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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
SCHEDULE 13E-4
ISSUER TENDER OFFER STATEMENT
(Pursuant to Section 13(e)(1) of the Securities Exchange Act of 1934)
KELLEY OIL & GAS CORPORATION
(Name of Issuer)
KELLEY OIL & GAS CORPORATION
(Name of Person Filing Statement)
$2.625 CONVERTIBLE EXCHANGEABLE PREFERRED STOCK
(Title of Class of Securities)
487-906-208
(CUSIP Number of Class of Securities)
JOHN F. BOOKOUT
CHAIRMAN OF THE BOARD, PRESIDENT AND
CHIEF EXECUTIVE OFFICER
KELLEY OIL & GAS CORPORATION
601 JEFFERSON, SUITE 1100
HOUSTON, TEXAS 77002
(713) 652-5200
(Name, Address and Telephone Number of Person Authorized To Receive Notices
and Communications On Behalf of the Person(s) Filing Statement)
With a Copy to:
CHARLES L. STRAUSS
FULBRIGHT & JAWORSKI L.L.P.
1301 MCKINNEY, SUITE 5100
HOUSTON, TEXAS 77010-3095
(713) 651-5151
JUNE 28, 1999
(Date Tender Offer First Published,
Sent or Given to Security Holders)
CALCULATION OF FILING FEE
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TRANSACTION VALUATION* AMOUNT OF FILING FEE**
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$8,018,029.50 $1,604
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* For the purpose of calculating the filing fee only, this amount is based on
the tender of 1,733,628 shares of the Company's $2.625 Convertible
Exchangeable Preferred Stock.
** The amount of the filing fee equals 1/50th of one percent (1%) of the value
of the securities to be acquired, based on the closing price of such
securities on June 25, 1999, as reported by the Nasdaq Stock Market.
[ ] Check box if any part of the fee is offset as provided by Rule
0-11(a)(2) and identify the filing with which the offsetting fee was
previously paid. Identify the previous filing by registration statement
number, or the form or schedule and the date of its filing.
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This Issuer Tender Offer Statement on Schedule 13E-4 (this "Schedule
13E-4") relates to the offer by Kelley Oil & Gas Corporation, a Delaware
corporation (the "Company"), to exchange 15 shares of its Common Stock, par
value $.01 per share ("Common Stock") for each outstanding share of its $2.625
Convertible Exchangeable Preferred Stock, par value $1.50 per share (the
"Preferred Stock" or the "Securities"), upon the terms and subject to the
conditions set forth in the Offer to Exchange dated June 28, 1999 (the "Offer to
Exchange"), and in the related Letter of Transmittal (the "Letter of
Transmittal"; the Offer to Purchase and the Letter of Transmittal, collectively,
as amended or supplemented from time to time, the "Offer"). The Offer to
Exchange and the Letter of Transmittal are filed as Exhibits (a)(1) and (a)(2)
hereto.
ITEM 1. SECURITY AND ISSUER.
(a) The issuer is Kelley Oil & Gas Corporation, a Delaware corporation, and
the address of its principal executive offices is 601 Jefferson, Suite 1100,
Houston, Texas 77002.
(b) The securities that are the subject of the Offer are shares of
Preferred Stock. The information set forth under the heading "The Offer" in the
Offer to Exchange is incorporated by reference herein.
The Offer is for up to 1,733,628 shares of Preferred Stock, which
constitutes all of the issued and outstanding Securities. The Offer is to
exchange 15 shares of Common Stock for each Share of Preferred Stock validly
tendered and not withdrawn. The Offer is being made to all holders of
Securities, including directors, officers, and affiliates of the Company. The
Company is not aware of any of its directors, officers, or affiliates that will
be tendering Securities pursuant to the Offer.
(c) Information with respect to the principal market for, and the price
range of, the Securities is set forth under the heading "The Offer" in the Offer
to Exchange, which is incorporated by reference herein.
(d) This statement is filed by the Company, the issuer of the Securities.
ITEM 2. SOURCE AND AMOUNT OF FUNDS OR OTHER CONSIDERATION.
No funds will be used as consideration in the Offer.
ITEM 3. PURPOSE OF THE TENDER OFFER AND PLANS OR PROPOSALS OF THE ISSUER OR
AFFILIATE.
Information with respect to the purpose of the Offer and the possible
effects of the Offer is set forth under the heading "Summary" and "Risk Factors"
of the Offer to Exchange, which is incorporated by reference herein. Other than
as indicated in the Offer to Exchange the Company has no current plans or
proposals that relate to or would result in: (a) the acquisition by any person
of additional securities of the Company or the disposition of securities of the
Company; (b) an extraordinary corporate transaction, such as a merger,
reorganization or liquidation, involving the Company or any of its subsidiaries;
(c) a sale or transfer of a material amount of assets of the Company or any of
its subsidiaries; (d) any change in the present Board of Directors or management
of the Company; (e) any material change in the present dividend rate or policy,
or indebtedness or capitalization of the Company; (f) any other material change
in the Company's corporate structure or business; (g) any change in the
Company's charter or bylaws or other actions that may impede the acquisition of
control of the Company by any person; (h) a class of equity security of the
Company being delisted from a national securities exchange or ceasing to be
authorized for quotation in an inter-dealer quotation system of a registered
national securities association; (i) a class of equity security of the Company
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becoming eligible for termination of registration pursuant to Section 12(g)(4)
of the Exchange Act; or (j) the suspension of the Company's obligation to file
reports pursuant to Section 15(d) of the Exchange Act.
ITEM 4. INTEREST IN SECURITIES OF THE ISSUER.
Neither the Company nor any of its subsidiaries nor, to the knowledge of
the Company, any of its executive officers or directors or any associate of any
of the foregoing has engaged in any transactions involving the Securities during
the 40 business days prior to the date hereof. See "Interests of Directors and
Officers; Transactions and Arrangements Concerning Securities" in the Offer to
Exchange, which is incorporated by reference herein.
ITEM 5. CONTRACTS, ARRANGEMENTS, UNDERSTANDINGS OR RELATIONSHIPS WITH RESPECT TO
THE ISSUER'S SECURITIES.
The Company is not a party to any contract, arrangement, understanding, or
relationship relating directly or indirectly to the Offer with respect to any
Securities of the Company.
ITEM 6. PERSONS RETAINED, EMPLOYED, OR TO BE COMPENSATED.
Information with respect to persons employed, compensated, retained, or to
be compensated by the Company to make the solicitations or recommendations in
connection with the Offer is set forth in "Fees and Expenses" in the Offer to
Exchange, which is incorporated by reference herein.
ITEM 7. FINANCIAL INFORMATION.
The financial and pro forma financial information set forth in "Certain
Information Regarding the Company" and the Financial Statements in the Company
Documents, which are attached to the Offer to Exchange, is incorporated by
reference herein.
ITEM 8. ADDITIONAL INFORMATION.
(a) To the best of the Company's knowledge, none of its executive officers,
directors, or affiliates is a party to any material contract, arrangement,
understanding, or relationship between such person and the Company that is
material to a decision by a Holder of Securities whether to hold or tender the
Securities in the Offer.
(b) Information with respect to applicable regulatory requirements is set
forth in "Certain Securities Laws Considerations" in the Offer to Exchange,
which is incorporated by reference herein.
(c) Not applicable.
(d) There are no material legal proceedings related to the Offer.
(e) The Offer to Exchange (including the Company Documents) and Letters of
Transmittal are incorporated in their entirety into this Schedule 13E-4.
ITEM 9. MATERIAL TO BE FILED AS EXHIBITS.
(a) (1) Form of Offer to Exchange dated June 28, 1999.
(2) Form of Letter of Transmittal.
(3) Form of Notice of Guaranteed Delivery.
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(b) Not applicable.
(c) Not applicable.
(d) Not applicable.
(e) Not applicable.
(f) Not applicable.
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SIGNATURE
After due inquiry and to the best of my knowledge and belief, I certify
that the information set forth in this statement is true, complete and correct.
Dated June 28, 1999
KELLEY OIL & GAS CORPORATION
By: /s/ RICK G. LESTER
----------------------------------
Rick G. Lester,
Chief Financial Officer
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EXHIBIT INDEX
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EXHIBIT
NUMBER DESCRIPTION
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(a)(1) -- Form of Offer to Exchange dated June 28, 1999.
(2) -- Form of Letter of Transmittal, together with Guidelines for
Certification of Taxpayer Identification Number on
Substitute Form W-9.
(3) -- Form of Notice of Guaranteed Delivery.
</TABLE>
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EXHIBIT (A)(1)
KELLEY OIL & GAS CORPORATION
OFFER TO EXCHANGE
15 SHARES OF COMMON STOCK,
PAR VALUE $.01 PER SHARE,
FOR EACH OUTSTANDING SHARE OF
$2.625 CONVERTIBLE EXCHANGEABLE PREFERRED STOCK,
PAR VALUE $1.50 PER SHARE
THIS OFFER WILL EXPIRE AT 12:01 A.M., NEW YORK CITY TIME, ON TUESDAY, JULY 27,
1999 UNLESS THE OFFER IS EXTENDED PURSUANT TO THE TERMS HEREOF (SUCH DATE, AS
THE SAME MAY BE EXTENDED, THE "EXPIRATION DATE"). HOLDERS OF PREFERRED STOCK (AS
DEFINED BELOW) MUST VALIDLY TENDER THEIR SHARES OF PREFERRED STOCK ON OR PRIOR
TO THE EXPIRATION DATE IN ORDER TO RECEIVE COMMON STOCK (AS DEFINED BELOW) IN
THE EXCHANGE (AS DEFINED BELOW). TENDERED SHARES OF PREFERRED STOCK MAY BE
WITHDRAWN AT ANY TIME PRIOR TO THE EXPIRATION DATE.
KELLEY OIL & GAS CORPORATION, a Delaware corporation (the "Company"),
hereby offers (the "Offer to Exchange") to exchange (the "Exchange") 15 shares
of its Common Stock, par value $.01 per share ("Common Stock"), for each
outstanding share of the Company's $2.625 Convertible Exchangeable Preferred
Stock, par value $1.50 per share ("Preferred Stock"), validly tendered. Holders
of Preferred Stock are sometimes referred to herein collectively as "Holders"
and each as a "Holder". The Company will accept all Preferred Stock validly
tendered for Exchange and not withdrawn as of the Expiration Date, upon the
terms and subject to the conditions set forth herein and in the accompanying
Letter of Transmittal (the "Letter of Transmittal"). This Offer to Exchange and
the Letter of Transmittal together constitute the "Offer".
Holders who tender their shares of Preferred Stock will not receive any
dividends with respect to such shares, including dividends accumulated to date.
There can be no assurance that Holders who do not tender their shares of
Preferred Stock will receive any such dividends in the future.
THIS TRANSACTION HAS NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION (THE "COMMISSION") NOR HAS THE COMMISSION PASSED UPON THE
FAIRNESS OR MERITS OF SUCH TRANSACTION NOR UPON THE ACCURACY OR ADEQUACY OF THE
INFORMATION CONTAINED IN THIS DOCUMENT. ANY REPRESENTATION TO THE CONTRARY IS
UNLAWFUL.
Subject to applicable securities laws and the terms set forth in the Offer,
the Company reserves the right to extend the Offer or otherwise to amend the
Offer in any respect.
SEE "RISK FACTORS" BEGINNING ON PAGE 5 AND "CERTAIN UNITED STATES FEDERAL
INCOME TAX CONSEQUENCES" BEGINNING ON PAGE 25 FOR DISCUSSIONS OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED IN EVALUATING THE OFFER.
Requests for additional copies of this Offer to Exchange, the Letter of
Transmittal, the Notice of Guaranteed Delivery and other related documents may
be directed to the Information Agent at the address and telephone number set
forth on the back cover page of this Offer to Exchange. Beneficial owners also
may contact their broker, dealer, commercial bank or trust company for
assistance concerning the Offer.
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The Date of this Offer to Exchange is June 28, 1999
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TABLE OF CONTENTS
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IMPORTANT INFORMATION REGARDING THE OFFER................... 2
ADDITIONAL INFORMATION REGARDING THE COMPANY................ 2
CAUTION AS TO FORWARD-LOOKING STATEMENTS.................... 2
CAUTION AS TO UNAUTHORIZED STATEMENTS....................... 2
SUMMARY..................................................... 3
RISK FACTORS................................................ 5
THE OFFER................................................... 9
Shares of Preferred Stock................................. 9
Terms of the Preferred Stock.............................. 9
Common Stock.............................................. 10
Market for the Common Stock and Preferred Stock and
Related Stockholder Matters............................ 10
Procedures for Tendering Preferred Stock.................. 11
Withdrawal Rights......................................... 13
Extension of the Offer; Amendment......................... 13
Exchange of Preferred Stock; Issuance of Replacement
Certificates for Unexchanged Portions.................. 14
Certain Conditions of the Offer........................... 14
CERTAIN INFORMATION REGARDING THE COMPANY................... 16
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION...... 19
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES....... 25
CERTAIN SECURITIES LAWS CONSIDERATIONS...................... 25
INTERESTS OF DIRECTORS AND OFFICERS; TRANSACTIONS AND
ARRANGEMENTS CONCERNING SECURITIES........................ 26
EFFECTS OF THE OFFER ON THE MARKET FOR PREFERRED STOCK;
REGISTRATION UNDER THE EXCHANGE ACT....................... 26
CERTAIN LEGAL MATTERS; REGULATORY APPROVALS................. 26
EXTENSION OF THE OFFER; TERMINATION; AMENDMENT.............. 26
FEES AND EXPENSES........................................... 27
MISCELLANEOUS............................................... 28
ANNEX A -- Description of Preferred Stock................. A-1
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The following documents (the "Company Documents") are attached hereto:
Annual Report on Form 10-K of Kelley Oil & Gas Corporation for the year
ended December 31, 1998 (the "Annual Report")
Quarterly Report on Form 10-Q of Kelley Oil & Gas Corporation for the
quarter ended March 31, 1999 (the "10-Q")
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IMPORTANT INFORMATION REGARDING THE OFFER
The Company is not aware of any jurisdiction where the making of the Offer
is not in compliance with applicable law. If the Company becomes aware that the
making of the Offer is not in compliance with any jurisdiction's valid
applicable law, the Company will make a good faith effort to comply with such
law. If, after such good faith effort, the Company cannot comply with such law,
the Offer will not be made to (nor will tenders be accepted from or on behalf
of) the holders of Preferred Stock residing in such jurisdiction. If any
jurisdiction's securities or blue sky laws require the Offer to be made by a
licensed broker or dealer, the Offer shall be deemed to be made on the Company's
behalf by one or more registered brokers or dealers licensed under such
jurisdiction's laws.
ADDITIONAL INFORMATION REGARDING THE COMPANY
The Company is subject to the informational filing requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and, in
accordance therewith, is obligated to file reports, proxy statements and other
information with the Commission relating to the Company's business, financial
condition and other matters. Such reports, proxy statements and other
information can be inspected and copied at the public reference facilities
maintained by the Commission at 450 Fifth Street, N.W., Room 2120, Washington,
D.C. 20549; at its regional offices located at 500 West Madison Street, Suite
1400, Chicago, Illinois 60661-2511 and 7 World Trade Center, New York, New York
10048. Copies of such material also may be obtained by mail, upon payment of the
Commission's customary charges, from the Public Reference Section of the
Commission at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549.
The Commission also maintains a Web site on the World Wide Web at
http://www.sec.gov that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Commission.
CAUTION AS TO FORWARD-LOOKING STATEMENTS
Statements contained in this Offer to Exchange, the Company Documents,
other materials related to the Offer or other materials filed or to be filed by
the Company with the Commission (as well as information included in oral or
other written statements made or to be made by the Company or its
representatives) relating to matters such as the Company's ability to repay its
debt obligations as they mature, anticipated operating and financial
performance, business prospects, developments and results of the Company are
"forward-looking statements". Actual performance, prospects, developments and
results may differ materially from any or all anticipated performance,
prospects, developments and results due to economic conditions and other risks,
uncertainties and circumstances partly or totally outside the control of the
Company, including rates of inflation, crude oil and natural gas prices,
uncertainty of reserve estimates, rates and timing of future production of oil
and natural gas, exploratory and development activities, acquisition risks and
activities, changes in the level and timing of future costs and expenses related
to drilling and operating activities and those risks described under "Risk
Factors" beginning on page 4 of this Offer to Exchange.
Words such as "anticipated", "expect", "estimate", "project" and similar
expressions are intended to identify forward-looking statements. Forward-looking
statements include the risks described under "Risk Factors".
CAUTION AS TO UNAUTHORIZED STATEMENTS
THE COMPANY HAS NOT AUTHORIZED ANY PERSON TO MAKE ANY RECOMMENDATION ON
BEHALF OF THE COMPANY AS TO WHETHER HOLDERS SHOULD TENDER OR REFRAIN FROM
TENDERING PREFERRED STOCK PURSUANT TO THE OFFER. THE COMPANY HAS NOT AUTHORIZED
ANY PERSON TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION IN CONNECTION
WITH THE OFFER ON BEHALF OF THE COMPANY OTHER THAN THOSE CONTAINED IN THIS OFFER
TO EXCHANGE OR IN THE LETTER OF TRANSMITTAL. DO NOT RELY ON ANY SUCH
RECOMMENDATION OR ANY SUCH INFORMATION OR REPRESENTATIONS, IF GIVEN OR MADE, AS
HAVING BEEN AUTHORIZED BY THE COMPANY.
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SUMMARY
THE OFFER
This general summary is solely for the convenience of the Holders of shares
of Preferred Stock and is qualified in its entirety by reference to the full
text and more specific details in this Offer to Exchange and the related Letter
of Transmittal.
The Company hereby invites the Holders of its Preferred Stock to tender up
to all of the outstanding shares of Preferred Stock to the Company in exchange
for 15 shares of Common Stock for each share of Preferred Stock validly
tendered, upon the terms and subject to the conditions set forth herein and in
the Letter of Transmittal.
Preferred Stock............ The Preferred Stock is the Company's $2.625
Convertible Exchangeable Preferred Stock par value
$1.50 per share. For a more complete description of
the Preferred Stock, see "Annex A -- Description of
Preferred Stock".
Number of Shares of
Preferred Stock to be
Exchanged................ Up to all of the shares of Preferred Stock
outstanding.
Common Stock Offered in
Exchange................. 15 shares of Common Stock for each share of
Preferred Stock tendered.
How to Tender Preferred
Stock...................... See "The Offer -- Procedures for Tendering
Preferred Stock". Call the Information Agent or
consult your broker for assistance.
Expiration Date............ Tuesday, July 27, 1999, at 12:01 a.m., New York
City time, unless the Offer is extended by the
Company. See "The Offer -- Extension of the Offer;
Amendment".
Exchange Date.............. As soon as practicable after the expiration of the
Offer.
Reasons for the Offer...... Because certain of the Company's indentures
restrict the Company's ability to pay dividends on
preferred stock; to reduce or eliminate dividend
arrearages on the Preferred Stock; and to provide
Holders with greater liquidity on their investment
in the Company.
WITHDRAWAL RIGHTS.......... TENDERED SHARES OF PREFERRED STOCK MAY BE WITHDRAWN
AT ANY TIME PRIOR TO THE EXPIRATION DATE. SEE "THE
OFFER -- WITHDRAWAL RIGHTS".
THE COMPANY
The Company is engaged in the development, exploration, acquisition and
production of oil and natural gas properties, primarily in Louisiana and the
shallow waters of the Gulf of Mexico. The Company's activities historically have
been concentrated on lower-risk development drilling in north Louisiana and
higher impact exploratory drilling in south Louisiana. As of January 1, 1999,
74% of the Company's estimated proved reserves were located in north Louisiana.
The Company had proved reserves of 315 Bcfe at January 1, 1999 and produced
37.8 Bcfe in 1998. At March 31, 1999, the Company had approximately $321 million
of long-term debt. At January 1, 1999, the Company had proved reserves with a
PV-10 Value of $234 million. As of January 1, 1999, the Company held an interest
in 174,556 gross (81,054 net) developed acres and 294,807 gross (90,703 net)
undeveloped acres and an interest in 584 gross (224.5 net) producing wells. For
1998, the Company's capital spending totaled $57 million, approximately 55% of
which was spent on development activities and acquisitions.
In April 1999, the Company entered into an exploration and development
agreement with Phillips Petroleum Company ("Phillips") relating to certain of
the Company's interests in the Bryceland, West Bryceland and Sailes fields in
north Louisiana (the "Phillips Transaction"). As a result of this transaction,
the Company (1) received an $83 million cash payment (subject to post-closing
adjustments), (2) retained a 42 Bcf, 8-year volumetric overriding royalty
interest and a 1% override on the excess production, as defined, applicable to
the transferred property interests and (3) retained 25% of its working interest
in the Cotton Valley formation. In addition, Phillips will, at its risk and
expense, operate, develop, exploit and explore the properties thereby relieving
the Company of significant operating, exploration and development costs in the
future. The effective date of the transaction was May 1, 1999 and it closed on
May 17, 1999. Following the
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Phillips Transaction, approximately 85% of the Company's reserves are natural
gas and 74% are proved developed.
In April 1999, the Company negotiated a private offering of $135 million
principal amount, 14% Senior Secured Notes due 2003 maturing at 105% of stated
principal amount (the "14% Notes"). The 14% Notes are secured by a first lien on
substantially all of the Company's proved oil and natural gas properties
remaining after the sale to Phillips and are guaranteed by three entities
wholly-owned by the Company. As required pursuant to the terms of the indenture
governing the 14% Notes, the Company has offered to repurchase $35 million
principal amount of the 14% Notes at a repurchase price equal to 104% of the
stated principal amount, plus accrued and unpaid interest to the date of the
repurchase within 30 days of such closing. Such repurchase is expected to close
by June 30, 1999.
In April 1999, the Company began an offer to purchase ("Offer to Purchase")
the outstanding principal amounts of its 7 7/8% Convertible Subordinated Notes
due December 15, 1999 and its 8 1/2% Convertible Subordinated Debentures due
April 1, 2000 (collectively, the "Securities") at a price equal to $590 per
$1,000 principal amount. On May 17, 1999, the Company funded the repurchase of
$46.1 million of the Securities through the Offer to Purchase and will recognize
an extraordinary gain of approximately $18.9 million in the second quarter of
1999.
The net proceeds from the combination of these transactions and cash on
hand were used by the Company to repay all borrowings outstanding under its
credit facility of $115.5 million plus accrued interest, to fund cash collateral
for a $1.5 million letter of credit (which was subsequently increased to $6.1
million), and to fund the repurchase of $46.1 million of Securities under the
Offer to Purchase, all at May 17, 1999. The remaining net proceeds and cash flow
from operations will be used to repurchase up to $35 million of 14% Notes at
104% of their stated principal amount and for general corporate purposes.
For additional information concerning the Company, see "Certain Information
Regarding the Company", "Unaudited Pro Forma Consolidated Financial Information"
and the Company Documents.
REASONS FOR THE OFFER
The Company is making the Offer at this time because:
- The indentures governing the Company's indebtedness that is senior to the
Preferred Stock restrict the payment of dividends on the Preferred Stock.
- The Exchange will reduce or eliminate dividend arrearages (which
currently aggregate approximately $6.8 million) on the Preferred Stock.
- The Exchange provides a means for Holders to gain greater liquidity on
their investment in the Company at a significant premium to the current
trading value of the Preferred Stock.
The Offer also allows a participating Holder the opportunity to receive
significantly more shares of Common Stock than such Holder would be entitled to
receive under the conversion provisions of the Preferred Stock. Absent the Offer
to Exchange, each share of Preferred Stock is currently convertible into 3.47
shares of Common Stock. To the extent a Holder elects not to tender Preferred
Stock pursuant to the Offer and the Offer is completed, the reduced amount of
outstanding Preferred Stock may result in further reduced trading activity,
which could adversely affect the market for the Preferred Stock. Such
non-tendering Holder also would remain subject to the risk that the Company's
financial condition and depressed industry conditions would continue to make it
unable to pay dividends and arrearages on the Preferred Stock.
SEE "RISK FACTORS" BEGINNING ON PAGE 5 AND "CERTAIN FEDERAL INCOME TAX
CONSEQUENCES" BEGINNING ON PAGE 25 FOR DISCUSSIONS OF CERTAIN FACTORS THAT
SHOULD BE CONSIDERED IN EVALUATING THE OFFER.
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RISK FACTORS
Holders should consider carefully the following factors, as well as the
other information contained in this Offer to Exchange and the Company Documents.
SUBSTANTIAL LEVERAGE; INABILITY TO SERVICE DEBT; INABILITY TO PAY DIVIDENDS ON
PREFERRED STOCK; LACK OF LIQUIDITY AND SUBSTANTIAL CAPITAL REQUIREMENTS
As of March 31, 1999, the Company had approximately $328 million principal
amount of debt outstanding, stockholders' deficit of approximately $78 million
and cash on hand of approximately $6.7 million. On May 17, 1999, the Company
repaid the entire $115.5 million of borrowings outstanding under its revolving
credit facility (the "Credit Facility") using proceeds from the sale of
$135,000,000 stated principal amount of its 14% Notes and funded the repurchase
of $46.1 million principal amount of its 8 1/2% Convertible Subordinated
Debentures due 2000 and 7 7/8% Convertible Subordinated Notes due 1999 at a cost
of $27.2 million using proceeds from the Phillips Transaction. The Company
anticipates that it will fund its future debt service payments with the net cash
proceeds remaining from sale of the 14% Notes and the Phillips Transaction and
cash flow from operations. However, there can be no assurance that the Company
will have sufficient funds to make all of its future debt service payments. If
the Company is not able to meet its debt service obligations, the Company may be
required to refinance or restructure all or a portion of its indebtedness, to
sell assets, to reduce or delay planned capital expenditures or to seek
protection under the federal bankruptcy laws.
Under the Company's Certificate of Designations that sets forth the rights
and preferences with respect to the Preferred Stock, Holders of Preferred Stock
are entitled to receive a dividend of $2.625 per annum, when, as and if declared
by the Board of Directors of the Company out of funds legally available
therefor, for each share of Preferred Stock held. No dividends have been paid by
the Company on the Preferred Stock since April 30, 1998. Such dividends are
cumulative and, as of the date hereof, the Company is in arrears as to $3.94 per
share, or an aggregate of $6.8 million, with respect to such dividends. Holders
who tender their shares of Preferred Stock will not receive any such accrued but
unpaid dividends with respect to such shares. Indentures governing the Company's
outstanding debt effectively prohibit the Company from paying dividends on the
Preferred Stock. There can be no assurance that Holders who do not tender their
shares of Preferred Stock will receive any such dividends in the future.
In the currently depressed oil and natural gas industry, the Company has
limited cash flow for capital expenditures. The ability of the Company to
service its debt levels and to finance capital expenditures depends
significantly on various factors including the continuation of current price
levels for oil and natural gas. The Company does not have access to a revolving
credit facility to supplement its cash needs. The Company is subject to various
commodity and economic factors beyond its control that may have an impact on its
ability to exploit its exploration prospects. The Company is dependent upon its
ability to obtain financing for acquiring, exploring and developing oil and
natural gas properties beyond its internally generated cash flow. Historically,
the Company has financed these activities primarily through the issuance of debt
and equity securities, through various credit facilities and with internally
generated funds. The Company currently has plans for substantial capital
expenditures to continue its development and exploration activities. The
Company's ability to expend the capital necessary to undertake or complete
future activities is limited. No assurance can be given that the Company will
have adequate funds available to it to carry out its strategy. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" in the Annual Report and the
10-Q.
RELINQUISHMENT OF ACCRUED AND FUTURE DIVIDENDS
Holders who participate in the Exchange will relinquish all rights to
accumulated dividends (which currently aggregate approximately $6.8 million) and
will forego the right to any future dividends on the Preferred Stock.
PLANNED REVERSE STOCK SPLIT
The Company expects to effect a 1 for 10 reverse stock split on July 30,
1999. There can be no assurance that, following such action, the Common Stock
will trade at ten times its trading price prior to such action or that the
liquidity of the Common Stock will not be reduced.
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RESTRICTIVE DEBT COVENANTS
The Company is subject to a number of significant covenants in its debt
agreements that, among other things, restrict the ability of the Company and its
subsidiaries to dispose of assets, incur capital expenditures, incur additional
indebtedness, repay other indebtedness, incur liens, enter into certain
investments or acquisitions, repurchase or redeem capital stock, pay dividends,
engage in mergers or consolidations, or engage in certain transactions with
subsidiaries and affiliates and that otherwise restrict corporate activities.
There can be no assurance that such restrictions will not adversely affect the
Company's ability to finance its future operations or capital needs or engage in
other business activities that may be in the best interest of the Company.
LACK OF ACCESS TO EQUITY CAPITAL
The market price for the Company's Common Stock has been substantially
depressed for an extended period of time, which has prevented the Company from
seeking additional capital through sales of equity. Given the substantial
leverage of the Company and other relevant market factors, it is unlikely that
the Company will be able to raise equity capital in the foreseeable future.
LIMITED TRADING MARKET
To the extent that Preferred Stock is tendered and accepted for payment
pursuant to the Offer, the trading volume of Preferred Stock that remains
outstanding could be more limited than historical levels. The extent of the
market for the Preferred Stock and the availability of market quotations will
depend upon the number of Holders of the Preferred Stock remaining at such time,
the interest in maintaining a market in the Preferred Stock on the part of
securities firms and other factors. As a result, there can be no assurance that
any trading market for the Preferred Stock will exist after consummation of the
Offer. A reduced trading volume also may make the trading price of Preferred
Stock that is not purchased in the Offer more volatile.
DEPLETION OF RESERVES; NECESSITY OF SUCCESSFUL EXPLORATION AND DEVELOPMENT
Producing oil and natural gas reservoirs generally are characterized by
declining production rates that vary depending upon reservoir characteristics
and other factors. The Company's future oil and natural gas reserves and
production, and, therefore, cash flow and income, are highly dependent upon the
Company's success in efficiently developing its current reserves and acquiring
additional reserves that are economically recoverable.
UNCERTAINTIES IN ESTIMATING RESERVES AND FUTURE NET CASH FLOWS
There are numerous uncertainties in acquiring valuable oil and natural gas
prospects and successfully exploring and developing them, in estimating
quantities of proved reserves believed to have been discovered and projecting
future rates of production and the timing of development expenditures, including
many factors beyond the control of the Company. The reserve data set forth in
the Offer to Exchange and the Company Documents are only estimates. Reserve
estimates are inherently imprecise and may be expected to change as additional
information becomes available. Furthermore, estimates of oil and natural gas
reserves, of necessity, are projections based on engineering data, and there are
uncertainties inherent in the interpretation of such data as well as the
projection of future rates of production and the timing of development
expenditures. Reservoir engineering is a subjective process of estimating
underground accumulations of oil and natural gas that cannot be measured
exactly, and the accuracy of any reserve estimate is a function of the quality
of available data and of engineering and geological interpretation and judgment.
Accordingly, estimates of the economically recoverable quantities of oil and
natural gas attributable to any particular group of properties, classifications
of such reserves based on risk of recovery and estimates of the future net cash
flows expected therefrom prepared by different engineers or by the same
engineers at different times may vary substantially. There also can be no
assurance that the reserves set forth in the Offer to Exchange and the Company
Documents will ultimately be produced or that the proved undeveloped reserves
set forth in the Offer to Exchange and the Company Documents will be developed
within the periods anticipated. It is likely that variances from the estimates
will be material. In addition, the estimates of future net cash flows from
proved reserves of the Company and the present value thereof are based upon
certain assumptions about future production levels, prices and costs that may
not be correct when judged against actual subsequent experience.
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<PAGE> 8
The Company emphasizes with respect to the estimates prepared by independent
petroleum engineers that the estimated future net cash flows should not be
construed as representative of the fair market value of the proved reserves
owned by the Company since estimated future net cash flows are based upon
projected cash flows that do not provide for changes in oil and natural gas
prices from those in effect on the date indicated or for escalation of expenses
and capital costs subsequent to such date. The meaningfulness of such estimates
is highly dependent upon the accuracy of the assumptions upon which they were
based. Actual results will differ, and are likely to differ materially, from the
results estimated. The Company's operations in south Louisiana in recent years
are illustrative of these uncertainties. Accordingly, Holders are cautioned not
to place undue reliance on the reserve data included in the Offer to Exchange
and the Company Documents.
VOLATILITY OF OIL, NATURAL GAS AND NATURAL GAS LIQUIDS PRICES
The Company's financial results are affected significantly by the prices
received for its oil, natural gas and natural gas liquids production.
Historically, the markets for oil, natural gas and natural gas liquids have been
volatile. Throughout 1998 and into the first quarter of 1999, the prices of oil
and natural gas fell sharply and reflected the volatility of commodity prices
and the industry generally. The Company cannot predict future prices of oil and
natural gas. Although both oil and natural gas prices recently have risen,
should prices decline, the Company's results of operations and liquidity could
be adversely impacted. The prices received by the Company for its oil, natural
gas and natural gas liquids production and the levels of such production are
subject to government regulation, legislation and policies. The Company's future
financial condition and results of operations will depend primarily upon the
prices received for its oil and natural gas production, as well as the costs of
finding, acquiring, developing and producing reserves.
OPERATING HAZARDS AND UNINSURED RISKS
Oil and natural gas drilling activities are subject to numerous risks, many
of which are uninsurable, including the risk that no commercially viable oil or
natural gas production will be obtained; many of such risks are beyond the
Company's control. The decision to purchase, explore or develop a prospect or
property will depend in part on the evaluation of data obtained through
geophysical and geological analyses, production data and engineering studies,
the results of which are often inconclusive or subject to varying
interpretations. The cost of drilling, completing and operating wells is often
uncertain, and overruns in budgeted expenditures are common risks that can make
a particular project uneconomical. Technical problems encountered in actual
drilling, completion and workover activities can delay such activity and add
substantial costs to a project. Further, drilling may be curtailed, delayed or
canceled as a result of many factors, including title problems, weather
conditions, compliance with government permitting requirements, shortages of or
delays in obtaining equipment, reductions in product prices and limitations in
the market for products.
The availability of a ready market for the Company's oil and natural gas
production also depends on a number of factors, including the demand for and
supply of oil and natural gas and the proximity of reserves to pipelines or
trucking and terminal facilities. Natural gas wells may be partially or totally
shut in for lack of a market or because of inadequacy or unavailability of
natural gas pipeline or gathering system capacity.
The Company's oil and natural gas business also is subject to all of the
operating risks associated with the drilling for and production of oil and
natural gas, including, but not limited to, uncontrollable flows of oil, natural
gas, brine or well fluids into the environment (including groundwater and
shoreline contamination), blowouts, cratering, mechanical difficulties, fires,
explosions, pollution and other risks, any of which could result in substantial
losses to the Company. Although the Company maintains insurance at levels that
it believes are consistent with industry practices, it is not fully insured
against all risks. Losses and liabilities arising from uninsured and
underinsured events could have a material adverse effect on the financial
condition and operations of the Company.
GOVERNMENT LAWS AND REGULATIONS
The Company's operations are affected from time to time in varying degrees
by political developments and federal and state laws and regulations. In
particular, oil and natural gas production, operations and economics are or have
been affected by price controls, taxes and other laws relating to the oil and
natural gas industry, by changes in such laws and by changes in administrative
regulations. The Company cannot predict how existing laws and regulations may be
interpreted by enforcement agencies or court rulings, whether
7
<PAGE> 9
additional laws and regulations will be adopted or the effect such changes may
have on the Company's business or financial condition. See "Business and
Properties -- Regulation" in the Annual Report.
The Company's operations are subject to complex and constantly changing
environmental laws and regulations adopted by federal, state and local
governmental authorities. The discharge of oil, natural gas, oil and natural gas
exploration and production wastes or other pollutants into the air, soil or
water may give rise to liabilities on the part of the Company to the government
and third parties and may require the Company to incur costs of remediation. No
assurance can be given that existing environmental laws or regulations, as
currently interpreted or reinterpreted in the future, or future laws or
regulations, will not materially and adversely affect the Company's operations
and financial condition or that material indemnity claims will not arise against
the Company with respect to properties acquired or sold by the Company. See
"Business and Properties -- Regulation" in the Annual Report.
RISKS OF HEDGING TRANSACTIONS
The Company regularly enters into hedging transactions for its natural gas
production and likely will continue to do so in the future. Such transactions
may limit potential gains by the Company if oil and natural gas prices were to
rise substantially over the price established by the hedges and may expose the
Company to the risk of financial loss in certain circumstances, including
possibly instances where the Company's production is less than expected or there
is an unexpected event materially affecting prices. The natural gas swap
agreements generally provide for the Company to receive or make counterparty
payments on the differential between a fixed price and a variable indexed price
for natural gas. The Company is exposed to the credit risk of nonperformance by
its hedging counterparties, which generally can be quantified as the amount of
unrealized gains under the contracts. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Market Risk Disclosure" in
the Annual Report and the 10-Q and Note 10 to the Company's Financial Statements
included in the 10-Q (the "Financial Statements").
COMPETITION
The Company operates in a highly competitive environment with respect to
acquiring reserves, marketing oil and natural gas and securing trained
personnel. Many of the Company's larger competitors possess and employ financial
and personnel resources substantially greater than those available to the
Company. Such companies may be able to pay more for productive oil and natural
gas properties and to define, evaluate, bid for and purchase a greater number of
properties than the Company's financial or personnel resources permit. The
Company's ability to acquire additional reserves in the future will be dependent
upon its ability to evaluate and select suitable properties and to consummate
transactions in a highly competitive environment. In addition, there is
substantial competition for capital available for investment in the oil and
natural gas industry. There can be no assurance that the Company will be able to
compete successfully in the future in acquiring reserves, developing reserves,
marketing hydrocarbons, attracting and retaining quality personnel, and raising
additional capital.
DEPENDENCE ON KEY PERSONNEL
The Company believes that its current operations and future prospects are
dependent to a significant extent upon the efforts of several members of its
senior management team. The loss of the services of certain of these key
individuals could have an adverse effect upon the Company. The Company currently
does not maintain insurance against the loss of any of these individuals.
CONTROL BY PRINCIPAL STOCKHOLDER
Contour Production Company L.L.C. ("Contour") owns approximately 57% of the
outstanding voting power of the Company. Accordingly, Contour is able to control
the election of the Company's directors, the appointment of the Company's
management, operations and affairs and the outcome of any corporate transaction
or other matter submitted to the Company's stockholders for approval, including
a merger, consolidation or sale of all or substantially all of the Company's
assets. Circumstances may occur in which the interests of Contour, as the
majority stockholder of the Company, may conflict with the interests of other
stockholders of the Company.
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<PAGE> 10
THE OFFER
SHARES OF PREFERRED STOCK
Upon the terms and subject to the conditions of the Offer, the Company will
exchange all of the shares of Preferred Stock outstanding, or such lesser number
of shares of Preferred Stock as are validly tendered and not withdrawn prior to
the Expiration Date for Common Stock at the rate of 15 shares of Common Stock
for each share of Preferred Stock validity tendered and not withdrawn.
The term "Expiration Date" means 12:01 a.m. New York City time, on Tuesday,
July 27, 1999, unless and until the Company shall have extended the period of
time during which the Offer will remain open, in which event the term
"Expiration Date" shall refer to the latest time and date at which the Offer, as
so extended by the Company, shall expire. See "-- Extension of the Offer;
Amendment" for a description of the Company's right to extend, delay or amend
the Offer.
This Offer to Exchange and the related Letter of Transmittal are being
mailed to record holders of Preferred Stock and will be furnished to brokers,
banks and similar persons whose names, or the names of whose nominees, appear on
the Company's stockholder lists or, if applicable, who are listed as
participants in a clearing agency's security position listing for subsequent
transmittal to beneficial owners of Preferred Stock.
TERMS OF THE PREFERRED STOCK
The following is a summary of the principal terms and conditions of the
Preferred Stock, as provided in the Company's Certificate of Designation with
respect to the Preferred Stock (the "Certificate of Designation"), which
Certificate of Designation constitutes a part of the Company's Certificate of
Incorporation, as amended. In addition, Holders of Preferred Stock have certain
rights pursuant to the Delaware General Corporation Law.
Number of Shares
Outstanding 1,733,628 shares.
Par Value $1.50 per share.
Dividends Cumulative dividends of $2.625 per share per annum,
accruing each February 1, May 1, August 1 and
November 1 payable when, as and if declared by the
Company's Board of Directors out of funds legally
available therefor.
Restriction on Dividends on
Common Stock No dividends may be declared or paid on the Common
Stock unless all accrued and unpaid dividends on
the Preferred Stock shall have been paid in full.
Optional Redemption The Preferred Stock is redeemable at the option of
the Company at the current redemption price of
$26.05 per share, plus accrued and unpaid
dividends, whether or not declared, to the
redemption date.
Debenture Exchange The Preferred Stock is exchangeable at the option
of the Company for the Company's 10 1/2%
Convertible Subordinated Debentures due 2004 at the
rate of $1,000 principal amount of Debentures for
each 40 shares of Preferred Stock.
Liquidation Preference $25 per share, plus accrued and unpaid dividends,
prior to any payment in respect of Common Stock.
Conversion Rights Holders may at any time convert each share of
Preferred Stock into 3.47 shares of Common Stock.
Voting Rights Holders have one vote for each share of Preferred
Stock held on all matters submitted to a vote of
stockholders, voting as a single class with the
Common Stock.
