ended September 30, 1997 and 1998, neither the common equivalent shares nor the
assumed conversion of the preferred stock had a dilutive effect on the loss per
share calculations. Accordingly, both basic and diluted loss per share
calculations for such periods are based on the weighted average number of common
shares outstanding during each period. SFAS 128 has been applied in the
computation of the loss per share data for all periods presented. However,
adoption of SFAS 128 had no effect on the per share amounts previously reported
for three and the nine month periods ended September 30, 1997.
5
<PAGE> 8
NATIONAL ENERGY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1998
1. BASIS OF PRESENTATION (CONTINUED)
In June 1998, the Financial Accounting Standards Board issued Statement
No. 133, Accounting for Derivative Instruments and Hedging Activities, which is
required to be adopted in years beginning after June 15, 1999. Because the
Company currently does not use or anticipate using derivatives and currently
discloses its hedging activities, management does not anticipate that the
adoption of the new statement will have an effect on earnings or the financial
position of the Company.
2. ACQUISITIONS
On March 31, 1998, the Company acquired Fortune Natural Resources
Corporation's 12.5% working interest in the East Bayou Sorrel Field for $4.5
million in cash.
3. CREDIT FACILITY
The Company has a revolving credit agreement (the "Revised Credit
Facility") with Bank One, Texas, N.A. and Credit Lyonnais, New York Branch, (the
"Banks") which matures August 29, 2000. Borrowings are subject to a borrowing
base that is redetermined at least semiannually. In September 1998, the Banks
notified the Company that availability under the Revised Credit Facility will be
limited to $25.0 million, which represents the amount of borrowing currently
outstanding. If the borrowing base is determined to be less than $25.0 million,
the Company could be required to prepay (within 30 days of notification by the
Banks), the principal amount of such excess plus accrued interest thereon. In
addition, if the Company is required to purchase or redeem any portion of the
Notes (as hereinafter defined), the borrowing base is subject to reduction. If
any portion of the Notes becomes due, the borrowing base will be automatically
reduced to $0.
Interest is currently payable monthly and is calculated at the BankOne
base rate, as determined from time to time by BankOne plus .25%. The Company may
elect to calculate interest under the EuroDollar Rate, as defined in the Revised
Credit Facility. The EuroDollar Rate increases by (i) 2.25% if the outstanding
loan balance is greater than 75% of the borrowing base, (ii) 2.0% if the
outstanding loan balance is greater than 50% but less than or equal to 75% of
the borrowing base or (iii) 1.75% if the outstanding loan amount is less than
50% of the borrowing base. The average interest rate on borrowings under the
Revised Credit Facility was 7.67% for the nine months ended September 30, 1998.
The Company has granted to the Banks liens on substantially all of the
Company's oil and natural gas properties, whether currently owned or hereafter
acquired, and a negative pledge on all other oil and natural gas properties.
The Revised Credit Facility requires, among other things, semiannual
engineering reports covering the Company's oil and natural gas properties, and
maintenance of certain financial ratios, including the maintenance of a minimum
interest coverage, a current ratio, and a minimum tangible net worth. The
Revised Credit Facility includes other covenants prohibiting cash dividends,
distributions, loans, or advances to third parties, except that cash dividends
on preferred stock will be allowed so long as no event of default exists or
would exist as a result of the payment thereof.
At September 30, 1998, the Company was not in compliance with the
interest coverage ratio and current ratio requirements of the Revised Credit
Facility. Unless the Company is able to obtain amendments or waivers of these
covenants the Banks may declare the entire principal amount immediately due and
payable. A default in the payment of the Notes that continues beyond the
applicable grace period ending December 2, 1998, shall constitute a default
under the Revised Credit Facility enabling the Banks, upon notice to the
Company, to declare the principal and all accrued interest immediately due and
payable. As a result, the balance of the outstanding borrowings under the
Revised Credit Facility is included as a current liability in the Company's
balance sheet at September 30, 1998. The Company is currently in discussions
with the Banks regarding renegotiation of the terms of the Revised Credit
Facility or the negotiation of a new credit facility. See Note 6.
6
<PAGE> 9
NATIONAL ENERGY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1998
4. 10 3/4% SENIOR NOTES DUE 2006
In November 1996, the Company issued $100 million aggregate principal
amount of unregistered 10 3/4% Series A Notes due 2006 (the "Series A Notes").
The net proceeds of the Series A Notes of approximately $96.1 million were used
to repay approximately $62.0 million of borrowings under the predecessor to the
Revised Credit Facility and to increase the Company's working capital. In 1997,
the Series A Notes were exchanged for the registered 10 3/4% Series B Notes due
2006 (the "Series B Notes") which are substantially identical to the Series A
Notes. Collectively, the Series A Notes and Series B Notes are referred to as
the "Series A/B Notes." In August 1997, the Company issued $65.0 million
aggregate principal amount of its unregistered 10 3/4% Series C Notes due 2006
(the "Series C Notes"). The net proceeds of the Series C Notes of approximately
$64.8 million were used to repay approximately $23.0 million of borrowings under
the Revised Credit Facility, to fund the drilling program and to increase the
Company's working capital. In December 1997, the Company exchanged substantially
all of the Series A/B Notes and the Series C Notes for registered 10 3/4% Series
D Notes due 2006 (the "Series D Notes"). The Series D Notes are substantially
identical to the Series A/B Notes and the Series C Notes. Collectively, the
Series A/B Notes, the Series C Notes, and the Series D Notes are referred to as
the "Notes." The Notes bear interest at 10 3/4% per annum, payable semi-annually
on May 1 and November 1.