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<PAGE> 11
Dividend Defaults Holders are entitled to vote separately as a class
to elect two directors if the equivalent of six or
more quarterly dividends (whether or not
consecutive) on the Preferred Stock are in arrears.
As of June 25, 1999, the Company was six quarters
in arrears on its quarterly dividends.
As of June 25, 1999 each share of Preferred Stock had accumulated unpaid
dividends of $3.94. For a more detailed description of the Preferred Stock, see
"Annex A -- Description of Preferred Stock".
COMMON STOCK
The Company is authorized to issue 200,000,000 shares of Common Stock, $.01
par value, of which 126,022,235 shares were outstanding on June 25, 1999. All
shares of Common Stock have equal rights to participate in the distribution of
assets in the event of a liquidation of the Company, subject to the preferences
established on the Preferred Stock. Each holder of Common Stock is entitled to
one vote for each share held on all matters submitted to a vote of the
stockholders, and voting rights for the election of directors are noncumulative.
Shares of Common Stock carry no conversion, preemptive or subscription rights
and are not subject to redemption. All outstanding shares of Common Stock are
fully paid and nonassessable. Although holders of Common Stock are entitled to
receive any dividends declared thereon by the Board of Directors out of legally
available funds, the Company has never paid a cash dividend on its Common Stock
and does not anticipate paying any in the foreseeable future. Payment of
dividends on the Common Stock is also restricted under the Company's credit
agreements.
MARKET FOR THE COMMON STOCK AND PREFERRED STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock and Preferred Stock are traded on the NASDAQ
SmallCap Market under the symbols "KOGC" and "KOGCP". The price ranges presented
below represent high and low sale prices for each quarter, as reported by the
NASDAQ Stock Market. On October 16, 1998, the Company was moved from the NASDAQ
National Market to the NASDAQ SmallCap Market due to the Company's failure to
maintain the minimum per share price requirements.
<TABLE>
<CAPTION>
COMMON STOCK PREFERRED STOCK
MARKET PRICES MARKET PRICES
----------------- -----------------
HIGH LOW HIGH LOW
------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1997:
First quarter............................................... $ 3 1/16 $ 1 7/8 $25 3/4 $23 3/4
Second quarter.............................................. 3 1/16 1 11/16 26 22 1/2
Third quarter............................................... 3 1/4 2 3/16 26 7/8 24 1/4
Fourth quarter.............................................. 3 15/16 2 1/8 25 1/2 21 1/2
1998:
First quarter............................................... $ 2 13/16 $ 1 3/4 $25 3/4 $20 3/4
Second quarter.............................................. 2 13/16 1 15/16 28 1/2 22
Third quarter............................................... 2 5/16 1 23 3/8 16
Fourth quarter.............................................. 1 5/8 15/32 16 1/2 8
1999:
First quarter............................................... $ 31/32 $ 15/32 $10 1/2 $ 3 11/16
Second quarter (through June 25)............................ 13/16 13/32 5 3/8 3 7/16
</TABLE>
As of January 31, 1999, there were approximately 1,495 record holders of
Common Stock and 120 record holders of Preferred Stock.
Dividends on the Preferred Stock accrue quarterly at the rate of $.65625
per share. In January 1996, the Company announced the suspension of dividend
payments on the Preferred Stock to conserve cash. On April 15, 1997, the Board
of Directors of the Company declared a dividend of $2.625 per preferred share
(approximately $4.6 million), which was paid on May 1, 1997. On April 14, 1998,
the Company declared a
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<PAGE> 12
dividend of $2.625 per share of Preferred Stock (approximately $4.6 million),
which was paid on April 30, 1998. The indentures governing the Company's
outstanding debt effectively prohibit the payment of future preferred dividends.
As of May 1, 1999, the total amount of dividend payments in arrears was
approximately $6.8 million, covering six quarters, giving the holders of
Preferred Stock, as a group, the right to elect two additional directors to the
Company's Board of Directors.
PROCEDURES FOR TENDERING PREFERRED STOCK
Proper Tender of Preferred Stock. For shares of Preferred Stock to be
validly tendered pursuant to the Offer, the certificates for such Preferred
Stock, including the required signature guarantee (or confirmation of receipt of
such Preferred Stock pursuant to the procedures for book-entry transfer set
forth below), together with a properly completed and duly executed Letter of
Transmittal (or manually signed facsimile thereof) including any required
signature guarantees or an Agent's Message (as defined below), and any other
documents required by the Letter of Transmittal, must be received prior to 12:01
a.m., New York City time, on the Expiration Date by the Depositary at its
address set forth on the back cover of this Offer to Exchange; or (b) the
tendering Holder must comply with the guaranteed delivery procedure set forth
below.
Signature Guarantees and Method of Delivery. Except as otherwise provided
below, all signatures on the Letter of Transmittal must be guaranteed by a
financial institution (including most commercial banks, savings and loan
associations and brokerage houses) that is an "eligible guarantor institution"
or a member of or participant in a recognized "signature guarantee program"
within the meaning of Rule 17Ad-15 under the Exchange Act (an "Eligible
Institution"), unless: (i) the Letter of Transmittal is signed by the registered
holders(s) of the Preferred Stock (which term, for purposes of this document,
shall include any participant in DTC (as defined below) whose name appears on a
security position listing as the owner of Preferred Stock) tendered herewith and
such holder(s) have not completed the box entitled "Special Payment
Instructions" or the box entitled "Special Delivery Instructions" on the Letter
of Transmittal; or (ii) such shares of Preferred Stock are tendered for the
account of an Eligible Institution. See Instruction 1 of the Letter of
Transmittal. If a certificate for shares of Preferred Stock is registered in the
name of a person other than the person executing a Letter of Transmittal, or if
Common Stock is to be issued, or shares of Preferred Stock not tendered are to
be issued, to a person other than the registered holder, then the certificate
must be endorsed or accompanied by an appropriate stock power, in either case
signed exactly as the name of the registered holder appears on the certificate
or stock power guaranteed by an Eligible Institution.
In all cases, the Exchange for Preferred Stock tendered and accepted
pursuant to the Offer will be made only after timely receipt by the Depositary
of certificates for such shares of Preferred Stock and including the required
signature guarantee (or a timely confirmation of a book-entry transfer of such
shares of Preferred Stock into the Depositary's account at DTC as described
above), a properly completed and duly executed Letter of Transmittal (or
manually signed facsimile thereof) and any other documents required by the
Letter of Transmittal.
THE METHOD OF DELIVERY OF ALL DOCUMENTS, INCLUDING CERTIFICATES FOR SHARES
OF PREFERRED STOCK, THE LETTER OF TRANSMITTAL AND ANY OTHER REQUIRED DOCUMENTS,
IS AT THE ELECTION AND RISK OF THE TENDERING HOLDER. IF DELIVERY IS BY MAIL,
THEN REGISTERED MAIL WITH RETURN RECEIPT REQUESTED, PROPERLY INSURED, IS
RECOMMENDED. IN ALL CASES SUFFICIENT TIME SHOULD BE ALLOWED TO ASSURE THAT
DOCUMENTS ARE RECEIVED BY THE DEPOSITARY PRIOR TO THE EXPIRATION DATE.
Book-Entry Delivery. The Depository Trust Company ("DTC") has authorized
DTC participants that hold Preferred Stock on behalf of beneficial owners of
Preferred Stock through DTC to tender their Preferred Stock as if they were
Holders. To effect a tender, DTC participants should either (i) complete and
sign the Letter of Transmittal or a facsimile thereof, have the signature
thereon guaranteed if required by Instruction 1 of the Letter of Transmittal and
mail or deliver the Letter of Transmittal or such facsimile pursuant to the
procedure set forth above or (ii) transmit their acceptance to DTC through the
DTC Automated Tender Offer Program ("ATOP"), for which the transaction will be
eligible (which acceptance will include an express acknowledgment from the
participant in DTC tendering the Preferred Stock that such participant has
11
<PAGE> 13
received, and agrees to be bound by, the terms of the Letter of Transmittal and
that the Company may enforce such agreement against the participant), and cause
DTC to transfer such Preferred Stock into the Depositary's account in accordance
with DTC's procedures for transfer. The confirmation of a book-entry transfer of
Preferred Stock into the Depositary's account at DTC as described above is
referred to herein as "confirmation of a book-entry transfer".
DELIVERY OF DOCUMENTS TO DTC DOES NOT CONSTITUTE DELIVERY TO THE
DEPOSITARY.
Guaranteed Delivery. Holders whose Preferred Stock certificates are not
immediately available, who cannot deliver their Preferred Stock certificates and
all other required documents to the Depositary, or who cannot complete the
procedure for delivery by book-entry transfer prior to the Expiration Date, must
tender their Preferred Stock pursuant to the guaranteed delivery procedure set
forth in this paragraph. Pursuant to such procedure: (i) such tender must be
made by or through an Eligible Institution; (ii) a properly completed and duly
executed Notice of Guaranteed Delivery substantially in the form provided by the
Company (with any required signature guarantees) must be received by the
Depositary prior to the Expiration Date; and (iii) the certificates for all
physically delivered Preferred Stock certificates in proper form for transfer by
delivery, or a confirmation of a book-entry transfer into the Depositary's
account at DTC of all Preferred Stock delivered electronically, in each case
together with a properly completed and duly executed Letter of Transmittal (or
facsimile thereof) and any other documents required by the Letter of
Transmittal, must be received by the Depositary within three New York Stock
Exchange trading days after the date the Depositary receives such Notice of
Guaranteed Delivery.
For a discussion of certain United States federal income tax consequences
to tendering Holders, see "Certain United States Federal Income Tax
Consequences".
Determination of Validity; Rejection of Preferred Stock; Waiver of Defects;
No Obligation to Give Notice of Defects. All questions as to the number of
shares of Preferred Stock to be accepted and the validity, form, eligibility
(including time of receipt) and acceptance of any tender of shares of Preferred
Stock will be determined by the Company, in its sole discretion, and its
determination shall be final and binding on all parties. The Company reserves
the absolute right to reject any or all tenders of any shares of Preferred Stock
that it determines in its reasonable judgment are not in appropriate form or the
acceptance for Exchange for which maybe unlawful. The Company also reserves the
absolute right in its sole discretion to waive any defect or irregularity in any
tender with respect to any particular shares of Preferred Stock or any
particular Holder. No tender of shares of Preferred Stock will be deemed to have
been properly made until all defects or irregularities have been cured by the
tendering Holder or waived by the Company. None of the Company, the Depositary
or any other person shall be obligated to give notice of any defects or
irregularities in tenders, nor shall any of them incur any liability for failure
to give any such notice.
Tendering Holder's Representation and Warranty; Company's Acceptance
Constitutes an Agreement. A tender of shares of Preferred Stock pursuant to any
of the procedures described above will constitute the tendering Holder's
acceptance of the terms and conditions of the Offer, as well as the tendering
Holder's representation and warranty to the Company that: (a) such Holder has a
net long position in the shares of Preferred Stock being tendered within the
meaning of Rule 14e-4 promulgated by the Commission under the Exchange Act; and
(b) the tender of such shares of Preferred Stock complies with Rule 14e-4. It is
a violation of Rule 14e-4 for a person, directly or indirectly, to tender Notes
for such person's own account unless, at the time of tendering the person so
tendering: (i) has a net long position equal to or greater than the amount of:
(x) shares of Preferred Stock tendered; or (y) other securities convertible into
or exchangeable or exercisable for the shares of Preferred Stock tendered and
will acquire such shares of Preferred Stock for tender by conversion, exchange
or exercise; and (ii) will deliver or cause to be delivered such shares of
Preferred Stock in accordance with the terms of the Offer. Rule 14e-4 provides a
similar restriction applicable to the tender or guarantee of a tender on behalf
of another person. The Company's acceptance for payment of shares of Preferred
Stock tendered pursuant to the Offer will constitute a binding agreement between
the tendering Holder and the Company upon the terms and conditions of the Offer.
12
<PAGE> 14
CERTIFICATES FOR SHARES OF PREFERRED STOCK, TOGETHER WITH A PROPERLY
COMPLETED LETTER OF TRANSMITTAL AND ANY OTHER DOCUMENTS REQUIRED BY THE LETTER
OF TRANSMITTAL, MUST BE DELIVERED TO THE DEPOSITARY AND NOT TO THE COMPANY. ANY
SUCH DOCUMENTS DELIVERED TO THE COMPANY WILL NOT BE FORWARDED TO THE DEPOSITARY
AND THEREFORE WILL NOT BE DEEMED TO BE VALIDLY TENDERED.
WITHDRAWAL RIGHTS
Except as otherwise provided herein, tenders of Preferred Stock pursuant to
the Offer are irrevocable. Preferred Stock tendered pursuant to the Offer may be
withdrawn in accordance with the following procedures at any time prior to the
Expiration Date. Following the Expiration Date, Preferred Stock tendered
pursuant to the Offer and not accepted by the Company for exchange may be
withdrawn at any time after 12:00 midnight, New York City time, on August 23,
1999.
For a withdrawal to be effective, a notice of withdrawal must be in
written, telegraphic, or facsimile transmission form and must be received in a
timely manner by the Depositary at its address set forth on the back cover of
this Offer to Exchange. Any such notice of withdrawal must specify the name of
the tendering Holder, the name of the registered Holder (if different from that
of the person who tendered such Preferred Stock), the number of shares of
Preferred Stock tendered, and the number of shares of Preferred Stock to be
withdrawn. If the certificates for shares of Preferred Stock to be withdrawn
have been delivered or otherwise identified to the Depositary, then, prior to
the release of such certificates, the tendering Holder must also submit the
serial numbers shown on the particular certificates for shares of Preferred
Stock to be withdrawn, and the signature on the notice of withdrawal must be
guaranteed by an Eligible Institution (except in the case of Preferred Stock
tendered by an Eligible Institution). If shares of Preferred Stock have been
tendered pursuant to the procedures for book-entry transfer set forth in
"-- Procedures for Tendering Preferred Stock", the notice of withdrawal also
must specify the name and the number of the account at the Book-Entry Transfer
Facility to be credited with the withdrawn Preferred Stock and otherwise comply
with the procedures of such facility. All questions as to the form and validity
(including time of receipt) of notices of withdrawal will be determined by the
Company, in its sole discretion, which determination shall be final and binding.
None of the Company, the Depositary, the Information Agent, or any other person
shall be obligated to give notice of any defects or irregularities in any notice
of withdrawal nor shall any of them incur liability for failure to give any such
notice.
Withdrawals may not be rescinded, and any shares of Preferred Stock
withdrawn will thereafter be deemed not tendered for purposes of the Offer,
unless such withdrawn shares of Preferred Stock are validly retendered prior to
the Expiration Date by again following one of the procedures described under
"-- Procedures for Tendering Preferred Stock".
If the Company extends the Offer, is delayed in its exchange of Preferred
Stock, or is unable to exchange Preferred Stock pursuant to the Offer for any
reason, then, without prejudice to the Company's rights under the Offer, the
Depositary may, subject to applicable law, retain tendered Preferred Stock on
behalf of the Company, and such Preferred Stock may not be withdrawn except to
the extent tendering Holders are entitled to withdrawal rights as described
herein.
EXTENSION OF THE OFFER; AMENDMENT
The Company expressly reserves the right, in its sole discretion, at any
time and from time to time, to extend the period of time during which the Offer
is open and thereby delay acceptance for payment of, and payment for, any shares
of Preferred Stock by giving oral or written notice of such extension to the
Depositary and making a public announcement thereof. The Company further
reserves the right to amend the Offer in any respect. Amendments to the Offer
may be made at any time and from time to time effected by public announcement
thereof, such announcement, in the case of an extension, to be issued no later
than 9:00 a.m., New York City time, on the next business day after the last
previously scheduled or announced Expiration Date. Any public announcement made
pursuant to the Offer will be disseminated promptly to Holders in a manner
reasonably designed to inform Holders of such change. Without limiting the
manner in which the
13
<PAGE> 15
Company may choose to make a public announcement, except as required by
applicable law, the Company shall have no obligation to publish, advertise or
otherwise communicate any such public announcement other than by making a
release to the Dow Jones News Service.
EXCHANGE OF PREFERRED STOCK; ISSUANCE OF REPLACEMENT CERTIFICATES FOR
UNEXCHANGED PORTIONS
For purposes of the Offer, the Company will be deemed to have accepted for
Exchange shares of Preferred Stock that are validly tendered only when, as and
if it gives oral or written notice to the Depositary of its acceptance of such
shares of Preferred Stock for exchange pursuant to the Offer.
Upon the terms and subject to the conditions of the Offer, the Company will
issue shares of Common Stock in exchange for all of the shares of Preferred
Stock accepted for exchange pursuant to the Offer as soon as practicable after
the Expiration Date. In all cases, shares of Common Stock to be issued in
exchange for shares of Preferred Stock will be issued only after timely receipt
by the Depositary of certificates for shares of Preferred Stock (or of a timely
confirmation of a book-entry transfer of such shares of Preferred Stock into the
Depositary's account at DTC), a properly completed and duly executed Letter of
Transmittal (or manually signed facsimile thereof) and any other required
documents.
The Company will issue shares of Common Stock for shares of Preferred Stock
tendered pursuant to the Offer by depositing the aggregate number of shares of
Common Stock therefor with the Depositary, which will act as agent for tendering
Holders for the purpose of receiving shares of Common Stock from the Company and
transferring such Common Stock to tendering Holders.
Holders whose shares of Preferred Stock are tendered only in part will be
issued new certificates representing the number of shares of Preferred Stock
equal to the unexchanged portion of the Preferred Stock surrendered.
CERTAIN CONDITIONS OF THE OFFER
Notwithstanding any other provision of the Offer, the Company shall not be
required to accept for exchange or exchange any shares of Preferred Stock
tendered, and may terminate or amend the Offer, or may postpone the acceptance
for exchange of, or the exchange of shares of Preferred Stock tendered, subject
to Rule 13e-4(f) under the Exchange Act, if at any time on or after the date
hereof, and on or prior to the Expiration Date any of the following events shall
have occurred (or shall have been determined by the Company to have occurred)
that, in the Company's sole discretion (regardless of the circumstances giving
rise thereto, including any action or omission to act by the Company), makes it
inadvisable to proceed with the Offer or with such acceptance for exchange or
exchange:
(a) there shall have been threatened, instituted, or pending, any
action or proceeding by any government or governmental, regulatory or
administrative agency, authority or tribunal or any other person, domestic
or foreign, before any court, authority, agency, or tribunal that directly
or indirectly: (i) challenges the making of the Offer, the acquisition of
some or all of the shares of Preferred Stock pursuant to the Offer, or
otherwise relates in any manner to the Offer; or (ii) in the Company's
reasonable judgment, could materially and adversely affect the business,
condition (financial or other), income, operations, or prospects of the
Company and its subsidiaries, taken as a whole, or otherwise materially
impair in any way the contemplated future conduct of the business of the
Company or any of its subsidiaries or materially impair the contemplated
benefits of the Offer to the Company;
(b) there shall have been any action threatened, pending, or taken, or
approval withheld, or any statute, rule, regulation, judgment, order, or
injunction threatened, proposed, sought, promulgated, enacted, entered,
amended, enforced, or deemed to be applicable to the Offer or the Company
or any of its subsidiaries, by any court or any authority, agency, or
tribunal that, in the Company's reasonable judgment, would or might
directly or indirectly: (i) make the acceptance for exchange of, or
exchange for, some or all of the shares of Preferred Stock illegal or
otherwise restrict or prohibit consummation of the Offer or otherwise
relates in any manner to the Offer; (ii) delay or restrict the ability of
the Company, or render the Company unable, to accept for exchange or
exchange some or all of the shares of Preferred
14
<PAGE> 16
Stock; (iii) materially impair the contemplated benefits of the Offer to
the Company; or (iv) materially and adversely affect the business,
condition (financial or other), income, operations, or prospects of the
Company and its subsidiaries, taken as a whole, or otherwise materially
impair in any way the contemplated future conduct of the business of the
Company or any of its subsidiaries;
(c) a tender or exchange offer with respect to some or all of the
shares of Preferred Stock (other than the Offer), or the Common Stock or a
merger or acquisition proposal for the Company, shall have been proposed,
announced, or made by another person or shall have been publicly disclosed,
or any person or group shall have filed a Notification and Report Form
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 reflecting
an intent to acquire the Company or any of its securities, or the Company
shall have learned that any person or "group" (within the meaning of
Section 13(d)(3) of the Exchange Act) shall have acquired or proposed to
acquire beneficial ownership of more than 5% of the outstanding shares of
Preferred Stock, or any new group shall have been formed that beneficially
owns more than 5% of the outstanding shares of Preferred Stock; or
(d) any change or changes shall have occurred, be pending, or
threatened or be proposed, which have affected or could affect the
business, scope, condition (financial or otherwise), assets, income, level
of indebtedness, operations, prospects, stock ownership or capital
structure of the Company or its subsidiaries which, in the Company's
reasonable judgment, is or may be material to the Company or its
subsidiaries.
The foregoing conditions are for the sole benefit of the Company and may be
asserted by the Company regardless of the circumstances (including any action or
inaction by the Company) giving rise to any such condition, and may be waived by
the Company, in whole or in part, at any time and from time to time in its
reasonable discretion. The Company's failure at any time to exercise any of the
foregoing rights shall not be deemed a waiver of any such right, and each such
right shall be deemed an ongoing right which may be asserted at any time and
from time to time. Any determination by the Company concerning the events
described above will be final and binding on all parties.
15
<PAGE> 17
CERTAIN INFORMATION REGARDING THE COMPANY
RECENT DEVELOPMENTS
The Board of Directors of the Company has approved changing the Company's
name to Contour Energy Co. and its NASDAQ ticker symbol to CONC. Concurrent with
the name change, the Company will establish the authorized capital stock of the
Company at 22 million shares, 20 million of which will be designated as Common
Stock and 2 million of which will be Preferred Stock, and will effect a 1-for-10
reverse split of the Common Stock, reducing the total outstanding shares of
Common Stock from approximately 126 million to approximately 12.6 million. These
actions have been approved by the Company's majority stockholder and are
expected to become effective on July 30, 1999. None of the share information in
this Offer to Exchange has been adjusted to reflect the reverse stock split. If
the Offer is extended beyond the effective time of the reverse stock split, the
Offer will automatically be converted to an offer to exchange 1.5 shares of
Common Stock for each outstanding share of Preferred Stock validly tendered and
not withdrawn.
In May 1999, the Harry S. Bourg #2 development well was spud in the Bayou
Sauveur field and is expected to reach a total depth of 18,500 feet near the end
of July 1999. The well is the first development well in the Bayou Sauveur field.
The Company believes this field has the potential to add significant proved
reserves and value to the Company and to continue the de-leveraging of the
Company commenced with the restructuring actions completed in May 1999. At
year-end 1998, 21.4 bcfe of proved reserves were attributable to the Company's
interest in the Bayou Sauveur field. The Company also plans to spud an
exploration well on its Matagorda Island 620 block in 1999, which the Company
believes has the potential to add significant reserves if successful.
FINANCIAL INFORMATION
The following tables present summary historical consolidated financial data
and the unaudited pro forma consolidated financial data for the Company to give
effect to the Pro Forma Transactions (as defined below). The historical
financial information for the years ended December 31, 1996, 1997 and 1998 and
the three months ended March 31, 1999 is derived from the Financial Statements.
The unaudited pro forma data are derived from the Unaudited Pro Forma
Consolidated Financial Information included elsewhere in this Offer to Exchange.
The unaudited pro forma income statement data and other financial data give
effect to the Pro Forma Transactions as if they occurred on January 1, 1998. The
unaudited pro forma balance sheet data as of March 31, 1999 gives effect to the
Pro Forma Transactions as if they occurred on March 31, 1999. The pro forma
financial information presented below is unaudited and is not necessarily
indicative of financial results that would have occurred had the Pro Forma
Transactions occurred on January 1, 1998 (for income statement data) or March
31, 1999 (for balance sheet data) and should not be viewed as indicative of
operations in future periods. For purposes hereof, "Pro Forma Transactions"
means the sale of the 14% Notes and the application of the proceeds therefrom
(including the Subordinated Repurchase, as defined below), the consummation of
the Phillips Transaction, the Company's outstanding offer to purchase up to $35
million stated principal amount of its 14% Notes (assuming $35 million stated
principal amount of such notes is validly tendered and purchased) and the Offer,
and "Subordinated Repurchase" means the purchase by the Company of an aggregate
of approximately $46.1 million principal of its 7 7/8% Convertible Subordinated
Notes due 1999 and its 8 1/2% Convertible Subordinated Debentures due 2000 at a
purchase price of $590 per $1,000 principal amount thereof pursuant to an Offer
to Purchase dated April 19, 1999, as amended. This information should be read in
conjunction with "Unaudited Pro Forma Consolidated Financial Information"
included elsewhere herein, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included in the Annual Report and the 10-Q
and the Financial Statements.
16
<PAGE> 18
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, THREE MONTHS ENDED
------------------------------------------ MARCH 31, 1999
PRO FORMA ----------------------
1996 1997 1998 1998 HISTORICAL PRO FORMA
-------- -------- -------- --------- ---------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Oil and gas revenues.................. $ 60,854 $ 75,864 $ 79,150 $ 55,338 $ 15,507 $ 11,058
Interest and other income............. 1,429 274 505 1,139 161 338
Gain on sale of oil and gas
properties.......................... -- -- -- 25,495 -- --
-------- -------- -------- -------- -------- --------
Total revenues.................... 62,283 76,138 79,655 81,972 15,668 11,396
-------- -------- -------- -------- -------- --------
Production expenses................... 10,709 10,955 19,878 17,022 5,284 4,567
Exploration expenses.................. 5,438 5,433 12,034 12,034 1,370 1,370
General and administrative expenses... 8,953 6,875 7,077 7,077 1,374 1,374
Interest and other debt expenses...... 24,401 25,071 33,333 40,638 8,666 9,703
Restructuring expenses................ 4,276 -- -- -- -- --
Depreciation, depletion and
amortization........................ 20,440 25,853 38,602 33,032 9,960 8,078
Impairment of oil and gas
properties(1)....................... -- -- 25,738 25,738 -- --
-------- -------- -------- -------- -------- --------
Income (loss) before income taxes and
extraordinary item.................. $(11,934) $ 1,951 $(57,007) $(53,569) $(10,986) $(13,696)
======== ======== ======== ======== ======== ========
OTHER DATA:
Ratio of Earnings to Fixed
Charges(2).......................... N/A 1.1x N/A N/A N/A N/A
EBITDAX(3)............................ $ 42,621 $ 58,308 $ 52,700 $ 57,873 $ 9,010 $ 5,455
</TABLE>
<TABLE>
<CAPTION>
AS OF MARCH 31, 1999
----------------------
HISTORICAL PRO FORMA
---------- ---------
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET AND RELATED DATA:
Cash and cash equivalents................................... $ 6,710 $ 40,254
Total assets................................................ 278,239 259,120
Long-term debt, including current maturities................ 320,810 265,439
Stockholders' deficit....................................... (77,925) (41,673)
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
------------------------
HISTORICAL PRO FORMA
----------- ----------
(IN THOUSANDS)
<S> <C> <C>
PV-10 Value(4).............................................. $234,284 $178,319
</TABLE>
- ---------------
(1) Reflects non-cash impairment charges against the carrying value of proved
and unproved oil and natural gas properties under SFAS 121. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Annual Report and the 10-Q and Note 2 to the Financial
Statements contained in the 10-Q.
(2) For purposes of computing the ratio of earnings to fixed charges, earnings
consist of pre-tax income from continuing operations, excluding interest
income of $0.9 million, $0.2 million, $0.2 million and $0.2 million for the
years ended December 31, 1996, 1997 and 1998, and the three months ended
March 31, 1999, respectively, plus fixed charges. Fixed charges consist of
interest expense and other debt expenses and interest within rental expense
of $0.4 million, $0.3 million, $0.2 million and $0.1 million for the years
ended December 31, 1996, 1997 and 1998 and the three months ended March 31,
1999, respectively. For the years ended December 31, 1996 and 1998, and the
three months ended March 31, 1999, earnings were insufficient to cover fixed
charges by $13.2 million, $57.4 million and $11.3 million, respectively, and
$51.8 million and $14.1 million for the year ended December 31, 1998, Pro
Forma and the three months ended March 31, 1999, Pro Forma, respectively.
(3) EBITDAX is calculated as income (loss) before extraordinary items, excluding
interest expense and other debt expenses, income taxes, exploration
expenses, restructuring expense, depletion, depreciation, amortization and
impairment of oil and gas properties. EBITDAX is not a measure of cash flow
as determined by generally accepted accounting principles ("GAAP"). Certain
items excluded from EBITDAX are significant components in understanding and
assessing a company's financial performance, such as a company's cost of
capital and tax structure, as well as historic costs of depreciable assets,
none of which are components of EBITDAX. The Company has included
information concerning EBITDAX because EBITDAX is a measure used by certain
investors in determining a company's historical ability to service its
indebtedness. EBITDAX should not be considered as an alternative to, or more
meaningful than, net income or cash flow as determined in accordance with
GAAP or as an indicator of the Company's operating performance or liquidity.
EBITDAX is not necessarily comparable to a similarly titled measure of
another company.
(4) "PV-10 Value" means with respect to any oil and gas assets the aggregate net
present value of such oil and gas assets calculated before income taxes and
discounted at 10 percent in accordance with SEC guidelines (including using
pricing provisions based on the most recent year-end prices), as reported in
the most recently prepared or audited report of the Company's independent
petroleum engineers. The PV-10 Value as of December 31, 1998 was calculated
using prices of $10.81 per barrel of oil and $2.07 per Mcf of natural gas.
PV-10 Value is not necessarily indicative of actual future cash flows. See
"Risk Factors -- Uncertainties in Estimating Reserves and Future Net Cash
Flows".
17
<PAGE> 19
SUMMARY RESERVE AND OPERATING DATA
The following table sets forth certain summary reserve and operating data
for each of the three years in the period ended December 31, 1998. The Company's
estimated net proved reserves for each of the three years in the period ended
December 31, 1998 are based on a reserve report prepared by H.J. Gruy &
Associates, Inc. ("Gruy"), independent petroleum engineers. Detailed additional
information concerning the Company's oil and natural gas production activities
is contained in the Supplementary Information in Note 12 to the Financial
Statements.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
ESTIMATED PROVED RESERVES (PERIOD-END):
Oil and other liquid hydrocarbons (Mbbls)................... 1,466 2,953 5,294
Natural gas (Mmcf).......................................... 297,634 354,867 283,559
Natural gas equivalent (Mmcfe).............................. 306,430 372,585 315,323
% proved developed.......................................... 59% 73% 64%
PV-10 Value(1) (in thousands)............................... $518,184 $378,811 $234,284
PRODUCTION DATA:
Oil and other liquid hydrocarbons (Mbbls)................... 232 226 375
Natural gas (Mmcf).......................................... 23,466 30,202 35,557
Natural gas equivalent (Mmcfe).............................. 24,858 31,558 37,807
AVERAGE SALES PRICE PER UNIT:
Oil and other liquid hydrocarbons (per Bbl)................. $ 22.11 $ 19.34 $ 13.09
Natural gas (per Mcf)(2).................................... 2.30 2.27 2.09
Natural gas equivalent (per Mcfe)(2)........................ 2.37 2.31 2.10
AVERAGE PRODUCTION EXPENSES (PER MCFE)...................... $ 0.43 $ 0.35 $ 0.53
GENERAL AND ADMINISTRATIVE EXPENSES (PER MCFE).............. $ 0.36 $ 0.22 $ 0.19
INTEREST EXPENSE (PER MCFE)................................. $ 0.98 $ 0.79 $ 0.88
</TABLE>
- ---------------
(1) PV-10 Value is not necessarily indicative of actual future cash flows. See
"Risk Factors -- Uncertainties in Estimating Reserves and Future Net Cash
Flows".
(2) Includes the effects of the Company's hedging activities.
18
<PAGE> 20
UNAUDITED PRO FORMA
CONSOLIDATED FINANCIAL INFORMATION
The following unaudited pro forma consolidated statements of operations for
the year ended December 31, 1998 and for the three months ended March 31, 1999
give effect to the Pro Forma Transactions as if each had occurred on January 1,
1998. The following unaudited pro forma consolidated balance sheet as of March
31, 1999 gives effect to the Pro Forma Transactions as if each had occurred on
March 31, 1999. The unaudited pro forma consolidated balance sheet as of March
31, 1999 and statement of operations for the year ended December 31, 1998 and
for the three months ended March 31, 1999 are based upon the Financial
Statements.
The pro forma adjustments are based upon available information and certain
assumptions that the Company believes are reasonable. The pro forma financial
information does not purport to represent what the Company's results of
operations would actually have been had the Pro Forma Transactions in fact
occurred on the assumed dates, particularly in light of the nature of the
Phillips Transaction regarding volumes that are contracted to be delivered in
certain years. See footnote 3 to the Pro Forma Statements of Operations. In
addition, the unaudited pro forma consolidated financial statements are not
necessarily indicative of the results of future operations of the Company and
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Annual Report and the 10-Q
and the Financial Statements.
19
<PAGE> 21
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
UNAUDITED PRO FORMA
CONSOLIDATED BALANCE SHEET
AS OF MARCH 31, 1999
<TABLE>
<CAPTION>
ADJUSTMENTS
-----------------------------------------------------
SALE OF PHILLIPS SUBORDINATED OFFER TO
HISTORICAL THE 14% NOTES TRANSACTION REPURCHASE EXCHANGE PRO FORMA
---------- ------------- ----------- ------------ -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents............ $ 6,710 $ 15,250(1) $ 46,600(4) $(28,306)(8) $ 40,254
Accounts receivable.................. 17,926 17,926
Accounts receivable -- drilling
programs........................... 573 573
Prepaid expenses and other current
assets............................. 768 768
--------- --------- -------- -------- ------- ---------
Total current assets............... 25,977 15,250 46,600 (28,306) 59,521
--------- --------- -------- -------- ------- ---------
Unproved properties.................. 38,455 38,455
Properties subject to amortization... 500,980 (57,505)(5) 443,475
Pipelines and other transportation
assets, at cost.................... 1,582 1,582
Furniture, fixtures and equipment.... 3,567 3,567
--------- --------- -------- -------- ------- ---------
Total property and equipment....... 544,584 (57,505) 487,079
Less: Accumulated depreciation,
depletion and amortization......... (293,620) (293,620)
--------- --------- -------- -------- ------- ---------
Total property and equipment,
net.............................. 250,964 (57,505) 193,459
--------- --------- -------- -------- ------- ---------
Other non-current assets, net........ 1,298 6,981(2) (2,139)(6) 6,140
--------- --------- -------- -------- ------- ---------
Total assets................. $ 278,239 $ 22,231 $(13,044) $(28,306) $ 259,120
========= ========= ======== ======== ======= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Accounts payable and accrued
expenses........................... $ 35,078 $ 35,078
Accounts payable -- drilling
programs........................... 276 276
Current portion of long-term debt.... 32,851 (27,486)(8) 5,365
--------- --------- -------- -------- ------- ---------
Total current liabilities.......... 68,205 (27,486) 40,719
--------- --------- -------- -------- ------- ---------
Credit Facility...................... 111,500 (111,500)(3) --
14% Senior Secured Notes............. -- 135,000(3) (35,000)(4) 100,000
10 3/8% Senior Subordinated Notes.... 150,818 150,818
8 1/2% Convertible Subordinated
Debentures......................... 25,641 (16,385)(8) 9,256
--------- --------- -------- -------- ------- ---------
Total long-term debt............... 287,959 23,500 (35,000) (16,385) 260,074
--------- --------- -------- -------- ------- ---------
Total liabilities............ 356,164 23,500 (35,000) (43,871) 300,793
--------- --------- -------- -------- ------- ---------
Preferred stock...................... 2,600 $(2,600)(9) --
Common stock......................... 1,260 260(9) 1,520
Additional paid-in capital........... 300,653 2,340(9) 302,993
Retained earnings.................... (382,438) (1,269)(2) 21,956(7) 15,565(10) (346,186)
--------- --------- -------- -------- ------- ---------
Total stockholders'
deficit.................... (77,925) (1,269) 21,956 15,565 (41,673)
--------- --------- -------- -------- ------- ---------
Total liabilities and
stockholders' deficit...... $ 278,239 $ 22,231 $(13,044) $(28,306) $ 259,120
========= ========= ======== ======== ======= =========
</TABLE>
- ---------------
(1) To record the cash proceeds from the sale of the 14% Notes in excess of the
repayment of the Credit Facility.
(2) To record the debt issuance costs associated with the sale of the 14% Notes
and the extraordinary loss associated with writeoff of the remaining
capitalized issuance costs associated with the Credit Facility.
(3) To record the aggregate stated principal amount of the 14% Notes sold and
the application of a portion of the net proceeds from the sale of the 14%
Notes to repay all outstanding borrowings under the Credit Facility.
(4) To record cash proceeds from the conveyance of oil and gas properties
pursuant to the Phillips Transaction in excess of the repurchase of $35
million stated principal amount of 14% Notes at 104% of the stated
principal amount pursuant to the Offer.
(5) To record the adjustment to oil and gas properties pursuant to the Phillips
Transaction. The Company has not completed its analysis of specific costs
of oil and gas properties and related accumulated depreciation, depletion
and amortization being sold and,
20
<PAGE> 22
accordingly, the reduction of properties subject to amortization is
presented net of estimated accumulated depreciation, depletion and
amortization.
(6) To record the writeoff of debt issuance costs associated with the
repurchase of 14% Notes.
(7) The pro forma adjustment to retained earnings resulting from the Phillips
Transaction includes the following:
<TABLE>
<S> <C>
Gain on the conveyance of the oil and gas properties
pursuant to the Phillips Transaction................... $25,495
Writeoff of a proportionate amount of debt issuance
costs associated with the repurchase of the 14%
Notes.................................................. (2,139)
Extraordinary loss on the repurchase of the 14% Notes... (1,400)
-------
Net gain................................................ $21,956
=======
</TABLE>
(8) To record the repurchase, net of deferred debt expenses, of the $46.1
million aggregate principal amount of subordinated debt repurchased
pursuant to the Subordinated Repurchase.
(9) Reflects the conversion of 1,733,628 shares of Preferred Stock (assumes a
100% tender offer acceptance rate) at the conversion rate of 15:1, into
26,004,420 shares of Common Stock.
(10) The pro forma adjustment to retained earnings resulting from the
Subordinated Repurchase includes the following:
<TABLE>
<S> <C>
Extraordinary gain resulting from the extinguishment of
subordinated debt..................................... $16,663
Commissions............................................ (1,098)
-------
Net gain............................................... $15,565
=======
</TABLE>
21
<PAGE> 23
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
UNAUDITED PRO FORMA
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
ADJUSTMENTS
--------------------------------------------------------------
SALE OF PHILLIPS SUBORDINATED OFFER
HISTORICAL THE 14% NOTES TRANSACTION REPURCHASE TO EXCHANGE PRO FORMA
---------- ------------- ----------- ------------ ----------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Oil and gas revenues..... $ 79,150 $(23,812)(3) $ 55,338
Interest and other
income................. 505 $ 370(1) 264(4) 1,139
Gain on sale of oil and
gas properties......... 25,495(5) 25,495
-------- -------- -------- ------- ------- --------
Total revenues......... 79,655 370 1,947 81,972
-------- -------- -------- ------- ------- --------
Production expenses...... 19,878 (2,856)(6) 17,022
Exploration expenses..... 12,034 12,034
General and
administrative
expenses............... 7,077 7,077
Interest and other debt
expenses............... 33,333 16,529(2) (5,484)(7) $(3,740)(9) 40,638
Depreciation, depletion
and amortization....... 38,602 (5,570)(8) 33,032
Impairment of oil and gas
properties............. 25,738 25,738
-------- -------- -------- ------- ------- --------
Total expenses......... 136,662 16,529 (13,910) (3,740) 135,541
-------- -------- -------- ------- ------- --------
Loss before income
taxes.................. (57,007) (16,159) 15,857 3,740 (53,569)
Income taxes.............
-------- -------- -------- ------- ------- --------
Net loss(11)............. (57,007) (16,159) 15,857 3,740 (53,569)
Preferred stock
dividends.............. (4,550) (6,704)(10) (11,254)
-------- -------- -------- ------- ------- --------
Net loss applicable to
common stock........... $(61,557) $(16,159) $ 15,857 $ 3,740 (6,704) $(64,823)
======== ======== ======== ======= ======= ========
Basic and diluted loss
per common share....... $ (0.49) $ (0.43)
-------- --------
Weighted average common
shares outstanding..... 125,783 26,004(10) 151,787
======== ======= ========
</TABLE>
- ---------------
(1) To record interest income on the net cash proceeds from the sale of the 14%
Notes in excess of the repayment of the Credit Facility.
(2) The pro forma adjustment to interest expense includes the following:
<TABLE>
<S> <C>
14% Notes................................................... $21,172
Amortization of costs from the sale of the 14% Notes........ 2,063
Credit Facility............................................. (8,170)
Writeoff of remaining debt issuance costs associated with
Credit Facility............................................ 1,464
-------
$16,529
=======
</TABLE>
(3) Pursuant to the Phillips Transaction, the Company received an $83 million
cash payment, retained a 42 Bcfe volumetric overriding royalty interest
(VORI) and retained 25% of its interest in the Cotton Valley formation.
This agreement also will allow the Company to forego an estimated $40
million in capital expenditures and an estimated $40 million in operating
costs over the next ten years. The VORI is projected to peak at an average
net production level of 26.5 million cubic feet of gas per day during 2001,
building up from a level of 9.5 million cubic feet per day in 1999, as
follows:
<TABLE>
<CAPTION>
1999 2000 2001 2002 2003 2004 2005 2006
---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Bcf.................................................. 2.29 4.22 9.60 7.78 6.35 3.66 4.63 3.37
</TABLE>
In the aggregate, the Company expects the contracted volumes to approximate
the actual volumes it would have received from its proved producing
reserves over the contract period had the Phillips Transaction not been
consummated.
To record the reduction in 1998 gas revenues resulting from the Company
receiving only 2.29 Bcf from the retained overriding royalty interest
between May 1, 1999 (the effective date of the Phillips Transaction) and
December 31, 1999. Pro forma rules require that the specific terms of the
transaction be reflected. However, management believes that if the Phillips
Transaction had actually occurred on January 1, 1998, the transaction would
have resulted in the Company retaining significantly more volumes than are
to be received in 1999 and, consequently, than are reflected in the 1998
pro forma financial statements, because of both the significant 1998
production from these properties and the significant capital investment
required to achieve such production.
(4) To record interest income on the net cash proceeds from the Phillips
Transaction in excess of the repurchase of $35 million of 14% Notes at 104%
of the stated principal amount.
(5) To record the gain on conveyance of oil and gas properties pursuant to the
Phillips Transaction. The Company has not completed its analysis of the
specific costs of the oil and gas properties and related accumulated
depreciation, depletion and amortization being sold, and, accordingly, the
gain is subject to further adjustment.
(6) To record the reduction in lease operating expenses pursuant to the
Phillips Transaction.
(7) To record the reduction in interest expense related to the repurchase of
14% Notes.
(8) To record the reduction in depreciation, depletion and amortization
pursuant to the Phillips Transaction.
22
<PAGE> 24
(9) The pro forma adjustment to interest expense includes the following:
<TABLE>
<S> <C>
7 7/8% Convertible Subordinated Notes....................... $(2,281)
8 1/2% Convertible Subordinated Debentures.................. (1,459)
-------
$(3,740)
=======
</TABLE>
(10) Reflects the conversion of 1,733,628 shares of Preferred Stock (assumes a
100% tender offer acceptance rate) at the conversion rate of 15:1, into
26,004,420 shares of Common Stock. Also reflects the excess of the fair
value of the exchange offer over the fair value of the original conversion
terms. The entry may be summarized as follows:
<TABLE>
<S> <C>
Elimination of dividends.................................... $ 4,550
Excess fair value........................................... (11,254)
--------
Additional reduction of earnings available to common
stockholders.............................................. $ (6,704)
========
</TABLE>
(11) Net loss from continuing operations excludes the extraordinary loss of
$3,539, from the repurchase of $35 million of 14% Notes at 104% of the
stated principal amount, the extraordinary loss of $1,269 from repayment of
the Credit Facility; and the extraordinary gain of $15,565 from the
repurchase of $46.1 million of the outstanding amount of the 7 7/8%
Convertible Subordinated Notes and 8 1/2% Convertible Subordinated
Debentures.
23
<PAGE> 25
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
UNAUDITED PRO FORMA
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1999
<TABLE>
<CAPTION>
ADJUSTMENTS
-------------------------------------------------
SALE OF
THE 14% PHILLIPS SUBORDINATED OFFER TO
HISTORICAL NOTES TRANSACTION REPURCHASE EXCHANGE PRO FORMA
---------- --------- ----------- ------------ -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Oil and gas revenues...................... $ 15,507 $ (4,449)(3) $ 11,058
Interest and other income................. 161 $ 80(1) 97(4) 338
-------- -------- -------- ------- ------- --------
Total revenues.......................... 15,668 80 (4,352) 11,396
-------- -------- -------- ------- ------- --------
Production expenses....................... 5,284 (717)(5) 4,567
Exploration expenses...................... 1,370 1,370
General and administrative expenses....... 1,374 1,374
Interest and other debt expenses.......... 8,666 3,338(2) (1,371)(6) $ (930)(8) 9,703
Depreciation, depletion and
amortization............................ 9,960 (1,882)(7) 8,078
-------- -------- -------- ------- ------- --------
Total expenses.......................... 26,654 3,338 (3,970) (930) 25,092
-------- -------- -------- ------- ------- --------
Loss before income taxes.................. (10,986) (3,258) (382) 930 (13,696)
Income taxes..............................
-------- -------- -------- ------- ------- --------
Net loss.................................. (10,986) (3,258) (382) 930 (13,696)
Preferred stock dividends................. (1,137) $ 1,137(9)
-------- -------- -------- ------- ------- --------
Net loss applicable to common stock....... $(12,123) (3,258) $ (382) $ 930 $ 1,137 $(13,696)
======== ======== ======== ======= ======= ========
Basic and diluted loss per common
share................................... $ (0.10) $ (0.09)
======== ========
Weighted average common shares
outstanding............................. 126,022 26,004(9) 152,026
======== ======= ========
</TABLE>
- ---------------
(1) To record interest income on the net cash proceeds from the sale of the 14%
Notes in excess of the repayment of the Credit Facility.
(2) The pro forma adjustment to interest expense includes the following:
<TABLE>
<S> <C>
14% Notes................................................... $ 5,293
Amortization of costs from the sale of the 14% Notes........ 516
Credit Facility, including amortization of debt issuance
costs...................................................... (2,471)
-------
$ 3,338
=======
</TABLE>
(3) Pursuant to the Phillips Transaction, the Company received an $83 million
cash payment, retained a 42 Bcfe volumetric overriding royalty interest
(VORI) and retained 25% of its interest in the Cotton Valley formation.
This agreement also will allow the Company to forego an estimated $40
million in capital expenditures and an estimated $40 million in operating
costs over the next ten years. The VORI is projected to peak at an average
net production level of 26.5 million cubic feet of gas per day during 2001,
building up from a level of 9.5 million cubic feet per day in 1999, as
follows:
<TABLE>
<CAPTION>
1999 2000 2001 2002 2003 2004 2005 2006
---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Bcf.................................................. 2.29 4.22 9.60 7.78 6.35 3.66 4.63 3.37
</TABLE>
In the aggregate, the Company expects the contracted volumes to approximate
the actual volumes it would have received from its proved producing
reserves over the contract period had the Phillips Transaction not been
consummated.
To record the reduction in gas revenues for the first quarter of 1999
resulting from the Company receiving only 0.9 Bcf from the retained
overriding royalty interest from January 1, 1999 to March 31, 1999. The gas
volumes represent the first quarters production retained through the VORI.
(4) To record interest income on the net cash proceeds from the Phillips
Transaction in excess of the repurchase of $35 million of 14% Notes at 104%
of the stated principal amount.
(5) To record the reduction in lease operating expenses pursuant to the
Phillips Transaction.
(6) To record the reduction in interest expense related to the repurchase of
14% Notes.
(7) To record the reduction in depreciation, depletion and amortization
pursuant to the Phillips Transaction.
(8) The pro forma adjustment to interest expense includes the following:
<TABLE>
<S> <C>
7 7/8% Convertible Subordinated Notes....................... $ (570)
8 1/2% Convertible Subordinated Debentures.................. (360)
-------
$ (930)
=======
</TABLE>
(9) Reflects the conversion of 1,733,628 shares of Preferred Stock, (assumes a
100% tender offer acceptance rate) at the conversion rate of 15:1, into
26,004,420 shares of Common Stock.
24
<PAGE> 26
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following discussion summarizes certain United States ("U.S.") federal
income tax consequences to Holders of Preferred Stock who exchange their
Preferred Stock for Common Stock pursuant to the Offer to Exchange. This
discussion is based upon the Internal Revenue Code of 1986, as amended (the
"Code"), Treasury Regulations promulgated thereunder, and administrative and
judicial interpretations thereof, all as in effect on the date hereof and all of
which are subject to change, possibly with retroactive effect, or different
interpretations. Tax consequences which are different from or in addition to
those described herein may apply to Holders of Preferred Stock who are subject
to special treatment under the U.S. federal income tax laws, such as non-U.S.
persons, tax exempt organizations, financial institutions, insurance companies,
broker-dealers, Holders who hold their Preferred Stock as part of a hedge,
straddle, wash sale, synthetic security, conversion transaction, or other
integrated investment comprised of Preferred Stock and one or more other
investments, and persons who acquired their shares in compensatory transactions.
This discussion does not address non-U.S. or state or local tax considerations.
THE U.S. FEDERAL INCOME TAX CONSEQUENCES SUMMARIZED BELOW ARE FOR GENERAL
INFORMATION ONLY. THIS DISCUSSION IS NOT A SUBSTITUTE FOR AN INDIVIDUAL ANALYSIS
OF THE TAX CONSEQUENCES OF THE EXCHANGE TO A HOLDER OF PREFERRED STOCK. EACH
HOLDER OF PREFERRED STOCK SHOULD CONSULT A TAX ADVISER REGARDING THE PARTICULAR
FEDERAL, STATE, LOCAL AND NON-U.S. TAX CONSEQUENCES OF THE EXCHANGE IN LIGHT OF
SUCH HOLDER'S OWN SITUATION.
The Exchange should constitute a reorganization under section 368(a) of the
Code. Provided that the Exchange constitutes a reorganization under section
368(a) of the Code, the following U.S. federal income tax consequences will
occur:
1. the Company will not recognize gain or loss as a result of the
Exchange;
2. a Holder of Preferred Stock will not recognize gain or loss upon
the receipt of shares of Common Stock solely in exchange for shares of
Preferred Stock pursuant to the Offer to Exchange;
3. the aggregate tax basis of the shares of Common Stock received by a
Holder in exchange for such Holder's shares of Preferred Stock will be the
same as the aggregate tax basis of the Preferred Stock surrendered in
exchange therefor; and
4. the holding period of the shares of Common Stock received by a
Holder in exchange for such Holder's shares of Preferred Stock will include
the holding period of the shares of the Preferred Stock surrendered in
exchange therefor, provided that such shares of Preferred Stock are held as
capital assets at the effective time of the Exchange.
CERTAIN SECURITIES LAWS CONSIDERATIONS
All of the 1,733,628 shares of Preferred Stock outstanding were issued by a
predecessor of the Company in 1994 pursuant to a public offering registered
pursuant to the Securities Act of 1933, as amended (the "Securities Act"). The
shares of Common Stock to be issued in the Exchange are being offered pursuant
to an exemption from the registration requirements of the Securities Act
pursuant to Section 3(a)(9) of the Securities Act. Section 3(a)(9) provides for
an exemption from registration for any security exchanged by an issuer with its
existing security holders exclusively where no commission or other remuneration
is paid or given directly or indirectly for soliciting such exchange. When
securities are exchanged for other securities of an issuer under Section
3(a)(9), the securities received in essence assume the character of the
exchanged securities for purposes of the Securities Act. Accordingly, the shares
of Common Stock issued in the Exchange to persons or entities not affiliated
with the Company should not be deemed to be "restricted securities" within the
meaning of Rule 144 under the Securities Act, and such shares will be freely
tradeable by such non-affiliated persons or entities.
25
<PAGE> 27
INTERESTS OF DIRECTORS AND OFFICERS;
TRANSACTIONS AND ARRANGEMENTS CONCERNING SECURITIES
The Company is not aware of any of its directors, officers, or affiliates
that will be tendering Preferred Stock pursuant to the Offer. Neither the
Company, nor any subsidiary of the Company nor, to the best of the Company's
knowledge, any of the Company's directors or executive officers, nor any
affiliates of any of the foregoing, had any transactions in the Preferred Stock
during the 40 business days prior to the date hereof.
EFFECTS OF THE OFFER ON THE MARKET FOR PREFERRED STOCK;
REGISTRATION UNDER THE EXCHANGE ACT
The Company's exchange of shares of Preferred Stock pursuant to the Offer
will reduce the number of shares of Preferred Stock that might otherwise be
traded publicly and may reduce the number of Holders.
The Preferred Stock is registered under the Exchange Act, which requires,
among other things, that the Company furnish certain information to its holders
and the Commission and comply with the Commission's proxy rules in connection
with meetings of the Company's stockholders. The Company believes that its
exchange of Common Stock for Preferred Stock pursuant to the Offer may result in
the Preferred Stock becoming eligible for deregistration under the Exchange Act.
CERTAIN LEGAL MATTERS; REGULATORY APPROVALS
The Company is not aware of any license or regulatory permit that appears
to be material to the Company's business that might be adversely affected by the
Company's acquisition of Preferred Stock as contemplated herein or of any
approval or other action by any government or governmental, administrative, or
regulatory authority or agency, domestic or foreign, that would be required for
the acquisition or ownership of Preferred Stock by the Company as contemplated
herein. Should any such approval or other action be required, the Company
presently contemplates that such approval or other action will be sought. The
Company is unable to predict whether it may determine that it is required to
delay the acceptance for exchange of or exchange of Preferred Stock tendered
pursuant to the Offer pending the outcome of any such matter. There can be no
assurance that any such approval or other action, if needed, would be obtained
or would be obtained without substantial conditions, or that the failure to
obtain any such approval or other action might not result in adverse
consequences to the Company's business. The Company's obligations under the
Offer to accept for exchange and exchange shares of Preferred Stock are subject
to certain conditions. See "The Offer -- Certain Conditions of the Offer".
EXTENSION OF THE OFFER; TERMINATION; AMENDMENT
The Company expressly reserves the right, in its sole discretion, at any
time and from time to time, and regardless of whether or not any of the events
set forth under "The Offer -- Certain Conditions of the Offer" shall have
occurred or shall be deemed by the Company to have occurred, to extend the
period of time during which the Offer is open and thereby delay acceptance for
exchange, and exchange for, any shares of Preferred Stock by giving oral or
written notice of such extension to the Depositary and making a public
announcement thereof. The Company also expressly reserves the right, in its sole
discretion, to terminate the Offer and not accept for exchange or exchange any
shares of Preferred Stock not theretofore accepted for exchange or exchanged or,
subject to applicable law, to postpone exchange of shares of Preferred Stock
upon the occurrence of any of the conditions specified under "The
Offer -- Certain Conditions of the Offer" hereof by giving oral or written
notice of such termination or postponement to the Depositary and making a public
announcement thereof. The Company's reservation of the right to delay exchange
for shares of Preferred Stock which it has accepted for exchange is limited by
Rule 13e-4(f)(5) promulgated under the Exchange Act, which requires that the
Company must pay the consideration offered or return the Preferred Stock
tendered promptly after termination or withdrawal of a tender offer. Subject to
compliance with applicable law, the Company further reserves the right, in its
reasonable discretion, and regardless of whether any of the events set forth
under the caption "The Offer -- Certain Conditions of the Offer" shall have
occurred or shall be deemed by the Company to have occurred, to amend the Offer
in any respect (including, without
26
<PAGE> 28
limitation, by decreasing or increasing the consideration offered in the Offer
to holders of Preferred Stock or by decreasing the number of shares of Preferred
Stock being sought in the Offer). Amendments to the Offer may be made at any
time and from time to time effected by public announcement thereof, such
announcement, in the case of an extension, to be issued no later than 9:00 a.m.,
New York City time, on the next business day after the last previously scheduled
or announced Expiration Date. Any public announcement made pursuant to the Offer
will be disseminated promptly to Holders in a manner reasonably designed to
inform Holders of such change. Without limiting the manner in which the Company
may choose to make a public announcement, except as required by applicable law,
the Company shall have no obligation to publish, advertise, or otherwise
communicate any such public announcement other than by issuing a press release
to the Dow Jones News Service.
If the Company materially changes the terms of the Offer or the information
concerning the Offer, or if it waives a material condition of the Offer, the
Company will extend the Offer to the extent required by Rules 13e-4(c)(2) and
13e-4(e)(2) promulgated under the Exchange Act. These rules require that the
minimum period during which an offer must remain open following material changes
in the terms of the Offer or information concerning the Offer (other than a
change in price or a change in percentage of shares of Preferred Stock sought)
will depend on the facts and circumstances, including the relative materiality
of such terms or information. If: (i) the Company increases or decreases the
price to be paid for shares of Preferred Stock or the number of shares of
Preferred Stock being sought in the Offer; and (ii) the Offer is scheduled to
expire at any time earlier than the tenth business day from, and including, the
date that notice of an increase or decrease is first published, sent, or given
in the manner specified herein, the Offer will then be extended until the
expiration of such ten business days.
FEES AND EXPENSES
The Depositary for the Offer is ChaseMellon Bank, National Association. The
Information Agent for the Offer is D.F. King & Company, Inc. The Company has not
retained any dealer manager or other agent to solicit tenders with respect to
the Offer.
All deliveries, correspondence and questions sent or presented to the
Depositary or the Information Agent relating to the Offer should be directed to
one of the addresses or telephone numbers set forth in this Offer to Exchange.
The Information Agent may request brokers, dealers, commercial banks, trust
companies and other nominees to forward this Offer to Exchange and related
materials to beneficial owners of Preferred Stock.
Requests for information or additional copies hereof or the Letter of
Transmittal should be directed to the Information Agent or the Depositary.
The Company will pay the Depositary and the Information Agent reasonable
and customary compensation for their services in connection with the Offer, plus
reimbursement for out-of-pocket expenses. The Company will indemnify the
Depositary against certain liabilities and expenses in connection therewith,
including liabilities under the federal securities laws.
Brokers, dealers, commercial banks and trust companies will be reimbursed
by the Company for customary mailing and handling expenses incurred by them in
forwarding material to their customers.
All fees and expenses of the Company attributable to the Offer will be paid
by the Company.
The Company will not pay fees or commissions to any broker, dealer, or
other person for soliciting tenders of Preferred Stock pursuant to the Offer.
The Company will, however, upon request through the Information Agent, reimburse
brokers, dealers, and commercial banks for customary mailing and handling
expenses incurred by such persons in forwarding the Offer and related materials
to the beneficial owners of Preferred Stock held by any such person as a nominee
or in a fiduciary capacity. No broker, dealer, commercial bank, or trust company
has been authorized to act as the agent of the Company for purposes of the
Offer.
27
<PAGE> 29
The Company will pay or cause to be paid all stock transfer taxes, if any,
on its exchange of Preferred Stock except as otherwise provided in Instruction
10 in the Letter of Transmittal.
MISCELLANEOUS
The Company is not aware of any jurisdiction where the making of the Offer
is not in compliance with applicable law. If the Company becomes aware of any
jurisdiction where the making of the Offer is not in compliance with any valid
applicable law, the Company will make a good faith effort to comply with such
law. If, after such good faith effort, the Company cannot comply with such law,
the Offer will not be made to (nor will tenders be accepted from or on behalf
of) the holders of Preferred Stock residing in such jurisdiction. In any
jurisdiction the securities or blue sky laws of which require the Offer to be
made by a licensed broker or dealer, the Offer shall be deemed to be made on the
Company's behalf by one or more registered brokers or dealers license under the
laws of such jurisdiction.
Pursuant to Rule 13e-4 of the General Rules and Regulations under the
Exchange Act, the Company has filed with the Commission an Issuer Tender Offer
Statement on Schedule 13E-4 which contains additional information with respect
to the Offer. Such Schedule 13E-4, including the exhibits and any amendments
thereto, may be examined, and copies may be obtained, at the same places and in
the same manner as is set forth under the caption "Additional Information
Regarding the Company" with respect to information concerning the Company.
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR MAKE ANY
REPRESENTATION ON BEHALF OF THE COMPANY IN CONNECTION WITH THE OFFER OTHER THAN
THOSE CONTAINED IN THIS OFFER TO EXCHANGE OR IN THE LETTER OF TRANSMITTAL. IF
GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY.
KELLEY OIL & GAS CORPORATION
June 28, 1999
28
<PAGE> 30
Facsimile copies of the Letter of Transmittal will be accepted from
Eligible Institutions. The Letter of Transmittal and certificates for Notes and
any other required documents should be sent or delivered by each Holder or his,
her or its broker, dealer, commercial bank, trust company or other nominee to
the Depositary at its address set forth below.
The Depositary for the Offer is:
ChaseMellon Shareholder Services, L.L.C.
<TABLE>
<S> <C> <C>
BY REGISTERED OR HAND DELIVERY OR
CERTIFIED MAIL: BY OVERNIGHT COURIER: IN PERSON:
Chase Mellon Shareholder Chase Mellon Shareholder Chase Mellon Shareholder
Services, L.L.C Services, L.L.C Services, L.L.C
Post Office Box 3301 85 Challenger Road- 120 Broadway, 13th Floor
South Hackensack, NJ 07606 Mail Drop-Reorg New York, NY 10271
Attn: Reorganization Department Ridgefield Park, NJ 07660 Attn: Reorganization Department
Attn: Reorganization Department
</TABLE>
BY FACSIMILE:
(201) 296-4293
CONFIRM FACSIMILE BY TELEPHONE
(201) 296-4860
The Information Agent for the Offer is:
D.F. KING & CO., INC.
77 Water Street, 20th Floor
New York, New York 10005
Banks and Brokers Call Collect:
(212) 269-5550
or
All Others Call Toll-Free:
(800) 488-8095
Additional copies of the Offer to Purchase, the Letter of Transmittal or
other tender offer materials may be obtained from the Information Agent or the
Depositary and will be furnished at the Company's expense. Questions and
requests for assistance may be directed to the Information Agent as set forth
above. Holders also may contact their local broker, dealer, commercial bank,
trust company or other nominee for assistance concerning the Offer.
<PAGE> 31
ANNEX A
DESCRIPTION OF PREFERRED STOCK
The following summary description of the Preferred Stock is qualified in
its entirety by reference to the Company's Certificate of Incorporation and
related Certificate of Designation governing the Preferred Stock.
General. The Company is authorized to issue 4,269,722 shares of Preferred
Stock, which is a series of preferred stock designated as $2.625 Convertible
Exchangeable Preferred Stock, of which 1,733,628 shares were outstanding as of
June 25, 1999. The Company's Certificate of Incorporation authorizes the Company
to issue, without any action on the part of its stockholders, an aggregate of
20,000,000 shares of preferred stock, par value $1.50 per share. The Company's
Board of Directors has authority to divide the preferred stock into one or more
series and has broad authority to determine the relative rights and preferences
of the shares within each series, including voting rights.
Dividends. Holders of Preferred Stock are entitled to receive, when, as and
if declared by the Board of Directors out of legally available funds, cash
dividends at an annual rate of $2.625 per share, payable quarterly in arrears on
February 1, May 1, August 1 and November 1 of each year, beginning August 1,
1994. If that date is a Saturday, Sunday or legal holiday, however, the dividend
will be payable on the next business day. Dividends will accrue and be
cumulative from the date of first issuance of the Preferred Stock and will be
payable to holders of record on the record date for each dividend payment fixed
by the Board of Directors.
The Preferred Stock has priority as to dividends over the Common Stock and
any other series or class of the Company's stock that ranks junior as to
dividends to the Preferred Stock ("Junior Dividend Stock"). No dividend (other
than dividends payable solely in Common Stock or any other Preferred Stock) may
be paid on Junior Dividend Stock and no purchase, redemption or other
acquisition of Junior Dividend Stock may be made unless all accrued and unpaid
dividends on the Preferred Stock, including the full dividend for the then-
current quarterly dividend period, have been paid or declared and set apart for
payment.
The Company may not pay dividends on any class or series of stock, if
hereafter issued, having parity with the Preferred Stock as to dividends
("Parity Dividend Stock") unless it has paid or declared and set apart for
payment or contemporaneously pays or declares and sets apart for payment all
accrued and unpaid dividends for all prior periods on the Preferred Stock. In
addition, the Company may not pay dividends on the Preferred Stock unless it has
paid or declared and set apart for payment or contemporaneously pays or declares
and sets apart for payment all accrued and unpaid dividends for all prior
periods on the Parity Dividend Stock. Whenever all accrued dividends are not
paid in full on Preferred Stock or any Parity Dividend Stock, all dividends
declared on the Preferred Stock and the Parity Dividend Stock will be declared
and made pro rata so that the amount of dividends declared per share on the
Preferred Stock and the Parity Dividend Stock will bear the same ratio that
accrued and unpaid dividends per share on the Preferred Stock and the Parity
Dividend Stock bear to each other.
If the Company hereafter issues any series or class of stock that ranks
senior as to dividends to the Preferred Stock ("Senior Dividend Stock") and
fails to pay or declare and set apart for payment accrued and unpaid dividends
on any Senior Dividend Stock, the Company may not pay any dividend on the
Preferred Stock. The Company has no Senior Dividend Stock outstanding on the
date of this Prospectus.
The dividend payable on Preferred Stock for each quarterly dividend period
is computed by dividing the annual dividend amount by four. The amount of
dividends payable for the initial dividend period and for any period shorter
than a full quarterly dividend period are computed on the basis of a 360-day
year of twelve 30-day months. No interest is payable on any scheduled Preferred
Stock dividend that may be in arrears.
Under Delaware law, the Company may declare and pay dividends or make other
distributions on its capital stock only out of surplus, as defined in the
Delaware General Corporation Law (the "DGCL"), or if no surplus is available,
out of its net profits for the fiscal year in which the dividend or distribution
is declared and the preceding fiscal year. No dividends or distributions may be
declared or paid if the Company is or would be
A-1
<PAGE> 32
rendered insolvent by virtue of the dividend or distribution, or if the
declaration, payment or distribution would contravene the Company's Certificate
of Incorporation.
Liquidation Rights. In the case of the voluntary or involuntary
liquidation, dissolution or winding up of the Company, holders of Preferred
Stock are entitled to receive the liquidation preference of $25.00 per share,
plus an amount equal to any accrued and unpaid dividends to the payment date,
before any payment or distribution is made to the holders of Common Stock or any
other series or class of stock hereafter issued that ranks junior as to
liquidation rights to the Preferred Stock ("Junior Liquidation Stock"). Holders
of Preferred Stock are not be entitled to receive the liquidation preference of
their shares until the liquidation preference of any other series or class of
stock hereafter issued that ranks senior as to liquidation rights to the
Preferred Stock ("Senior Liquidation Stock"), if any, has been paid in full. The
holders of Preferred Stock and any series or class of stock hereafter issued
that ranks on a parity as to liquidation rights with the Preferred Stock
("Parity Liquidation Stock") are entitled to share ratably, in accordance with
the respective preferential amounts payable on their stock, in any distribution
(after payment of the liquidation preference on any Senior Liquidation Stock)
that is not sufficient to pay in full the aggregate liquidation preference on
both the Preferred Stock and the Parity Liquidation Stock.
After payment in full of the liquidation preference plus any accrued and
unpaid dividends on the Preferred Stock, the holders will not be entitled to any
further participation in any distribution of assets by the Company. Neither a
consolidation or merger of the Company with another entity nor a sale or
transfer of all or part of the Company's assets for cash, securities or other
property will be considered a liquidation, dissolution or winding up of the
Company.
Voting Rights. The Holders of Preferred Stock have one vote for each share
held on all matters submitted to a vote of the stockholders of the Company,
voting as a single class with the outstanding shares of Common Stock, except as
described below or as required by law. Shares of Preferred Stock held by the
Company or any entity controlled by the Company have no voting rights.
Whenever dividends on the Preferred Stock are in arrears in an aggregate
amount equal to at least six quarterly dividends (whether or not consecutive),
the size of the Company's Board of Directors will be increased by two, and the
holders of Preferred Stock, voting separately as a class, will be entitled to
select the two additional directors to the Board of Directors at any meeting of
stockholders at which directors are to be elected held during the period when
the dividends remain in arrears. These voting rights will terminate when all
dividends accrued and in default have been paid in full or set apart for
payment. The term of office of all directors so elected will terminate
immediately upon that payment or provision for payment.
In addition, so long as any Preferred Stock is outstanding, the Company
will not, without the affirmative vote or consent of the holders of at least
66 2/3% of all outstanding shares of Preferred Stock, voting separately as a
class (i) amend, alter or repeal (by merger or otherwise) any provision of the
Certificate of Incorporation, as amended, or the by-laws so as to affect
adversely the relative rights, preferences, qualifications, limitations or
restrictions of the Preferred Stock, (ii) authorize or issue, or increase the
authorized amount of, any Senior Dividend Stock, any Senior Liquidation Stock or
any security convertible into Senior Dividend Stock or Senior Liquidation Stock
or (iii) effect any reclassification of the Preferred Stock.
Redemption at Option of Company. The Preferred Stock may be redeemed by the
Company, at its option, in whole or in part at any time, if redeemed during the
12-month period ending April 30 of any year specified below, at the following
redemption prices:
<TABLE>
<CAPTION>
PRICE PRICE
YEAR PER SHARE YEAR PER SHARE
- ---- --------- ---- ---------
<S> <C> <C> <C>
1998........................... $26.58 2002........................... $25.53
1999........................... 26.31 2003........................... 25.26
2000........................... 26.05 2004 and thereafter............ 25.00
2001........................... 25.79
</TABLE>
plus in each case accrued and unpaid dividends to the redemption date.
A-2
<PAGE> 33
If fewer than all the outstanding shares of Preferred Stock are to be
redeemed, the Company will select those share to be redeemed pro rata or by lot
or in such other manner as the Board of Directors may determine. There is no
mandatory redemption or sinking fund obligation for the Preferred Stock. In the
event that the Company has failed to pay accrued and unpaid dividends on the
Preferred Stock, it may not redeem any of the outstanding shares of the
Preferred Stock until all accrued and unpaid dividends have been paid in full.
Notice of redemption will be mailed at least 20 days but not more than 60
days before the redemption date to each holder of record of Preferred Stock to
be redeemed at the address shown on the stock transfer books. After the
redemption date, dividends will cease to accrue on the shares of Preferred Stock
called for redemption and all rights of the holders of those shares will
terminate, except the right to receive the redemption price without interest.
Conversion Rights. Each Holder of Preferred Stock has the right, at the
Holder's option, to convert any or all the shares into Common Stock at any time
at a rate (subject to adjustment as described below) of 3.47 shares of Common
Stock for each share of Preferred Stock, equivalent to a conversion price of
$7.20 per share of underlying Common Stock. However, if the Preferred Stock is
called for redemption, the conversion right will terminate at the close of
business on the date fixed for redemption.
No payment or adjustment for accrued dividends on the Preferred Stock will
be made on conversion, but holders of Preferred Stock on a record date fixed for
the payment of a dividend on the Preferred Stock will be entitled to receive the
dividend notwithstanding the conversion of shares prior to the dividend payment
date. No fractional shares of Common Stock will be issued upon conversion but,
in lieu thereof, an appropriate amount will be paid in cash based on the last
reported sale price for the Common Stock on the day of conversion.
The conversion rate is subject to adjustment in certain events, including
the issuance of stock as a dividend on the Common Stock; subdivisions or
combinations of the Common Stock; the issuance to all holders of Common Stock of
certain rights or warrants (expiring within 45 days after the record date for
determining stockholders entitled to receive them) to subscribe for or purchase
Common Stock at a less than current market price; or the distribution to all
holders of Common Stock of evidences of indebtedness, cash (excluding ordinary
cash dividends paid out of retained earnings), other assets or rights or
warrants to subscribe for or purchase any securities (other than those referred
to above); the issuance, in certain circumstances, of Common Stock at less than
the current market price on the date of issuance; or the issuance, in certain
circumstances, of securities convertible into or exchangeable for Common Stock
(other than pursuant to transactions described above) for a consideration per
share of Common Stock deliverable upon a conversion or exchange of the
securities less than the current market price per share on the date of issuance
of the securities. No adjustment of the conversion rate will be required to be
made until cumulative adjustments amount to 1% or more of the conversion rate as
last adjusted, and any adjustment below 1% will be carried forward.
The Company from time to time may increase the conversion rate by any
amount for any period of at least 20 days, in which case the Company shall give
at least 15 days' notice of the increase. The Company may, at its option, make
any increase in the conversion rate, in addition to those set forth above, as
the Board of Directors deems advisable to avoid or diminish any income tax to
holders of Common Stock resulting from any dividend or distribution of stock (or
rights to acquire stock) or from any event treated as such for income tax
purposes. See "Certain Federal Income Tax Considerations -- Adjustment of
Conversion Price."
In case of any reclassification of the Common Stock, any consolidation of
the Company with, or merger of the Company into, any other entity, any merger of
any entity into the Company (other than a merger that does not result in
reclassification, conversion, exchange or cancellation of the outstanding shares
of Common Stock), any sale or transfer of all or substantially all of the assets
of the Company or any compulsory share exchange whereby the Common Stock is
converted into other securities, cash or other property, then the holder of each
share of Preferred Stock then outstanding shall have the right thereafter,
during the period that the Preferred Stock shall be convertible, to convert that
share only into the kind and amount of securities, cash and other property
receivable upon the reclassification, consolidation, merger, sale, transfer or
share exchange
A-3
<PAGE> 34
by a holder of the number of shares of Common Stock into which one share of
Preferred Stock might have been converted immediately prior to the
reclassification, consolidation, merger, sale, transfer or share exchange.
Special Conversion Rights. The Preferred Stock has a special conversion
right that becomes effective upon the occurrence of certain types of significant
transactions affecting ownership or control of the Company or the market for the
Common Stock. The purpose of the special conversion right is to provide (subject
to certain exceptions) partial loss protection upon the occurrence of a Change
in Control or a Fundamental Change (as defined below) at a time when the Market
Value (as defined below) of the Common Stock is less than the prevailing
conversion price. In that event, the special conversion right would, for a
limited period, reduce the conversion price to the Market Value of the Common
Stock, except that the conversion price will not be reduced below $4.00 per
share of Common Stock (subject to certain adjustments). Consequently, to the
extent that the Market Value of the Common Stock is less than the minimum
conversion price, a holder will not be fully protected from loss upon exercise
of a special conversion right.
The special conversion right is intended to provide limited loss protection
to investors in certain circumstances, while not giving holders a veto power
over significant transactions affecting ownership or control of the Company.
Although the special conversion right may inhibit certain extraordinary
transactions or make them more costly, its primary purpose is not to inhibit or
discourage takeovers or other business combinations.
Each holder of Preferred Stock is entitled to a special conversion right if
a Change of Control or Fundamental Change occurs. A Change of Control will occur
if an unaffiliated person or group acquires more than 50% of the Common Stock. A
Fundamental Change is, generally, a sale of all or substantially all the
Company's assets or a transaction in which at least 66 2/3% of the Common Stock
is transferred for, or is converted into, any other asset. However, if the
majority of the value of the consideration received in a transaction by holders
of Common Stock is marketable stock or if the holders of Common Stock hold a
majority of the voting stock of the Company's successor, the transaction will
not be a Change of Control or a Fundamental Change, and holders of Preferred
Stock will not have a special conversion right as a result of that transaction.
The full definitions of the terms "Change of Control" and "Fundamental Change"
appear below.
A special conversion right will permit a holder of Preferred Stock, at the
holder's option during the 45-period described below, to convert all, but not
less than all, the holder's Preferred Stock at a conversion price equal to the
Special Conversion Price, which is generally equal to the Market Value of the
Common Stock, but not less than $4.00 per share (representing 66 2/3% of the
closing price of the Common Stock as set forth on the cover page of this
Prospectus, and subject to adjustment as described below). The full definition
of "Special Conversion Price" is set forth below. A holder exercising a special
conversion right will receive Common Stock if a Change of Control occurs or, if
a Fundamental Change occurs, will receive the same consideration received for
the number of shares of Common Stock into which the holder's Preferred Stock
would have been-convertible at the Special Conversion Price. In either case,
however, the Company or its successor may, at its option, elect to provide the
holder with cash equal to the Market Value of the Common Stock into which the
holder's Preferred Stock is convertible at the Special Conversion Price.
The Company will mail to each registered holder of Preferred Stock a notice
setting forth details of any special conversion right occasioned by a Change of
Control or Fundamental Change within 30 days after the event occurs. A special
conversion right may be exercised only within the 45-day period after the notice
is mailed and will expire at the end of that period. Exercise of a special
conversion right is irrevocable, and all Preferred Stock tendered for conversion
will be converted at the end of the 45-day conversion period. Preferred Stock
that is not converted under a special conversion right will continue to be
convertible pursuant to the general conversion rights described above under the
caption "Conversion Rights."
The special conversion right is not intended to, and does not, protect
holders of convertible Preferred Stock in all circumstances that might affect
ownership or control of the Company or the market for the Common Stock, or
otherwise adversely affect the value of an investment in the Preferred Stock.
The ability to control the Company may be obtained by a person even if that
person does not, as is required to constitute a Change of Control, acquire a
majority of the Company's voting stock. The Company and the market for the
A-4
<PAGE> 35
Common Stock may be affected by various transactions that do not constitute a
Fundamental Change. Transactions involving transfer or conversion of less than
66 2/3% of the Common Stock may have a significant effect on the Company and the
market for the Common Stock, as could transactions in which holders of Common
Stock receive primarily marketable stock or continue to own a majority of the
voting securities of a successor to the Company. In addition, if the special
conversion right does arise as the result of a Fundamental Change, the special
conversion right will allow a holder exercising a special conversion right to
receive the same type of consideration received by the holders of Common Stock
and, thus, the degree of protection afforded by the special conversion right may
be affected by the type of consideration received.
As used herein, a "Change of Control" shall be deemed to have occurred if
any person within the meaning of Section 13(d)(3) and 14(d)(2) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), including a group (within
the meaning of Rule 13d-5 under the Exchange Act), together with any of its
Affiliates or Associates (as defined below), files or becomes obligated to file
a report (or any amendment or supplement thereto) on Schedule 13D or 14D-1
pursuant to the Exchange Act disclosing that the person has become the
beneficial owner of either (i) more than 50% of the shares of Common Stock then
outstanding or (ii) securities representing more than 50% of the combined voting
power of the Voting Stock then outstanding. A Change of Control will not be
deemed to have occurred with respect to any transaction that constitutes a
Fundamental Change. An "Affiliate" of a specified person is a person that
directly or indirectly controls, or is controlled by or is under common control
with, the person specified. An "Associate" of a person means (a) any corporation
or organization, other than the Company or any subsidiary, of which the person
is an officer or partner or is, directly or indirectly, the beneficial owner of
10% or more or any class of equity securities; (b) any trust or estate in which
the person has a substantial beneficial interest or as to which the person
serves as trustee or in a similar fiduciary capacity; and (c) any relative or
spouse of the person or any relative of the spouse, who has the same home as the
person or who is a director or officer of the person or any of its parents or
subsidiaries.
As used herein, a "Fundamental Change" means (i) the occurrence of any
transaction or event in connection with which all or substantially all the
Common Stock is exchanged for, converted into, acquired for or constitutes
solely the right to receive cash, securities, property or other assets (whether
by means of an exchange offer, liquidation, tender offer, consolidation, merger,
combination, reclassification, recapitalization or otherwise) or (ii) the
conveyance, sale, lease, assignment, transfer or other disposal of all or
substantially all of the Company's property, business or assets. A Fundamental
Change will not include (a) any transaction or event in which more than 50% (by
value as determined in good faith by the Board of Directors) of the
consideration received by holders of Common Stock consists of Marketable Stock
(as defined below) or (b) any consolidation or merger of the Company in which,
immediately prior to the transaction, the holders of Common Stock and units in
the development drilling partnerships sponsored by the Company own, directly or
indirectly, (1) 50% or more of the common stock of the surviving corporation (or
of the ultimate parent of the surviving corporation) outstanding at the time
immediately after the consolidation or merger and (2) securities representing
50%or more of the combined voting power of the surviving corporation's Voting
Stock (or the Voting Stock of the ultimate parent of the surviving corporation)
outstanding at such time. "Voting Stock" means capital stock having general
voting power under ordinary circumstances to elect at least a majority of the
board of directors, managers or trustees (exclusive of capital stock that has or
might have voting power by reason of the happening of any contingency). The
phrase "all or substantially all" means 66 2/3% or more of the aggregate
outstanding amount.
As used herein, "Special Conversion Price" means the higher of the Market
Value of the Common Stock or $4.00 per share (which amount will, each time the
conversion price is adjusted, be adjusted so that the ratio of such amount to
the conversion price, after giving effect to the adjustment, shall always be the
same as the ratio of $4.00 to the initial conversion price, without giving
effect to the adjustment).
As used herein, "Market Value" of the Common Stock or any other Marketable
Stock is the average of the last reported sales prices of the Common Stock or
other Marketable Stock for the five business days ending on the last business
day preceding the date of the Fundamental Change or Change of Control. If the
Marketable Stock is not traded on any national securities exchange or similar
quotation system as described in the definition of "Marketable Stock" during
that period, then the Market Value of the Marketable Stock is
A-5
<PAGE> 36
the average of the last reported sales prices per share of Marketable Stock
during the first five days after the date on which the Marketable Stock was
first distributed to the general public and traded on the New York Stock
Exchange, the American Stock Exchange, the Nasdaq National Market or any similar
system of automated dissemination of quotations of securities prices in the
United States.