The Indenture governing the Senior Notes contains certain covenants
limiting the Company, with respect to the following: (i) assets sales; (ii)
restricted payments; (iii) the incurrence of additional indebtedness and the
issuance of certain redeemable preferred stock; (iv) liens; (v) sale and
leaseback transactions; (vi) lines of business; (vii) dividend and other payment
restrictions affecting subsidiaries; (viii) mergers and consolidations; and (ix)
transactions with affiliates.
The Company did not make the interest payment of $8.9 million due on
November 2, 1998. If the Company does not make such interest payment prior to
the close of business on December 2, 1998, the Indenture trustee or not less
than 25% in interest of the bondholders have the right to accelerate the
principal on the Senior Notes and declare the entire principal and interest
amount of the Notes immediately due and payable. The Company, through the
Indenture trustee, has requested a meeting of the holders of the Notes to
discuss a proposed restructuring of the Notes, and expects such meeting to be
held prior to December 2, 1998. See Note 6.
In addition, if the Company does not make the interest payment to the
bondholders by December 2, 1998, the holder of the Company's Series D
Convertible Preferred Stock ("Series D") will have the right, upon notice to the
Company, to appoint a majority of the Company's Board of Directors. The Company
has been orally advised that the Series D holder has no current intention of
exercising such right.
5. CRUDE OIL AND NATURAL GAS PRODUCING ACTIVITIES
At March 31, 1998, June 30, 1998 and September 30, 1998, the net book
value of the Company's oil and natural gas properties exceeded the full cost
ceiling, based on the weighted average prices of crude oil and natural gas
received by the Company, resulting in a non-cash writedowns of $26.5 million,
$24.8 million and $38.7 million during the three month periods ended March 31,
1998, June 30, 1998 and September 30, 1998, respectively. There can be no
assurance that there will not be additional writedowns in future periods under
the full cost method of accounting as a result of sustained decreases in oil and
natural gas prices or other factors.
7
<PAGE> 10
NATIONAL ENERGY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1998
6. FINANCIAL RESTRUCTURING
The sustained period of low commodity prices experienced by the Company
during 1998 has had a material adverse impact on the Company's results of
operations, cash flows and financial position. The average price received for
the Company's crude oil production declined 32.9% compared to the first nine
months of 1997. The average price received for the Company's natural gas
production declined 8.9% compared to the first nine months of 1997. At September
30, 1998, the Company had a working capital deficit of $25.2 million and a
deficiency in stockholders' equity of $54.0 million.
As a result of the reduction in the Company's cash flows and working
capital and the lack of availability of additional borrowings under the Revised
Credit Facility (Note 3), the Company currently is not able to continue paying
interest on the Notes (See Note 4) and make the capital investments required to
develop the Company's oil and gas properties. The Company, through the Indenture
trustee, has requested a meeting of the holders of the Notes to discuss a
proposed restructuring of the Notes. No date has been set for this meeting, but
the Company expects to hold such a meeting prior to December 2, 1998. In
addition, the Company is currently not in compliance with certain financial
covenants of the Revised Credit Facility and is in discussions with the Banks
regarding renegotiation of the terms of the Revised Credit Facility or the
negotiation of a new credit facility. If an acceptable restructuring of the
Notes can be negotiated, the Company also expects to be able to renegotiate the
terms of the Revised Credit Facility or negotiate a new credit facility with the
Banks or another financial institution. If the Company is unable to negotiate an
acceptable restructuring of its outstanding indebtedness in a reasonable period
of time, the Company may be required to complete the restructuring under the
protection of the federal bankruptcy laws. Upon consummation of the
restructuring, the Company expects that the relative ownership interests of the
current holders of the Company's common stock may be reduced.
7. RECLASSIFICATIONS
Beginning with the three months ended September 30, 1998, the Company
classifies natural gas marketing fees and transportation costs as a reduction of
natural gas revenues. These costs were previously included in lease operating
costs. In addition, lease operating overhead reimbursements, previously included
in revenues, are now included as a reduction in general and administrative
costs. Information for prior periods has been reclassified to conform with this
presentation. Such reclassifications had no impact on previously reported net
income (loss) and related per share data. For comparative purposes, the
following table sets forth the Company's statements of operations and certain
operating data for each of the six quarters in the period ended June 30, 1998,
giving effect to such reclassifications (in thousands, except per share and unit
data):
8
<PAGE> 11
NATIONAL ENERGY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1998
7. RECLASSIFICATIONS (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1997 1997 1997 1997 1998 1998
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Statements of Operations:
Oil and natural gas sales ...... $ 12,864 $ 11,622 $ 13,122 $ 14,809 $ 10,529 $ 10,544
Cost and expenses:
Operating costs .............. 2,517 2,251 2,326 2,773 2,444 2,901
Depreciation, depletion, and
amortization ............... 5,047 5,813 6,366 5,979 5,938 6,218
Write-down of oil and natural
gas properties ............. -- -- -- 46,396 26,500 24,800
Restructuring charge ......... -- -- -- -- -- 598
General and administrative ... 677 806 1,330 1,580 1,404 1,530
--------- --------- --------- --------- --------- ---------
Operating income (loss) ........ 4,623 2,752 3,100 (41,919) (25,757) (25,503)
--------- --------- --------- --------- --------- ---------
Other income (expense):
Interest expense ............. (2,691) (2,106) (2,976) (3,438) (3,511) (3,525)