As used herein, the term "Marketable Stock" means Common Stock or common
stock of any corporation that is the successor to all or substantially all of
the business or assets of the Company as a result of a Fundamental Change or of
the ultimate parent of that successor, which is (or will, upon distribution
thereof, be) listed or quoted on the New York Stock Exchange, the American Stock
Exchange, the Nasdaq National Market or any similar system of automated
dissemination of quotation of securities prices in the United States:
Exchange Provisions. The Preferred Stock may be exchanged, in whole but not
in part, at the option of the Company, for the Company's 10 1/2% convertible
Subordinated Debentures due 2004 (the "Debentures") on any dividend payment
date, commencing May 1, 1995, at a rate of $1,000 principal amount of Debentures
for each 40 shares of Preferred Stock, provided that all accumulated and unpaid
dividends through the date of exchange have been paid and certain other
conditions have been met. The Company will mail written notice of its intention
to exchange to each holder of record of Preferred Stock not less than 30 nor
more than 60 days prior to the exchange.
Other Provisions. In the event of a Change of Control or Fundamental Change
or upon an exchange of the Preferred Stock for Debentures, the Company will
comply with all applicable tender offer rules under the federal securities laws,
including Rule 13e-4 under the Exchange Act.
The Holders of shares of Preferred Stock have no preemptive rights with
respect to any securities of the Company.
A-6
<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 COMMISSION FILE NO. 0-25214
KELLEY OIL & GAS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 76-0447267
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
601 JEFFERSON - SUITE 1100
HOUSTON, TEXAS 77002
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (713) 652-5200
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
<TABLE>
<S> <C>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
8 1/2% Convertible Subordinated Debentures due 2000 American Stock Exchange
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
<TABLE>
<S> <C>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Common Stock NASDAQ SmallCap Market
$2.625 Convertible Exchangeable Preferred Stock NASDAQ SmallCap Market
</TABLE>
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
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K under the Securities Exchange Act of 1934 is not contained
herein, and will not be contained, to the best of the Registrant's knowledge, in
definitive proxy or information statements incorporated in Part III of this Form
10-K or any amendments to this Form 10-K. [ ]
As of March 26, 1999, 126,022,235 shares of Common Stock and 1,733,628 shares of
Preferred Stock were outstanding, and the aggregate market values of shares held
by unaffiliated stockholders were approximately $26,942,095 and $8,499,285,
respectively.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Proxy Statement for the 1999 Annual Meeting of
Stockholders are incorporated by reference into Part III of this Report.
================================================================================
<PAGE> 2
PART I
ITEMS 1 AND 2. BUSINESS AND PROPERTIES
INTRODUCTION
Kelley Oil & Gas Corporation, incorporated in Delaware in 1994, with
its subsidiaries and subsidiary partnerships (individually and collectively the
"Company"), is engaged in the acquisition, exploration, development and
production of oil and natural gas. The Company's strategy is to increase
reserves, production and cash flows in a cost-efficient manner through strategic
domestic acquisitions and a program of balanced development and exploration
activities. The Company's executive offices are located at 601 Jefferson Street,
Suite 1100, Houston, Texas 77002, and its telephone number is (713) 652-5200.
As used in this Report, "Mcf" means thousand cubic feet, "Mmcf" means
million cubic feet, "Bcf" means billion cubic feet, "Bbl" means barrel or 42
U.S. gallons liquid volume, "Mbbl" means thousand barrels, "Mcfe" means thousand
cubic feet of natural gas equivalent using the ratio of six Mcf of natural gas
to one Bbl of crude oil, condensate and natural gas liquids, "Mmcfe" means
million cubic feet of natural gas equivalent, "Bcfe" means billion cubic feet of
natural gas equivalent, and "Mmbtu" means million British thermal units. This
Report includes various other capitalized terms that are defined when first
used.
INDUSTRY CONDITIONS / SUBSEQUENT EVENTS
During 1998, the oil and gas industry experienced a worldwide excess of
supply over demand for oil and natural gas resulting in sharply reduced prices.
As a result, many companies in the oil and gas industry, including the Company,
experienced reduced profitability and cash flows which, in turn, created
significant liquidity problems. As discussed in Note 4 to the Consolidated
Financial Statements, although the Company was in compliance with its Credit
Facility debt covenants at December 31, 1998, the Company was not in compliance
as of March 31, 1999, which could result in all borrowings under such Credit
Facility being declared immediately due and payable and the Credit Facility
being terminated and the payment of other subordinated obligations being
accelerated. In addition, other long-term debt repayments of $34.1 million are
scheduled to be made in December 1999. These uncertainties create substantial
doubt about the Company's ability to continue its operations as a going
concern. To address these liquidity issues, the Company is attempting to take
the measures discussed in the following paragraphs.
In April 1999, the Company entered into an Exploration and Development
Agreement with Phillips Petroleum Company ("Phillips") relating to certain of
the Company's interests in the Bryceland, West Bryceland and Sailes fields in
north Louisiana. Pursuant to the agreement, the Company will: (1) receive an $83
million cash payment (subject to certain post-closing adjustments), (2) retain a
42 Bcf, 8-year volumetric overriding royalty interest and a 1% override on the
excess production above such royalty interest and (3) retain 25% of its working
interest in the Cotton Valley formation. In addition, Phillips will at its risk
and expense, operate, develop, exploit and explore the properties thereby
relieving the Company of significant operating, exploration and development
costs in the future. The effective date of the transaction will be May 1, 1999
and is scheduled to close on April 30, 1999, subject to the parties obtaining
required consents and meeting substantial closing requirements.
In addition, the Company is negotiating a private offering of debt
securities (the "Notes"), the net proceeds which will be used to repay all
amounts outstanding under its Credit Facility, and some of which proceeds may be
used to redeem or otherwise retire a portion of the outstanding convertible
subordinated indebtedness. If issued, the Notes will be secured by a first lien
on substantially all of the Company's proved crude oil and natural gas
properties and guaranteed by three entities wholly-owned by the Company. The
issuance of the Notes will be conditioned upon the completion of the transaction
with Phillips noted in the preceding paragraph and upon the completion of
certain other conditions. There can be no assurance that the issuance of the
Notes will be consummated on such terms, or at all.
1
<PAGE> 3
While industry conditions cannot be predicted with certainty and are
dependent upon a number of commodity and economic factors beyond its control,
the Company believes the net cash proceeds from the Phillips transaction and
issuance of the Notes, if consummated, in conjunction with cash on hand and cash
flow from operations will be sufficient to provide adequate working capital and
fund its capital expenditure program during 1999. However, the Company will
continue to have significant debt outstanding and industry conditions beyond its
control may adversely affect its results of operations and financial condition.
COMPANY HISTORY
The Consolidation. The Company was formed in 1994 to consolidate the
equity ownership (the "Consolidation") of Kelley Oil & Gas Partners, Ltd.
("Kelley Partners") and Kelley Oil Corporation ("Kelley Oil"). Before the
Consolidation in 1994, Kelley Partners and developmental drilling partnership
subsidiaries of Kelley Oil ("DDPs") jointly conducted drilling activities.
Historically, Kelley Oil (the managing general partner of Kelley Partners)
participated proportionately in these operations, with Kelley Partners retaining
one-third of its working interest in each prospect and assigning drilling rights
for the balance of its interest to a DDP. In addition to serving as managing
general partner of each DDP, Kelley Oil purchased for its own investment account
all units in DDPs that were not subscribed preemptively by other investors in
Kelley Partners. In the Consolidation, the Company acquired Kelley Oil's
interests in the remaining DDPs sponsored during 1994 and 1992 aggregating 92.2%
and 84.3%, respectively. The Consolidation was completed on February 7, 1995
upon approval by investors in Kelley Partners and Kelley Oil.
In the Consolidation, the outstanding capital stock of Kelley Oil and
units in Kelley Partners ("Units") held by investors other than Kelley Oil and
its subsidiaries ("Public Unitholders") were converted into a total of 43.7
million shares of Common Stock of the Company, 2.4 million shares of the
Company's $2.625 convertible exchangeable preferred stock ("Preferred Stock")
and 2.2 million shares of cumulative convertible preferred stock ("ESOP
Preferred Stock") held by its Employee Stock Ownership Plan (the "ESOP"). As a
result of the Consolidation, Kelley Oil became a wholly owned subsidiary of the
Company, and Kelley Partners became a 99.99%-owned subsidiary partnership. The
Consolidation was treated as a purchase of the Public Unitholders' interests in
Kelley Partners by the Company for financial accounting purposes. In 1996,
Kelley Partners was merged into the Company and each of the then outstanding
shares of ESOP Preferred Stock was redeemed for one share of the Company's
Common Stock.
Contour Transaction. In January 1996, the Company entered into
financing and related agreements with Contour Production Company L.L.C.
("Contour"), pursuant to which Contour purchased 48.0 million newly issued
shares of Common Stock for $48.0 million on February 15, 1996, and an option
(the "Contour Option") to purchase an additional 27.0 million shares of Common
Stock for $27.0 million, which was exercised on December 1, 1997. In February
1996, in connection with the first stage of Contour's investment in the Company,
John F. Bookout was appointed Chairman, President and Chief Executive Officer of
the Company, and certain other experienced oil industry executives were
appointed to senior management positions within the Company (all such
transactions are referred to collectively as the "Contour Transaction").
In connection with the Contour Transaction, the Company also (i)
obtained consents from its principal stockholders to amend its Certificate of
Incorporation to increase its authorized Common Stock from 100 million shares to
200 million shares, (ii) entered into employment agreements with John F. Bookout
and other new executives elected by the Company's Board of Directors, (iii)
reduced the size of its Board to seven members and reconstituted the Board with
three continuing directors and four designees of Contour and (iv) replaced its
existing lines of credit.
Acquisition of Oil and Gas Properties. Effective as of December 1,
1997, the Company purchased substantially all of the assets of SCANA Petroleum
Resources, Inc. ("SPR") for approximately $110 million (the "SPR Acquisition").
The assets acquired include interests in proved oil and natural gas reserves
primarily located in Louisiana, the shallow waters of the Gulf of Mexico and
east Texas, as well as exploratory leasehold acreage in those areas ("SPR
Properties"). The Company financed this acquisition with $27 million of proceeds
received upon the exercise of the Contour Option and borrowings under the Credit
Facility. In July 1998, the Company sold, for $17.4 million, its interests in
the Waskom field acquired from SPR.
2
<PAGE> 4
OPERATIONS AND PROPERTIES
Operation Activities. The Company's production is derived primarily
from four contiguous fields in the Vacherie Salt Dome region of north Louisiana,
south Louisiana and the shallow waters of the Gulf of Mexico.
Development Activities. During 1998, the Company continued development
drilling activities within its existing properties in the Vacherie Salt Dome
region of north Louisiana, where at December 31, 1998, approximately 71% of its
proved reserves were located on 46,460 gross (21,514 net) acres. In north
Louisiana, the Company drilled or participated in drilling 44 gross (21.1 net)
development wells, of which 43 gross (20.7 net) were completed as producing
wells. At year-end 1998, 156 locations included in the H.J. Gruy & Associates,
Inc. reserve report were defined as proved undeveloped locations totaling 114.6
bcfe of reserves.
Exploration Activities. The Company focuses its exploration activities
primarily on its existing leaseholdings in Terrebonne and LaFourche Parishes,
Louisiana, which the Company believes have, with higher risk, the potential for
larger reserve and production increases as compared to development activity in
north Louisiana. Additional exploration activities include the Company's
existing blocks located in the shallow waters of the Gulf of Mexico and
properties located in the Permian Basin. The Company has approximately 273,460
gross undeveloped acres of exploratory properties principally in these regions
on which it has identified over 30 prospective exploratory well sites. However,
the number, type and timing of these proposed wells is subject to continued
revision as a result of many factors, including test and drilling results on
these properties and others, the price of oil and natural gas, availability of
capital funds and drilling rigs, weather, and general economic factors. See
"Caution as to Forward-Looking Statements" and "Risk Factors".
The Company is utilizing sophisticated technologies to identify
exploration prospects and advanced geophysical techniques to continue to develop
and refine interpretations of its 3-D seismic database, which covers (i) 600
square miles, a major portion of its existing leaseholdings in Terrebonne and
LaFourche Parishes, in south Louisiana, (ii) 50 square miles offshore Texas, and
(iii) 600 square miles of its Permian Basin exploratory prospects.
In 1998, the Company drilled 15 gross (5.8 net) exploratory wells, of
which 8 gross (2.5 net) were completed as producing wells. Included in these
amounts are 3 gross (0.8 net) exploratory wells that were drilled and completed
as producing wells on acreage acquired in the SPR Acquisition.
Description of Properties. The Company's properties are located in
Louisiana, and in the Gulf of Mexico, Texas, New Mexico and Arkansas. As of
January 1, 1999, the Company owned interests in a total of 584 gross (224.5 net)
producing wells, of which 298 wells were operated by the Company, accounting for
74% of its current production. As of that date, the Company had leaseholdings
covering 174,556 gross (81,054 net) developed acres and 294,807 gross (90,703
net) undeveloped acres. Approximately 90% of its proved oil and natural gas
reserves as of January 1, 1999, was natural gas on an energy content basis. The
reserves to production ratio for these properties (based on 1998 production) was
estimated to be 8.3 as of January 1, 1999.
Significant Properties. The Company's natural gas properties in north
Louisiana are located primarily in the Sailes, Sibley, West Bryceland and Ada
fields of Webster and Bienville Parishes, while its properties in south
Louisiana are concentrated in the Orange Grove/Humphreys, Lirette, Lake Pagie,
Ouiski Bayou and Bayou Sauveur fields (Bourg prospect) in Terrebonne Parish.
Production is primarily from the Hosston (north Louisiana) and Miocene (south
Louisiana) formations. Other properties are located primarily in the shallow
waters of the Gulf of Mexico, south Louisiana, and Texas. Substantially all of
the Company's oil and natural gas properties are pledged to secure borrowings
under the Company's Credit Facility. The following table sets forth certain
information as of the dates indicated regarding the Company's interests by major
geographic region. See "Estimated Proved Reserves--Uncertainties in Estimating
Reserves and Future Net Cash Flows."
3
<PAGE> 5
SIGNIFICANT PROVED PROPERTIES
<TABLE>
<CAPTION>
PROVED RESERVES AT JANUARY 1, 1999 PRODUCTION
-------------------------------------------------- -----------------------------------
YEAR ENDED
PRESENT VALUE DECEMBER 31, 1998
OF ESTIMATED -----------------------------------
GAS FUTURE NET GAS
OIL GAS EQUIVALENT CASH FLOWS(1) OIL GAS EQUIVALENT
Mbbls Mmcf (Mmcfe) (IN THOUSANDS) (Mbbls) (Mmcf) (Mmcfe)
-------- -------- ---------- --------------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
North Louisiana .... 604 229,565 233,189 $169,938 93 24,293 24,851
South Louisiana .... 3,735 26,555 48,965 40,369 113 4,798 5,476
Offshore ........... 475 23,976 26,826 18,955 52 5,584 5,896
Other as a group ... 480 3,463 6,343 5,022 117 882 1,584
-------- -------- -------- -------- -------- -------- --------
Totals ............. 5,294 283,559 315,323 $234,284 375 35,557 37,807
======== ======== ======== ======== ======== ======== ========
</TABLE>
(1) The estimates were prepared in accordance with SEC regulations using
market or contract prices at the end of each reported period. Prices and
operating and development costs are held constant over the estimated life of the
reserves. A discount factor of 10% was used to reflect the timing of future net
cash flow. See "Estimated Proved Reserves--Uncertainties in Estimating Reserves
and Future Net Cash Flows" and Note 11 to the Consolidated Financial Statements.
The Company has entered into an exploration and development agreement
relating to certain of its proved behind pipe and undeveloped interests in the
Bryceland, West Bryceland and Sailes fields in north Louisiana, pursuant to
which the Company expects to receive a cash payment and retain certain
overriding royalty interests on existing production and working interests in
certain currently non-producing deeper zones. If the Company consummates the
Phillips transaction, substantially more funds will be available for the
Company's drilling activities. The consummation of such transaction would be
subject to substantial closing conditions. There is no assurance that the
Company will complete the Phillips transaction as currently contemplated or at
all.
ADDITIONAL INFORMATION REGARDING THESE REGIONS IS SET FORTH BELOW.
UNLESS OTHERWISE NOTED, ACREAGE AND WELL INFORMATION IS PROVIDED AS OF DECEMBER
31, 1998, AND RESERVE INFORMATION IS PROVIDED AS OF JANUARY 1, 1999.
North Louisiana. The Company's operations in this region are 64% proved
developed, and its wells are typically drilled to a maximum depth of
approximately 10,500 feet. Operations in this region do not typically experience
geopressured formations or significant associated salt-water production. The
Company's reserves to production ratio in north Louisiana is approximately 9.4.
Its lifting costs in this region are generally low (approximately $0.17 per Mcfe
in 1998) as a result of relatively low formation pressures and minimal liquid
hydrocarbon and salt water production. In the past three years, completed wells
in north Louisiana had an average development cost of $0.69 per Mcfe with gross
average reserves per well of 2.4 Bcfe. At December 31, 1998, the Company
operated an aggregate of 222 gross (122.0 net) wells in this region and was
drilling or completing 1 gross (0.34 net) well in the region. The Company's
weighted average working interest in these properties based on estimated proved
reserves is approximately 51%. The Company's share of proved reserves associated
with these fields totaled approximately 233.2 Bcfe at December 31, 1998.
South Louisiana. The Company's operations in this region primarily are
focused on five fields in the Houma Embayment and Terrebonne Trough areas. These
areas contain high-quality reservoir rock, contributing to high production
rates. Wells are typically drilled to a depth of approximately 11,000 to 19,000
feet. The Company's share of proved reserves associated with these fields
totaled approximately 49.0 Bcfe at December 31, 1998. Production from the
Company's south Louisiana properties generally receives premium wellhead prices
because of the close proximity of the properties to transportation and market
locations, and because of their rich condensate content. The Company believes
these factors partially offset the higher operating costs associated with higher
formation pressures, salt water disposal and inland water well locations
associated with the region. At December 31, 1998, the Company operated an
aggregate of 23 gross (13.4 net) wells and was drilling 1 gross (0.50 net) well
in this region, which was subsequently completed. The Company's weighted average
working interest in these properties based on estimated proved reserves
4
<PAGE> 6
is approximately 56%. In 1998, the Harry S. Bourg #1 deep exploratory test was
drilled to total depth. The well has been designated as a new completion in the
Bayou Sauveur field. Development of the field will begin in the second quarter
of 1999 with the drilling of the first appraisal well, which will test most of
the sands encountered in the discovery well but at a structurally higher
position.
Offshore. The Company's operations in this region are primarily focused
in the shallow waters of the Gulf of Mexico, offshore Texas, Louisiana and
Alabama. The Company's share of proved reserves associated with these fields
totals approximately 26.8 Bcfe at December 31, 1998. At December 31, 1998, the
Company operated an aggregate of 34 gross (30.6 net) wells in this region and
had an interest in 67 gross (37.7 net) wells with a weighted average working
interest based on estimated proved reserves of approximately 74%.
JOINT VENTURE PARTNERSHIPS
The Company participates in joint ventures with industry partners to
accelerate the exploration and evaluation of its properties and to mitigate the
risks associated with exploratory drilling projects.
In December 1996, the Company entered into a joint venture with
Williams Production, Gulf Coast Company ("Williams"), a unit of The Williams
Companies, Inc., relating to the Company's south Louisiana properties. Pursuant
to the terms and conditions of this joint venture, effective December 1, 1996,
Williams purchased a 50% interest in the Company's 27,000 net acreage position
in the Houma Embayment, including 50% of the Company's interest in 23 wells and
related facilities in the Orange Grove/Humphreys and Ouiski Bayou fields, for a
total purchase price of $20.5 million, a portion of which was committed under
the joint venture to drill up to eight exploration wells in those areas.
Together with Williams, the Company drilled 3 gross (1.5 net) wells in south
Louisiana in 1998, of which 2 gross (1.0 net) were completed and are producing
and 1 gross (0.5 net) resulted in a dry hole. Pursuant to the joint venture, the
Company and Williams are expected to continue exploratory drilling in 1999 on
their south Louisiana properties. However, the Company's participation in
drilling these wells is at its discretion.
The Company is involved in other joint ventures with third-party
interest holders, including Fina Oil and Chemical Company, a subsidiary of FINA,
Inc. ("Fina"), and Cobra Oil and Gas Corporation ("Cobra"). The Fina joint
venture represents a joint exploration and development agreement covering an
area of mutual interest (the "AMI") of approximately 400,000 acres in south
Louisiana. The agreement provides for the parties to obtain 3-D seismic coverage
over all mutually agreeable prospective lands within the AMI. To date, the
Company and Fina have acquired 3-D seismic data covering approximately 450
square miles within the AMI. The Cobra program involves exploitation of
approximately 68,000 acres in Texas, New Mexico, Arkansas, Louisiana and Alabama
and includes 3-D seismic data covering approximately 975 square miles.
5
<PAGE> 7
ESTIMATED PROVED RESERVES
The following table sets forth the estimated quantities of proved and
proved developed reserves of crude oil (including condensate and natural gas
liquids) and natural gas owned by the Company for the years ended December 31,
1996, 1997 and 1998, which were prepared by H.J. Gruy & Associates, Inc.
("Gruy") independent petroleum engineers.
ESTIMATED PROVED RESERVES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------
1996 1997 1998
---------------------- ---------------------- ----------------------
OIL GAS OIL GAS OIL GAS
(Mbbls) (Mmcf) (Mbbls) (Mmcf) (Mbbls) (Mmcf)
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
PROVED RESERVES:
Beginning balance ................. 1,387 196,273 1,466 297,634 2,953 354,867
Revisions of previous estimates ... (89) (30,519) 106 21,831 (79) (31,674)
Purchases of reserves in place .... 57 30,844 1,351 51,712 -- --
Extensions and discoveries ........ 477 128,692 256 13,892 3,082 9,512
Sale of reserves in place ......... (134) (4,190) -- -- (287) (13,589)
Production ........................ (232) (23,466) (226) (30,202) (375) (35,557)
-------- -------- -------- -------- -------- --------
Ending balance .................. 1,466 297,634 2,953 354,867 5,294 283,559
======== ======== ======== ======== ======== ========
PROVED DEVELOPED RESERVES:
Producing ......................... 608 113,831 1,856 180,307 1,062 129,787
Non-producing ..................... 369 59,634 576 77,493 919 59,037
-------- -------- -------- -------- -------- --------
Total proved developed .......... 977 173,465 2,432 257,800 1,981 188,824
======== ======== ======== ======== ======== ========
</TABLE>
The estimates of proved reserves set forth in the above table were
prepared in accordance with SEC regulations using market or contract prices at
the end of each reported period. Prices and operating and development costs are
held constant over the estimated life of the reserves.
Estimated proved developed reserves are reserves that can be expected
to be recovered from existing wells with existing equipment and operating
methods. Proved undeveloped reserves are proved reserves that are expected to be
recovered from new wells drilled to known reservoirs on undrilled acreage for
which the existence and recoverability of reserves can be estimated with
reasonable certainty, or from existing wells where a relatively major
expenditure is required for recompletion.
Uncertainties in Estimating Reserves and Future Net Cash Flows. There
are numerous uncertainties in estimating quantities of proved reserves believed
to have been discovered and in projecting future rates of production and the
timing of development expenditures, including many factors beyond the control of
the Company. The reserve data set forth in this document are only estimates.
Reserve estimates are inherently imprecise and may be expected to change as
additional information becomes available. Furthermore, estimates of oil and
natural gas reserves, of necessity, are projections based on engineering data,
and there are uncertainties inherent in the interpretation of such data as well
as the projection of future rates of production and the timing of development
expenditures. Reservoir engineering is a subjective process of estimating
underground accumulations of oil and natural gas that cannot be measured
exactly, and the accuracy of any reserve estimate is a function of the quality
of available data and of engineering and geological interpretation and judgment.
Accordingly, estimates of the economically recoverable quantities of oil and
natural gas attributable to any particular group of properties, classifications
of such reserves based on risk of recovery and estimates of the future net cash
flows expected therefrom prepared by different engineers or by the same
engineers at different times may vary substantially. There also can be no
assurance that the reserves set forth herein will ultimately be produced or that
the proved undeveloped reserves set forth herein will be developed within the
periods anticipated. It is possible that variances from the estimates will be
material. In addition, the estimates of future net cash flows from proved
reserves of the Company and the present value thereof are based upon certain
assumptions about future production levels, prices and costs that may not be
correct when judged against actual subsequent experience. The Company emphasizes
with respect to the estimates prepared by independent petroleum engineers that
the discounted
6
<PAGE> 8
future net cash flows should not be construed as representative of the fair
market value of the proved reserves owned by the Company since discounted future
net cash flows are based upon projected cash flows which do not provide for
changes in oil and natural gas prices from those in effect on the date indicated
or for escalation of expenses and capital costs subsequent to such date. The
meaningfulness of such estimates is highly dependent upon the accuracy of the
assumptions upon which they were based. Accordingly, investors in the Common
Stock are cautioned not to place undue reliance on the reserve data included in
this document.
The Company has not filed any estimates of reserves with any federal
authority or agency during the past year other than estimates contained in
filings with the SEC.
PRODUCTION, PRICE AND COST HISTORY
The following table sets forth certain production data, average sales
prices and average production expenses attributable to the Company's properties
for 1996, 1997 and 1998. Detailed additional information concerning the
Company's oil and natural gas production activities is contained in the
Supplementary Information in Note 12 to the Consolidated Financial Statements
included elsewhere in this Report.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
PRODUCTION DATA:
Oil and other liquid hydrocarbons (Mbbls) ........................... 232 226 375
Natural gas (Mmcf) .................................................. 23,466 30,202 35,557
Natural gas equivalent (Mmcfe) ...................................... 24,858 31,558 37,807
AVERAGE SALES PRICE PER UNIT:
Oil and other liquid hydrocarbons (per Bbl) ......................... $ 22.11 $ 19.34 $ 13.09
Natural gas (per Mcf, including effects of hedging) ................. 2.30 2.27 2.09
Natural gas equivalent (per Mcfe, including effects of hedging) ..... 2.37 2.31 2.10
AVERAGE PRODUCTION EXPENSES PER MCFE ................................... $ .43 $ .35 $ .53
</TABLE>
PRODUCTIVE WELLS AND ACREAGE
As of December 31, 1998, the Company had leaseholdings comprising
174,556 gross (81,054 net) developed acres and 294,807 gross (90,703 net)
undeveloped acres, all located within the continental United States. The oil and
gas leases in which the Company has an interest are for varying primary terms
and many, particularly in south Louisiana, require the payment of delay rentals
in lieu of drilling operations. In north Louisiana, most of the Company's
leasehold interests are held by production; that is, so long as natural gas and
oil are produced from the properties covered thereby, the leases continue
indefinitely. The leases may be surrendered at any time by notice to the
lessors, by the cessation of production or by failure to make timely payment of
delay rentals, if applicable.
7
<PAGE> 9
The following table sets forth the Company's ownership interests in its
leaseholds as of December 31, 1998.
<TABLE>
<CAPTION>
DEVELOPED(1) UNDEVELOPED(2)
------------------------- --------------------------
GROSS ACRES NET ACRES GROSS ACRES NET ACRES
----------- --------- ----------- --------
<S> <C> <C> <C> <C>
Louisiana ........ 78,683 33,085 234,427 70,112
Texas ............ 24,055 4,366 19,429 3,162
Offshore ......... 58,840 38,772 2,830 1,054
Other states ..... 12,978 4,831 38,121 16,375
------- ------- ------- -------
Total ......... 174,556 81,054 294,807 90,703
======= ======= ======= =======
</TABLE>
(1) Acres spaced or assignable to productive wells.
(2) Acres on which wells have not been drilled or completed to a point that
would permit the production of commercial quantities of oil and gas, regardless
of whether that acreage contains proved reserves.
As of December 31, 1998, the Company had working interests in 514 gross
(213.0 net) productive gas wells and 70 gross (11.5 net) productive oil wells
(including producing wells and wells capable of production).
8
<PAGE> 10
EXPLORATION AND DEVELOPMENT
The following table sets forth the number of gross and net productive
and dry exploratory and development wells drilled by the Company.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------
1996 1997 1998
------------ ------------ ------------
GROSS NET GROSS NET GROSS NET
----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
NORTH LOUISIANA:
Exploratory wells:
Oil .......................... -- -- -- -- -- --
Natural gas .................. -- -- -- -- 2 .72
Dry .......................... -- -- -- -- -- --
----- ----- ----- ----- ----- -----
Total ........................ -- -- -- -- 2 .72
===== ===== ===== ===== ===== =====
Development wells:
Oil .......................... 1 .03 -- -- -- --
Natural gas .................. 65 31.63 82 34.96 43 20.68
Dry .......................... 3 1.74 -- -- 1 .46
----- ----- ----- ----- ----- -----
Total ...................... 69 33.40 82 34.96 44 21.14
===== ===== ===== ===== ===== =====
Total north Louisiana:
Producing .................... 66 31.66 82 34.96 45 21.40
Dry .......................... 3 1.74 -- -- 1 .46
----- ----- ----- ----- ----- -----
Total ...................... 69 33.40 82 34.96 46 21.86
===== ===== ===== ===== ===== =====
SOUTH LOUISIANA AND OTHER:
Exploratory wells:
Oil .......................... -- -- -- -- -- --
Natural gas .................. -- -- 9 3.50 6 1.81
Dry .......................... -- -- 1 .50 7 3.22
----- ----- ----- ----- ----- -----
Total ...................... -- -- 10 4.00 13 5.03
===== ===== ===== ===== ===== =====
Development wells:
Oil .......................... -- -- -- -- 3 .04
Natural gas .................. -- -- -- -- -- --
Dry .......................... -- -- -- -- -- --
----- ----- ----- ----- ----- -----
Total ...................... -- -- -- -- 3 .04
===== ===== ===== ===== ===== =====
Total south Louisiana and other:
Producing .................... -- -- 9 3.50 9 1.85
Dry .......................... -- -- 1 .50 7 3.22
----- ----- ----- ----- ----- -----
Total ...................... -- -- 10 4.00 16 5.07
===== ===== ===== ===== ===== =====
</TABLE>
As of December 31, 1998, the Company had 1 gross (0.34 net) development
well in progress, in north Louisiana, and 1 gross (0.50 net) exploratory well in
progress in south Louisiana. Subsequent to year-end 1998, the south Louisiana
exploratory well (Bourg discovery) was completed as a producing well.
9
<PAGE> 11
MARKETING OF NATURAL GAS AND CRUDE OIL
The Company does not refine or process any of the oil and natural gas
it produces. Substantially all of the Company's natural gas is sold under term
contracts, contracts providing for periodic price adjustments or in the spot
market. Its revenue streams are therefore sensitive to changes in current market
prices. The Company's sales of crude oil, condensate and natural gas liquids
generally are made at prices related to posted field prices.
In addition to marketing the Company's natural gas production, it
secures gas transportation arrangements, provides nomination and gas control
services, supervises gas aggregation operations and performs revenue receipt and
disbursement services as well as regulatory filing, recordkeeping, inspection,
testing, monitoring and marketing functions.
The Company believes that its activities are not currently constrained
by a lack of adequate transportation systems or system capacity and does not
foresee any material disruption in available transportation for its production.
However, there can be no assurance that the Company will not encounter these
constraints in the future. In that event, the Company would be forced to seek
alternate sources of transportation and may face increased costs.
HEDGING OF NATURAL GAS
The Company periodically uses forward sales contracts, natural gas
price swap agreements, natural gas basis swap agreements and options to reduce
exposure to downward price fluctuations on its natural gas production. The
Company does not engage in speculative transactions. During 1998, the Company
used price and basis swap agreements to hedge its exposure to possible declines
in natural gas prices. Additional information concerning hedging activities of
the Company during 1998 is set forth in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and in Note 10 to the
Consolidated Financial Statements contained elsewhere in this Report.
COMPETITION
The Company operates in a highly competitive environment with respect
to acquiring reserves, marketing oil and natural gas and securing trained
personnel. Many of the Company's larger competitors possess and employ financial
and personnel resources substantially greater than those available to it. Such
companies may be able to pay more for productive oil and natural gas properties
and to define, evaluate, bid for and purchase a greater number of properties
than the Company's financial or personnel resources permit. The Company's
ability to acquire additional reserves in the future will be dependent upon its
ability to evaluate and select suitable properties and to consummate
transactions in a highly competitive environment. In addition, there is
substantial competition for capital available for investment in the oil and
natural gas industry. There can be no assurance that the Company will be able to
compete successfully in the future in acquiring reserves, developing reserves,
marketing hydrocarbons, attracting and retaining quality personnel, and raising
additional capital.
TITLE TO PROPERTIES
The Company's properties, in addition to being mortgaged to secure the
Credit Facility, are subject to royalty interests, liens incident to operating
agreements, liens for current taxes and other customary burdens, including other
mineral encumbrances and restrictions. The Company does not believe that any
mortgage, lien or other burden materially interferes with the use of such
properties in the operation of its business.
The Company believes that it has satisfactory title to or rights in all
of its producing properties. As is customary in the oil and natural gas
industry, minimal investigation of title is made at the time of acquisition of
undeveloped properties. Title investigation is made, and title opinions of local
counsel are generally obtained before commencement of drilling operations or at
least in connection with the preparation of division orders when production is
obtained and the revenues therefrom are allocated.
10
<PAGE> 12
EMPLOYEES
As of December 31, 1998, the Company had 68 employees. The Company's
staff includes employees experienced in acquisitions, geology, geophysics,
petroleum engineering, land acquisition and management, finance and accounting.
None of the Company's employees are represented by a union. The Company has not
experienced an interruption in its operations due to any labor dispute and
believes that its working relationships with its employees are satisfactory.
REGULATION
The Company's operations are subject to extensive and continually
changing regulation, as legislation affecting the oil and natural gas industry
is under constant review for amendment and expansion. Many departments and
agencies, both federal and state, are authorized by statute to issue and have
issued rules and regulations binding on the oil and natural gas industry and its
individual participants. The failure to comply with such rules and regulations
can result in substantial penalties. The regulatory burden on the oil and
natural gas industry increases the Company's cost of doing business and,
consequently, affects its profitability. However, the Company does not believe
that it is affected in a significantly different manner by these regulations
than are its competitors in the oil and natural gas industry. Because of the
numerous and complex federal and state statutes and regulations that may affect
the Company, directly or indirectly, the following discussion of certain
statutes and regulations should not be relied upon as an exhaustive review of
all matters affecting the Company's operations.
Transportation and Production
Transportation and Sale of Natural Gas and Crude Oil. Sales of natural
gas, crude oil and condensate ("Products") can be made by the Company at market
prices not subject at this time to price controls. The price that the Company
receives from the sale of these Products is affected by the ability to transport
and cost of transporting the Products to market. Under applicable laws, the
Federal Energy Regulation Commission ("FERC") regulates both the construction of
pipeline facilities and the transportation of Products in interstate commerce.
Regulation of Drilling and Production. Drilling and production
operations of the Company are subject to regulation under a wide range of state
and federal statutes, rules, orders and regulations. State and federal statutes
and regulations govern, among other matters, the amounts and types of substances
and materials that may be released into the environment, the discharge and
disposition of waste materials, the reclamation and abandonment of wells and
facility sites and remediation of contaminated sites, and require permits for
drilling operations, drilling bonds and reports concerning operations. The
federal leases are administered by the Bureau of Land Management ("BLM") and the
Minerals Management Service ("MMS"), which are administered, along with the
Bureau of Indian Affairs, by the federal Department of the Interior. These
leases contain relatively standard terms and require compliance with detailed
MMS and BLM regulations and orders, which are subject to change. In addition to
permits required by other federal agencies (such as the Coast Guard, the Army
Corps of Engineers and the Environmental Protection Agency), lessees must obtain
a permit from the MMS or BLM prior to commencement of offshore or onshore
drilling. States in which the Company owns and operates properties have varying
laws and regulations governing conservation matters, including provisions for
the unitization or pooling of oil and natural gas properties, the establishment
of maximum rates of production from oil and natural gas wells and the regulation
of the spacing, plugging and abandonment of wells. Many states also restrict
production to the market demand for oil and natural gas and several states have
indicated interest in revising applicable regulations. The effect of these
regulations is to limit the amount of oil and natural gas the Company can
produce from its wells and to limit the number of wells or the locations at
which the Company can drill. Moreover, each state generally imposes an ad
valorem, production or severance tax with respect to the production and sale of
crude oil, natural gas and gas liquids within its jurisdiction.
Environmental Regulations
General. The various federal environmental laws, including the National
Environmental Policy Act; the Clean Air Act of 1990, as amended ("CAA"); Oil
Pollution Act of 1990, as amended ("OPA"); Water Pollution Control Act,
11
<PAGE> 13
as amended ("FWPCA"); the Resource Conservation and Recovery Act as amended
("RCRA"); the Toxic Substances Control Act; and the Comprehensive Environmental
Response, Compensation and Liability Act, as amended ("CERCLA"), and the various
state and local environmental laws, and the regulations adopted pursuant to such
law, governing the discharge of materials into the environment, or otherwise
relating to the protection of the environment, continue to be taken seriously by
the Company. In particular, the Company's drilling, development and production
operations, its activities in connection with storage and transportation of
crude oil and other liquid hydrocarbons and its use of facilities for treating,
processing or otherwise handling hydrocarbons and wastes therefrom are subject
to stringent environmental regulation, and violations are subject to reporting
requirements, civil penalties and criminal sanctions. As with the industry
generally, compliance with existing regulations increases the Company's overall
cost of business. The increased costs are not reasonably ascertainable. Such
areas affected include unit production expenses primarily related to the control
and limitation of air emissions and the disposal of produced water, capital
costs to drill exploration and development wells resulting from expenses
primarily related to the management and disposal of drilling fluids and other
oil and natural gas exploration wastes and capital costs to construct, maintain
and upgrade equipment and facilities and plug and abandon inactive well sites
and pits.
Environmental regulations historically have been subject to frequent
change by regulatory authorities, and the Company is unable to predict the
ongoing cost of compliance with these laws and regulations or the future impact
of such regulations on its operations. However, the Company does not believe
that changes to these regulations will materially adversely affect the Company's
competitive position because its competitors are similarly affected. A discharge
of hydrocarbons or hazardous substances into the environment could subject the
Company to substantial expense, including both the cost to comply with
applicable regulations pertaining to the remediation of releases of hazardous
substances into the environment and claims by neighboring landowners and other
third parties for personal injury and property damage. The Company maintains
insurance, which may provide protection to some extent against environmental
liabilities, but the coverage of such insurance and the amount of protection
afforded thereby cannot be predicted with respect to any particular possible
environmental liability and may not be adequate to protect the Company from
substantial expense.
The OPA and regulations thereunder impose a variety of regulations on
"responsible parties" related to the prevention of oil spills and liability for
damages resulting from such spills in United States waters. A "responsible
party" includes the owner or operator of an onshore facility, vessel, or
pipeline, or the lessee or permittee of the area in which an offshore facility
is located. The OPA assigns liability to each responsible party for oil removal
costs and a variety of public and private damages. The FWPCA imposes
restrictions and strict controls regarding the discharge of produced waters and
other oil and natural gas wastes into navigable waters. State laws for the
control of water pollution also provide varying civil, criminal and
administrative penalties and impose liabilities in the case of a discharge of
petroleum or its derivatives, or other hazardous substances, into state waters.
In addition, the Environmental Protection Agency ("EPA") has promulgated
regulations that require many oil and natural gas production operations to
obtain permits to discharge storm water runoff.
The CAA requires or will require most industrial operations in the
United States to incur capital expenditures in order to meet air emission
control standards developed by the EPA and state environmental agencies.
Although no assurances can be given, the Company believes implementation of such
amendments will not have a material adverse effect on its financial condition or
results of operations. RCRA is the principal federal statute governing the
treatment, storage and disposal of hazardous wastes. RCRA imposes stringent
operating requirements (and liability for failure to meet such requirements) on
a person who is either a "generator" or "transporter" of hazardous waste or an
"owner" or "operator" of a hazardous waste treatment, storage or disposal
facility. At present, RCRA includes a statutory exemption that allows oil and
natural gas exploration and production wastes to be classified as non-hazardous
waste. As a result, the Company is not required to comply with a substantial
portion of RCRA's requirements because the Company's operations generate minimal
quantities of hazardous wastes.
12
<PAGE> 14
CERCLA, also known as "Superfund", imposes liability, without regard to
fault or the legality of the original act, on certain classes of persons that
contributed to the release of a "hazardous substance" into the environment.
These persons include the "owner" or "operator" of the site and companies that
disposed or arranged for the disposal of the hazardous substances found at the
site. CERCLA also authorizes the EPA and, in some instances, third parties to
act in response to threats to the public health or the environment and to seek
to recover from the responsible classes of persons the costs they incur. In the
course of its ordinary operations, the Company may generate waste that may fall
within CERCLA's definition of a "hazardous substance". As a result, the Company
may be jointly and severally liable under CERCLA or under analogous state laws
for all or part of the costs required to clean up sites at which such wastes
have been disposed. The Company currently owns or leases, and has in the past
owned or leased, numerous properties that for many years have been used for the
exploration and production of oil and natural gas. Although the Company has
utilized operating and disposal practices that were standard in the industry at
the time, hydrocarbons or other wastes may have been disposed of or released on
or under the properties owned or leased by the Company or on or under other
locations where such wastes have been taken for disposal. In addition, many of
these properties have been operated by third parties whose actions with respect
to the treatment and disposal or release of hydrocarbons or other wastes were
not under the Company's control. These properties and wastes disposed thereon
may be subject to CERCLA, RCRA and analogous state laws. Under such laws, the
Company could be required to remove or remediate previously disposed wastes
(including wastes disposed of or released by prior owners or operators), to
clean up contaminated property (including contaminated groundwater) or to
perform remedial plugging operations to prevent future contamination.
CAUTION AS TO FORWARD-LOOKING STATEMENTS
Statements contained in this Report and other materials filed or to be
filed by the Company with the Securities and Exchange Commission (as well as
information included in oral or other written statements made or to be made by
the Company or its representatives) that are forward-looking in nature are
intended to be "forward-looking statements" within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, relating to matters such as anticipated
operating and financial performance, business prospects, developments and
results of the Company. Actual performance, prospects, developments and results
may differ materially from any or all anticipated results due to economic
conditions and other risks, uncertainties and circumstances partly or totally
outside the control of the Company, including rates of inflation, natural gas
prices, uncertainty of reserve estimates, rates and timing of future production
of oil and gas, exploratory and development activities, acquisition risks and
activities, changes in the level and timing of future costs and expenses related
to drilling and operating activities and those risks described under "Risk
Factors" below.
Words such as "anticipated," "expect," "estimate," "project" and
similar expressions are intended to identify forward-looking statements.
Forward-looking statements include the risks described in "Risk Factors".
RISK FACTORS
The Company cautions that the following risk factors could affect its
actual results in the future in addition to "Estimated Proved
Reserves--Uncertainties in Estimating Reserves and Future Net Cash Flows"
included elsewhere in this Report.
Substantial Leverage; Inability to Service Debt; Lack of Liquidity;
Substantial Capital Requirements. As of December 31, 1998, the Company had
$327.9 million principal amount of debt outstanding, stockholders' deficit of
approximately $66.9 million and cash on hand of approximately $8.4 million.
However, there can be no assurance that the Company will have sufficient funds
to make all of its future debt service payments. Further, there can be no
assurance that the Phillips transaction or the sale of the Notes will be
consummated. If the Company does not consummate the Phillips transaction or the
sale of the Notes, the Company may be unable to make its scheduled payments of
principal and interest in 1999 and 2000. If that occurs, the Company may be
required to refinance or restructure all or a portion of its indebtedness, to
sell assets and to reduce or delay planned capital expenditures.
13
<PAGE> 15
In the currently depressed oil and natural gas commodity price
environment, the Company has limited cash flow for capital expenditures. The
ability of the Company to service its debt levels and finance capital
expenditures depends significantly on various factors including an improved oil
and natural gas commodity price environment. If the Company sells the Notes, it
is not likely to have access to a revolving credit facility to supplement its
cash needs.
Following the Phillips and the Notes transactions, if consummated, the
Company would continue to have significant debt outstanding and will be subject
to various commodity and economic factors beyond its control that may have an
impact on its ability to exploit its exploration prospects.
The Company is dependent upon its ability to obtain financing for
acquiring, exploring and developing oil and natural gas properties beyond its
internally generated cash flow. Historically, the Company has financed these
activities primarily through the issuance of debt and equity securities, through
various credit facilities and with internally generated funds. The Company
currently has plans for substantial capital expenditures to continue its
development and exploration activities. The Company's ability to expend the
capital necessary to undertake or complete future activities may be limited. No
assurance can be given that the Company will have adequate funds available to it
to carry out its strategy. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital
Resources".
Depletion of Reserves; Necessity of Successful Exploration and
Development. Producing oil and natural gas reservoirs generally are
characterized by declining production rates that vary depending upon reservoir
characteristics and other factors. The Company's future oil and natural gas
reserves and production, and, therefore, cash flow and income, are highly
dependent upon the Company's success in efficiently developing its current
reserves and acquiring additional reserves that are economically recoverable.
Volatility of Oil, Natural Gas and Natural Gas Liquids Prices. The
Company's financial results are affected significantly by the prices received
for its oil, natural gas and natural gas liquids production. Historically, the
markets for oil, natural gas and natural gas liquids have been volatile. Oil
prices in general have been depressed since the first quarter of 1998 while
natural gas prices have fallen approximately 18% since November 1998. No
assurance can be given as to when and if either oil or natural gas price may
recover. The prices received by the Company for its oil, natural gas and natural
gas liquids production and the levels of such production are subject to
government regulation, legislation and policies. The Company's future financial
condition and results of operations will depend, in part, upon the prices
received for its oil and natural gas production, as well as the costs of
finding, acquiring, developing and producing reserves.
Operating Hazards and Uninsured Risks. Oil and gas drilling activities
are subject to numerous risks, many of which are uninsurable, including the risk
that no commercially viable oil or natural gas production will be obtained; many
of such risks are beyond the Company's control. The decision to purchase,
explore or develop a prospect or property will depend in part on the evaluation
of data obtained through geophysical and geological analyses, production data
and engineering studies, the results of which are often inconclusive or subject
to varying interpretations. The cost of drilling, completing and operating wells
is often uncertain, and overruns in budgeted expenditures are common risks that
can make a particular project uneconomical. Technical problems encountered in
actual drilling, completion and workover activities can delay such activity and
add substantial costs to a project. Further, drilling may be curtailed, delayed
or canceled as a result of many factors, including title problems, weather
conditions, compliance with government permitting requirements, shortages of or
delays in obtaining equipment, reductions in product prices and limitations in
the market for products. Although domestic drilling activity is currently at a
relatively low level, resulting in less demand for such services and a general
decrease in service costs, there can be no assurance that such market conditions
will continue.
The availability of a ready market for the Company's oil and natural
gas production also depends on a number of factors, including the demand for and
supply of oil and natural gas and the proximity of reserves to pipelines or
trucking and terminal facilities. Natural gas wells may be partially or totally
shut in for lack of a market or because of inadequacy or unavailability of
natural gas pipeline or gathering system capacity.
14
<PAGE> 16
The Company's oil and natural gas business also is subject to all of
the operating risks associated with the drilling for and production of oil and
natural gas, including, but not limited to, uncontrollable flows of oil, natural
gas, brine or well fluids into the environment (including groundwater and
shoreline contamination), blowouts, cratering, mechanical difficulties, fires,
explosions, pollution and other risks, any of which could result in substantial
losses to the Company. Although the Company maintains insurance at levels that
it believes are consistent with industry practices, it is not fully insured
against all risks. Losses and liabilities arising from uninsured and
underinsured events could have a material adverse effect on the financial
condition and operations of the Company.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various claims and lawsuits incidental to
its business. In the opinion of management, the ultimate liability thereunder,
if any, will not have a material effect on the financial condition of the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted for a vote of the Company's stockholders
during the fourth quarter of 1998.
15
<PAGE> 17
PART II
ITEM 5. MARKET FOR THE COMPANY'S SECURITIES AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock and Preferred Stock are traded on the NASDAQ
SmallCap Market under the symbols "KOGC" and "KOGCP." The price ranges presented
below represent high and low sale prices for each quarter, as reported by the
NASDAQ Stock Market. On October 16, 1998, the Company was moved from the NASDAQ
National Market to the NASDAQ SmallCap Market due to the Company's failure to
maintain the minimum per share price requirements. The Company has also received
notice from NASDAQ that it is not in compliance with the NASDAQ rule regarding
minimum stock price. If the Company's stock price does not trade at or above
$1.00/share for ten consecutive days prior to April 23, 1999, the Company's
stock is subject to delisting.
<TABLE>
<CAPTION>
KOGC COMMON STOCK KOGC PREFERRED STOCK
MARKET PRICES MARKET PRICES
-------------------------- ---------------------------
HIGH LOW HIGH LOW
---------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
1996:
First quarter .............. $ 3 5/16 $ 1 $ 18 3/4 $ 6 3/4
Second quarter.............. 4 2 3/16 22 5/8 15 1/4
Third quarter............... 4 1/8 29/16 26 20 3/8
Fourth quarter.............. 3 1/4 27/16 25 23 3/4
1997:
First quarter .............. $ 3 1/16 $ 1 7/8 $ 25 3/4 $ 23 3/4
Second quarter.............. 3 1/16 11 1/16 26 22 1/2
Third quarter............... 3 1/4 2 3/16 26 7/8 24 1/4
Fourth quarter.............. 3 15/16 2 1/8 25 1/2 21 1/2
1998:
First quarter .............. $ 2 13/16 $ 1 3/4 $ 25 3/4 $ 20 3/4
Second quarter.............. 2 13/16 1 15/16 28 1/2 22
Third quarter............... 2 5/16 1 23 3/8 16
Fourth quarter.............. 1 5/8 15/32 16 1/2 8
</TABLE>
As of the January 31, 1999, there were approximately 1,495 record
holders of Common Stock and 120 record holders of Preferred Stock.
Dividends on the Preferred Stock accrue quarterly at the rate of
$.65625 per share. In January 1996, the Company announced the suspension of
dividend payments on the Preferred Stock to conserve cash. On April 15, 1997,
the Board of Directors of the Company declared a dividend of $2.625 per
preferred share (approximately $4.6 million), which was paid on May 1, 1997. On
April 14, 1998, the Company declared a dividend of $2.625 per share of Preferred
Stock (approximately $4.6 million), which was paid on April 30, 1998. The
Company's existing credit facility and the Company's indenture governing its 10
3/8% Senior Subordinated Notes (the "10 3/8% Notes") restrict the payment of
future preferred dividends. As of February 1, 1999, the total amount of dividend
payments in arrears was approximately $5.7 million, covering five quarters.
Should the Company not pay dividends on the Preferred Stock for a period of six
quarters, the holders of Preferred Stock, as a group, have the right to elect
two additional directors to the Company's Board of Directors.
16
<PAGE> 18
ITEM 6. SELECTED FINANCIAL DATA
The following tables present selected financial data for the Company
that is derived from the audited consolidated financial statements of the
Company. The historical financial information for the year ended December 31,
1995 reflects the Consolidation in February 1995. Prior to the Consolidation,
the financial information reflects Kelley Oil's historical results of
Operations. The impact of the acquisition of the SPR Properties is reflected in
the selected financial data as of December 1, 1997. This information should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Consolidated Financial Statements
of the Company and related Notes included elsewhere in this Report.
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1994 1995 1996 1997 1998
--------- --------- ---------- -------- ---------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Oil and gas revenues.............................. $ 16,822 $ 36,998 $ 60,854 $ 75,864 $ 79,150
Interest and other income......................... 1,416 1,763 1,429 274 505
--------- --------- ---------- -------- ---------
Total revenues .............................. 18,238 38,761 62,283 76,138 79,655
--------- --------- ---------- -------- ---------
Production expenses............................... 3,760 10,835 10,709 10,955 19,878
Exploration expenses.............................. 7,404 23,387 5,438 5,433 12,034
General and administrative expenses............... 5,172 7,030 8,953 6,875 7,077
Interest and other debt expenses.................. 4,571 21,956 24,401 25,071 33,333
Restructuring expenses............................ 1,814 1,115 4,276 -- --
Depreciation, depletion and amortization.......... 20,474 35,591 20,440 25,853 38,602
Impairment of oil and gas properties(1)........... -- 150,138 -- -- 25,738
--------- --------- ---------- -------- ---------
Income (loss) before income taxes and
extraordinary item............................. (24,957) (211,291) (11,934) 1,951 (57,007)
Provision for taxes............................... -- -- -- -- --
--------- --------- ---------- -------- ---------
Net income (loss) before extraordinary item....... (24,957) (211,291) (11,934) 1,951 (57,007)
Extraordinary loss(2)............................. -- -- (17,030) -- --
--------- --------- ---------- -------- ---------
Net income (loss)................................. $ (24,957) $(211,291) $ (28,964) $ 1,951 $ (57,007)
========= ========= ========== ======== =========
Basic and diluted loss per common share
before extraordinary item(3) .................. $ (1.58) $ (5.31) $ (.18) $ (.03) $ (.49)
Basic and diluted loss per common share(3)........ $ (1.58) $ (5.31) $ (.37) $ (.03) $ (.49)
Weighted average common shares outstanding........ 17,653 41,032 90,113 100,757 125,783
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------------------------------------------------
1994 1995 1996 1997 1998
--------- --------- -------- -------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Property and equipment, net.................... $ 74,912 $ 128,642 $158,468 $293,613 $ 256,455
Long term debt, excluding current maturities... 37,242 164,980 184,253 286,183 287,500
Stockholders' equity (deficit)................. 45,180 (45,568) (30,535) (5,621) (66,939)
Total assets................................... 106,513 151,342 189,227 322,602 286,197
</TABLE>
- -----------------------
(1) Reflects noncash impairment charges against the carrying value of
proved and unproved properties under SFAS 121. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Notes to
Consolidated Financial Statements."
(2) Incurred in connection with the refinancing of the 13 1/2% Senior Notes
and represents the excess of the aggregate purchase price of the 13 1/2% Senior
Notes (including consent payments) over their carrying value as of the date the
refinancing was consummated.
(3) Dividends on the Company's cumulative preferred stock are deducted from
"Net Income (Loss) Before Extraordinary Item" and "Net Income (Loss)" in
calculating related per share amounts, whether or not declared, and amounted to
$2.9 million, $6.6 million, $4.6 million, $4.6 million and $4.6 million for the
years ended December 31, 1994, 1995, 1996, 1997 and 1998, respectively.
17
<PAGE> 19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following information should be read in conjunction with the
information contained in the Financial Statements of the Company included
elsewhere in this Report.
GENERAL
Introduction. Kelley Oil & Gas Corporation and its consolidated
subsidiaries (the "Company") are engaged in oil and natural gas exploration,
development, production and acquisition. The Company's 1998 operational
activities were focused primarily on exploiting its north Louisiana properties
and exploration activities on its south Louisiana acreage. In 1998, the Company
drilled or participated in drilling 47 gross (21.2 net) development wells and 15
gross (5.8 net) exploratory wells of which 46 gross (20.7 net) and 8 gross (2.5
net), respectively, were completed as producing wells. The Company's most
significant event was the drilling of the Harry S. Bourg #1 discovery well in
Terrebonne Parish, Louisiana which added 21.4 bcfe of proved reserves to the
Company's reserve base at year-end. The Company has a 50% working interest in
this well.
General Conditions of the Oil and Natural Gas Industry and Commodity
Prices. The prices of oil and natural gas during recent months have fallen
sharply and continue to reflect the volatility of commodity prices and the
industry generally. The Company cannot predict future prices of oil and natural
gas. Current low prices, if they continue, could adversely impact the Company's
results of operations and liquidity. The success of the Company is in part
dependent on factors outside the control of the Company, but which directly
affect the financial condition of the Company, including capital market
conditions and highly volatile oil and natural gas prices. Due to recent
industry conditions, the Company, as others within the industry, has been
required to reconsider its capital expenditures budgets, which could adversely
impact production levels, and to evaluate various financing and strategic
alternatives.
Hedging Activities. The Company periodically uses forward sales
contracts, natural gas price swap agreements, natural gas basis swap agreements
and options to reduce exposure to downward price fluctuations on its natural gas
production. The Company does not engage in speculative transactions. During
1998, the Company used price and basis swap agreements. Price swap agreements
generally provide for the Company to receive or make counterparty payments on
the differential between a fixed price and a variable indexed price for natural
gas. Basis swap agreements generally provide for the Company to receive or make
counterparty payments on the differential between a variable indexed price and
the price it receives from the sale of natural gas production, and are used to
hedge against unfavorable price movements in the relationship between such
variable indexed price and the price received for such production. Gains and
losses realized by the Company from hedging activities are included in oil and
gas revenues and average sales prices in the period that the related production
is sold. The Company's hedging activities also cover the oil and gas production
attributable to the interest in such production of the public unitholders in its
subsidiary partnerships.
Through natural gas price swap agreements, the Company hedged
approximately 49% of its natural gas production for 1998 at an average NYMEX
quoted price of $2.31 per Mmbtu before transaction and transportation costs. As
of December 31, 1998, 5,400,000 Mmbtu's of natural gas production for 1999 has
been hedged by natural gas price swap agreements at an average NYMEX quoted
price of $2.36 per Mmbtu before transaction and transportation costs. Additional
hedging activities since December 31, 1998 have increased the volumes hedged in
1999 to 10,720,000 Mmbtu of natural gas at an average NYMEX quoted price of
$2.15 per Mmbtu before transaction and transportation costs. As of December 31,
1998, 16,380,000 Mmbtu's of natural gas production for 1999 has been hedged by
natural gas basis swap agreements. Hedging activities increased revenues by
approximately $3.5 million in 1998 as compared to estimated revenues had no
hedging activities been conducted. At December 31, 1998, the unrealized gain on
the Company's existing hedging instruments for future production months in 1999
approximated $2.5 million.
The credit risk exposure from counterparty nonperformance on natural
gas forward sales contracts and derivative financial instruments is generally
the amount of unrealized gains under the contracts. The Company has not
experienced counterparty nonperformance on these agreements and does not
anticipate any in future periods.
18
<PAGE> 20
RESULTS OF OPERATIONS
Years Ended December 31, 1998 and 1997. The Company's oil and gas
revenues of $79.2 million for 1998 increased 4% compared to $75.9 million in
1997 primarily as a result of an increase in gas production 18%, partially
offset by lower oil prices (32%) and gas prices (8%). The increase in gas
production is primarily due to the Company's SPR acquisition and drilling
activities in north Louisiana.
Interest and other income increased from $0.3 million in 1997 to $0.5
million in 1998 primarily due to business interruption insurance proceeds
related to hurricane disruptions on offshore properties.
Production expenses for 1998 increased 81% to $19.9 million from $11.0
million in the prior year, resulting primarily from the SPR properties acquired
during the fourth quarter of 1997 and higher current period workover expenses.
Higher-cost production from the Gulf of Mexico properties acquired in the SPR
acquisition contributed to a 78% increase in lifting costs (production expenses
less ad valorem and severance taxes) per Mcfe to $.41 in 1998 as compared to
$0.23 in 1997.
Exploration expenses increased 122% from $5.4 million in 1997 to $12.0
million in 1998 due to increased dry hole, seismic and unproved property
abandonment expenses and higher overhead allocated to exploration activities.
General and administrative expenses of $7.1 million in 1998 increased
3% compared to $6.9 million last year. On a unit of production basis, general
and administrative expenses were $0.19 per Mcfe in 1998 compared to $0.22 per
Mcfe in 1997.
Interest and other debt expenses of $33.3 million in 1998 increased 33%
from $25.1 million in 1997. The increase in interest expense resulted primarily
from higher average debt levels during the current period due to increased
borrowings under the Credit Facility and issuance of the Series C Notes. In
addition to its 1998 interest expense of $28.1 million, the Company recorded
non-cash charges in 1998 of $2.2 million for amortization of debt issuance
costs, $1.0 million for accretion of note discount and $2.0 million for
accretion of debt valuation discount.
Depreciation, depletion and amortization ("DD&A") expense increased 49%
from $25.9 million in 1997 to $38.6 million in 1998, as a result of higher 1998
production levels and an increase in the units-of-production DD&A rate for oil
and gas activities from $0.80 per Mcfe in 1997 to $1.01 in 1998.
In 1998, under Statement of Financial Accounting Standards No. 121
("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of", the Company recognized noncash impairment
charges of $25.7 million against the carrying values of its proved and unproved
oil and gas properties, aggregating $21.6 million and $4.1 million,
respectively, for the year ended December 31, 1998 (see "Property Impairment
under SFAS No. 121" in the "Notes to Consolidated Financial Statements").
The Company recognized a net loss of $(57.0) million in 1998 and net
income of $2.0 million in the prior year. The reasons for the earnings changes
are described in the foregoing discussion.
Years Ended December 31, 1997 and 1996. The Company's oil and gas
revenues of $75.9 million for 1997 increased 25% compared to $60.9 million in
1996 primarily as a result of an increase in gas production (29%), partially
offset by lower oil prices (13%) and gas prices (1%). The increase in gas
production is primarily due to the Company's drilling activities in north
Louisiana and the addition of one month of production from the SPR properties
partially offset by the sale of one-half of its interest in 23 wells and related
facilities in the Houma Embayment in Terrebonne Parish, Louisiana in the fourth
quarter of 1996.
Interest and other income decreased 79% from $1.4 million in 1996 to
$0.3 million in 1997 primarily due to higher 1996 interest income resulting from
invested funds received from the sale of common stock in February 1996 and gains
on the sale of assets recognized in 1996.
19
<PAGE> 21
Production expenses for 1997 increased 3% to $11.0 million from $10.7
million in the prior year, primarily reflecting higher overall production
levels. On a unit basis, lifting costs (production expenses less ad valorem and
severance taxes) decreased to $0.23 per Mcfe in 1997 compared to $0.31 per Mcfe
in 1996, primarily reflecting lower average costs on north Louisiana production,
which is increasing in proportion to other higher cost production.
Exploration expenses remained constant from 1996 to 1997 at $5.4
million. Increased dry hole expenses were offset by a reduction in lease rental
expense reflecting the joint exploration agreement effective December 1996 in
south Louisiana with Williams.
General and administrative expenses of $6.9 million in 1997 decreased
23% compared to $9.0 million in 1996, reflecting efficiencies obtained in the
realignment of the workforce. This decrease is somewhat offset by a reduction in
1997 in the level of general and administrative expenses either being
capitalized or allocated to exploration expense. One a unit basis, general and
administrative expenses were $0.22 per Mcfe in 1997 compared to $0.36 per Mcfe
in 1996.
Interest and other debt expenses of $25.1 million in 1997 increased 3%
from $24.4 million in 1996. The increase in interest expense resulted primarily
from higher average debt levels during the current period and the payment of
interest associated with the settlement of a lawsuit. These were partially
offset by lower interest rates under the 10 3/8% Senior Subordinated Notes than
under the 13 1/2% Senior Notes retired in October 1996, and lower debt
amortization expenses as a result of the refinancing of the 13 1/2% Senior Notes
and the bank credit facility. See "Liquidity and Capital Resources." In addition
to its 1997 interest expense of $20.9 million, the Company recorded non-cash
charges in 1997 of $1.3 million for amortization of debt issuance costs, $0.9
million for accretion of note discount and $2.0 million for accretion of debt
valuation discount.
Restructuring expense in 1996 was $4.3 million. There was no
restructuring expense in 1997.
Depreciation, depletion and amortization ("DD&A") expense increased 27%
from $20.4 million in 1996 to $25.9 million in 1997, primarily as a result of
higher 1997 production levels. The units-of-production DD&A rate for oil and gas
activities was $0.80 per Mcfe in both 1996 and 1997.
The Company recognized net income of $2.0 million in 1997 and a net
loss before extraordinary item of $(11.9) million in the prior year. The reasons
for the earnings improvement are described in the foregoing discussion.
LIQUIDITY AND CAPITAL RESOURCES
General. The Company had $327.9 million principal amount of debt
outstanding as of December 31, 1998 ($320 million recorded on the balance
sheet), requiring approximately $29.1 million in annual cash interest payments.
In addition, dividends on the Company's preferred stock accrue quarterly at a
rate of $0.65625 per share. On April 14, 1998, the Board of Directors of the
Company declared a dividend on the Company's preferred stock of $2.625 per share
(approximately $4.6 million), which was paid on April 30, 1998. The Company has
not declared the quarterly dividends of $0.65625 for five quarters including
February 1, 1999 aggregating approximately $5.7 million. Future dividends are
restricted under both the Company existing Credit Facility and the indenture for
the 10 3/8% Senior Subordinated Notes. However, the Company's outstanding
preferred stock is cumulative, requires dividends to accumulate currently at the
rate of $4.6 million annually and carries liquidation preferences over the
Common Stock totaling $48.6 million at December 31, 1998, including such
dividend arrearages. Furthermore, should the Company not pay dividends on the
preferred stock for a period of six quarters the holders of preferred stock, as
a group, have the right to elect two additional directors to the Company's Board
of Directors.
During 1998, the oil and gas industry experienced a worldwide excess of
supply over demand for oil and natural gas resulting in sharply reduced prices.
As a result, many companies in the oil and gas industry, including the Company,
experienced reduced profitability and cash flows which, in turn, created
significant liquidity problems. As discussed in Note 4 to the Consolidated
Financial Statements, although the Company was in compliance with its Credit
20
<PAGE> 22
Facility debt covenants at December 31, 1998, the Company was not in compliance
as of March 31, 1999, which could result in all borrowings under such Credit
Facility being declared immediately due and payable and the Credit Facility
being terminated and the payment of other subordinated obligations being
accelerated. In addition other long-term debt repayments of $34.1 million are
scheduled to be made in December 1999. These uncertainties create substantial
doubt about the Company's ability to continue its operations as a going
concern. To address these liquidity issues, the Company is attempting to take
the measures discussed in the following paragraphs.
In April 1999, the Company entered into an Exploration and Development
Agreement with Phillips Petroleum Company ("Phillips") relating to certain of
the Company's interests in the Bryceland, West Bryceland and Sailes fields in
north Louisiana. Pursuant to the agreement, the Company will: (1) receive an $83
million cash payment (subject to certain post-closing adjustments), (2) retain a
42 Bcf, 8-year volumetric overriding royalty interest and a 1% override on the
excess production above such royalty interest and (3) retain 25% of its working
interest in the Cotton Valley formation. In addition, Phillips will at its risk
and expense, operate, develop, exploit and explore the properties thereby
relieving the Company of significant operating, exploration and development
costs in the future. The effective date of the transaction will be May 1, 1999
and is scheduled to close on April 30, 1999, subject to the parties obtaining
required consents and meeting substantial closing requirements.
In addition, the Company is negotiating a private offering of debt
securities (the "Notes"), the net proceeds which will be used to repay all
amounts outstanding under its Credit Facility, and some of which proceeds may be
used to redeem or otherwise retire a portion of the outstanding convertible
subordinated indebtedness. If issued, the Notes will be secured by a first lien
on substantially all of the Company's proved crude oil and natural gas
properties and guaranteed by three entities wholly-owned by the Company. The
issuance of the Notes will be conditioned upon the completion of the transaction
with Phillips noted in the preceding paragraph and upon the completion of
certain other conditions. There can be no assurance that the issuance of the
Notes will be consummated on such terms, or at all. Following the issuance of
the Notes, the Company likely will not have access to a revolving credit
facility to supplement its cash needs and its ability to incur additional
indebtedness will be substantially limited.
While industry conditions cannot be predicted with certainty and are
dependent upon a number of commodity and economic factors beyond its control,
the Company believes the net cash proceeds from the Phillips transaction and
issuance of the Notes, if consummated, in conjunction with cash on hand and cash
flow from operations will be sufficient to provide adequate working capital
and fund its capital expenditure program during 1999. However, the Company
will continue to have significant debt outstanding and industry conditions
beyond its control may adversely affect its results of operations and
financial condition.
Liquidity. Net cash provided by operating activities, before working
capital adjustments, during 1998 aggregated $24.6 million. Funds used in
investing activities were comprised of capital expenditures of $56.6 million
partially offset by property sales of $17.4 million. Funds provided by financing
activities were comprised of net borrowing repayments of $0.2 million, proceeds
from the sale of notes of $29.5 million and payment of preferred dividends of
$4.6 million. Cash equivalents increased from $0.2 million at December 31, 1997
to $8.4 million as of December 31, 1998. As of December 31, 1998, the Company
had a working capital deficit of $37.4 million, compared to a working capital
deficit of $15.2 million at the end of 1997. The increased deficit is primarily
a result of the reclassification of the 7 7/8% bonds, which are redeemable on
December 15, 1999, to current portion of long-term debt.
21
<PAGE> 23
The following table sets forth on an unaudited basis net cash provided
by operating activities before working capital adjustments, net cash used in
investing activities and EBITDAX.
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1996 1997 1998
--------- --------- --------
<S> <C> <C> <C>
Net cash provided by operating activities before
working capital adjustments..................................... $ 23,214 $ 37,534 $ 24,603
Net cash used in investing activities.............................. (53,392) (164,275) (39,216)
EBITDAX(1)......................................................... 42,621 58,308 52,700
</TABLE>
(1) EBITDAX is calculated as net income (loss) before extraordinary items,
excluding interest expense and other debt expenses, income taxes, exploration
expenses, restructuring expense, depletion, depreciation, amortization, and
impairment of oil and gas properties. EBITDAX is not a measure of cash flow as
determined by generally accepted accounting principles ("GAAP"). The Company has
included information concerning EBITDAX because EBITDAX is a measure used by
certain investors in determining a company's historical ability to service its
indebtedness. EBITDAX should not be considered as an alternative to, or more
meaningful than, net income or cash flow as determined in accordance with GAAP
as an indicator of the Company's operating performance or liquidity. EBITDAX is
not necessarily comparable to a similarly titled measure of another company.
On July 24, 1998, the Company sold, effective June 1, 1998, its entire
interest in the Waskom field in Harrison County, Texas for total consideration
of $17.4 million (before purchase price adjustment). These non-core assets were
acquired by the Company in the December 1997 asset purchase from SPR. The
properties were producing approximately 4.5 million cubic feet equivalent per
day. See Capital Resources.
Capital Resources. The Company's bank credit facility provides for a
maximum $140.0 million revolving credit loan and matures, with all amounts owed
thereunder becoming due and payable on December 1, 2000 (the "Credit Facility").
Availability under the Credit Facility is limited to a borrowing base (the
"Borrowing Base") determined by, among other things, the proved oil and natural
gas reserves and other assets of the borrowers and the value of those reserves
based on the underlying prices for oil and natural gas. The Borrowing Base is
redetermined at least semiannually by the agent under the Credit Facility, with
the consent of 100% of the lenders, and may be redetermined more frequently at
the election of the lenders or the borrowers. On April 14, 1998, the Borrowing
Base was set at $138 million and the threshold amount (the "Threshold Amount"),
which is the amount that would ordinarily be made available by the lenders to a
similar borrower under a borrowing base, was set at $125 million. Following the
Company's sale of its interest in the Waskom field in July, 1998, the Borrowing
Base and Threshold Amount were reduced to $130 million and $117 million,
respectively. As provided in the Credit Facility, on November 1, 1998 the
Borrowing Base was reduced to equal the Threshold Amount of $117 million.
On December 29, 1998, the Borrowing Base under the Credit Facility was
maintained at $117 million and certain terms were amended, including (i) an
increase in the margin borrowing rate to 250 basis points over LIBOR, (ii) a
reduction in the grace periods available under certain default provisions, (iii)
a change in the definition of majority banks for purposes of setting the
semi-annual Borrowing Base and implementing other provisions from 75% to 100%
and (iv) a reduction in the time allowed to cure a Borrowing Base deficiency.
At December 31, 1998, $111.5 million of borrowings and $1.5 million of
letters of credit were outstanding under the Credit Facility. The Company's
typical monthly cash flow cycle is such that the Company usually receives a
substantial portion of its proceeds from operations near the end of each month.
Accordingly, outstanding balances under the Credit Facility may be higher on any
given day during the month than at the end of the month.
As provided in the Credit Facility, a review of the Borrowing Base is
scheduled to be performed by the Company's banks by May 1, 1999. While the
amount of the Borrowing Base will not be known until such time as the banks make
the redetermination, the Company has been advised that the redetermination
likely will result in the Borrowing Base being lowered. If the Borrowing Base
were to be lowered below the level of outstanding advances,
22
<PAGE> 24
the Company would be required to repay 100% of the excess within thirty days.
Further, no additional borrowings would be available to the Company under the
Credit Facility until amounts outstanding are less than the Borrowing Base.
Further, under the current terms of the Credit Facility, certain of the
Company's financial covenants thereunder become more restrictive in future
periods. Specifically, the interest coverage ratio increases from 2.0/1 to
2.25/1 beginning with the rolling four quarters ended March 31, 1999. The
Company was not in compliance with this covenant under the Credit Facility as of
March 31, 1999. If the Company is not successful in either finding alternative
financing or negotiating a waiver of such noncompliance, all borrowings under
the Credit Facility could be declared immediately due and payable, the Credit
Facility being terminated and the payment of other subordinated obligations
being accelerated. The indebtedness under the Credit Facility is secured by
substantially all of the oil and natural gas assets of the Company.
Included in the outstanding debt at December 31, 1998 was $30.0 million
principal amount of the Company's Series C Notes issued in May 1998 at a cash
price of $1,015 per $1,000 principal amount. The net proceeds received were used
to reduce outstanding borrowings under the Credit Facility. See Note 3 - Long
Term Debt in the Notes to Consolidated Financial Statements contained in this
Report for further discussion. The Series C Notes were sold pursuant to Rule
144A of the Securities Act of 1933. The Company has registered under the
Securities Act, notes identical in terms to the Series C Notes ("Series D
Notes") and completed the exchange of the Series C Notes for the Series D Notes
on November 12, 1998.
In addition to long-term debt requiring principal payments of $34.6
million in December 1999, the Company has long-term debt obligations in the
aggregate principal amounts at maturity of $26.9 million maturing in April 2000.
The Company anticipates that it will meet this obligation with net proceeds form
oil and natural gas property sales. The Company can provide no assurance that
such property sales will be completed or that, if completed, will provide
sufficient proceeds to repay this outstanding long term debt.
Capital Commitments. The Company's 1999 capital expenditure budget
provides for $10.0 million to be expended on development drilling primarily in
north Louisiana and on the Bayou Sauveur field (Bourg prospect) in south
Louisiana and $5.0 million to be expended on exploratory prospects primarily in
south Louisiana and the shallow waters of the Gulf of Mexico. However, the
Company's ability to fund its 1999 capital expenditure budget will depend on the
actual amount of cash flow from operations and proceeds from oil and gas
property sales.
During 1998, the Company participated in drilling 62 gross (26.93 net)
wells, of which 54 gross (23.25 net) wells were completed. The 1998 drilling
performance reflects lower risk operations in north Louisiana and past
exploratory successes in south Louisiana. The Company, with its partners,
continues exploration activities in south Louisiana. As of December 31, 1998,
the Company was participating in the drilling or completing of 2 gross (0.84
net) wells.
23
<PAGE> 25
Year 2000. The Company has instigated reviews and evaluations in
response to Year 2000 issues. These issues involve the potential disruption to
systems, processes, and business practices that may occur if system hardware and
software utilized by the Company, its vendors, and customers are unable to
process year 2000 data. The planning phase is completed and the Company is
nearing completion of internal corrective measures.
The Company is working closely with its information systems and
technology vendors to install updated software, where appropriate, that will be
Year 2000 compliant. Currently, more than 90% of the critical Year 2000 internal
systems issues have been tested and corrected. The remainder are expected to be
installed and tested by the end of the third quarter of 1999.
The Company has identified those vendors and others that it believes
provide material services or are vital to its business. Discussions with these
companies to determine their Year 2000 readiness are expected to be completed in
the second quarter 1999. By mid-year 1999 the Company plans to have completed
its Year 2000 review and implemented necessary corrective measures.
The cost of reviewing and implementing corrective measures for Year
2000 issues to date has not been material to the Company and has been limited to
use of Company and vendor personnel for review and implementation of corrective
measures. The Company expects the remainder of the Year 2000 review and
corrective measures to not involve significant costs.
Based on assessments to date and compliance plans in progress, nothing
has come to the attention of management to cause it to believe that Year 2000
issues, including the cost of implementing corrective measures, will have an
adverse material impact on the business or operations of the Company.
Nevertheless, as indicated above, achieving Year 2000 readiness is subject to
risk and uncertainties, especially regarding third parties, and there can be no
assurance the Company will not be adversely affected by Year 2000 issues.
The foregoing statements are intended to be and are hereby designated
"Year 2000 Readiness Disclosures" within the meaning of the Year 2000
Information and Readiness Act.
Inflation and Changing Prices. Oil and natural gas prices, as with most
commodities, are highly volatile, have fluctuated during recent years and
generally have not followed the same pattern as inflation. The following table
shows the changes in the average oil and natural gas prices (including the
effects of hedging) received by the Company during the periods indicated.
<TABLE>
<CAPTION>
AVERAGE AVERAGE
OIL PRICE GAS PRICE
($/BBL) ($/MCF)
--------- ---------
<S> <C> <C>
YEAR ENDED:
December 31, 1998 ........................................................... $ 13.09 $ 2.09
December 31, 1997............................................................ 19.34 2.27
December 31, 1996............................................................ 22.11 2.30
</TABLE>
24
<PAGE> 26
ITEM 7A. MARKET RISK DISCLOSURE
The Company is exposed to market risk from changes in interest rates
and commodity prices. The Company uses its Credit Facility and Senior and
Subordinated debt instruments to finance a significant portion of its
operations. The Company's exposure to market risk for interest rate changes
relates to its Credit Facility variable rate debt. In the normal course of
business the Company enters into hedging transactions, including natural gas
price and basis swap agreements, to mitigate its exposure to commodity price
movements, but not for trading or speculative purposes. In 1998, the Company
used price and basis swap agreements to reduce exposure to downward price
fluctuations for its natural gas production. For debt obligations the table
below presents principal cash flows and weighted average interest rates by year
of maturity. For natural gas price and basis swap agreements, the table presents
notional amounts in Mmbtu's and weighted average prices for contracts in place
at December 31, 1998. The information presented below should be read in
conjunction with Note 4 and Note 10 to the Consolidated Financial Statements
(amounts in thousands otherwise indicated).
<TABLE>
<CAPTION>
MATURITY DATE
----------------------------------------------------- FAIR VALUE
1999 2000 2001 2002 2003 THEREAFTER TOTAL @ 12/31/98
--------- --------- --------- --------- -------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Variable Debt:
Credit Facility
(Maturity) 7.03%(1)....... $ 111,500 $ 111,500 $ 111,500
Fixed Debt:
13.50% (Maturity)......... $ 435 435 431
7.88% (Maturity).......... 34,147 34,147 15,366
8.50% (Maturity).......... 26,856 26,856 12,085
10.38% (Maturity)......... $ 155,000 155,000 111,600
---------- --------- --------- --------- ---------
Total Maturity............... $ 34,582 $ 138,356 $ 155,000 $ 327,938 $ 250,982
========== ========= ========= ========= =========
Blended weighted
average interest rate..... 7.95% 8.5% 10.38%
Commodity price
derivatives:
Price swaps:
Notional amounts
(Mmbtu's) ............. 5,400,000
Weighted average price..... $ 2.36
Fair value at 12/31/98(2).. $ 2,506
Basis swaps:
Notional amounts
(Mmbtu's) ............. 16,380,000
Margin differential(3)..... $ (0.01)
Fair value at 12/31/98(2).. $ (142)
</TABLE>
(1) Reflects the weighted average interest rate on borrowings outstanding at
December 31, 1998.
(2) Represents estimated amounts to settle the contracts at December 31, 1998.
(3) Estimated weighted average margin differential at December 31, 1998.
25
<PAGE> 27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES: PAGE
----
<S> <C>
Independent Auditors' Report.............................................................................. 27
Consolidated Balance Sheets - December 31, 1997 and 1998.................................................. 28
Consolidated Statements of Income (Loss) - For the years ended December 31, 1996, 1997 and 1998........... 29
Consolidated Statements of Cash Flows - For the years ended December 31, 1996, 1997 and 1998.............. 30
Consolidated Statements of Changes in Stockholders' Deficit - For the years ended
December 31, 1996, 1997 and 1998........................................................................ 31
Notes to Consolidated Financial Statements................................................................ 32
</TABLE>
26
<PAGE> 28
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Kelley Oil & Gas Corporation:
We have audited the accompanying consolidated balance sheets of Kelley
Oil & Gas Corporation and subsidiaries (the "Company") as of December 31, 1997
and 1998, and the related consolidated statements of income (loss), cash flows,
and changes in stockholders' deficit for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Corporation's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly,
in all material respects, the financial position of Kelley Oil & Gas Corporation
and subsidiaries as of December 31, 1997 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements for the year ended
December 31, 1998 have been prepared assuming that the Company will continue as
a going concern. As discussed in Note 1 to the financial statements, the
Company's liquidity issues and difficulties in meeting certain loan agreement
covenants raise substantial doubt about its ability to continue as a going
concern. Management's plans concerning these matters are also described in Note
1. The financial statements do not include any adjustments that might result
from the outcome of this uncertainty.
DELOITTE & TOUCHE LLP
Houston, Texas
April 13, 1999
27
<PAGE> 29
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1998
--------- ---------
<S> <C> <C>
ASSETS:
Cash and cash equivalents ............................................................. $ 162 $ 8,435
Accounts receivable ................................................................... 24,566 18,071
Accounts receivable - drilling programs ............................................... 718 624
Prepaid expenses and other current assets ............................................. 1,412 1,121
--------- ---------
Total current assets ................................................................ 26,858 28,251
--------- ---------
Oil and gas properties, successful efforts method:
Unproved properties, net ............................................................ 49,854 38,293
Properties subject to amortization .................................................. 463,263 496,686
Pipelines and other transportation assets, at cost .................................... 4,690 1,582
Furniture, fixtures and equipment ..................................................... 2,969 3,554
--------- ---------
520,776 540,115
Less: Accumulated depreciation, depletion and amortization ........................... (227,163) (283,660)
--------- ---------
Total property and equipment, net ................................................... 293,613 256,455
Other non-current assets, net ......................................................... 2,131 1,491
--------- ---------
Total assets ........................................................................ $ 322,602 $ 286,197
========= =========
LIABILITIES:
Accounts payable and accrued expenses ................................................. $ 41,474 $ 33,113
Accounts payable - drilling programs .................................................. 566 272
Current portion of long-term debt ..................................................... -- 32,251
--------- ---------
Total current liabilities ........................................................... 42,040 65,636
--------- ---------
Long term debt ........................................................................ 286,183 287,500
--------- ---------
Total liabilities ................................................................... 328,223 353,136
--------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT:
Preferred stock, $1.50 par value, 20,000,000 shares authorized at December
31, 1997 and 1998; 1,745,443 and 1,733,628 shares issued and outstanding at
December 31, 1997 and 1998, respectively
(liquidation value $48,977 and $48,633, respectively) ............................... 2,618 2,600
Common stock, $.01 par value, 200,000,000 shares authorized at December 31,
1997 and 1998; 125,709,093 and 126,022,235 shares issued and outstanding at
December 31, 1997 and 1998, respectively ............................................ 1,257 1,260
Additional paid-in capital ............................................................ 300,367 300,653
Accumulated deficit ................................................................... (309,863) (371,452)
--------- ---------
Total stockholders' deficit ......................................................... (5,621) (66,939)
--------- ---------
Total liabilities and stockholders' deficit ......................................... $ 322,602 $ 286,197
========= =========
</TABLE>
See Notes to Consolidated Financial Statements.