Interest income and other, net 194 42 269 525 224 60
--------- --------- --------- --------- --------- ---------
Income (loss) before
income taxes ................. 2,126 688 393 (44,832) (29,044) (28,968)
Benefit (provision) for income (723) (234) (122) 8,364 -- --
--------- --------- --------- --------- --------- ---------
taxes
Net income (loss) .............. 1,403 454 271 (36,468) (29,044) (28,968)
Preferred stock dividend
requirements ................. (236) (236) (236) (175) (157) (157)
--------- --------- --------- --------- --------- ---------
Net income (loss) applicable to
common shareholders .......... $ 1,167 $ 218 $ 35 $ (36,643) $ (29,201) $ (29,125)
========= ========= ========= ========= ========= =========
Net income (loss) per common
share, basic and diluted ..... $ .03 $ .01 $ .00 $ (.93) $ .(72) $ (.72)
========= ========= ========= ========= ========= =========
Weighted average number of
common shares outstanding .... 36,094 36,149 36,172 37,380 40,481 40,481
========= ========= ========= ========= ========= =========
Operating Data:
Average sales price:
Oil (per Bbl) ................ $ 21.90 $ 18.92 $ 18.61 $ 18.42 $ 14.57 $ 12.90
Natural gas (per Mcf) ........ 2.66 1.97 2.15 2.26 2.04 2.14
Unit economics (per Mcfe):
Average sales price .......... 2.99 2.35 2.46 2.87 2.18 2.14
Operating expenses ........... .58 .45 .44 .54 .51 .59
Depreciation, depletion and
amortization ............... 1.17 1.17 1.19 1.16 1.23 1.26
General and administrative ... .16 .16 .25 .31 .29 .31
</TABLE>
9
<PAGE> 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The sustained period of low commodity prices experienced by the Company
in 1998 has had a material adverse impact on the Company's results of
operations, cash flows, and financial position. The average price received for
the Company's crude oil production declined 32.9% compared to the first nine
months of 1997. The average price received for the Company's natural gas
production declined 8.9% compared to the first nine months of 1997. The market
price for crude oil reached a twelve year low during the quarter ended September
30, 1998. See "Results of Operations" and "Liquidity and Capital Resources -
Financial Restructuring."
RESULTS OF OPERATIONS
OVERVIEW OF PRODUCTION, SALES AND UNIT ECONOMICS
The following table sets forth certain information regarding the
production volumes, oil and natural gas sales, average sales prices, and unit
economics per Mcfe for revenues and costs and expenses related to the Company's
oil and natural gas production for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
1997 1998 1997 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net production:
Oil (Mbbls) ............................ 292 278 790 906
Natural gas (Mmcf) ..................... 3,580 2,682 9,853 8,675
Natural gas equivalent (Mmcfe) ......... 5,329 4,350 14,594 14,110
Oil and natural gas sales (in thousands):
Oil .................................... $ 5,427 $ 3,393 $ 15,566 $ 11,976
Natural gas ............................ 7,695 5,180 22,042 17,670
-------------- -------------- -------------- --------------
Total .................................. $ 13,122 $ 8,573 $ 37,608 $ 29,646
============== ============== ============== ==============
Average sales price:
Oil (per Bbl) .......................... $ 18.61 $ 12.21 $ 19.70 $ 13.22
Natural gas (per Mcf) .................. 2.15 1.93 2.24 2.04
Unit economics (per Mcfe):
Average sales price .................... 2.46 1.97 2.58 2.10
Operating expenses ..................... 44 .67 .49 .59
Depreciation, depletion and amortization 1.19 1.16 1.13 1.20
General and administrative ............. .25 .31 .20 .36
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1998, COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 1997
Revenues. Total revenues decreased by $4.5 million (34.4%) to $8.6
million for 1998 from $13.1 million in 1997. The reduction in revenues was
primarily due to the decline in commodity prices from the same period in 1997.
Average natural gas prices decreased $.22 per Mcf to $1.93 per Mcf from $2.15
for 1997 and average oil prices declined $6.40 per barrel to $12.21 for 1998
from $18.61 for 1997. The decrease in average prices reduced third quarter 1998
revenues by approximately $2.4 million compared to 1997.
In 1998, the Company produced 278 Mbbls of oil, a decrease of 4.7% over
the 292 Mbbls produced in 1997. Production at the East Bayou Sorrel field was
shut-in for seven days in September 1998 due to drilling and completion of the
State Lease #2102 well and hurricane George. The production also decreased due
to natural decline as well as the flush production in 1997 due to the drilling
program in the East Texas and Arkoma properties. Also, the Company discontinued
additional developmental drilling at Goldsmith Adobe Unit in March 1998 due to
the current decline of crude oil prices. The 1997 sale of certain non-strategic
properties also reduced 1998 production compared with 1997.
10
<PAGE> 13
Costs and Expenses. Operating costs, including production taxes,
increased $.6 million to $2.9 million for 1998 from $2.3 million for 1997, due
to additional wells brought into production during 1997 and 1998 This increase
was partially offset by the 1997 sale of certain non-strategic properties and
the Company's efforts to reduce operating expenses. Operating costs per Mcfe
increased $.23 to $.67 for 1998 from $.44 for 1997 due to the increase in costs
combined with the decline in production during the period.
Depreciation, depletion and amortization decreased $1.3 million (20.3%)
to $5.1 million for 1998 compared to $6.4 million for 1997 due to the decrease
in the average depletion rate per Mcfe which was $1.05 for 1998 compared to
$1.13 for 1997. The decrease in the depletion rate was due to the full cost
ceiling writedowns in 1998 discussed below.
At September 30, 1998, the net book value of the Company's oil and
natural gas properties exceeded the full cost ceiling, resulting in a non-cash
writedown of the Company's oil and natural gas properties of $38.7 million for
the three months ended September 30, 1998. This writedown resulted primarily
from the decline in natural gas prices and costs incurred on unsuccessful
exploratory wells drilled during the period, combined with revisions of
estimated proved reserves as of September 30, 1998.