28
<PAGE> 30
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
REVENUES:
Oil and gas revenues ................................................... $ 60,854 $ 75,864 $ 79,150
Interest and other income .............................................. 1,429 274 505
--------- --------- ---------
Total revenues ......................................................... 62,283 76,138 79,655
--------- --------- ---------
COSTS AND EXPENSES:
Production expenses .................................................... 10,709 10,955 19,878
Exploration expenses ................................................... 5,438 5,433 12,034
General and administrative expenses .................................... 8,953 6,875 7,077
Interest and other debt expenses ....................................... 24,401 25,071 33,333
Restructuring expenses ................................................. 4,276 -- --
Depreciation, depletion and amortization ............................... 20,440 25,853 38,602
Impairment of oil and gas properties ................................... -- -- 25,738
--------- --------- ---------
Total expenses ......................................................... 74,217 74,187 136,662
--------- --------- ---------
Income (loss) before income taxes and extraordinary item .................. (11,934) 1,951 (57,007)
Income taxes ........................................................... -- -- --
--------- --------- ---------
Net income (loss) before extraordinary item ............................... (11,934) 1,951 (57,007)
Extraordinary item ..................................................... (17,030) -- --
--------- --------- ---------
Net income (loss) ......................................................... (28,964) 1,951 (57,007)
Less: cumulative preferred stock dividends ............................. (4,582) (4,582) (4,550)
--------- --------- ---------
Net loss applicable to common stock ....................................... $ (33,546) $ (2,631) $ (61,557)
========= ========= =========
Basic and diluted loss per common share before extraordinary item ......... $ (.18) $ (.03) $ (0.49)
========= ========= =========
Basic and diluted loss per common share ................................... $ (.37) $ (.03) $ (0.49)
========= ========= =========
Weighted average common shares outstanding ................................ 90,113 100,757 125,783
========= ========= =========
</TABLE>
See Notes to Consolidated Financial Statements.
29
<PAGE> 31
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) ...................................................... $ (28,964) $ 1,951 $ (57,007)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation, depletion and amortization ............................. 20,440 25,853 38,602
Impairment of oil and gas properties ................................. -- -- 25,738
Gain on sale of properties ........................................... (176) -- --
Exploration expenses ................................................. 5,438 5,433 12,034
Accretion and amortization of other debt expenses .................... 5,170 4,297 5,236
Restructuring expenses ............................................... 4,276 -- --
Extraordinary loss ................................................... 17,030 -- --
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable
and other current assets ........................................... (9,054) (1,297) 6,880
Increase in other non-current assets ................................. (1,945) (1,203) (526)
Increase (decrease) in accounts payable and accrued expenses ......... (2,953) 4,570 (8,655)
--------- --------- ---------
Net cash provided by operating activities .............................. 9,262 39,604 22,302
--------- --------- ---------
INVESTING ACTIVITIES:
Capital expenditures ................................................... (47,601) (53,140) (56,579)
Acquisition of oil and gas properties .................................. (11,594) (111,135) --
Proceeds from sale of properties ....................................... 5,803 -- 17,363
--------- --------- ---------
Net cash used in investing activities .................................. (53,392) (164,275) (39,216)
--------- --------- ---------
FINANCING ACTIVITIES:
Proceeds from long term borrowings ..................................... 50,000 180,500 119,100
Principal payments on long term borrowings ............................. (58,500) (82,700) (118,900)
Proceeds from sale of notes, net ....................................... 120,938 -- 29,526
Debenture conversion costs ............................................. (1,100) -- --
Proceeds from sale of common stock, net ................................ 43,998 27,545 273
Proceeds from conversion of preferred stock ............................ -- -- (2)
Retirement of notes .................................................... (113,488) -- (228)
Dividends on preferred stock ........................................... -- (4,582) (4,582)
--------- --------- ---------
Net cash provided by financing activities .............................. 41,848 120,763 25,187
--------- --------- ---------
(Decrease) increase in cash and cash equivalents .......................... (2,282) (3,908) 8,273
Cash and cash equivalents, beginning of period ............................ 6,352 4,070 162
--------- --------- ---------
Cash and cash equivalents, end of period .................................. $ 4,070 $ 162 $ 8,435
========= ========= =========
</TABLE>
See Notes to Consolidated Financial Statements.
30
<PAGE> 32
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
ADDITIONAL
PREFERRED COMMON PAID IN ACCUMULATED
STOCK STOCK CAPITAL DEFICIT
--------- --------- ---------- -----------
<S> <C> <C> <C> <C>
Stockholders' deficit at January 1, 1996 ........................ $ 6,456 $ 440 $ 225,804 $(278,268)
Issuance of 48,000 shares of common stock in
Contour Transaction .......................................... -- 480 47,520 --
Conversion of 697 shares of preferred stock into
4,355 shares of common stock ................................. (1,045) 44 1,001 --
Conversion of 1,862 shares of preferred stock into
1,862 shares of common stock ................................. (2,793) 19 2,774 --
Issuance of 36 shares of common stock pursuant to
employee incentive stock options ............................. -- -- 62 --
Syndication costs ............................................... -- -- (4,065) --
Net loss ........................................................ -- -- -- (28,964)
------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1996 ................................. 2,618 983 273,096 (307,232)
------- --------- --------- ---------
Issuance of 27,000 shares of common stock in
Contour Transaction .......................................... -- 270 26,730 --
Issuance of 415 shares of common stock pursuant to
employee incentive stock options ............................. -- 4 541 --
Preferred stock dividends ....................................... -- -- -- (4,582)
Net income ...................................................... -- -- -- 1,951
------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1997 ................................. 2,618 1,257 300,367 (309,863)
------- --------- --------- ---------
Conversion of 11,815 shares of preferred stock
into 40,976 share of common stock ............................ (18) 1 17 --
Issuance of 272,166 shares of common stock pursuant to
employee incentive stock options ............................. -- 2 269 --
Preferred stock dividends ....................................... -- -- -- (4,582)
Net loss ........................................................ -- -- -- (57,007)
------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1998 ................................. $ 2,600 $ 1,260 $ 300,653 $(371,452)
======= ========= ========= =========
</TABLE>
See Notes to Consolidated Financial Statements.
31
<PAGE> 33
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - INDUSTRY CONDITIONS AND LIQUIDITY
During 1998, the oil and gas industry experienced a worldwide excess of
supply over demand for oil and natural gas resulting in sharply reduced prices.
As a result, many companies in the oil and gas industry, including the Company,
experienced reduced profitability and cash flows which, in turn, created
significant liquidity problems. As discussed in Note 4 to the Consolidated
Financial Statements, although the Company was in compliance with its Credit
Facility debt covenants at December 31, 1998, the Company was not in compliance
as of March 31, 1999, which could result in all borrowings under such Credit
Facility being declared immediately due and payable and the Credit Facility
being terminated and the payment of other subordinated obligations being
accelerated. In addition other long-term debt repayments of $34.1 million are
scheduled to be made in December 1999. These uncertainties create substantial
doubt about the Company's ability to continue its operations as a going concern.
To address these liquidity issues, the Company is attempting to take the
measures discussed in the following paragraphs.
In April 1999, the Company entered into an Exploration and Development
Agreement with Phillips Petroleum Company ("Phillips") relating to certain of
the Company's interests in the Bryceland, West Bryceland and Sailes fields in
north Louisiana. Pursuant to the agreement, the Company will: (1) receive an $83
million cash payment (subject to certain post-closing adjustments), (2) retain a
42 Bcf, 8-year volumetric overriding royalty interest and a 1% override on the
excess production above such royalty interest and (3) retain 25% of its working
interest in the Cotton Valley formation. In addition, Phillips will at its risk
and expense, operate, develop, exploit and explore the properties thereby
relieving the Company of significant operating, exploration and development
costs in the future. The effective date of the transaction will be May 1, 1999
and is scheduled to close on April 30, 1999, subject to the parties obtaining
required consents and meeting substantial closing requirements.
In addition, the Company is negotiating a private offering of debt
securities (the "Notes"), the net proceeds which will be used to repay all
amounts outstanding under its Credit Facility, and some of which proceeds may be
used to redeem or otherwise retire a portion of the outstanding convertible
subordinated indebtedness. If issued, the Notes will be secured by a first lien
on substantially all of the Company's proved crude oil and natural gas
properties and guaranteed by three entities wholly-owned by the Company. The
issuance of the Notes will be conditioned upon the completion of the transaction
with Phillips noted in the preceding paragraph and upon the completion of
certain other conditions. There can be no assurance that the issuance of the
Notes will be consummated on such terms, or at all. Following the issuance of
the Notes, the Company likely will not have access to a revolving credit
facility to supplement its cash needs and its ability to incur additional
indebtedness will be substantially limited.
While industry conditions cannot be predicted with certainty and are
dependent upon a number of commodity and economic factors beyond its control,
the Company believes the net cash proceeds from the Phillips transaction and
issuance of the Notes, if consummated, in conjunction with cash on hand and cash
flow from operations will be sufficient to provide adequate working capital
and fund its capital expenditure program during 1999. However, the Company
will continue to have significant debt outstanding and industry conditions
beyond its control may adversely affect its results of operations and
financial condition.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Operations. Kelley Oil & Gas Corporation (a Delaware
Corporation), its corporate subsidiaries and proportionate partnership interests
are referred to herein as the "Company". The Company is an independent oil & gas
company engaged in the exploration, development and acquisition of domestic oil
and gas properties, principally in the Gulf Coast region and northern Louisiana.
Cash and Cash Equivalents. The Company considers all highly liquid
investments with an original maturity of three months or less when purchased to
be cash equivalents. Cash payments attributable to interest on all
32
<PAGE> 34
indebtedness aggregated $19.2 million, $19.6 million and $26.5 million for the
years ended December 31, 1996, 1997 and 1998, respectively.
Financial Instruments. The Company's financial instruments consist of
cash and cash equivalents, receivables, payables and long term debt. As of
December 31, 1998, the estimated fair value of the Company's long-term debt was
$251 million. The fair value of such long-term debt has been estimated based on
quoted market prices and the Black-Scholes pricing model. The carrying amount of
the Company's other financial instruments approximates fair value.
Oil and Gas Properties. All of the Company's interests in its oil and
gas properties are located in the United States and are accounted for using the
successful efforts method. Under the successful efforts method, the costs of
successful wells, development dry holes and leases containing productive
reserves are capitalized and amortized on a unit-of-production basis over the
life of the related reserves. Estimated future abandonment and site restoration
costs, net of anticipated salvage values, are amortized on a unit-of-production
basis over the life of the related reserves. Exploratory drilling costs are
initially capitalized pending determination of proved reserves but are charged
to expense if no proved reserves are found. Other exploration costs, including
geological and geophysical expenses, leasehold expiration costs and delay
rentals, are expensed as incurred. Unproved leasehold costs are capitalized and
are not amortized pending an evaluation of the exploration results. Unproved
properties are periodically assessed for impairment in value, with any
impairment charged to expense.
Property Impairment under SFAS 121. Under Financial Accounting
Standards Board's Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 121"),
certain assets are required to be reviewed periodically for impairment whenever
circumstances indicate their carrying amount exceeds their fair value and may
not be recoverable. As a result of a decline in its proved reserves at January
1, 1999 from year-earlier levels, the Company performed an assessment of the
fair value of its oil and gas properties indicating an impairment should be
recognized as of year end. Under this analysis, the fair value for the Company's
proved oil and gas properties was estimated using escalated pricing and present
value discount factors reflecting risk assessments. The fair value of the
Company's unproved properties was predicated on current acreage cost estimates.
Based on this analysis, the Company recognized noncash impairment charges
against the carrying values of its proved and unproved oil and gas properties
under SFAS 121 aggregating $21.6 million and $4.1 million, respectively, at
December 31, 1998.
Other Property and Equipment. The costs of pipelines and other
transportation assets are depreciated using the straight-line method over the
estimated useful lives of the related assets. Furniture, fixtures and equipment
are recorded at cost and depreciated using the straight-line method over the
estimated useful lives of three to five years. Maintenance and repairs are
charged to expense as incurred.
Other Non-Current Assets. Other non-current assets consist primarily of
debt issue costs, net of accumulated amortization. These costs are amortized
over the anticipated term of the related debt.
Oil and Gas Revenues. The Company recognizes oil and gas revenue from
its interests in producing wells as oil and gas is produced and sold from those
wells. Oil and gas sold is not significantly different from the Company's
production entitlement. Revenues from gas marketing, net of cost of gas sold,
are included in oil and gas revenues and amounted to $1.8 million, $2.8 million
and $1.3 million for the years ended December 31, 1996, 1997 and 1998,
respectively.
Earnings per Share. In 1997, the Company implemented the Financial
Accounting Standards Board Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS 128"). SFAS 128 establishes standards for computing
and presenting earnings per share ("EPS") and is effective for financial
statements issued for periods ending after December 15, 1997. This statement
requires restatement for all prior-period EPS data presented. The basic loss per
common share before extraordinary item and basic loss per common share as shown
on the Consolidated Statements of Income (Loss) reflects net income (loss)
before extraordinary item and net income (loss), respectively, less cumulative
preferred stock dividends, whether or not declared, divided by the weighted
average number of common
33
<PAGE> 35
shares outstanding during the respective years. The extraordinary loss per
common share for the year ended 1996 was $0.19. In calculating diluted income
(loss) per share, common shares issuable under stock options and upon conversion
of convertible subordinated debentures and convertible preferred stock are added
to the weighted average common shares outstanding when dilutive. For the years
ended December 31, 1996, 1997 and 1998, all potentially dilutive securities are
anti-dilutive and therefore are not included in the EPS calculations.
Potentially dilutive securities which could impact EPS in the future include
stock options granted to employees to purchase 4.5 million common shares, the
Company's 7 7/8% Convertible Subordinated Notes and 8 1/2% Convertible
Subordinated Debentures which can be converted into 2.5 million and 1.4 million
common shares, respectively, and the Company's $2.625 Convertible Preferred
Stock ("Preferred Stock") which can be can be converted into 6.0 million common
shares.
Stock Based Compensation. The Company applies Accounting Principles
Board Opinion No. 25 ("APB 25") and related Interpretations in accounting for
stock option and purchase plans. Under APB 25, compensation expense, if any, is
based on the intrinsic value of the equity instrument at the measurement date.
The Company has not recognized any compensation expense because the exercise
price of employee stock options equals the market price of the underlying stock
on the date of the grant.
Derivatives and Hedging Activities. See Note 10 for a discussion of
the Company's accounting policies related to hedging activities. In June 1998,
the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting
standards for derivative instruments and hedging activities that require an
entity to recognize all derivatives as an asset or liability measured at its
fair value. Depending on the intended use of the derivatives, changes in its
fair value will be reported in the period of change as either a component of
earnings or a component of other comprehensive income.
SFAS 133 is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Earlier application of SFAS 133 is encouraged, but not
prior to the beginning of any fiscal quarter that begins after issuance of the
Statement. Retroactive application to periods prior to adoption is not allowed.
The Company has not quantified the impact of adoption on its financial
statements or the date it intends to adopt.
Comprehensive Income. In June 1997, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for reporting
and displaying comprehensive income and its components. SFAS 130 is effective
for periods beginning after December 15, 1997. The purpose of reporting
comprehensive income is to report a measure of all changes in equity of an
enterprise that results from recognized transactions and other economic events
of the period other than transactions with owners in their capacity as owners.
As of December 31, 1998, there are no adjustments ("Other Comprehensive Income")
to net income in deriving comprehensive income.
Risks and Uncertainties. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that 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.
Changes in Presentation. Certain financial statement items in 1996 and
1997 have been reclassified to conform to the 1998 presentation.
NOTE 3 - ACQUISITION OF OIL AND GAS PROPERTIES
SPR Acquisition. On December 1, 1997, the Company purchased from SCANA
Petroleum Resources, Inc. ("SPR") substantially all of SPR's assets, including
its oil and gas properties, exploratory leasehold interests and associated
obligations, in exchange for approximately $110 million ("SPR Acquisition"),
subject to adjustment as provided by the Purchase and Sale Agreement between the
Company and SPR. The acquisition was accounted for using the purchase method of
accounting, and accordingly, the purchase price has been preliminarily allocated
to the assets
34
<PAGE> 36
acquired based on estimated fair values at the date of acquisition. The
operating results of the assets acquired from SPR have been included in Kelley's
Statements of Income (Loss) since December 1, 1997. The pro forma information
shown below assumes that the acquisition occurred at the beginning of each year
presented. Adjustments have been made to reflect changes in the Company's
results from the revenues and direct operating expenses of the producing
properties acquired from SPR, additional interest expense to finance the
acquisition, depreciation, depletion and amortization based on assigned fair
values to the assets acquired and general and administrative expenses incurred
from hiring additional employees. The unaudited pro forma financial data are not
necessarily indicative of financial results that would have occurred had the SPR
Acquisition occurred on January 1, 1996 and January 1, 1997, and should not be
viewed as indicative of operations in future periods.
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
(UNAUDITED)
-----------------------------
YEAR ENDED DECEMBER 31,
-----------------------------
1996 1997
----------- -----------
<S> <C> <C>
Revenues......................................................................... $ 112,936 $ 112,142
Income (loss) before extraordinary item.......................................... (12,484) 1,315
Net income (loss)................................................................ (29,514) 1,315
Loss per common share............................................................ (0.29) (0.03)
</TABLE>
NOTE 4 - LONG TERM DEBT
Long Term Debt. The Company's long term debt at December 31, 1997 and
1998 is comprised of the following:
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1997 1998
---------- ----------
<S> <C> <C>
Bank credit facilities............................................................ $ 111,300 $ 111,500
13 1/2% Senior Notes.............................................................. 435 435
10 3/8% Senior Subordinated Notes................................................. 120,615 150,662
7 7/8% Convertible Subordinated Notes............................................. 29,710 31,816
8 1/2% Convertible Subordinated Debentures........................................ 24,123 25,338
---------- ----------
286,183 319,751
Less current maturities........................................................ -- (32,251)
---------- -----------
$ 286,183 $ 287,500
========== ==========
</TABLE>
Bank Credit Facilities. The Company replaced its prior credit facility
with a new credit facility effective as of December 12, 1996 (the "Credit
Facility") that was subsequently amended and restated in connection with the SPR
Acquisition effective December 1, 1997. The borrowers under the Credit Facility
are the Company, Kelley Oil Corporation ("Kelley Oil") and Kelley Operating
Company, Ltd., with Concorde Gas Marketing, Inc. (a wholly-owned subsidiary of
the Company) and the Company's subsidiary partnerships as guarantors.
The Credit Facility provides for a maximum $140 million revolving
credit loan and matures, with all amounts owed thereunder becoming due and
payable on December 1, 2000. Availability under the Credit Facility is limited
to a borrowing base determined by, among other things, the proved oil and
natural gas reserves and other assets of the borrowers and the value of those
reserves based on the underlying prices for oil and natural gas. The Borrowing
Base is redetermined at least semiannually by the Agent under the Credit
Facility, with the consent of 100% of the lenders, and may be redetermined more
frequently at the election of the lenders or the borrowers. On April 14, 1998,
the
35
<PAGE> 37
Borrowing Base was set at $138 million and the threshold amount (the "Threshold
Amount"), which is the amount that would ordinarily be made available by the
lenders to a similar borrower under a borrowing base, was set at $125 million.
Following the Company's sale of its interest in the Waskom field in July 1998,
the Borrowing Base and Threshold Amount were reduced to $130 million and $117
million, respectively. As provided in the Credit Facility, on November 1, 1998
the Borrowing Base was reduced to equal the Threshold Amount of $117 million.
On December 29, 1998 the Borrowing Base under the Credit Facility was
maintained at $117 million and certain terms were amended, including: (i) an
increase in the margin borrowing rate to 250 basis points over LIBOR, (ii) a
reduction in the grace periods available under certain default provisions, (iii)
a change in the definition of majority banks for purposes of setting the
semi-annual Borrowing Base and implementing other provisions from 75% to 100%,
and (iv) a reduction in the time allowed to cure a Borrowing Base deficiency to
30 days.
At December 31, 1998, $111.5 million of borrowings and $1.5 million of
letters of credit were outstanding under the Credit Facility. The Company's
typical monthly cash flow cycle is such that the Company usually receives a
substantial portion of its proceeds from operations near the end of each month.
Accordingly, outstanding balances under the Credit Facility may be higher on any
given day during the month than at the end of the month.
As provided in the Credit Facility, a review of the Borrowing Base is
expected to be performed by the Company's banks by May 1, 1999. While the amount
of the Borrowing Base will not be known until such time as the banks make the
redetermination, the Company has been advised that the redetermination likely
will result in the Borrowing Base being lowered. If the Borrowing Base were to
be lowered below the level of outstanding advances, the Company would be
required to repay 100% of the excess within thirty days. Further, no additional
borrowings would be available to the Company under the Credit Facility until
amounts outstanding are less than the Borrowing Base.
Further, under the current terms of the Credit Facility, certain of the
Company's financial covenants thereunder become more restrictive in future
periods. Specifically, the interest coverage ratio increases from 2.0/1 to
2.25/1 beginning with the rolling four quarters ended March 31, 1999. The
Company was not in compliance with this covenant under the Credit Facility as of
March 31, 1999, which could result in all borrowings under the Credit Facility
being declared immediately due and payable, the Credit Facility being terminated
and the payment of other subordinated obligations being accelerated. The
indebtedness under the Credit Facility is secured by substantially all of the
oil and natural gas assets of the Company. The weighted average interest rate on
borrowings outstanding at December 31, 1998 under the Credit Facility was 7.03%.
In addition to the $140 million revolving credit loan, at December 31,
1997 the Credit Facility, as amended, provided a $32.3 million term loan ("Term
Loan Facility") for use by the Company in the event that holders of the
Company's 7 7/8% Convertible Subordinated Notes exercised their redemption right
that occurred in connection with the exercise by Contour of its option to
purchase additional common shares of the Company. Holders of $0.2 million of
these notes exercised their redemption right in January 1998, and as a result,
the Term Loan Facility was terminated without being used on January 23, 1998.
So long as no default or event of default (as defined in the Credit
Facility) is continuing, borrowings under the Credit Facility, as amended, bear
interest, at the option of the borrowers, at either (i) LIBOR plus 2.5% or (ii)
the higher of (a) the agent's prime rate plus 1.1% and (b) the federal funds
rate plus 1.5%. The Borrowers incur a quarterly commitment fee of 0.50% per
annum on the average unused portion of the borrowing base.
The Credit Facility contains covenants which, among other things, limit
the amount of debt the Company may incur, limit the placement of liens on its
assets, limit lease transactions, limit its ability to enter into certain
hedging transactions, restrict its ability to merge with or into another person
and prevent it from prepaying certain subordinated indebtedness unless certain
conditions are met. The Credit Facility also restricts the payment of dividends.
Further, certain covenants require that, for specified periods, the Company
maintain specified ratios between EBITDAX and senior indebtedness and EBITDAX
and interest on indebtedness.
36
<PAGE> 38
1996 Fourth Quarter Extraordinary Loss. Pursuant to an offer to
purchase and consent solicitation, dated September 24, 1996, as amended , the
Company offered to purchase for cash up to the aggregate principal amount of
$100 million of its 13 1/2% Senior Notes at a cash price equal to $1,110 per
$1,000 principal amount, plus interest accrued and unpaid through the payment
date. In conjunction with the offering, the Company also solicited consents to
the adoption of certain amendments to the 13 1/2% Senior Notes indenture
pursuant to which the 13 1/2% Senior Notes were issued, and offered to pay each
consenting holder of the 13 1/2% Senior Notes, $30 for each $1,000 principal
amount of the 13 1/2% Senior Notes consenting. The Company received the
requisite consents which allowed it to amend the 13 1/2% Senior Notes indenture
on October 28, 1996. The Company also received tenders from holders of
approximately $99.6 million principal amount of the 13 1/2% Senior Notes. These
transactions resulted in an extraordinary loss in the fourth quarter of 1996 of
$17.0 million, representing the excess of the aggregate purchase price of the 13
1/2% Notes (including Consent Payments) over their carrying value as of the date
of the consummation of the refinancing.
10 3/8% Senior Subordinated Notes. In connection with the refinancing
of the 13 1/2% Senior Notes, the Company issued an aggregate principal amount of
$125.0 million of 10 3/8% Senior Subordinated Notes due 2006 (the "10 3/8%
Senior Subordinated Notes"). The 10 3/8% Senior Subordinated Notes are
redeemable at the option of the Company, in whole or in part, at redemption
prices declining from 105.19% in 2001 to 100% in 2003 and thereafter. The
Company may redeem up to 35% of the principal amount of the 10 3/8% Senior
Subordinated Notes before October 15, 1999 with the proceeds of an equity
offering (provided that either at least $75.0 million aggregate principal amount
of such notes remains outstanding or such redemption retires such notes in their
entirety). The 10 3/8% Senior Subordinated Notes represent unsecured obligations
of the Company and are subordinate in right of payment to all existing and
future senior indebtedness. The indenture for the notes contains conditions and
limitations, including but not limited to restrictions on additional
indebtedness, payment of dividends, redemption of capital stock, and certain
mergers and consolidations. The holder of the 10 3/8% Senior Subordinated Notes
also can require the Company to repurchase the notes at 101% of the principal
amount upon a Change of Control, as defined. Kelley Oil Corporation, a
wholly-owned subsidiary of the Company and Kelley Operating Company, Ltd., an
indirect wholly-owned partnership of the Company are guarantors of the 10 3/8%
Senior Subordinated Notes.
On February 3, 1997, the Company completed an exchange of $125.0
million aggregate principal amount of publicly registered 10 3/8% Senior
Subordinated Notes, Series B, for all of the then outstanding Series A notes.
The Series B notes were substantially identical to the Series A notes.
In May 1998, the Company sold $30.0 million principal amount of the
Company's 10 3/8% Senior Subordinated Notes due 2006, Series C ("Series C
Notes") at a cash price of $1,015 per $1,000 principal amount. The net proceeds
received were used to reduce outstanding borrowings under the Company's bank
credit facility ("Credit Facility"). The Series C Notes are redeemable at the
option of the Company, in whole or in part, at redemption prices declining
ratably from 105.19% on October 15, 2001 to 100% at October 15, 2003 and
thereafter. The Company may redeem up to 35% of the original principal amount of
the Series C Notes before October 15, 1999 at 110.38% with the proceeds of an
equity offering (provided that either at least $18.0 million aggregate principal
amount of such notes remains outstanding or such redemption retires such notes
in their entirety). The Series C Notes represent unsecured obligations of the
Company and are subordinate in right of payment to all existing and future
senior indebtedness. The indenture for the notes contains conditions and
limitations, including but not limited to restrictions on additional
indebtedness, payment of dividends, redemption of capital stock, and certain
mergers and consolidations. The holders of the Series C Notes also can require
the Company to repurchase the notes at 101% of the principal amount upon a
Change of Control, as defined. Kelley Oil Corporation, a wholly owned subsidiary
of the Company, and Kelley Operating Company, Ltd., an indirect wholly owned
partnership of the Company, are guarantors of the Series C Notes.
The Series C Notes were sold pursuant to Rule 144A of the Securities
Act of 1933. In issuing the Series C Notes, the Company agreed to use its best
efforts to register under the Securities Act notes identical in terms to the
Series C Notes ("Series D Notes"). The Company completed the exchange of the
Series C Notes for the Series D Notes on November 12, 1998.
37
<PAGE> 39
7 7/8% Convertible Subordinated Notes and 8 1/2% Convertible
Subordinated Debentures. The Company has outstanding 7 7/8% Convertible
Subordinated Notes due December 1999 (the "7 7/8% Subordinated Notes") in the
aggregate principal amount at maturity of $34.1 million and 8 1/2% Convertible
Subordinated Debentures due April 1, 2000 (the "8 1/2% Subordinated Debentures")
in the aggregate principal amount of $26.9 million (together, the "Subordinated
Debt"). Each $1,000 face value amount of the 7 7/8% Subordinated Notes is
convertible into 71.263 shares of the Company's Common Stock or 35.632 shares of
the Company's Common Stock and 7.435 shares of Preferred Stock. Each $1,000 face
value amount of the 8 1/2% Subordinated Debentures is convertible into 51.864
shares of the Company's Common Stock or 25.932 shares of the Company's Common
Stock and 5.411 shares of Preferred Stock.
Under the Indenture for the 7 7/8% Subordinated Notes, as amended, a
"Change in Control" is defined to occur if, among other things, any person
becomes the beneficial owner of securities representing 50% or more of the
equity interests in the Company. With the purchase by Contour of 27 million
shares on December 1, 1997, each holder of 7 7/8% Subordinated Notes, was
afforded the right, at the holder's option, subject to terms and conditions of
the Indenture, to require the Company to redeem all or any part of the holder's
notes by January 22, 1998 at a specified cash price. Holders redeemed $0.2
million of the 7 7/8% Subordinated Notes under the Change of Control provision.
Debt Maturities. The Company has aggregate debt maturities of $34.6
million in 1999, $138.4 million in 2000 and $155.0 million in 2006.
NOTE 5 - STOCKHOLDERS' DEFICIT
Contour Stock Purchase. In February 1996, the Company issued 48 million
shares of its Common Stock at $1.00 per share to Contour Production Company
L.L.C. ("Contour") upon the closing of a Stock Purchase Agreement between the
Company and Contour (the "Contour Transaction"). The newly issued shares
represented 49.8% of the Company's voting power. In connection with the Contour
Transaction, the Company (i) entered into an option agreement with Contour (the
"Contour Option Agreement"), (ii) obtained consents from its principal
stockholders, subject to compliance with applicable securities law, to amend its
Certificate of Incorporation to increase its authorized Common Stock from 100
million shares to 200 million shares, (iii) entered into employment agreements
with John F. Bookout, President of Contour, and three other new executives named
by him, (iv) adopted a nonqualified stock option plan for the new executives
other than Mr. Bookout, (v) amended its existing incentive stock option plans,
(vi) reduced the size of its board of directors (the "Board") to seven members
and reconstituted the Board with three continuing directors and four designees
of Contour and (vii) replaced its credit facility.
Contour Option. Under the Contour Option Agreement, the Company granted
Contour an option (the "Contour Option") to purchase up to 27 million shares
(the "Maximum Option Number") of Common Stock at $1.00 per share (subject to
antidilution adjustments) upon satisfaction of certain conditions, including the
absence of any Company debt repurchase or redemption obligations as a result of
the purchase. Contour voluntarily exercised its option in full on December 1,
1997 to partially fund the SPR Acquisition.
Preferred Stock. In May 1994, Kelley Oil completed a public offering of
1,380,000 shares of $2.625 Preferred Stock ("KOIL Preferred Stock") at $25 per
share. Each outstanding share of KOIL Preferred Stock was converted in the
Consolidation into one share of the Company's Preferred Stock, which has the
same terms as the KOIL Preferred Stock, except for expanded voting rights. The
Company issued 649,807 shares of its Preferred Stock to Public Unitholders in
the Consolidation, resulting in a total of 2,442,323 outstanding shares of
Preferred Stock after giving effect to the shares issued to holders of KOIL
Preferred Stock.
In January 1996, the Company suspended the payment of the quarterly
Preferred Stock dividend scheduled for February 1, 1996 to conserve cash. On
April 15, 1997, the Board of Directors of the Company declared a dividend of
$2.625 per preferred share (approximately $4.6 million), which was paid on May
1, 1997. On April 14, 1998, the Company declared a dividend of $2.625 per share
of Preferred Stock (approximately $4.6 million), which was paid on April 30,
1998. The Company has not declared the quarterly dividends of $0.65625 per
preferred share for February 1, 1998,
38
<PAGE> 40
May 1, 1998, August 1, 1998, November 1, 1998 and February 1, 1999, aggregating
approximately $5.7 million, covering 5 quarters. Future dividends on the
Preferred Stock are prohibited under the agreement covering the New Credit
Facility. No interest is payable on Preferred Stock arrearages; however, the
terms of the Preferred Stock enable holders, voting separately as a class, to
elect two additional directors to the Board at each meeting of stockholders at
which directors are to be elected during any period when Preferred Stock
dividends are in arrears in an aggregate amount equal to at least six quarterly
dividends, whether or not consecutive.
Each share of Preferred Stock is convertible, at the holder's option,
into 3.47 shares of Common Stock, equivalent to a conversion price of $7.20 per
share of Common Stock relative to the $25 per share liquidation preference of
the Preferred Stock (the "Preferred Conversion Price"). Under the terms of the
Certificate of Designation governing the Preferred Stock, the Contour
Transaction triggered a special conversion right under which the Preferred Stock
conversion price was reduced to $4.00 for a period of 45 days commencing March
12, 1996. On April 25, 1996, 696,823 shares of Preferred Stock were converted
into 4,355,040 shares of Common Stock under the special conversion right.
ESOP Preferred Stock. As of December 31, 1995, 1,861,619 shares of ESOP
Preferred Stock were outstanding and held by the Company's Employee Stock
Ownership Plan ("ESOP"). In June 1996, each of the 1,861,619 shares of ESOP
Preferred Stock was redeemed for one share of the Company's Common Stock.
NOTE 6 - EMPLOYEE STOCK PLANS
Employee Stock Options. The Company has both qualified and nonqualified
stock option plans that provide for granting of options for the purchase of
common stock to key employees. These stock options may be granted for periods up
to ten years and are generally subject to vesting periods up to three years,
except options granted during 1997 and 1998 which are subject to a four year
vesting period.
Stock option activity for the Company during 1996, 1997 and 1998 was as
follows:
<TABLE>
<CAPTION>
1996 1997 1998
-------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS IN THOUSANDS OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
------- -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Stock options outstanding, beginning of year ..... 2,105 $ 2.38 4,589 $ 1.63 4,601 $ 1.75
Granted ....................................... 2,520 1.01 482 2.61 727 2.20
Exercised ..................................... (36) 2.38 (415) 1.31 (272) 1.00
Surrendered or expired ........................ -- -- (55) 2.62 (559) 1.73
------ ------ ------
Stock options outstanding, end of year ........... 4,589 $ 1.63 4,601 $ 1.75 4,497 $ 1.87
====== ====== ====== ====== ====== ======
</TABLE>
In February 1995, all previously issued options to the extent
outstanding, aggregating options to acquire 234,000 shares at prices ranging
from $7.00 to $7.63, were repriced at $4.13 per share. In February 1996, in
connection with the Contour Transaction, all unvested options then held by
employees were fully vested. Additionally, the then-existing plans were amended
to extend the period during which a terminated employee may exercise vested
options to three years after termination of employment.
39
<PAGE> 41
At December 31, 1998, approximately 3.6 million shares were available
for future option grants.
The following table summarizes information about the options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------- --------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
RANGE OF REMAINING WEIGHTED EXERCISE
EXERCISE PRICE OPTIONS CONTRACTUAL AVERAGE OPTIONS PRICE
LIFE (YEARS) EXERCISE PRICE
- --------------------- ------------- ----------------- ----------------- -------------- -------------
<S> <C> <C> <C> <C> <C>
$ 0.69 - 1.00 1,688 7.8 $ 1.00 793 $ 1.00
$ 1.75 - 2.56 2,531 7.2 2.25 1,808 2.23
$ 2.72 - 4.13 278 4.0 3.78 226 3.98
</TABLE>
The weighted average fair value of options granted during 1996, 1997
and 1998 was $0.59, $1.51 and $1.46, respectively. The fair value of the options
granted was estimated on the date of grant using the Black-Scholes
option-pricing model with the following assumptions: weighted average risk-free
interest rate of 6.8% for 1996, 6.4% for 1997 and 5.2% for 1998; an expected
volatility of 60% for 1996 and 1997 and 78% for 1998; expected life of five
years and no dividend yield for all three years.
The Company applies Accounting Principles Board Opinion No. 25 and related
Interpretations in accounting for stock option and purchase plans. Accordingly,
no compensation cost has been recognized for the stock option plans. Had
compensation cost been recognized based upon the fair market value at the grant
dates for awards under those plans consistent with the method of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock Based
compensation", the Company's net loss and earnings per share for the years ended
December 31, 1996, 1997 and 1998 would have been as reflected in the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Net income (loss) before extraordinary item (in thousands)............ $ (14,512) $ 1,319 $ (57,708)
Loss per common share before extraordinary item....................... (.21) (.03) (.49)
Net income (loss) (in thousands)...................................... (31,542) $ 1,319 $ (57,708)
Loss per common share................................................. (.40) (.03) (.49)
</TABLE>
ESOP/401K. Kelley Oil established the ESOP effective January 1, 1984
for the benefit of substantially all of its employees. No ESOP contributions
were made in 1996. Effective September 1, 1996, the ESOP was amended to include
a 401(k) feature whereby the Company is obligated to make matching contributions
up to 6% of each employee's salary. The plan also provides for additional
discretionary contributions. For 1996, 1997 and 1998, the Company made matching
contributions totaling $0.1 million, $0.2 million and $0.3 million,
respectively.
40
<PAGE> 42
NOTE 7 - INCOME TAXES
The following table sets forth a reconciliation of the statutory
federal income tax for the years ended December 31, 1996, 1997 and 1998:
(IN THOUSANDS)
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Income (loss) before income taxes ............................... $ (28,965) $ 1,951 $ (57,007)
--------- --------- ---------
Income tax expense (benefit) computed at statutory rates ........ (9,848) 663 (19,382)
Increase in valuation allowance .............................. 16,322 301 16,272
Adjustment to net operating loss carryforward and other ...... (7,209) (1,459) 2,463
Permanent differences:
Nondeductible expenses ....................................... 735 708 700
Other-net .................................................... -- (213) (53)
--------- --------- ---------
Tax expense (benefit) ...................................... $ -- $ -- $ --
========= ========= =========
</TABLE>
No federal income taxes were paid for the years ended December 31,
1996, 1997 and 1998.
The Company's deferred tax position reflects the net tax effects of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax reporting.
Significant components of the deferred tax liabilities and assets are as
follows:
(IN THOUSANDS)
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ----------
<S> <C> <C> <C>
Deferred tax liabilities:
Tax over book depletion, depreciation and
capitalization methods on oil and gas properties................... $ -- $ -- $ --
Deferred tax assets:
Book over tax depletion, depreciation and capitalization methods
on oil and gas properties.......................................... 42,696 32,210 43,730
Net operating loss carryforwards..................................... 62,179 72,992 77,741
Charitable contribution carryforwards................................ 78 52 54
Alternative minimum tax credit carryforwards......................... 21 21 21
Valuation allowance.................................................. (104,974) (105,275) (121,546)
--------- --------- ----------
Total deferred tax assets............................................ -- -- --
--------- --------- ---------
Net deferred tax liability.............................................. $ -- $ -- $ --
========= ========= =========
</TABLE>
Net Operating Loss Carryforwards and Alternative Minimum Tax Credits.
As of December 31, 1998, the Company had cumulative net operating loss
carryforwards ("NOL") for federal income tax purposes of approximately $228
million, which expire in 2000 through 2018, and net operating loss carryforwards
for alternative minimum tax purposes of approximately $218 million, which expire
in 2008 through 2018. Due to previous ownership changes, future utilization of
the net operating loss carry forwards will be limited by Internal Revenue Code
section 382.
41
<PAGE> 43
NOTE 8 - RELATED PARTY TRANSACTIONS
The 1994 DDP. In February 1994, the 1994 DDP completed a public
offering of 20.9 million units of its limited and general partner interests at
$3.00 per unit. As of December 31, 1998, the Company owned 19.2 million units
(91.9%) in the 1994 DDP, together with its 3.94% general partner interest.
The 1994 DDP's partnership agreement provides that any contributions of
the partners not used or committed to be used for drilling activities during the
two-year period from the commencement of operations through February 29, 1996
(the "Commitment Period") shall be distributed to the partners on a pro rata
basis as a return of capital. In 1997, Kelley Oil reduced the estimate for
Committed Expenditures to $58.0 million based on the amount of committed capital
actually used and committed or allocated to drilling activities by the end of
the Commitment Period. In accordance with the 1994 DDP's partnership agreement,
the 1994 DDP distributed the Outside Share of uncommitted capital to its
unitholders other than Kelley Oil aggregating $0.3 million in March 1996 and
$0.1 million in July 1997.
The 1992 DDP. During November 1992, the 1992 DDP completed a public
offering of 16.0 million units of limited and general partner interests at $3.00
per unit. As of December 31, 1998, Kelley Oil owned 13.4 million units (83.7%)
in the 1992 DDP, together with its 3.94% general partner interest. As of
December 31, 1998, the 1992 DDP was indebted to Kelley Oil for loans aggregating
$2.5 million ($0.4 million, net of intercompany eliminations). The Company
recorded interest income on this indebtedness of $45,000 in 1998, net of
intercompany eliminations.
Reimbursements from Affiliated Programs. The Company is reimbursed for
administrative and overhead expenses incurred in connection with the management
and administration of each of these affiliated programs. Such amounts, net of
intercompany eliminations, aggregated $0.2 million, $0.1 million and $21,000 in
1996, 1997 and 1998, respectively.
Interest on DDP Commitments. During 1996, 1997 and 1998, the Company
paid or accrued interest at a market rate in the amounts, net of intercompany
elimination, of $91,000, $11,000 and zero, respectively, on deferred
subscription commitments to DDPs.
Advisory Fees. In connection with the Contour Transaction, the Company
entered into an agreement (the "Advisory Agreement") with Bessemer Partners &
Co. ("BPCO"), an affiliate of Bessemer, providing for the engagement of BPCO to
provide the Company with financial advisory services. Under the Advisory
Agreement, BPCO has assisted the Company in arranging a new credit facility and
negotiating the related agreements and is assisting the Company in restructuring
its current capital structure. For its services under the Advisory Agreement,
BPCO received an advisory fee of $2.0 million at the closing of the Contour
Transaction and $500,000 in each of December 1996, 1997 and 1998, and will
receive an additional $500,000 in each December of 1999, 2000 and 2001. In
addition, BPCO is entitled to reimbursement of expenses incurred in connection
with rendering advisory services. The Company also has agreed to indemnify BPCO
and its affiliates against certain liabilities under the Advisory Agreement.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
Significant Customers. Substantially all of the Company's receivables
are due from a limited number of natural gas transmission companies and other
gas purchasers. During 1998, natural gas sales to three purchasers accounted for
48%, 22% and 18% of the Company's total sales. To date, this concentration has
not had a material adverse effect on the consolidated financial condition of the
Company.
Litigation. As previously disclosed, following Kelley Oil's
announcement of the initial proposal for the Consolidation in August 1994, four
separate lawsuits were filed against Kelley Oil and its directors relating to
the Consolidation. In November 1994, Kelley Oil entered into a memorandum of
understanding with the plaintiffs in three of the lawsuits, providing for a
proposed settlement based on a revised Consolidation proposal negotiated by a
special committee of Kelley Oil's non-management directors and the settling
plaintiffs. A stipulation and agreement of compromise, settlement and release
reflecting the terms of the proposed settlement was filed in the United States
District Court for the Southern District of Texas on November 23, 1994. At a
hearing held on the same date, the court approved
42
<PAGE> 44
the Consolidation of all four lawsuits and the certification of a Unitholder
class requested by the settling parties. On March 3, 1995, following a hearing
on the fairness of the settlement, the court entered a final order approving the
settlement, dismissing the consolidated lawsuits with prejudice and reducing the
award of attorneys' fees and disbursements contemplated by the stipulation to
$1.5 million, plus interest from March 3, 1995 through the payment date. On
April 29, 1997, the U.S. Court of Appeals for the Fifth Circuit affirmed the
final judgement and order of the District Court. On August 4, 1997, the Company
made a cash payment of $1.7 million which included $0.2 million of interest.
The Company is involved in various claims and lawsuits incidental to
its business. In the opinion of management, the ultimate liability thereunder,
if any, will not have a material effect on the financial statements of the
Company.
Restructuring Expenses. In 1996, the Company incurred restructuring
expenses of $4.3 million associated primarily with staff reductions, related
severance settlements and reorganization costs. Accrued expenses on the balance
sheet include $0.9 million and $0.2 million at December 31, 1997 and 1998,
respectively, related to the unpaid portion of these charges.
Leases. The Company leases office space and equipment under operating
leases with options to renew. Rental expenses related to these leases for the
years ended December 31, 1996, 1997 and 1998 were $1.3 million, $0.8 million and
$0.6 million, respectively. For the balance of the lease terms, minimum rentals
are as follows:
(IN THOUSANDS)
<TABLE>
<S> <C>
1999............................................................... $ 667
2000............................................................... 636
2001 .............................................................. 341
2002 .............................................................. 39
2003............................................................... 7
-------
Total.............................................................. $ 1,690
</TABLE>
The terms of the Company's office space lease provide that the Company
may terminate its rental obligation upon six months notice and incurring a
maximum obligation of $0.2 million.
NOTE 10 - HEDGING ACTIVITIES
The Company periodically uses forward sales contracts, natural gas
price swap agreements, natural gas basis swap agreements and options to reduce
exposure to downward price fluctuations on its natural gas production. The
Company does not engage in speculative transactions. During 1998, the Company
used price and basis swap agreements. Price swap agreements generally provide
for the Company to receive or make counterparty payments on the differential
between a fixed price and a variable indexed price for natural gas. Basis swap
agreements generally provide for the Company to receive or make counterparty
payments on the differential between a variable indexed price and the price it
receives from the sale of natural gas production, and are used to hedge against
unfavorable price movements in the relationship between such variable indexed
price and the price received for such production. Gains and losses realized by
the Company from hedging activities are included in oil and gas revenues and
average sales prices in the period that the related production is sold. The
Company's hedging activities also cover the oil and gas production attributable
to the interest in such production of the public unitholders in its subsidiary
partnerships.
Through natural gas price swap agreements, the Company hedged
approximately 49% of its natural gas production for 1998 at an average NYMEX
quoted price of $2.31 per Mmbtu before transaction and transportation costs. As
of December 31, 1998, 5,400,000 Mmbtu's of natural gas production for 1999 has
been hedged by natural gas price swap agreements at an average NYMEX quoted
price of $2.36 per Mmbtu before transaction and transportation costs. Additional
hedging activities since December 31, 1998 have increased the volumes hedged in
1999 to 10,720,000 Mmbtu of natural gas at an average NYMEX quoted price of
$2.15 per Mmbtu before transaction and transportation costs. As of December 31,
1998, 16,380,000 Mmbtu's of natural gas production for 1999 has been hedged by
natural gas basis swap agreements. Hedging activities increased revenues by
approximately $3.5 million in 1998 as compared to estimated revenues had no
hedging activities been conducted. At December 31, 1998, the unrealized gain on
the Company's existing hedging instruments for future production months in 1999
approximated $2.5 million.
The credit risk exposure from counterparty nonperformance on natural
gas forward sales contracts and derivative financial instruments is generally
the amount of unrealized gains under the contracts. The Company has not
experienced counterparty nonperformance on these agreements and does not
anticipate any in future periods.
43
<PAGE> 45
NOTE 11 - GUARANTOR FINANCIAL STATEMENTS
Kelley Oil Corporation, a wholly-owned subsidiary of the Company and
Kelley Operating Company Ltd., an indirect wholly-owned partnership of the
Company are guarantors of the Company's Series B and Series D 10 3/8% Senior
Subordinated Notes due 2006. The following guarantor consolidating condensed
financial statements present:
1. Consolidating condensed balance sheets as of December 31, 1997
and 1998, consolidating condensed statements of income (loss) for
each of the years ended December 31, 1996, 1997 and 1998 and
consolidating condensed statements of cash flows for each of the
years ended December 31, 1996, 1997 and 1998.
2. Kelley Oil & Gas Corporation (the "Parent"), combined Guarantor
Subsidiaries and combined Non-Guarantor Subsidiaries, all with
their investments in subsidiaries accounted for using the equity
method.
3. Elimination entries necessary to consolidate the Parent and all
of its subsidiaries.
CONSOLIDATING CONDENSED BALANCE SHEET
DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
---------- ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
ASSETS:
Current assets........................ $ 427,445 $ 212,780 $ 18,926 $ (632,293) $ 26,858
Property and equipment, net........... -- 276,744 17,698 (829) 293,613
Other non-current assets, net......... (141,957) 24,418 -- 119,670 2,131
---------- ---------- -------- ---------- ----------
Total assets........................ $ 285,488 $ 513,942 $ 36,624 $ (513,452) $ 322,602
========== ========== ======== ========== ==========
LIABILITIES AND STOCKHOLDERS' DEFICIT:
Current liabilities................... $ 4,926 $ 657,128 $ 12,279 $ (632,293) $ 42,040
Long term debt........................ 286,183 -- -- -- 286,183
Stockholders' deficit................. (5,621) (143,186) 24,345 118,841 (5,621)
---------- ---------- -------- ---------- ----------
Total liabilities and
stockholders' deficit........... $ 285,488 $ 513,942 $ 36,624 $ (513,452) $ 322,602
========== ========== ======== ========== ==========
</TABLE>
44
<PAGE> 46
CONSOLIDATING CONDENSED BALANCE SHEET
DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
ASSETS:
Current assets....................... $ 424,609 $ 212,946 $ 10,859 $ (620,163) $ 28,251
Property and equipment, net.......... -- 243,927 14,008 (1,480) 256,455
Other non-current assets, net........ (165,642) 18,611 -- 148,522 1,491
----------- ---------- -------- ---------- ----------
Total assets....................... $ 258,967 $ 475,484 $ 24,867 $ (473,121) $ 286,197
========== ========== ======== =========== ==========
LIABILITIES AND STOCKHOLDERS' DEFICIT:
Current liabilities.................. $ 38,406 $ 641,113 $ 6,281 $ (620,164) $ 65,636
Long term debt....................... 287,500 -- -- -- 287,500
Stockholders' deficit................ (66,939) (165,629) 18,586 147,043 (66,939)
----------- ----------- -------- ---------- -----------
Total liabilities and
stockholders' deficit.......... $ 258,967 $ 475,484 $ 24,867 $ (473,121) $ 286,197
========== ========== ======== =========== ==========
</TABLE>
45
<PAGE> 47
CONSOLIDATING CONDENSED STATEMENTS OF INCOME (LOSS)
FOR THE YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues................................ $ -- $ 39,248 $ 24,784 $ (1,749) $ 62,283
Costs and expenses...................... (22,397) (39,293) (13,150) 623 (74,217)
Equity in earnings of subsidiaries...... 10,463 11,634 -- (22,097) --
Extraordinary item...................... (17,030) -- -- -- (17,030)
---------- ---------- -------- ---------- ----------
Net income (loss)....................... $ (28,964) $ 11,589 $ 11,634 $ (23,223) $ (28,964)
========== ========== ======== ========== ==========
</TABLE>
CONSOLIDATING CONDENSED STATEMENTS OF INCOME (LOSS)
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues.............................. $ 8 $ 57,064 $ 19,508 $ (442) $ 76,138
Costs and expenses.................... (27,196) (36,975) (10,329) 313 (74,187)
Equity in earnings of subsidiaries.... 29,139 9,179 -- (38,318) --
---------- ---------- -------- ---------- ----------
Net income (loss)................... $ 1,951 $ 29,268 $ 9,179 $ (38,447) $ 1,951
========== ========== ======== ========== ==========
</TABLE>
CONSOLIDATING CONDENSED STATEMENTS OF INCOME (LOSS)
FOR THE YEAR ENDED DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues.............................. $ (18) $ 69,958 $ 9,715 $ -- $ 79,655
Costs and expenses.................... (33,893) (94,457) (7,742) (570) (136,662)
Equity in earnings of subsidiaries.... (23,096) 1,973 -- 21,123 --
---------- ---------- -------- ---------- ----------
Net income (loss)................... $ (57,007) $ (22,526) $ 1,973 $ 20,553 $ (57,007)
========== ========== ======== ========== ==========
</TABLE>
46
<PAGE> 48
CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss).................... $ (28,964) $ 11,589 $ 11,634 $ (23,223) $ (28,964)
Non-cash income (loss)
adjustments........................ 10,133 12,280 6,542 23,223 52,178
Changes in operating assets
and liabilities.................... (31,460) 26,767 (9,259) -- (13,952)
---------- ---------- -------- ---------- ----------
Net cash provided by (used in)
operating activities............... (50,291) 50,636 8,917 -- 9,262
---------- ---------- -------- ---------- ----------
INVESTING ACTIVITIES:
Capital expenditures................. -- (35,203) (12,398) -- (47,601)
Acquisition of oil and gas
properties......................... -- (11,594) -- -- (11,594)
Proceeds from sale of properties..... -- 3,811 1,992 -- 5,803
---------- ---------- -------- ---------- ----------
Net cash used in investing
activities........................... -- (42,986) (10,406) -- (53,392)
---------- ---------- -------- ---------- ----------
FINANCING ACTIVITIES:
Net payments on long term
borrowings......................... -- (8,500) -- -- (8,500)
Proceeds from sale of notes,
net................................ 120,938 -- -- -- 120,938
Debenture conversion costs........... (1,100) -- -- -- (1,100)
Proceeds from sale of
common stock, net.................. 43,998 -- -- -- 43,998
Retirement of senior notes........... (113,488) -- -- -- (113,488)
---------- ---------- -------- ---------- ----------
Net cash provided by (used in)
financing activities............... 50,348 (8,500) -- -- 41,848
---------- ---------- -------- ---------- ----------
Increase (decrease) in cash and
cash equivalents................... 57 (850) (1,489) -- (2,282)
Cash and cash equivalents,
beginning of period................ 1 3,654 2,697 -- 6,352
---------- ---------- -------- ---------- ----------
Cash and cash equivalents, end of
period............................... $ 58 $ 2,804 $ 1,208 $ -- $ 4,070
========== ========== ======== ========== ==========
</TABLE>
47
<PAGE> 49
CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income ....................................... $ 1,951 $ 29,268 $ 9,179 $ (38,447) $ 1,951
Non-cash income (loss) adjustments ............... (24,842) 16,880 5,098 38,447 35,583
Changes in operating assets
and liabilities ................................ (97,813) 105,584 (5,701) -- 2,070
--------- --------- --------- --------- ---------
Net cash provided by (used in)
operating activities ............................. (120,704) 151,732 8,576 -- 39,604
--------- --------- --------- --------- ---------
INVESTING ACTIVITIES:
Capital expenditures ............................. -- (51,592) (1,548) -- (53,140)
Acquisition of oil and gas properties ............ -- (111,135) -- -- (111,135)
Capital contributed to partnerships .............. -- (5,819) -- 5,819 --
Distributions from partnerships .................. -- 14,014 -- (14,014) --
--------- --------- --------- --------- ---------
Net cash used in investing activities ............... -- (154,532) (1,548) (8,195) (164,275)
--------- --------- --------- --------- ---------
FINANCING ACTIVITIES:
Net proceeds on long term borrowings ............. 97,800 -- -- -- 97,800
Proceeds from sale of common stock, net .......... 27,545 -- -- -- 27,545
Distributions to partners ........................ -- -- (14,014) 14,014 --
Capital contributed by partners .................. -- -- 5,819 (5,819) --
Dividends on preferred stock ..................... (4,582) -- -- -- (4,582)
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing
activities ....................................... 120,763 -- (8,195) 8,195 120,763
--------- --------- --------- --------- ---------
Increase (decrease) in cash
and cash equivalents ............................. 59 (2,800) (1,167) -- (3,908)
Cash and cash equivalents,
beginning of period .............................. 58 2,804 1,208 -- 4,070
--------- --------- --------- --------- ---------
Cash and cash equivalents,
end of period .................................... $ 117 $ 4 $ 41 $ -- $ 162
========= ========= ========= ========= =========
</TABLE>
48
<PAGE> 50
CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) ............................... $ (57,007) $ (22,526) $ 1,973 $ 20,553 $ (57,007)
Non-cash income (loss) adjustments .............. 28,109 70,144 3,687 (20,553) 81,387
Changes in operating assets
and liabilities ............................... 3,869 (7,976) 2,029 -- (2,078)
--------- --------- --------- --------- ---------
Net cash provided by (used in)
operating activities ............................ (25,029) 39,642 7,689 -- 22,302
--------- --------- --------- --------- ---------
INVESTING ACTIVITIES:
Capital expenditures ............................ -- (56,579) -- -- (56,579)
Proceeds from sale of property .................. -- 17,363 -- -- 17,363
Distributions from partnerships ................. -- 7,730 -- (7,730) --
--------- --------- --------- --------- ---------
Net cash used in investing activities .............. -- (31,486) -- (7,730) (39,216)
--------- --------- --------- --------- ---------
FINANCING ACTIVITIES:
Payments on long term borrowings ................ (118,900) -- -- -- (118,900)
Net proceeds on long term borrowings ............ 119,100 -- -- -- 119,100
Redemption on subordinated notes ................ (228) -- -- -- (228)
Proceeds from sale of common stock .............. 273 -- -- -- 273
Proceeds from conversion of preferred ........... (2) -- -- -- (2)
Proceeds from sale of common stock, net ......... 29,526 -- -- -- 29,526
Distributions to partners ....................... -- -- (7,730) 7,730 --
Dividends on preferred stock .................... (4,582) -- -- -- (4,582)
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing
activities ...................................... 25,187 -- (7,730) 7,730 25,187
--------- --------- --------- --------- ---------
Increase (decrease) in cash
and cash equivalents ............................ 158 8,156 (41) -- 8,273
Cash and cash equivalents,
beginning of period ............................. 117 4 41 -- 162
--------- --------- --------- --------- ---------
Cash and cash equivalents,
end of period ................................... $ 275 $ 8,160 $ -- $ -- $ 8,435
========= ========= ========= ========= =========
</TABLE>
49
<PAGE> 51
NOTE 12 - SUPPLEMENTARY FINANCIAL AND OPERATING INFORMATION ON OIL AND GAS
EXPLORATION, DEVELOPMENT AND PRODUCTION ACTIVITIES (UNAUDITED)
This footnote provides unaudited information required by Statement of
Financial Accounting Standards No. 69, "Disclosures about Oil and Gas Producing
Activities".
Capitalized Costs. Capitalized costs and accumulated depreciation,
depletion and amortization relating to the Company's oil and gas producing
activities, all of which are conducted within the continental United States, are
summarized below.
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Unevaluated properties............................................... $ 12,521 $ 49,854 $ 38,293
Properties subject to amortization................................... 338,794 463,263 496,686
--------- --------- ---------
Capitalized costs.................................................... 351,315 513,117 534,979
Accumulated depreciation, depletion and amortization................. (194,367) (221,729) 280,640
--------- --------- ---------
Net capitalized costs................................................ $ 156,948 $ 291,388 $ 254,339
========= ========= =========
</TABLE>
Costs Incurred. Costs incurred in oil and gas property acquisition,
exploration and development activities are summarized below.
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Property acquisition costs:
Proved............................................................ $ 11,594 $ 73,190 $ 2,338
Unproved (1)...................................................... 2,160 40,997 1,405
Exploration costs.................................................... 5,438 9,525 25,414
Development costs.................................................... 41,790 40,713 27,875
--------- --------- ---------
Total costs incurred.............................................. $ 60,982 $ 164,425 $ 57,032
========= ========= =========
</TABLE>
(1) Includes $40 million in unproved assets acquired from SPR on
December 1, 1997.
50
<PAGE> 52
Reserves. The following table summarizes the Company's net ownership
interests in estimated quantities of proved oil and gas reserves and changes in
net proved reserves, all of which are located in the continental United States,
for the years ended December 31, 1996, 1997 and 1998. Reserves estimates
contained below were prepared by H.J. Gruy & Associates, Inc. ("Gruy"),
independent petroleum engineers. See "Estimated Proved Reserves--Uncertainties
in Estimating Reserves and Future Net Cash Flows" under Items 1 and 2 of this
Report.
<TABLE>
<CAPTION>
CRUDE OIL, CONDENSATE
AND NATURAL GAS LIQUIDS NATURAL GAS
(MBBLS) (MMCF)
-------------------------------- -----------------------------------
1996 1997 1998 1996 1997 1998
------ ------ ------ -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Proved developed
and undeveloped reserves:
Beginning of year.................. 1,387 1,466 2,953 196,273 297,634 354,867
Revisions of previous estimates.... (89) 106 (79) (30,519) 21,831 (31,674)
Purchases of reserves in place..... 57 1,351 -- 30,844 51,712 --
Extensions and discoveries......... 477 256 3,082 128,692 13,892 9,512
Sale of reserves in place.......... (134) -- (287) (4,190) -- (13,589)
Production......................... (232) (226) (375) (23,466) (30,202) (35,557)
------ ------ ------ -------- -------- --------
End of year........................ 1,466 2,953 5,294 297,634 354,867 283,559
====== ====== ====== ======== ======== ========
Proved developed reserves
at end of year..................... 977 2,432 1,981 173,465 257,800 188,824
====== ====== ====== ======== ======== ========
</TABLE>
Standardized Measure. The following table of the Standardized Measure
of Discounted Future Net Cash Flows concerning the standardized measure of
future cash flows from proved oil and gas reserves are presented in accordance
with Statement of Financial Accounting Standards No. 69. As prescribed by this
statement, the amounts shown are based on prices and costs at the end of each
period, and assume continuation of existing economic conditions. Future income
taxes are based on year-end statutory rates, adjusted for operating loss
carryforwards and tax credits. A discount factor of 10% was used to reflect the
timing of future net cash flow. Extensive judgments are involved in estimating
the timing of production and the costs that will be incurred throughout the
remaining lives of the fields. Accordingly, the estimates of future net revenues
from proved reserves and the present value thereof may not be materially correct
when judged against actual subsequent results. Further, since prices and costs
do not remain static, and no price or cost changes have been considered, and
future production and development costs are estimates to be incurred in
developing and producing the estimated proved oil and gas reserves, the results
are not necessarily indicative of the fair market value of estimated proved
reserves, and the results may not be comparable to estimates disclosed by other
oil and gas producers.
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1996 1997 1998
----------- ---------- ----------
<S> <C> <C> <C>
Future cash inflows.................................................. $ 1,099,089 $ 930,357 $ 643,473
Future production costs.............................................. (113,178) (196,048) (159,378)
Future development costs............................................. (81,932) (106,123) (93,321)
Future income tax expenses........................................... (162,887) (37,050) (1,627)
----------- ---------- ----------
Future net cash flows............................................ 741,092 591,136 389,147
10% annual discount for estimating timing of cash flows.............. (307,321) (227,249) (155,677)
----------- ---------- ----------
Standardized measure of discounted future net cash flows......... $ 433,771 $ 363,887 $ 233,470
=========== ========== ==========
</TABLE>
51
<PAGE> 53
The standardized measure of discounted future net cash flows as of
December 31, 1996, 1997 and 1998 was calculated using prices in effect as of
those dates, which averaged $25.18, $16.93 and $10.81, respectively, per barrel
of oil and $3.66, $2.49 and $2.07, respectively, per Mcf of natural gas.
Change in Standardized Measure. Changes in standardized measure of
future net cash flows relating to proved oil and gas reserves are summarized
below.
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Changes due to current year operations:
Sales of oil and gas, net of production costs ................ $ (48,307) $ (62,080) $ (57,940)
Sale of reserves in place .................................... (6,836) -- (15,424)
Extensions and discoveries ................................... 192,174 21,945 20,097
Purchases of reserves in place ............................... 11,594 91,034 --
Future development costs incurred ............................ 24,500 21,806 9,218
Changes due to revisions in standardized variables:
Prices and production costs .................................. 159,292 (243,851) (94,569)
Revisions of previous quantity estimates ..................... (50,594) 25,345 (29,853)
Estimated future development costs ........................... 3,254 (17,413) (29,240)
Income taxes ................................................. (82,831) 69,489 (14,110)
Accretion of discount ........................................ 17,575 51,818 24,903
Production rates (timing) and other .......................... 42,898 (27,977) 56,501
--------- --------- ---------
Net increase (decrease) .................................... 262,719 (69,884) (130,417)
Beginning of year ............................................ 171,052 433,771 363,887
--------- --------- ---------
End of year ................................................ $ 433,771 $ 363,887 $ 233,470
========= ========= =========
</TABLE>
Sales of oil and gas, net of production costs, are based on historical
pre-tax results. Extensions and discoveries, purchases of reserves in place and
the changes due to revisions in standardized variables are reported on a pre-tax
discounted basis, while the accretion of discount is presented after tax.
Extensions and discoveries include proved undeveloped reserves attributable to
Kelley Oil's interests in drill sites assigned to DDPs.
NOTE 13 - QUARTERLY RESULTS (UNAUDITED)
<TABLE>
<CAPTION>
1997 1998
-------------------------------------- --------------------------------------
1ST 2ND 3RD 4TH (1) 1ST 2ND 3RD 4TH(2)
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues........................... $ 18,947 16,178 17,105 23,634 $ 23,047 21,162 18,630 16,311
Operating profit................... 7,368 4,892 6,121 8,367 3,245 (1,251) (85) (26,087)
Net income (loss).................. 1,703 (1,248) 59 1,437 (4,823) (9,433) (8,411) (34,340)
Basic and diluted income
(loss) per common share $ 0.01 (0.02) (0.01) -- $ (0.05) (0.08) (0.08) (0.28)
</TABLE>
(1) Reflects the acquisition of SPR on December 1, 1997.
(2) Reflects non-cash impairment charges against the carrying value of proved
and unproved oil and natural gas properties under SFAS 121 (see Note 2).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
52
<PAGE> 54
PART III
ITEMS 10, 11, 12 AND 13. EXECUTIVE OFFICERS OF THE COMPANY; EXECUTIVE
COMPENSATION; SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT;
AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, RESPECTIVELY.
The information called for by these Items is incorporated by reference
to the Company's definitive Proxy Statement to be filed by the Company pursuant
to Regulation 14A of the General Rules and Regulations under the Securities and
Exchange Act not later than April 30, 1999.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) FINANCIAL STATEMENTS AND SCHEDULES:
(1) Financial Statements: The financial statements required to be
filed are included under Item 8 of this Report.
(2) Schedules: All schedules for which provision is made in
applicable accounting regulations of the SEC have been omitted as
the schedules are either not required under the related
instructions, are not applicable or the information required
thereby is set forth in the Company's Consolidated Financial
Statements or the Notes thereto.
(3) Exhibits:
EXHIBIT
NUMBER: EXHIBIT
2.1 Agreement and Plan of Consolidation among the Registrant,
Kelley Oil Corporation, Kelley Oil & Gas Partners, Ltd.
("Kelley Partners") and the other parties named therein
(incorporated by reference to Exhibit 2.1 to the
Registrant's Registration Statement (the "Consolidation
Registration Statement") on Form S-4 (Reg No. 33-84338)
filed September 26, 1994, as amended).
3.1 Certificate of Incorporation of the Registrant
(incorporated by reference to Exhibit 3.1 to the
Consolidation Registration Statement).
3.2 Certificate of Amendment to Certificate of Incorporation
of the Registrant dated December 20, 1994 (incorporated by
reference to Exhibit 3.2 to the Consolidation Registration
Statement).
3.3 Certificate of Correction to Certificate of Incorporation
of the Registrant dated February 12, 1996 (incorporated by
reference to Exhibit 3.1 to the Registrant's Current
Report on Form 8-K (File No. 0-25214) dated February 15,
1996).
3.4 Certificate of Designation of $2.625 Convertible
Exchangeable Preferred Stock of the Registrant
(incorporated by reference to Exhibit 3.1 to the
Registrant's Current Report on Form 8-K (File No. 0-25214)
dated February 10, 1995).
53
<PAGE> 55
3.5 Certificate of Designations of Cumulative Convertible
Preferred Stock of the Registrant (incorporated by
reference to Exhibit 3.2 to the Registrant's Current
Report on Form 8-K (File No. 0-25214) dated February 10,
1995).
3.6 Certificate of Merger of Kelley Oil & Gas Partners, Ltd.
into Kelley Oil & Gas Corporation dated March 28, 1996.
3.7 Certificate of Amendment to Certificate of Incorporation
of the Registrant dated April 29, 1996.
3.8 Bylaws of the Registrant (incorporated by reference to
Exhibit 3.5 to the Consolidation Registration Statement).
4.1 Certificate representing Common Stock of the Registrant
(incorporated by reference to Exhibit 4.1 to the
Consolidation Registration Statement).
4.2 Certificate representing $2.625 Convertible Exchangeable
Preferred Stock of the Registrant (incorporated by
reference to Exhibit 4.2 to the Consolidation Registration
Statement).
4.3 Supplemental Indenture dated February 7, 1995 among the
Registrant, Kelley Partners and United States Trust
Company of New York, relating to Kelley Partners' 8 1/2%
Convertible Subordinated Debentures (the "8 1/2%
Debentures") due 2000 (incorporated by reference to
Exhibit 4.1 to the Registrant's Current Report on Form 8-K
(File No. 0-25214) dated February 10, 1995).
4.4 Supplemental Indenture dated March 29, 1996 between the
Registrant and the United States Trust Company of New
York, relating to the 8 1/2% Debentures (incorporated by
reference to Exhibit 4.4 to the Registrant's Annual Report
on Form 10-K (File No. 0-25214) for the year ended
December 31, 1995).
4.5 Supplemental Indenture dated February 7, 1995 among the
Registrant, Kelley Partners and United States Trust
Company of New York, relating to Kelley Partners' 7 7/8%
Convertible Subordinated Notes (the "7 7/8% Notes") due
1999 (incorporated by reference to Exhibit 4.2 to the
Registrant's Current Report on Form 8-K (File No. 0-25214)
dated February 10, 1995).
4.6 Supplemental Indenture dated March 29, 1996 between the
Registrant and the United States Trust Company of New
York, relating to the 7 7/8% Notes (incorporated by
reference to Exhibit 4.6 to the Registrant's Annual Report
on Form 10-K (File No. 0-25214) for the year ended
December 31, 1995).
4.7 Indenture dated as of June 15, 1995 among the Registrant,
as issuer, Kelley Partners, Kelley Operating Company, Ltd.
and Kelley Oil Corporation, as guarantors, and Chemical
Bank, as trustee, relating to the Registrant's 13 1/2%
Senior Notes due 1999 (incorporated by reference to
Exhibit 4.5 to the Registrant's Registration Statement on
Form S-3 (Reg. No. 33-92214) dated June 9, 1995.
4.8 Supplemental Indenture dated as of October 28, 1996, among
the Registrant, as issuer, Kelley Operating Company, Ltd.
and Kelley Oil Corporation, as guarantors, and The Chase
Manhattan Bank (formerly Chemical Bank), as trustee,
relating to the Registrant's 13 1/2% Senior Notes due 1999
(incorporated by reference to Exhibit 4.3 to the
Registrant's Quarterly Report on Form 10-Q (File No.
0-25214) for the quarterly period ended September 20,
1996).
4.9 Indenture dated as of October 15, 1996, among the
Registrant, as issuer, Kelley Oil Corporation and Kelley
Operating Company, Ltd., as guarantors, and United States
Trust Company of New
54
<PAGE> 56
York, relating to the Registrant's 10 3/8% Senior
Subordinated Notes due 2006 (incorporated by reference to
Exhibit 4.1 to the Registrant's Quarterly Report on Form
10-Q (File No. 0-25214) for the quarterly period ended
September 30, 1996).
4.10 Form of the Registrant's 10 3/8% Senior Subordinated Note
Due 2006, Series B (incorporated by reference to Exhibit
4.5 to the Registrant's Registration Statement on Form S-4
(Reg. No. 333-18481) filed December 20, 1996, as amended).
4.11 Option Agreement dated as of February 15, 1996 between the
Registrant and Contour Production Company L.L.C.
(incorporated by reference to Exhibit 4.1 to the
Registrant's Current Report on Form 8-K (File No. 0-25214)
dated February 15, 1996).
10.1 Amended and Restated Employee Stock Ownership Plan of
Kelley Oil effective as of January 1, 1989 (incorporated
by reference to Exhibit 10.15 to Kelley Oil's Annual
Report on Form 10-K (File No. 0-17585) for the year ended
December 31, 1991).
10.2 1987 Incentive Stock Option Plan (the "1987 Plan") of
Kelley Oil (incorporated by reference to Kelley Oil's
Annual Report on Form 10-K (File No. 0-17585) for the year
ended December 31, 1988).
10.3 1991 Incentive Stock Option Plan (the "1991 Plan") of
Kelley Oil (incorporated by reference to Exhibit 10.3 to
Kelley Oil's Annual Report on Form 10-K (File No. 0-175850
for the year ended December 31, 1991).
10.4 1995 Incentive Stock Option Plan of the Registrant (the
"1995 Plan") (incorporated by reference to Exhibit 10.4 to
the Registrant's Annual Report on Form 10-K (File No.
0-25214) for the year ended December 31, 1995).
10.5 Amendment to the 1987 Plan, 1991 Plan and 1995 Plan
(incorporated by reference to Exhibit 10.5 to the
Registrant's Current Report on Form 8-K (File No. 0-25214)
dated February 15, 1996).
10.6 1996 Nonqualified Stock Option Plan of the Registrant
(incorporated by reference to Exhibit 10.4 to the
Registrant's Current Report on Form 8-K (File No. 0-25214)
dated February 15, 1996).
10.7 Employment Agreement dated as of February 15, 1996 between
the Registrant and John F. Bookout, Jr. (incorporated by
reference to Exhibit 10.2 to the Registrant's Current
Report on Form 8-K (File No. 0-25214) dated February 15,
1996).
10.8 Form of Employment Agreement dated as of February 15, 1996
between the Registrant and Dallas Laumbach (incorporated
by reference to Exhibit 10.3 to the Registrant's Current
Report on Form 8-K (File No. 0-25214) dated February 15,
1996).
10.9 Employment Agreement dated as of October 1, 1998 with Rick
G. Lester.
10.10 Amended and Restated Credit Agreement among Kelley Oil &
Gas Corporation, Kelley Oil Corporation and Kelley
Operating Company, Ltd., as Borrowers, Concorde Gas
Marketing, Inc., Kelley Partners 1992 Development Drilling
Joint Venture, Kelley Partners 1994 Development Drilling
Joint Venture, Kelley Partners 1992 Development Drilling
Program and Kelley Partners 1994 Development Drilling
Program, as Guarantors, Texas Commerce Bank National
Association, as Agent, Chase Securities Inc., as Arranger
and Syndication Agent, and the Lenders Signatory thereto,
dated as of December 12, 1996 (incorporated by reference
to Exhibit 4.3 to
55
<PAGE> 57
the Registrant's Registration Statement on Form S-4 (Reg.
No. 333-18481) filed December 20, 1996, as amended).
10.11 1996 Incentive Stock Option Plan of the Registrant
(incorporated by reference to Exhibit 10.11 to the
Registrant's Annual Report on Form 10-K (File No. 0-25214)
for the year ended December 31, 1996).
10.12 1997 Annual and Long-Term Incentive-Performance Plan of
the Registrant.
10.13 Purchase and Sale Agreement, dated October 21, 1997,
between the Company and SCANA Petroleum Resources, Inc.
(incorporated by reference to Exhibit 10.2 to the
Registrant's Current Report on Form 8-K (File No. 0-25214)
dated December 1, 1997).
10.14 Amended and Restated Credit Agreement dated December 1,
1997 among the Company, Kelley Oil Corporation and Kelley
Operating Company, Ltd., as Borrowers; Concorde Gas
Marketing, Inc., Kelley Partners 1992 Development Drilling
Joint Venture, Kelley Partners 1994 Development Drilling
Joint Venture, Kelley Partners 1992 Development Drilling
Program, and Kelley Partners 1994 Development Drilling
Program, as Guarantors; Texas Commerce Bank National
Association, as Agent; Chase Securities Inc., as Arranger
and Syndication Agent; and certain other lenders signatory
thereto (incorporated by reference to Exhibit 10.3 to the
Registrant's Current Report on Form 8-K (File No. 0-25214)
dated December 1, 1997).
10.15 Amendment to the Amended and Restated Credit Agreement
dated December 29, 1998, 1998 among the company, Kelley
Oil Corporation and Kelley Operating Company, Ltd., as
Borrower; Concorde Gas Marketing, Inc., Kelley Partners
1992 Development Drilling Joint Venture, Kelley Partners
1994 Development Drilling Joint Venture, Kelley Partners
1992 Development Drilling Program, and Kelley Partners
1994 Development Drilling Program, as Guarantors; Texas
Commerce Bank National Association, as Agent; Chase
Securities Inc., as Arranger and Syndication Agent; and
certain other lenders signatory thereto (incorporated by
reference to exhibit 10.3 to the Registrant's Current
Report on Form 8-K (File No. 0-25214) dated December 1,
1997).
21.1 Subsidiaries of the Registrant (incorporated by reference
to Exhibit 21.1 to the Registrant's Annual Report on Form
10-K (File No. 0-25214) for the year ended December 31,
1996).
23.1 Consent of Deloitte & Touche LLP.
23.2 Consent of H.J. Gruy & Associates, Inc.
27 Financial Data Schedule (included only in the electronic
filing of this document).
(b) REPORTS ON FORM 8-K:
The Company filed a Current Report on Form 8-K dated October 21, 1997
and a Current Report on Form 8-K dated December 1, 1997, filed on
December 16, 1997 and amended on February 17, 1998 and March 30, 1998.
56
<PAGE> 58
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, this 15th day of
April, 1999.
KELLEY OIL & GAS CORPORATION
By: /s/ John F. Bookout By: /s/ Rick G. Lester
----------------------------------- ------------------------------
John F. Bookout Rick G. Lester
Chief Executive Officer Senior Vice President
and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed as of the 15th day of April, 1999 by the following
persons in their capacity as directors of the Registrant.
/s/ John F. Bookout /s/ Adam P. Godfrey
- ------------------------------------- ----------------------------------
John F. Bookout Adam P. Godfrey
/s/ John J. Conklin, Jr. /s/ William J. Murray
- ------------------------------------- ----------------------------------
John J. Conklin, Jr. William J. Murray
/s/ Ralph P. Davidson /s/ Ogden M. Phipps
- ------------------------------------- ----------------------------------
Ralph P. Davidson Ogden M. Phipps
/s/ Ward W. Woods
----------------------
Ward W. Woods
<PAGE> 59
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED MARCH 31, 1999 COMMISSION FILE NO. 0-25214
KELLEY OIL & GAS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 76-0447267
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
601 JEFFERSON
SUITE 1100
HOUSTON, TEXAS 77002
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (713) 652-5200
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
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
<TABLE>
<CAPTION>
TITLE OF CLASS OUTSTANDING AT APRIL 30, 1999
<S> <C>
Common Stock 126,022,235
</TABLE>
================================================================================
<PAGE> 60
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
----
<S> <C>
See Part II. , Item 5. Other Information.
PART II. OTHER INFORMATION................................................................................. 2
Item 3. Arrearages in Payments of Dividends............................................................. 2
Item 5. Other Information............................................................................... 3
Section A. Index to Financial Statements.............................................................. 3
Section B. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 36
Section C. Quantitative and Qualitative Disclosure About Market Risk.................................. 43
</TABLE>
1
<PAGE> 61
PART II. OTHER INFORMATION
ITEM 3. ARREARAGES IN PAYMENT OF DIVIDENDS
As of May 17, 1999, total dividends in arrears on the Company's $2.625
Convertible Exchangeable Preferred Stock ("Preferred Stock") were $6.8 million.
2
<PAGE> 62
ITEM 5. OTHER INFORMATION
DISPOSITION OF ASSETS.
In April 1999, the Company entered into an Exploration and Development
Agreement with Phillips Petroleum Company ("Phillips") relating to certain of
the Company's interests in the Bryceland, West Bryceland and Sailes fields in
north Louisiana. Pursuant to the agreement, the Company (1) received an $83
million cash payment (subject to certain post-closing adjustments), (2)
retained a 42 Bcf, 8-year volumetric overriding royalty interest and a 1%
override on the excess of production above such royalty interest and (3)
retained 25% of its working interest in the Cotton Valley formation. In
addition, Phillips, will at its risk and expense, operate, develop, exploit and
explore the properties thereby relieving the Company of significant operating,
exploration and development costs in the future. The effective date of the
transaction was May 1, 1999 and it closed on May 17, 1999.