In the third quarter of 1998, the Company recorded additional charges
of approximately $.3 million for severance and related costs resulting from the
restructuring of its management team and other personnel changes incurred during
the period.
General and administrative costs increased $.1 million to $1.4 million
compared to $1.3 million for 1997. The increase in general and administrative
expenses remaining relatively constant due to the Company's efforts in
restructuring the management team and other personnel. As discussed in Note 1,
the Company capitalizes internal general and administrative costs that can be
directly identified with acquisition, exploration and development activities.
These costs totaled $.3 million and $.6 million for the three months ended
September 30, 1997 and 1998, respectively.
Other Income and Expenses. The increase of $1.0 million in interest
expense to $4.0 million for 1998 from $3.0 million for 1997 was due to the
issuance of the Series C Notes issued in August of 1997 and interest on
borrowings under the Revised Credit Facility, partially offset by an increase of
$.1 million of interest costs which were capitalized in 1998 related to the
Company's unproved oil and natural gas properties. The average balance of debt
outstanding during 1998 was $187.8 million as compared to average debt
outstanding of $113.0 million for 1997. The weighted average interest rate for
1998 was 10.31% compared to 10.4% for 1997.
Net Income (Loss). The Company incurred a net loss of $43.6 million for
1998, compared with net income of $.3 million for 1997. The net loss for 1998
includes a writedown of oil and natural gas properties of $38.7 million and a
non-recurring restructuring charge of $.3 million. Excluding these charges, net
income declined $4.9 million in 1998 compared with 1997, primarily due to the
decrease in revenues and the increase in interest expense discussed above.
NINE MONTHS ENDED SEPTEMBER 30, 1998, COMPARED WITH NINE MONTHS ENDED
SEPTEMBER 30, 1997
Revenues. Total revenues decreased by $8.0 million (21.3%) to $29.6
million for 1998 from $37.6 million in 1997. The reduction in revenues was
primarily due to the decline in commodity prices from the same period in 1997.
Average natural gas prices declined $.20 per Mcf to $2.04 per Mcf for 1998 from
$2.24 for 1997, and average oil prices declined $6.48 per barrel to $13.22 for
1998 from $19.70 for 1997. The decreases in average prices reduced 1998 revenues
by approximately $7.6 million compared to 1997.
In 1998, the Company produced 906 Mbbls of oil, an increase of 14.7%
over the 790 Mbbls produced in 1997. The Company produced 8,675 Mmcf of natural
gas in 1998, a decrease of 12.0% from the 9,853 Mmcf produced in the same period
of 1997. Production increases from the Company's drilling program were partially
offset by the temporary shut-in of the East Bayou Sorrel field to allow for
repair of a pipeline, which reduced 1998 production by 291 Mmcfe. In addition,
the East Bayou Sorrel field was shut-in for seven days in September 1998 due to
drilling and completion of the State Lease #2102 well and hurricane George. The
production also decreased due to natural decline as well as the flush production
in 1997 due to the drilling program in the East Texas and Arkoma properties.
Also, the Company discontinued additional developmental drilling at Goldsmith
Adobe Unit in March 1998 due to the current decline of crude oil prices. The
1997 sale of certain non-strategic properties also reduced the 1998 production.
11
<PAGE> 14
Costs and Expenses. Operating costs, including production taxes,
increased $1.2 million to $8.3 million for 1998 from $7.1 million for 1997,
primarily due to the additional wells brought into production during 1997 and
1998. This increase was partially offset by the 1997 sale of certain
non-strategic properties and the Company's efforts to reduce operating expenses.
Operating costs per Mcfe increased $.10 to $.59 for 1998 from $.49 for 1997 due
to the increased costs combined with the decline in production during the
period.
Depreciation, depletion and amortization decreased $.2 million (1.2%)
to $17.0 million for 1998 compared to $17.2 million for 1997 due to the decrease
in the average depletion rate per Mcfe to $1.12 for 1998 compared to $1.14 for
1997. The decrease in the depletion rate was due to the full cost ceiling
writedowns in 1998 discussed below.
At March 31, 1998, June 30, 1998 and September 30, 1998, the net book
value of the Company's oil and natural gas properties exceeded the full cost
ceiling, resulting in non-cash writedowns of the oil and natural gas properties
totaling $90.0 million for the nine months ended September 30, 1998. These
writedowns resulted primarily from the decline in oil and natural gas prices in
1998, costs incurred on unsuccessful exploratory wells drilled during the
period, and revisions of estimated proved reserves at September 30, 1998.
During 1998, the Company recorded non-recurring charges of
approximately $.9 million for severance and related costs resulting from the
restructuring of its management team and other personnel changes.
General and administrative costs increased $1.5 million to $4.3 million
compared to $2.8 million for 1997. The increase in general and administrative
expenses compared to 1997 was primarily due to increased personnel and office
space due to the increase in the scope of the Company's operations. However, as
discussed above, the Company has restructured management and personnel and as a
result third quarter general and administrative expenses were reduced by $.1
million from the same period in 1997. The Company's capitalized general and
administrative expenses totaled $1.0 million and $1.6 million for the nine
months ended September 30, 1997 and 1998, respectively (See Note 1).
Other Income and Expenses. The increase of $3.4 million in interest
expense to $11.2 million for 1998 from $7.8 million for 1997 was due to the
issuance of the Series C Notes in August of 1997 and interest on borrowings
under the Revised Credit Facility, partially offset by an increase of $1.3
million of interest costs which were capitalized in 1998 related to the
Company's unproved oil and natural gas properties. The average balance of debt
outstanding during 1998 was $177.4 million as compared to average debt
outstanding of $113.0 million for 1997. The weighted average interest rate was
10.5% for both 1998 and 1997.
Net Income (Loss). The Company incurred a net loss of $101.6 million
for 1998, compared with net income of $2.1 million for 1997. The net loss for
1998 includes writedowns of oil and natural gas properties aggregating $90.0
million and a nonrecurring restructuring charge of $.9 million. Excluding these
charges, net income declined $12.8 million in 1998 compared with 1997, primarily
due to the decrease in revenues, the increase in depreciation, depletion and
amortization and the increase in interest expense discussed above.
LIQUIDITY AND CAPITAL RESOURCES
NINE MONTHS ENDED SEPTEMBER 30, 1998, COMPARED WITH NINE MONTHS ENDED
SEPTEMBER 30, 1997
Net cash provided by activities was $2.7 million for the nine months
ended September 30, 1998, compared to net cash provided by operating activities
of $15.0 million for the same period in 1997. Net cash flow from operating
activities before changes in operating assets and liabilities decreased to $5.5
million in 1998 from $20.5 million in 1997. The decline in cash flows from
operating activities is primarily due to the decrease in operating income,
excluding non-cash charges, and the increase in interest expense discussed
above.
Net cash used in investing activities was $48.0 million for 1998
compared with $59.3 million for 1997. The cash used by investing activities for
1998, included $46.9 million of expenditures for the Company's Drilling Program,
leasehold and seismic costs, and the acquisition of additional interests in East
Bayou Sorrel.
Net cash provided by financing activities was $24.8 million for 1998
compared with $65.7 million for 1997. The net cash provided by financing
activities during 1998 consisted primarily of proceeds from borrowings under the
Revised Credit Facility. In 1997, net cash provided by financing activities
consisted primarily of proceeds from the issuance of additional 10 3/4% Notes
due 2006.
12
<PAGE> 15
CREDIT FACILITIES
Borrowings under the Revised Credit Facility are subject to a borrowing
base that is redetermined at least semiannually. In September 1998, the Banks
notified the Company that availability under the Revised Credit Facility will be
limited to $25.0 million, which represents the amount of borrowing currently
outstanding. If the borrowing base is determined to be less than $25.0 million,
the Company could be required to prepay (within 30 days of notification by the
Banks) the principal amount of such excess plus accrued interest thereon. In
addition, if the Company is required to purchase or redeem any portion of the
Notes (as hereinafter defined), the borrowing base is subject to reduction. If
any portion of the Notes becomes due, the borrowing base will be automatically
reduced to $0.
Interest is currently payable monthly and is calculated at the BankOne
base rate, as determined from time to time by BankOne plus .25%. The Company may
elect to calculate interest under the EuroDollar Rate, as defined in the Revised
Credit Facility. The EuroDollar Rate increases by (i) 2.25% if the outstanding
loan balance is greater than 75% of the borrowing base, (ii) 2.0% if the
outstanding loan balance is greater than 50% but less than or equal to 75% of
the borrowing base or (iii) 1.75% if the outstanding loan amount is less than
50% of the borrowing base. The average interest rate on borrowings under the
Revised Credit Facility was 7.67% for the nine months ended September 30, 1998.
The Company has granted to the Banks liens on substantially all of the
Company's oil and natural gas properties, whether currently owned or hereafter
acquired, and a negative pledge on all other oil and natural gas properties.
The Revised Credit Facility requires, among other things, semiannual
engineering reports covering the Company's oil and natural gas properties, and
maintenance of certain financial ratios, including the maintenance of a minimum
interest coverage, a current ratio, and a minimum tangible net worth. The
Revised Credit Facility includes other covenants prohibiting cash dividends,
distributions, loans, or advances to third parties, except that cash dividends
on preferred stock will be allowed so long as no event of default exists or
would exist as a result of the payment thereof.
At September 30, 1998, the Company was not in compliance with the
interest coverage ratio and current ratio requirements of the Revised Credit
Facility. Unless the Company is able to obtain amendments or waivers of this
covenant, the Banks may declare the entire principal amount outstanding
immediately due and payable. A default in the payment of the Notes that
continues beyond the applicable grace period ending December 2, 1998, shall
constitute a default under the Revised Credit Facility enabling the Banks, upon
notice to the Company, to declare the principal and all accrued interest
immediately due and payable. As a result, the balance of the outstanding
borrowings under the Revised Credit Facility is included as a current liability
in the Company's balance sheet at September 30, 1998. The Company is currently
in discussions with the Banks regarding renegotiation of the terms of the
Revised Credit Facility or the negotiation of a new credit facility. See
"Financial Restructuring".
10 3/4% SENIOR NOTES DUE 2006
The Company has $165.0 million principal amount of publicly-held debt
outstanding. In November 1996, the Company issued $100 million aggregate
principal amount of unregistered 10 3/4% Series A Notes due 2006 (the "Series A
Notes") and used the net proceeds of approximately $96.1 million to repay
approximately $62.0 million of borrowings under the predecessor to the Revised
Credit Facility and to increase the Company's working capital. In 1997, the
Series A Notes were exchanged for the registered 10 3/4% Series B Notes due 2006
(the "Series B Notes") which are substantially identical to the Series A Notes.
Collectively, the Series A Notes and Series B Notes are referred to as the
"Series A/B Notes." In August 1997, the Company issued $65.0 million aggregate
principal amount of its unregistered 10 3/4% Series C Notes due 2006 (the
"Series C Notes") and used the net proceeds of approximately $64.8 million to
repay approximately $23.0 million of borrowings under the Revised Credit
Facility, to fund the Drilling Program, and to increase the Company's working
capital. In December 1997, the Company exchanged substantially all of the Series
A/B Notes and the Series C Notes for registered 10 3/4% Series D Notes due 2006
(the "Series D Notes"). The Series D Notes are substantially identical to the
Series A/B Notes and the Series C Notes. Collectively, the Series A/B Notes, the
Series C Notes, and the Series D Notes are referred to as the "Notes." The Notes
bear interest at 10 3/4% per annum, payable semi-annually on May 1 and November
1.
13
<PAGE> 16
The Indenture governing the Senior Notes contains certain covenants
limiting the Company, with respect to the following: (i) assets sales; (ii)
restricted payments; (iii) the incurrence of additional indebtedness and the
issuance of certain redeemable preferred stock; (iv) liens; (v) sale and
leaseback transactions; (vi) lines of business; (vii) dividend and other payment
restrictions affecting subsidiaries; (viii) mergers and consolidations; and (ix)
transactions with affiliates.
The Company did not make the interest payment of $8.9 million due on
November 2, 1998. If the Company does not make such interest payment prior to
the close of business on December 2, 1998, the Indenture trustee or not less
than 25% in interest of the bondholders have the right to accelerate the
principal amount on the Notes and declare the entire principal and interest
amount of the Notes immediately due and payable. The Company, through the
Indenture trustee, has requested a meeting of the holders of the Notes to
discuss a proposed restructuring of the Notes. No date for the meeting has been
set, but the Company expects to hold such meeting prior to December 2, 1998.
In addition, if the Company does not make the interest payment to the
bondholders by December 2, 1998, the holder of the Company's Series D
Convertible Preferred Stock ("Series D") will have the right, upon notice to the
Company, to appoint a majority of the Company's Board of Directors. The Company
has been orally advised that the Series D holder has no current intention of
exercising such right.
FINANCIAL RESTRUCTURING
As a result of the reduction in the Company's cash flows and working
capital and the lack of availability of additional borrowings under the Revised
Credit Facility, the Company is currently not able to continue paying interest
on the Notes and make the capital investments required to develop the Company's
oil and gas properties. The Company, through the Indenture trustee, has
requested a meeting of the holders of the Notes to discuss a proposed
restructuring of the Notes. In addition, the Company is currently not in
compliance with certain financial covenants of the Revised Credit Facility and
is in discussions with the Banks regarding renegotiation of the terms of the
Revised Credit Facility or the negotiation of a new credit facility. If an
acceptable restructuring of the Notes can be negotiated, the Company also
expects to be able to renegotiate the terms of the Revised Credit Facility or
negotiate a new credit facility with the Banks or another financial institution.
If the Company is unable to negotiate an acceptable restructuring of its
outstanding indebtedness in a reasonable period of time, the Company may be
required to complete a restructuring under the protection of the federal
bankruptcy laws. Upon consummation of the restructuring, the Company expects
that the relative ownership interests of current holders of the Company's common
stock may be reduced.
FUTURE CAPITAL AND FINANCING REQUIREMENTS
The Company has made and, to the extent funds are available, expects to
continue to make substantial capital expenditures for the exploration,
acquisition, development, and exploitation of oil and natural gas reserves.
Actual amounts to be expended by the Company for these activities will be
dependent upon a number of factors, including: (i) the availability of capital;
(ii) oil and natural gas prices; (iii) seismic and contract service costs; (iv)
availability of drilling rigs; and (v) future drilling results.
The amount of capital resources ultimately available for capital
expenditures is currently dependent on a successful financial restructuring. See
"Financial Restructuring." Should the Company be unable to successfully
implement a financial restructuring such that sufficient cash flows and capital
are not available, the development and exploration of the Company's properties
could be delayed or reduced and, accordingly, oil and natural gas revenues and
operating results would be adversely affected.
FINANCIAL REPORTING IMPACT OF FULL COST METHOD OF ACCOUNTING
The Company follows the full cost method of accounting for oil and
natural gas properties. Under such method, the net book value of such
properties, less related deferred income taxes, may not exceed a calculated
"ceiling." The ceiling is the estimated after-tax future net revenues from
proved oil and natural gas properties, discounted at 10% per year. In
calculating future net revenues, prices and costs in effect at the time of the
calculation are held constant indefinitely, except for charges which are fixed
and determinable by existing contracts.
14
<PAGE> 17
FINANCIAL REPORTING IMPACT OF FULL COST METHOD OF ACCOUNTING (CONTINUED)
The net book value is compared to the ceiling on a quarterly and yearly basis.
The excess, if any, of the net book value above the ceiling is required to be
written off as a non-cash expense. At March 31, 1998, June 30, 1998, and
September 30, 1998, the net book value of the Company's oil and natural gas
properties exceeded the full cost ceiling, based on the weighted average prices
of crude oil and natural gas received by the Company, resulting in non-cash
writedowns aggregating $90.0 million. There can be no assurance that there will
not be additional writedowns in future periods under the full cost method of
accounting as a result of sustained decreases in oil and natural gas prices or
other factors.
CHANGES IN PRICES AND INFLATION
The prices received by the Company for its oil and natural gas
production have declined dramatically during the first nine months of 1998. The
prices received for crude oil reached a twelve-year low during the period. The
Company's revenues and value of its oil and natural gas properties have been and
will continue to be adversely affected until such prices recover. Oil and gas
prices are also subject to seasonal and other fluctuations that are beyond the
Company's ability to control or predict.
The Company has entered into forward sales contracts with three
purchasers covering the future production of natural gas. Deliveries under these
contracts are priced based on NYMEX prices less a differential whereby the
Company may fix the price for deliveries under these contracts at any time three
days prior to the close of the then current contract based on the NYMEX prices
at that time. The Company pays the cost of transportation of the natural gas to
the delivery point specified in the contracts. Currently, the Company has fixed
the sales prices of approximately 1,098,626 Mcf of gas to be delivered under
these contracts during the months of October 1998, November 1998 and March 1999.
The average price of the natural gas for these deliveries is approximately $2.30
per Mcf.
Although certain of the Company's costs and expenses are affected by
the level of inflation, inflation has not had a significant effect on the
Company's results of operations during the nine months ended September 30, 1997
and 1998.
YEAR 2000
The Company has begun addressing the potential impact of the year 2000
("Y2K") issue on its operations. The Y2K problem arises because of computer
programs which use two digits rather than four digits to define a year. This may
result in miscalculations or complete system failures in processing data with
programs using date sensitive information. The Company currently uses
commercially available software for its management information systems,
including accounting, engineering, and word processing applications. This
software has either already been warranted by the suppliers or publishers to be
Y2K compliant or the suppliers and publishers have represented such software
will be compliant in upgrades the Company will receive in 1999 at minimal or no
cost to the Company. The Company expects to conduct tests of its primary
management information system during 1999. The Company has begun a review of its
other systems. Management believes that the cost of compliance will be minimal.
As its management information systems are warranted to be compliant or are
represented to be compliant in upgrades the Company will receive in 1999, the
Company has not incurred, nor does it expect to incur any significant
incremental costs to modify or replace such systems to make them compliant.
Management does not currently believe that the amount of non-compliant equipment
used in other systems will be found to be significant, nor will the cost to
modify or replace such equipment be material.
Management expects to obtain confirmation from its major suppliers and
customers that they also are or will be Y2K compliant. The costs of seeking such
confirmation are expected to be minimal. Management believes that it will not be
practical to independently verify the responses because it does not believe that
the Company would be given access to carry out such verification or that the
costs of doing so would be affordable. The cost of replacing non-compliant or
non-responsive suppliers and customers will not be possible to determine until
the review process has been completed. Any Y2K problems that do occur will
likely manifest themselves in reduced production through equipment shut downs or
impaired liquidity through inability of customers to take delivery of production
or process payments. The Company plans to establish contingency plans once its
confirmation program is complete and the risks have been more fully quantified.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
None
15
<PAGE> 18
NATIONAL ENERGY GROUP, INC.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On August 30, 1995, the Company filed a lawsuit in the District Court
of Ector County, Texas, against R.E. Steakley in which the Company seeks to
enjoin Mr. Steakley from interfering with its operations on the surface property
controlled by Mr. Steakley. The lawsuit alleges tortuous interference with the
Company's access to its facilities and wrongful conduct with respect to the
Company's personnel.
On August 31, 1995, R.E. Steakley and N.M. Steakley filed a lawsuit in
the District Court of Harris County, Texas, against Amoco Production Company,
Phillips Petroleum Company, the Company, and others. The lawsuit alleges certain
environmental claims and related tortuous and contractual claims and seeks
unspecified damages. On December 19, 1996, the Court in Harris County, Texas,
signed an order transferring the R.E. Steakley claim to the court in Ector
County, Texas as a part of the Company's claim against R.E. Steakley.
Subsequently, R.E. Steakley filed a Fourth Amended Original Answer and Original
Counterclaims against the Company in Ector County District Court in which he
reasserts the claims filed in the Harris County action. The Company believes
that it is operating in compliance with applicable environmental laws and
regulations and believes, based on the advice of counsel, that the ultimate
resolution of the lawsuit will not have a material effect on the Company's
financial condition or results of operations.
The Company is not a defendant in any additional pending legal
proceedings other than routine litigation incidental to its business. While the
ultimate results of these proceedings cannot be predicted with certainty, the
Company does not believe that the outcome of these matters will have a material
adverse effect on the Company.
ITEM 5. OTHER INFORMATION
The National Association of Securities Dealers and Automated Quotations
has given notice to the Company that its common stock was delisted, at the close
of business November 9, 1998 for failure to maintain a minimum bid price
pursuant to Rule 4450(a)(5) and failure to meet the net tangible asset test
pursuant to Rule 4450 (a)(3). Nasdaq further advised that the Nasdaq Listing and
Hearing Review Counsel may, on its own motion, review the decision within 45
days. Additionally, the Company may request the Review Counsel to review the
decision. However, the Company has no plans to request a review.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The list of exhibits required by Item 601 of Regulation S-K and filed
as part of this report is set forth in the Index to Exhibits.
(b) No reports on Form 8-K were filed during the nine months ended
September 30, 1998.
16
<PAGE> 19
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NATIONAL ENERGY GROUP, INC.
By: /s/ Miles D. Bender November 16, 1998
------------------------------
Miles D. Bender
Chairman, President and
Chief Executive Officer
By: /s/ Melissa H. Rutledge November 16, 1998
------------------------------
Melissa H. Rutledge
Vice President, Controller and
Chief Accounting Officer
17
<PAGE> 20
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
<S> <C>
2.1 Agreement and Plan of Merger, dated June 6, 1996, among the Company,
NEG-OK, Inc. ("NEG-OK"), and Alexander Energy Corporation ("Alexander") (1)
2.2 First Amendment to Agreement and Plan of Merger, dated as of June 20, 1996,
among the Company, NEG-OK, and Alexander (2)
2.3 Mutual Waiver Agreement dated as of August 29, 1996 by and among the
Company, NEG-OK and Alexander (3)
3.1 Certificate of Incorporation of the Company, which includes the Certificate
of Incorporation of the Company filed with the Secretary of State of
Delaware on November 20, 1990 (4), the Certificate of Elimination of the
Redeemable Convertible Preferred Stock, Series A of the Company, filed with
the office of the Secretary of State of the State of Delaware on June 2,
1994 (3), the Certificate of Amendment of Certificate of Incorporation of
the Company, filed with the office of the Secretary of State of the State
of Delaware on August 29, 1996 (3), the Certificate of Designations of the
Company of 10% Cumulative Convertible Preferred Stock, Series B (5), the
Certificate of Designations of the Company of 10 1/2% Cumulative
Convertible Preferred Stock, Series (6), the Certificate of Designations of
the Company of Convertible Preferred Stock, Series D (3), and the
Certificate of Designations of the Company of Convertible Preferred Stock,
Series E (3)
3.2 By-laws of the Company (4)
4.1 Certificate of Designations of the Company of 10% Cumulative Convertible
Preferred Stock, Series B (5)
4.2 Certificate of Designations of the Company of 10 1/2 % Cumulative
Convertible Preferred Stock, Series C (6)
4.3 Certificate of Designations of the Company of Convertible Preferred Stock,
Series D (3)
4.4 Certificate of Designations of the Company of Convertible Preferred Stock,
Series E (3)
4.5 Indenture dated as of November 1, 1996, among the Company, National Energy
Group of Oklahoma, Inc. (the "Guarantor"), formerly NEG-OK, and BankOne,
Columbus, N.A. (7)
4.6 Indenture dated August 21, 1997, among the Company and Bank One, N.A. (8)
11.1 Computation of Earnings Per Share (9)
27.1 Financial Data Schedule (10)
</TABLE>
- -----------
(1) Incorporated by reference to the Company's Registration Statement on Form
S-4 (No. 333-9045), dated July 29, 1996.
(2) Incorporated by reference to Amendment No. 1 to the Company's Registration
Statement on Form S-4 (No. 333-9045), dated August 7, 1996.
(3) Incorporated by reference to the Company's Current Report on Form 8-K,
dated August 29, 1996.
(4) Incorporated by reference to the Company's Registration Statement on Form
S-4 (No. 33-38331), dated April 23, 1991.
(5) Incorporated by reference to the Company's Current Report on Form 8-K,
dated June 17, 1994.
(6) Incorporated by reference to the Company's Current Report on Form 8-K,
dated July 18, 1995.
(7) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1996.
(8) Incorporated by reference to the Company's Form S-4 (No. 333-38075), filed
October 16, 1997.
(9) Filed herewith.
(10) The Financial Data Schedule, is filed herewith for EDGAR filings only.
18
<PAGE> 1
EXHIBIT 11.1
NATIONAL ENERGY GROUP, INC.
COMPUTATION OF EARNINGS PER SHARE
NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
BASIC DILUTED
------------ ------------
<S> <C> <C>
Income applicable to common stockholders:
Net income .................................................... $ 2,128,967 $ 2,128,967
Preferred dividend requirements ............................... (708,750) --
------------ ------------
Income applicable to common stockholders ...................... $ 1,420,217 $ 2,128,967
============ ============
Common and common equivalent shares:
Weighted average number of common shares outstanding .......... 36,151,259 36,151,259
Shares issuable upon exercise of options and warrants ......... 4,447,835 4,447,835
Less shares assumed repurchased ............................... (3,379,966) (2,227,349)
------------ ------------
Shares issuable upon conversion of Convertible Preferred Stock:
Series B and Series C ...................................... -- 5,230,769
Series D and Series E ...................................... 6,666,666 6,666,666
------------ ------------
Common and common equivalent shares ........................... 43,885,794 50,269,180
============ ============
Net income per common and common equivalent shares .............. $ .032 $ .042
============ ============
</TABLE>
Note: Diluted net income per common share data is not presented because the
effect of assumed conversion of the Convertible Preferred Stock, Series B
and C, is antidilutive.
THREE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
BASIC DILUTED
------------ ------------
<S> <C> <C>
Income applicable to common stockholders:
Net income .................................................... $ 271,008 $ 271,008
Preferred dividend requirements ............................... (236,250) --
------------ ------------
Income applicable to common stockholders ...................... $ (34,838) $ 271,008
============ ============
Common and common equivalent shares:
Weighted average number of common shares outstanding .......... 36,172,159 36,172,159
Shares issuable upon exercise of options and warrants ......... 4,447,835 4,447,835
Less shares assumed repurchased ............................... (3,379,966) (2,227,349)
------------ ------------
Shares issuable upon conversion of Convertible Preferred Stock:
Series B and Series C ...................................... -- 5,230,769
Series D and Series E ...................................... 6,666,666 6,666,666
------------
------------ ------------
Common and common equivalent shares ........................... 43,906,694 50,290,080
============ ============
Net income per common and common equivalent shares .............. $ .001 $ .005
============ ============
</TABLE>
Note: Diluted net income per common share data is not presented because the
effect of assumed conversion of the Convertible Preferred Stock, Series B
and C, is antidilutive.
<TABLE> <S> <C>
<ARTICLE> CT
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<TOTAL-ASSETS> 155,257
0
172
<COMMON> 405
<OTHER-SE> (54,613)
<TOTAL-LIABILITY-AND-EQUITY> 155,257
<TOTAL-REVENUES> 29,646
<INCOME-TAX> 0
<INCOME-CONTINUING> (101,603)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (101,603)
<EPS-PRIMARY> (2.52)
<EPS-DILUTED> (2.52)
</TABLE>