SECTION A. INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES: PAGE
----
<S> <C>
Independent Auditors' Report.............................................................................. 4
Consolidated Balance Sheets - December 31, 1997, 1998 and March 31, 1999.................................. 5
Consolidated Statements of Income (Loss) - For the years ended December 31, 1996,
1997 and 1998, the three months ended March 31, 1998 (unaudited) and 1999............................... 6
Consolidated Statements of Cash Flows - For the years ended December 31, 1996,
1997 and 1998, the three months ended March 31, 1998 (unaudited) and
1999................................................................................................... 7
Consolidated Statements of Changes in Stockholders' Deficit - For the years ended
December 31, 1996, 1997 and 1998, and for the three months ended March 31, 1999......................... 8
Notes to Consolidated Financial Statements................................................................ 9
</TABLE>
3
<PAGE> 63
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Kelley Oil & Gas Corporation:
We have audited the accompanying consolidated balance sheets of Kelley
Oil & Gas Corporation and subsidiaries (the "Company") as of December 31, 1997
and 1998 and March 31, 1999, and the related consolidated statements of income
(loss), cash flows, and changes in stockholders' deficit for each of the three
years in the period ended December 31, 1998 and the three months ended March 31,
1999. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly,
in all material respects, the financial position of Kelley Oil & Gas Corporation
and subsidiaries as of December 31, 1997 and 1998 and March 31, 1999, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998 and the three months ended March 31, 1999, in
conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Houston, Texas
May 17, 1999
4
<PAGE> 64
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------ MARCH 31,
1997 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
ASSETS:
Cash and cash equivalents .................................................. $ 162 $ 8,435 $ 6,710
Accounts receivable ........................................................ 24,566 18,071 17,926
Accounts receivable - drilling programs .................................... 718 624 573
Prepaid expenses and other current assets .................................. 1,412 1,121 768
---------- ---------- ----------
Total current assets ..................................................... 26,858 28,251 25,977
---------- ---------- ----------
Oil and gas properties, successful efforts method:
Unproved properties, net ................................................. 49,854 38,293 38,455
Properties subject to amortization ....................................... 463,263 496,686 500,980
Pipelines and other transportation assets, at cost ......................... 4,690 1,582 1,582
Furniture, fixtures and equipment .......................................... 2,969 3,554 3,567
---------- ---------- ----------
520,776 540,115 544,584
Less: Accumulated depreciation, depletion and amortization ................ (227,163) (283,660) (293,620)
---------- ---------- ----------
Total property and equipment, net ........................................ 293,613 256,455 250,964
Other non-current assets, net .............................................. 2,131 1,491 1,298
---------- ---------- ----------
Total assets ............................................................. $ 322,602 $ 286,197 $ 278,239
========== ========== ==========
LIABILITIES:
Accounts payable and accrued expenses ...................................... $ 41,474 $ 33,113 $ 35,078
Accounts payable - drilling programs ....................................... 566 272 276
Current portion of long-term debt .......................................... -- 32,251 32,851
---------- ---------- ----------
Total current liabilities ................................................ 42,040 65,636 68,205
---------- ---------- ----------
Long-term debt ............................................................. 286,183 287,500 287,959
---------- ---------- ----------
Total liabilities ........................................................ 328,223 353,136 356,164
---------- ---------- ----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT:
Preferred stock, $1.50 par value, 20,000,000 shares authorized at December
31, 1997, 1998 and March 31, 1999; 1,745,443, 1,733,628 and 1,733,628
shares issued and outstanding at December 31, 1997, 1998 and March 31,
1999, respectively
(liquidation value $48,977, $48,633 and $49,771, respectively) ........... 2,618 2,600 2,600
Common stock, $.01 par value, 200,000,000 shares authorized
at December 31, 1997, 1998 and March 31, 1999; 125,709,093,
126,022,235 and 126,022,235 shares issued and outstanding at
December 31, 1997, 1998 and March 31, 1999, respectively ................. 1,257 1,260 1,260
Additional paid-in capital ................................................. 300,367 300,653 300,653
Accumulated deficit ........................................................ (309,863) (371,452) (382,438)
---------- ---------- ----------
Total stockholders' deficit .............................................. (5,621) (66,939) (77,925)
---------- ---------- ----------
Total liabilities and stockholders' deficit .............................. $ 322,602 $ 286,197 $ 278,239
========== ========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
5
<PAGE> 65
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
-------------------------------------- ------------------------
1996 1997 1998 1998 1999
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUES:
Oil and gas revenues ....................... $ 60,854 $ 75,864 $ 79,150 $ 23,047 $ 15,507
Interest and other income .................. 1,429 274 505 24 161
---------- ---------- ---------- ---------- ----------
Total revenues ............................. 62,283 76,138 79,655 23,071 15,668
---------- ---------- ---------- ---------- ----------
COSTS AND EXPENSES:
Production expenses ........................ 10,709 10,955 19,878 4,898 5,284
Exploration expenses ....................... 5,438 5,433 12,034 2,051 1,370
General and administrative expenses ........ 8,953 6,875 7,077 1,909 1,374
Interest and other debt expenses ........... 24,401 25,071 33,333 8,092 8,666
Restructuring expenses ..................... 4,276 - - - -
Depreciation, depletion and amortization ... 20,440 25,853 38,602 10,944 9,960
Impairment of oil and gas properties ....... - - 25,738 - -
---------- ---------- ---------- ---------- ----------
Total expenses ............................. 74,217 74,187 136,662 27,894 26,654
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes and
extraordinary item ......................... (11,934) 1,951 (57,007) (4,823) (10,986)
Income taxes ............................... - - - - -
---------- ---------- ---------- ---------- ----------
Net income (loss) before extraordinary item ... (11,934) 1,951 (57,007) (4,823) (10,986)
Extraordinary item ......................... (17,030) - - - -
---------- ---------- ---------- ---------- ----------
Net income (loss) ............................. (28,964) 1,951 (57,007) (4,823) (10,986)
Less: cumulative preferred stock dividends . (4,582) (4,582) (4,550) (1,145) (1,137)
---------- ---------- ---------- ---------- ----------
Net loss applicable to common stock ........... $ (33,546) $ (2,631) $ (61,557) $ (5,968) $ (12,123)
========== ========== ========== ========== ==========
Basic and diluted loss per common share
before extraordinary item .................. $ (.18) $ (.03) $ (0.49) $ (0.05) $ (0.10)
========== ========== ========== ========== ==========
Basic and diluted loss per common share ....... $ (.37) $ (.03) $ (0.49) $ (0.05) $ (0.10)
========== ========== ========== ========== ==========
Weighted average common shares outstanding .... 90,113 100,757 125,783 125,710 126,022
========== ========== ========== ========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
6
<PAGE> 66
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
-------------------------------------- ------------------------
1996 1997 1998 1998 1999
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) ................................. $ (28,964) $ 1,951 $ (57,007) $ (4,823) $ (10,986)
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Depreciation, depletion
and amortization .............................. 20,440 25,853 38,602 10,944 9,960
Impairment of oil and gas properties ............ -- -- 25,738 -- --
Gain on sale of properties ...................... (176) -- -- -- --
Exploration expenses ............................ 5,438 5,433 12,034 2,051 1,370
Accretion and amortization of other
debt expenses ................................. 5,170 4,297 5,236 1,394 1,233
Restructuring expenses .......................... 4,276 -- -- -- --
Extraordinary loss .............................. 17,030 -- -- -- --
Changes in operating assets and liabilities:
Decrease (increase) in accounts
receivable and other current assets ........... (9,054) (1,297) 6,880 676 549
(Increase) decrease in other non-current assets . (1,945) (1,203) (526) 33 3
Increase (decrease) in accounts
payable and accrued expenses .................. (2,953) 4,570 (8,655) (589) 1,969
---------- ---------- ---------- ---------- ----------
Net cash provided by operating activities ......... 9,262 39,604 22,302 9,686 4,098
---------- ---------- ---------- ---------- ----------
INVESTING ACTIVITIES:
Capital expenditures .............................. (47,601) (53,140) (56,579) (12,881) (5,823)
Acquisition of oil and gas properties ............. (11,594) (111,135) -- -- --
Proceeds from sale of properties .................. 5,803 -- 17,363 -- --
---------- ---------- ---------- ---------- ----------
Net cash used in investing activities ............. (53,392) (164,275) (39,216) (12,881) (5,823)
---------- ---------- ---------- ---------- ----------
FINANCING ACTIVITIES:
Proceeds from long-term borrowings ................ 50,000 180,500 119,100 34,100 --
Principal payments on long-term borrowings ........ (58,500) (82,700) (118,900) (30,800) --
Proceeds from sale of notes, net .................. 120,938 -- 29,526 -- --
Debenture conversion costs ........................ (1,100) -- -- -- --
Proceeds from sale of common stock, net ........... 43,998 27,545 273 1 --
Proceeds from conversion of preferred stock ....... -- -- (2) -- --
Retirement of notes ............................... (113,488) -- (228) (228) --
Dividends on preferred stock ...................... -- (4,582) (4,582) -- --
---------- ---------- ---------- ---------- ----------
Net cash provided by financing activities ......... 41,848 120,763 25,187 3,073 --
---------- ---------- ---------- ---------- ----------
(Decrease) increase in cash and cash equivalents ..... (2,282) (3,908) 8,273 (122)
(1,725)
Cash and cash equivalents, beginning of period ....... 6,352 4,070 162 162 8,435
---------- ---------- ---------- ---------- ----------
Cash and cash equivalents, end of period ............. $ 4,070 $ 162 $ 8,435 $ 40 $ 6,710
========== ========== ========== ========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
7
<PAGE> 67
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
ADDITIONAL
PREFERRED COMMON PAID IN ACCUMULATED
STOCK STOCK CAPITAL DEFICIT
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Stockholders' deficit at January 1, 1996 ................. $ 6,456 $ 440 $ 225,804 $ (278,268)
Issuance of 48,000 shares of common stock in
Contour Transaction ................................... -- 480 47,520 --
Conversion of 697 shares of preferred stock into
4,355 shares of common stock .......................... (1,045) 44 1,001 --
Conversion of 1,862 shares of preferred stock into
1,862 shares of common stock .......................... (2,793) 19 2,774 --
Issuance of 36 shares of common stock pursuant to
employee incentive stock options ...................... -- -- 62 --
Syndication costs ........................................ -- -- (4,065) --
Net loss ................................................. -- -- -- (28,964)
------------- ------------- ------------- -------------
BALANCE AT DECEMBER 31, 1996 .......................... 2,618 983 273,096 (307,232)
------------- ------------- ------------- -------------
Issuance of 27,000 shares of common stock in
Contour Transaction ................................... -- 270 26,730 --
Issuance of 415 shares of common stock pursuant to
employee incentive stock options ...................... -- 4 541 --
Preferred stock dividends ................................ -- -- -- (4,582)
Net income ............................................... -- -- -- 1,951
------------- ------------- ------------- -------------
BALANCE AT DECEMBER 31, 1997 .......................... 2,618 1,257 300,367 (309,863)
------------- ------------- ------------- -------------
Conversion of 11,815 shares of preferred stock
into 40,976 share of common stock ..................... (18) 1 17 --
Issuance of 272,166 shares of common stock pursuant to
employee incentive stock options ...................... -- 2 269 --
Preferred stock dividends ................................ -- -- -- (4,582)
Net loss ................................................. -- -- -- (57,007)
------------- ------------- ------------- -------------
BALANCE AT DECEMBER 31, 1998 .......................... 2,600 1,260 300,653 (371,452)
------------- ------------- ------------- -------------
Net loss ................................................. -- -- -- (10,986)
------------- ------------- ------------- -------------
BALANCE AT MARCH 31, 1999 ............................. $ 2,600 $ 1,260 $ 300,653 $ (382,438)
============= ============= ============= =============
</TABLE>
See Notes to Consolidated Financial Statements.
8
<PAGE> 68
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - INDUSTRY CONDITIONS AND LIQUIDITY
During 1998 and through the first quarter of 1999, the oil and gas
industry experienced a worldwide excess of supply over demand for oil and
natural gas resulting in sharply reduced prices. As a result, many companies in
the oil and gas industry, including Kelley Oil & Gas Corporation ("the
Company"), experienced reduced profitability and cash flows which, in turn,
created significant liquidity problems. To address these liquidity issues, the
Company has taken the measures discussed in the following paragraphs.
In April 1999, the Company entered into an Exploration and Development
Agreement with Phillips Petroleum Company ("Phillips") relating to certain of
the Company's interests in the Bryceland, West Bryceland and Sailes fields in
north Louisiana. Pursuant to the agreement, the Company (1) received an $83
million cash payment (subject to certain post-closing adjustments), (2) retained
a 42 Bcf, 8-year volumetric overriding royalty interest and a 1% override on the
excess of production above such royalty interest and (3) retained 25% of its
working interest in the Cotton Valley formation. In addition, Phillips, will at
its risk and expense, operate, develop, exploit and explore the properties
thereby relieving the Company of significant operating, exploration and
development costs in the future. The effective date of the transaction was May
1, 1999 and it closed on May 17, 1999. The Company anticipates recognition of a
gain ranging from approximately $24 million to $28 million in the second quarter
of 1999. The Company has not completed its analysis of the specific costs of the
oil and gas properties and related accumulated depreciation, depletion and
amortization being sold, and accordingly, the gain is subject to further
adjustment.
In April 1999, the Company negotiated a private offering of $135
million principal amount, 14% Senior Secured Notes (the "Notes"). The Notes are
secured by a first lien on substantially all of the Company's proved oil and
natural gas properties remaining after the sale to Phillips and guaranteed by
three entities wholly-owned by the Company. With the consummation of the
Phillips transaction, the Company is obligated to offer to repurchase $35
million principal amount of the Notes at a repurchase price equal to 104% of the
principal amount, plus accrued and unpaid interest to the date of the repurchase
within 30 days of such closing.
In April 1999, the Company began an offer to purchase ("Offer to
Purchase") the outstanding principal amounts of its 7 7/8% Convertible
Subordinated Notes due December 15, 1999 and its 8 1/2% Convertible Subordinated
Debentures due April 1, 2000 (collectively, the "Securities") at a price equal
to $590 per $1,000 principal amount. On May 17, 1999, the Company funded the
repurchase of $46.1 million of the Securities through the Offer to Purchase and
will recognize an extraordinary gain of approximately $18.9 million in the
second quarter of 1999.
The net proceeds from the combination of these transactions and cash
on hand were used by the Company to repay all borrowings outstanding under its
Credit Facility of $115.5 million plus accrued interest, to fund cash
collateral for a $1.5 million letter of credit, and to fund the repurchase of
$46.1 million of Securities under the Offer to Purchase, all at May 17, 1999.
The remaining net proceeds and cash flow from operations will be used to
repurchase up to $35 million of Notes at 104% of their principal amount and
for general corporate purposes.
While industry conditions cannot be predicted with certainty and are
dependent upon a number of commodity and economic factors which are beyond the
company's control, the Company believes that the cash on hand subsequent to the
consummation of the above transactions and the recent increase in oil and
natural gas prices, if continued, will sustain its operations over the
short-term. However, the Company will continue to have significant debt
outstanding and limited ability to incur further indebtedness, which, combined
with industry conditions beyond its control, may adversely affect its financial
condition, results of operations and cash flows.
9
<PAGE> 69
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Operations. Kelley Oil & Gas Corporation (a Delaware
Corporation), its corporate subsidiaries and proportionate partnership interests
are referred to herein as the "Company". The Company is an independent oil & gas
company engaged in the exploration, development and acquisition of domestic oil
and gas properties, principally in the Gulf Coast region and northern Louisiana.
Cash and Cash Equivalents. The Company considers all highly liquid
investments with an original maturity of three months or less when purchased to
be cash equivalents. Cash payments attributable to interest on all indebtedness
aggregated $19.2 million, $19.6 million and $26.5 million for the years ended
December 31, 1996, 1997 and 1998, respectively, and $2.3 million and $2.0
million for the periods ended March 31, 1998 (unaudited) and March 31, 1999,
respectively.
Financial Instruments. The Company's financial instruments consist of
cash and cash equivalents, receivables, payables and long term debt. As of
December 31, 1998 and March 31, 1999, the estimated fair value of the Company's
long-term debt was $251 million and $246 million, respectively. The fair value
of such long-term debt has been estimated based on quoted market prices. The
carrying amount of the Company's other financial instruments approximates fair
value.
Oil and Gas Properties. All of the Company's interests in its oil and
gas properties are located in the United States and are accounted for using the
successful efforts method. Under the successful efforts method, the costs of
successful wells, development dry holes and leases containing productive
reserves are capitalized and amortized on a unit-of-production basis over the
life of the related reserves. Estimated future abandonment and site restoration
costs, net of anticipated salvage values, are amortized on a unit-of-production
basis over the life of the related reserves. Exploratory drilling costs are
initially capitalized pending determination of proved reserves but are charged
to expense if no proved reserves are found. Other exploration costs, including
geological and geophysical expenses, leasehold expiration costs and delay
rentals, are expensed as incurred. Unproved leasehold costs are capitalized and
are not amortized pending an evaluation of the exploration results. Unproved
properties are periodically assessed for impairment in value, with any
impairment charged to expense.
Property Impairment under SFAS 121. Under Financial Accounting
Standards Board's Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 121"),
certain assets are required to be reviewed periodically for impairment whenever
circumstances indicate their carrying amount exceeds their fair value and may
not be recoverable. As a result of a decline in its proved reserves at January
1, 1999 from year-earlier levels, the Company performed an assessment of the
fair value of its oil and gas properties indicating an impairment should be
recognized as of year end. Under this analysis, the fair value for the Company's
proved oil and gas properties was estimated using escalated pricing and present
value discount factors reflecting risk assessments. The fair value of the
Company's unproved properties was predicated on current acreage cost estimates.
Based on this analysis, the Company recognized noncash impairment charges
against the carrying values of its proved and unproved oil and gas properties
under SFAS 121 aggregating $21.6 million and $4.1 million, respectively, at
December 31, 1998. Prices of oil and natural gas have increased since December
31, 1998 so that no additional impairment was required at March 31, 1999.
Other Property and Equipment. The costs of pipelines and other
transportation assets are depreciated using the straight-line method over the
estimated useful lives of the related assets. Furniture, fixtures and equipment
are recorded at cost and depreciated using the straight-line method over the
estimated useful lives of three to five years. Maintenance and repairs are
charged to expense as incurred.
Other Non-Current Assets. Other non-current assets consist primarily of
debt issue costs, net of accumulated amortization. These costs are amortized
over the anticipated term of the related debt.
Oil and Gas Revenues. The Company recognizes oil and gas revenue from
its interests in producing wells as oil and gas is produced and sold from those
wells. Oil and gas sold is not significantly different from the Company's
production entitlement. Revenues from gas marketing, net of cost of gas sold,
are included in oil and gas revenues and amounted to $1.8 million, $2.8 million
and $1.3 million for the years ended December 31, 1996,
10
<PAGE> 70
1997 and 1998, respectively, and $0.5 million and $0.6 million, for the periods
ended March 31, 1998 (unaudited) and March 31, 1999, respectively.
Earnings per Share. In 1997, the Company implemented the Financial
Accounting Standards Board Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS 128"). SFAS 128 establishes standards for computing
and presenting earnings per share ("EPS") and is effective for financial
statements issued for periods ending after December 15, 1997. This statement
requires restatement for all prior-period EPS data presented. The basic loss per
common share before extraordinary item and basic loss per common share as shown
on the Consolidated Statements of Income (Loss) reflects net income (loss)
before extraordinary item and net income (loss), respectively, less cumulative
preferred stock dividends, whether or not declared, divided by the weighted
average number of common shares outstanding during the respective years. The
extraordinary loss per common share for the year ended 1996 was $0.19. In
calculating diluted income (loss) per share, common shares issuable under stock
options and upon conversion of convertible subordinated debentures and
convertible preferred stock are added to the weighted average common shares
outstanding when dilutive. For the years ended December 31, 1996, 1997 and 1998,
and for the periods ended March 31, 1998 (unaudited) and 1999, all potentially
dilutive securities are anti-dilutive and therefore are not included in the EPS
calculations. As of March 31, 1999, potentially dilutive securities which could
impact EPS in the future include stock options granted to employees to purchase
4.0 million common shares, the Company's 7 7/8% Convertible Subordinated Notes
and 8 1/2% Convertible Subordinated Debentures which can be converted into 2.5
million and 1.4 million common shares, respectively, and the Company's $2.625
Convertible Preferred Stock which can be converted into 6.0 million shares. See
Note 1 regarding the Company's purchase of a portion of the outstanding 7 7/8%
Convertible Subordinated Notes and 8 1/2% Convertible Subordinated Debentures.
Stock Based Compensation. The Company applies Accounting Principles
Board Opinion No. 25 ("APB 25") and related Interpretations in accounting for
stock option and purchase plans. Under APB 25, compensation expense, if any, is
based on the intrinsic value of the equity instrument at the measurement date.
The Company has not recognized any compensation expense because the exercise
price of employee stock options equals the market price of the underlying stock
on the date of the grant.
Derivatives and Hedging Activities. See Note 10 for a discussion of
the Company's accounting policies related to hedging activities. In June 1998,
the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting
standards for derivative instruments and hedging activities that require an
entity to recognize all derivatives as an asset or liability measured at its
fair value. Depending on the intended use of the derivatives, changes in its
fair value will be reported in the period of change as either a component of
earnings or a component of other comprehensive income.
SFAS 133 is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Earlier application of SFAS 133 is encouraged, but not
prior to the beginning of any fiscal quarter that begins after issuance of the
Statement. Retroactive application to periods prior to adoption is not allowed.
Comprehensive Income. In June 1997, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for reporting
and displaying comprehensive income and its components. SFAS 130 is effective
for periods beginning after December 15, 1997. The purpose of reporting
comprehensive income is to report a measure of all changes in equity of an
enterprise that results from recognized transactions and other economic events
of the period other than transactions with owners in their capacity as owners.
For all applicable periods through March 31, 1999, there are no adjustments
("Other Comprehensive Income") to net income in deriving comprehensive income.
Risks and Uncertainties. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that 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.
11
<PAGE> 71
Interim Presentation. The accompanying consolidated interim financial
statements and disclosures for 1998 (unaudited) and 1999, have been prepared by
the Company in accordance with generally accepted accounting principles and, in
the opinion of management, reflect all adjustments (consisting solely of normal
recurring adjustments) necessary for a fair presentation in all material
respects of the results for the interim periods. The interim financial
statements for the three months ended March 31, 1998 (unaudited) and 1999 should
be read in conjunction with the Company's annual consolidated financial
statements contained in its Annual Report on Form 10-K for the year ended
December 31, 1998. The results of operations for the three months ended March
31, 1999 are not necessarily indicative of results to be expected for the full
year.
Changes in Presentation. Certain financial statement items in 1996,
1997 and 1998 have been reclassified to conform to the 1999 presentation.
NOTE 3 - ACQUISITION OF OIL AND GAS PROPERTIES
SPR Acquisition. On December 1, 1997, the Company purchased from SCANA
Petroleum Resources, Inc. ("SPR") substantially all of SPR's assets, including
its oil and gas properties, exploratory leasehold interests and associated
obligations, in exchange for approximately $110 million ("SPR Acquisition"),
subject to adjustment as provided by the Purchase and Sale Agreement between the
Company and SPR. The acquisition was accounted for using the purchase method of
accounting, and accordingly, the purchase price has been allocated to the assets
acquired based on estimated fair values at the date of acquisition. The
operating results of the assets acquired from SPR have been included in Kelley's
Consolidated Statements of Income (Loss) since December 1, 1997. The pro forma
information shown below assumes that the acquisition occurred at the beginning
of each year presented. Adjustments have been made to reflect changes in the
Company's results from the revenues and direct operating expenses of the
producing properties acquired from SPR, additional interest expense to finance
the acquisition, depreciation, depletion and amortization based on assigned fair
values to the assets acquired and general and administrative expenses incurred
from hiring additional employees. The unaudited pro forma financial data are not
necessarily indicative of financial results that would have occurred had the SPR
Acquisition occurred on January 1, 1996 and January 1, 1997, and should not be
viewed as indicative of operations in future periods.
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
(UNAUDITED)
-----------------------------
YEAR ENDED DECEMBER 31,
-----------------------------
1996 1997
----------- -----------
<S> <C> <C>
Revenues............................................................... $ 112,936 $ 112,142
Income (loss) before extraordinary item................................ (12,484) 1,315
Net income (loss)...................................................... (29,514) 1,315
Loss per common share.................................................. (0.29) (0.03)
</TABLE>
12
<PAGE> 72
NOTE 4 - LONG-TERM DEBT
Long-Term Debt. The Company's long-term debt at December 31, 1997 and
1998 and March 31, 1999 is comprised of the following:
(IN THOUSANDS)
<TABLE>
<CAPTION>
December 31, March 31,
----------------------- ----------
1997 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
Bank credit facilities ....................................... $ 111,300 $ 111,500 $ 111,500
13 1/2% Senior Notes ......................................... 435 435 435
10 3/8% Senior Subordinated Notes ............................ 120,615 150,662 150,818
7 7/8% Convertible Subordinated Notes ........................ 29,710 31,816 32,416
8 1/2% Convertible Subordinated Debentures ................... 24,123 25,338 25,641
---------- ---------- ----------
286,183 319,751 320,810
Less current maturities ................................... -- (32,251) (32,851)
---------- ---------- ----------
$ 286,183 $ 287,500 $ 287,959
========== ========== ==========
</TABLE>
Bank Credit Facilities. The Company replaced its prior credit facility
with a new credit facility effective as of December 12, 1996 (the "Credit
Facility") that was subsequently amended and restated in connection with the SPR
Acquisition effective December 1, 1997. The borrowers under the Credit Facility
are the Company, Kelley Oil Corporation ("Kelley Oil") and Kelley Operating
Company, Ltd., with Concorde Gas Marketing, Inc. (a wholly-owned subsidiary of
the Company) and the Company's subsidiary partnerships as guarantors.
The Credit Facility provides for a maximum $140 million revolving
credit loan and matures, with all amounts owed thereunder becoming due and
payable on December 1, 2000. Availability under the Credit Facility is limited
to a borrowing base determined by, among other things, the proved oil and
natural gas reserves and other assets of the borrowers and the value of those
reserves based on the underlying prices for oil and natural gas. The Borrowing
Base is redetermined at least semiannually by the Agent under the Credit
Facility, with the consent of 100% of the lenders, and may be redetermined more
frequently at the election of the lenders or the borrowers. On April 14, 1998,
the Borrowing Base was set at $138 million and the threshold amount (the
"Threshold Amount"), which is the amount that would ordinarily be made available
by the lenders to a similar borrower under a borrowing base, was set at $125
million. Following the Company's sale of its interest in the Waskom field in
July 1998, the Borrowing Base and Threshold Amount were reduced to $130 million
and $117 million, respectively. As provided in the Credit Facility, on November
1, 1998 the Borrowing Base was reduced to equal the Threshold Amount of $117
million.
On December 29, 1998 the Borrowing Base under the Credit Facility was
maintained at $117 million and certain terms were amended, including: (i) an
increase in the margin borrowing rate to 250 basis points over LIBOR, (ii) a
reduction in the grace periods available under certain default provisions, (iii)
a change in the definition of majority banks for purposes of setting the
semi-annual Borrowing Base and implementing other provisions from 75% to 100%,
and (iv) a reduction in the time allowed to cure a Borrowing Base deficiency to
30 days.
At December 31, 1998 and March 31, 1999, $111.5 million of borrowings
and $1.5 million of letters of credit were outstanding under the Credit
Facility. In April 1999 the Company borrowed an additional $4 million under the
Credit Facility, raising its total outstanding borrowings to $115.5 million as
of April 30, 1999. The Company's typical monthly cash flow cycle is such that
the Company usually receives a substantial portion of its proceeds from
operations near the end of each month. Accordingly, outstanding balances under
the Credit Facility may be higher on any given day during the month than at the
end of the month. The weighted average interest rates on borrowings outstanding
at December 31, 1998 and March 31, 1999 under the Credit Facility were 7.03% and
6.78%, respectively.
13
<PAGE> 73
As of March 31, 1999, the Company was in default on certain covenants
under the Credit Facility. In addition, a review of the Borrowing Base was
scheduled for May 1, 1999, at which time the Company expected the current $117
million Borrowing Base to be lowered. The excess of the amounts outstanding over
the new Borrowing Base would have been due and payable within 30 days. The
Company received waivers of these defaults through May 17, 1999, at which time
all amounts due under the Credit Facility were repaid and the Credit Facility
was terminated (see Note 1). Following the sale of the Notes, the Company's
ability to negotiate a new revolving credit facility will be severely limited.
1996 Fourth Quarter Extraordinary Loss. Pursuant to an offer to
purchase and consent solicitation, dated September 24, 1996, as amended , the
Company offered to purchase for cash up to the aggregate principal amount of
$100 million of its 13 1/2% Senior Notes at a cash price equal to $1,110 per
$1,000 principal amount, plus interest accrued and unpaid through the payment
date. In conjunction with the offering, the Company also solicited consents to
the adoption of certain amendments to the 13 1/2% Senior Notes indenture
pursuant to which the 13 1/2% Senior Notes were issued, and offered to pay each
consenting holder of the 13 1/2% Senior Notes, $30 for each $1,000 principal
amount of the 13 1/2% Senior Notes consenting. The Company received the
requisite consents which allowed it to amend the 13 1/2% Senior Notes indenture
on October 28, 1996. The Company also received tenders from holders of
approximately $99.6 million principal amount of the 13 1/2% Senior Notes. These
transactions resulted in an extraordinary loss in the fourth quarter of 1996 of
$17.0 million, representing the excess of the aggregate purchase price of the 13
1/2% Notes (including Consent Payments) over their carrying value as of the date
of the consummation of the refinancing.
10 3/8% Senior Subordinated Notes. In connection with the refinancing
of the 13 1/2% Senior Notes, the Company issued an aggregate principal amount of
$125.0 million of 10 3/8% Senior Subordinated Notes due 2006 (the "10 3/8%
Senior Subordinated Notes"). The 10 3/8% Senior Subordinated Notes are
redeemable at the option of the Company, in whole or in part, at redemption
prices declining from 105.19% in 2001 to 100% in 2003 and thereafter. The
Company may redeem up to 35% of the principal amount of the 10 3/8% Senior
Subordinated Notes before October 15, 1999 with the proceeds of an equity
offering (provided that either at least $75.0 million aggregate principal amount
of such notes remains outstanding or such redemption retires such notes in their
entirety). The 10 3/8% Senior Subordinated Notes represent unsecured obligations
of the Company and are subordinate in right of payment to all existing and
future senior indebtedness. The indenture for the notes contains conditions and
limitations, including but not limited to restrictions on additional
indebtedness, payment of dividends, redemption of capital stock, and certain
mergers and consolidations. The holder of the 10 3/8% Senior Subordinated Notes
also can require the Company to repurchase the notes at 101% of the principal
amount upon a Change of Control, as defined. Kelley Oil Corporation, a
wholly-owned subsidiary of the Company and Kelley Operating Company, Ltd., an
indirect wholly-owned partnership of the Company are guarantors of the 10 3/8%
Senior Subordinated Notes.
On February 3, 1997, the Company completed an exchange of $125.0
million aggregate principal amount of publicly registered 10 3/8% Senior
Subordinated Notes, Series B, for all of the then outstanding Series A notes.
The Series B notes were substantially identical to the Series A notes.
In May 1998, the Company sold $30.0 million principal amount of the
Company's 10 3/8% Senior Subordinated Notes due 2006, Series C ("Series C
Notes") at a cash price of $1,015 per $1,000 principal amount. The net proceeds
received were used to reduce outstanding borrowings under the Company's bank
credit facility ("Credit Facility"). The Series C Notes are redeemable at the
option of the Company, in whole or in part, at redemption prices declining
ratably from 105.19% on October 15, 2001 to 100% at October 15, 2003 and
thereafter. The Company may redeem up to 35% of the original principal amount of
the Series C Notes before October 15, 1999 at 110.38% with the proceeds of an
equity offering (provided that either at least $18.0 million aggregate principal
amount of such notes remains outstanding or such redemption retires such notes
in their entirety). The Series C Notes represent unsecured obligations of the
Company and are subordinate in right of payment to all existing and future
senior indebtedness. The indenture for the notes contains conditions and
limitations, including but not limited to restrictions on additional
indebtedness, payment of dividends, redemption of capital stock, and certain
mergers and consolidations. The holders of the Series C Notes also can require
the Company to repurchase the notes at 101% of the principal amount upon a
Change of Control, as defined. Kelley Oil Corporation, a wholly owned subsidiary
of the Company, and Kelley Operating Company, Ltd., an indirect wholly owned
partnership of the Company, are guarantors of the Series C Notes.
14
<PAGE> 74
The Series C Notes were sold pursuant to Rule 144A of the Securities
Act of 1933. In issuing the Series C Notes, the Company agreed to use its best
efforts to register under the Securities Act notes identical in terms to the
Series C Notes ("Series D Notes"). The Company completed the exchange of the
Series C Notes for the Series D Notes on November 12, 1998.
7 7/8% Convertible Subordinated Notes and 8 1/2% Convertible
Subordinated Debentures. The Company has outstanding 7 7/8% Convertible
Subordinated Notes due December 1999 (the "7 7/8% Subordinated Notes") in the
aggregate principal amount at maturity of $34.1 million and 8 1/2% Convertible
Subordinated Debentures due April 1, 2000 (the "8 1/2% Subordinated Debentures")
in the aggregate principal amount of $26.9 million (together, the "Subordinated
Debt"). Each $1,000 face value amount of the 7 7/8% Subordinated Notes is
convertible into 71.263 shares of the Company's Common Stock or 35.632 shares of
the Company's Common Stock and 7.435 shares of Preferred Stock. Each $1,000 face
value amount of the 8 1/2% Subordinated Debentures is convertible into 51.864
shares of the Company's Common Stock or 25.932 shares of the Company's Common
Stock and 5.411 shares of Preferred Stock.
Under the Indenture for the 7 7/8% Subordinated Notes, as amended, a
"Change in Control" is defined to occur if, among other things, any person
becomes the beneficial owner of securities representing 50% or more of the
equity interests in the Company. With the purchase by Contour of 27 million
shares on December 1, 1997, each holder of 7 7/8% Subordinated Notes, was
afforded the right, at the holder's option, subject to terms and conditions of
the Indenture, to require the Company to redeem all or any part of the holder's
notes by January 22, 1998 at a specified cash price. Holders redeemed $0.2
million of the 7 7/8% Subordinated Notes under the Change of Control provision.
See Note 1 regarding the Company's purchase of a portion of the
outstanding 7 7/8% Convertible Subordinated Notes and 8 1/2% Convertible
Subordinated Debentures.
14% Senior Secured Notes Due 2003. On April 16, 1999, the Company
issued $135,000,000 of Senior Secured Notes due 2003, maturing at 105% of the
stated principal amount. Interest will accrue from the issue date and will be
payable semi-annually in cash in arrears on each April 15 and October 15,
commencing October 15, 1999. As a result of the consummation of the Phillips
transaction, by June 16, 1999, the Company must offer to redeem $35 million of
the Notes at 104% of par. The remaining Notes are redeemable by the Company on
or after April 15, 2001. Scheduled mandatory redemptions of $2,000,000 per
quarter begin July 15, 2002. In addition, the indenture contains covenants that
restrict the Company's ability to incur additional indebtedness, pay dividends,
incur capital expenditures, sell assets, merge or consolidate and redeem
subordinated indebtedness.
Debt Maturities. At December 31, 1998 and March 31, 1999, the Company
has aggregate debt maturities of $34.6 million in 1999, $138.4 million in 2000
and $155.0 million in 2006.
NOTE 5 - STOCKHOLDERS' DEFICIT
Contour Stock Purchase. In February 1996, the Company issued 48 million
shares of its Common Stock at $1.00 per share to Contour Production Company
L.L.C. ("Contour") upon the closing of a Stock Purchase Agreement between the
Company and Contour (the "Contour Transaction"). The newly issued shares
represented 49.8% of the Company's voting power. In connection with the Contour
Transaction, the Company (i) entered into an option agreement with Contour (the
"Contour Option Agreement"), (ii) obtained consents from its principal
stockholders, subject to compliance with applicable securities law, to amend its
Certificate of Incorporation to increase its authorized Common Stock from 100
million shares to 200 million shares, (iii) entered into employment agreements
with John F. Bookout, President of Contour, and three other new executives named
by him, (iv) adopted a nonqualified stock option plan for the new executives
other than Mr. Bookout, (v) amended its existing incentive stock option plans,
(vi) reduced the size of its board of directors (the "Board") to seven members
and reconstituted the Board with three continuing directors and four designees
of Contour and (vii) replaced its credit facility.
Contour Option. Under the Contour Option Agreement, the Company granted
Contour an option (the "Contour Option") to purchase up to 27 million shares
(the "Maximum Option Number") of Common Stock at $1.00
15
<PAGE> 75
per share (subject to antidilution adjustments) upon satisfaction of certain
conditions, including the absence of any Company debt repurchase or redemption
obligations as a result of the purchase. Contour voluntarily exercised its
option in full on December 1, 1997 to partially fund the SPR Acquisition.
Preferred Stock. In May 1994, Kelley Oil completed a public offering of
1,380,000 shares of $2.625 Preferred Stock ("KOIL Preferred Stock") at $25 per
share. Each outstanding share of KOIL Preferred Stock was converted in the
Consolidation into one share of the Company's Preferred Stock, which has the
same terms as the KOIL Preferred Stock, except for expanded voting rights. The
Company issued 649,807 shares of its Preferred Stock to Public Unitholders in
the Consolidation, resulting in a total of 2,442,323 outstanding shares of
Preferred Stock after giving effect to the shares issued to holders of KOIL
Preferred Stock.
In January 1996, the Company suspended the payment of the quarterly
Preferred Stock dividend scheduled for February 1, 1996 to conserve cash. On
April 15, 1997, the Board of Directors of the Company declared a dividend of
$2.625 per preferred share (approximately $4.6 million), which was paid on May
1, 1997. On April 14, 1998, the Company declared a dividend of $2.625 per share
of Preferred Stock (approximately $4.6 million), which was paid on April 30,
1998. The Company has not declared the quarterly dividends of $0.65625 per
preferred share for February 1, 1998, May 1, 1998, August 1, 1998, November 1,
1998, February 1, 1999 and May 1, 1999 aggregating approximately $6.8 million,
covering 6 quarters. Further dividends are restricted under the Company's
indentures governing its 10 3/8% Senior Subordinated Notes and its 14% Senior
Secured Notes. No interest is payable on Preferred Stock arrearages; however,
the terms of the Preferred Stock enable holders, voting separately as a class,
to elect two additional directors to the Board at each meeting of stockholders
at which directors are to be elected during any period when Preferred Stock
dividends are in arrears in an aggregate amount equal to at least six quarterly
dividends, whether or not consecutive.
Each share of Preferred Stock is convertible, at the holder's option,
into 3.47 shares of Common Stock, equivalent to a conversion price of $7.20 per
share of Common Stock relative to the $25 per share liquidation preference of
the Preferred Stock (the "Preferred Conversion Price"). Under the terms of the
Certificate of Designation governing the Preferred Stock, the Contour
Transaction triggered a special conversion right under which the Preferred Stock
conversion price was reduced to $4.00 for a period of 45 days commencing March
12, 1996. On April 25, 1996, 696,823 shares of Preferred Stock were converted
into 4,355,040 shares of Common Stock under the special conversion right.
ESOP Preferred Stock. As of December 31, 1995, 1,861,619 shares of ESOP
Preferred Stock were outstanding and held by the Company's Employee Stock
Ownership Plan ("ESOP"). In June 1996, each of the 1,861,619 shares of ESOP
Preferred Stock was redeemed for one share of the Company's Common Stock.
NOTE 6 - EMPLOYEE STOCK PLANS
Employee Stock Options. The Company has both qualified and nonqualified
stock option plans that provide for granting of options for the purchase of
common stock to key employees. These stock options may be granted for periods up
to ten years and are generally subject to vesting periods up to three years,
except options granted during 1997 and 1998 which are subject to a four year
vesting period.
16
<PAGE> 76
Stock option activity for the Company during 1996, 1997, 1998 and the
three month period ended March 31, 1999, was as follows:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
1996 1997 1998 MARCH 31, 1999
----------------------- ----------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE EXERCISE
OPTIONS IN THOUSANDS OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
--------- ----------- ---------- ---------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Stock options outstanding,
beginning of year ......... 2,105 $ 2.38 4,589 $ 1.63 4,601 $ 1.75 4,497 $ 1.87
Granted ................. 2,520 1.01 482 2.61 727 2.20 -- --
Exercised ............... (36) 2.38 (415) 1.31 (272) 1.00 -- --
Surrendered or expired .. -- -- (55) 2.62 (559) 1.73 (482) 1.15
--------- --------- --------- ---------
Stock options outstanding,
end of year/period ........ 4,589 $ 1.63 4,601 $ 1.75 4,497 $ 1.87 4,015 $ 1.96
========= ========= ========= ========= ========= ========= ========= =========
</TABLE>
In February 1995, all previously issued options to the extent
outstanding, aggregating options to acquire 234,000 shares at prices ranging
from $7.00 to $7.63, were repriced at $4.13 per share. In February 1996, in
connection with the Contour Transaction, all unvested options then held by
employees were fully vested. Additionally, the then-existing plans were amended
to extend the period during which a terminated employee may exercise vested
options to three years after termination of employment.
At December 31, 1998 and March 31, 1999, approximately 3.6 million and
4.1 million shares, respectively, were available for future option grants.
The following table summarizes information about the options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------- --------------------------------
WEIGHTED
AVERAGE WEIGHTED
REMAINING WEIGHTED AVERAGE
RANGE OF OPTIONS CONTRACTUAL LIFE AVERAGE OPTIONS EXERCISE
EXERCISE PRICE (THOUSANDS) (YEARS) EXERCISE PRICE (THOUSANDS) PRICE
- --------------------- ------------- ----------------- ----------------- -------------- -------------
<S> <C> <C> <C> <C> <C>
$0.69 - 1.00 1,688 7.8 $1.00 793 $1.00
$1.75 - 2.56 2,531 7.2 2.25 1,808 2.23
$2.72 - 4.13 278 4.0 3.78 226 3.98
</TABLE>
17
<PAGE> 77
The following table summarizes information about the options outstanding at
March 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------- --------------------------------
WEIGHTED
AVERAGE WEIGHTED
REMAINING WEIGHTED AVERAGE
RANGE OF OPTIONS CONTRACTUAL LIFE AVERAGE OPTIONS EXERCISE
EXERCISE PRICE (THOUSANDS) (YEARS) EXERCISE PRICE (THOUSANDS) PRICE
- --------------------- ------------- ----------------- ----------------- -------------- -------------
<S> <C> <C> <C> <C> <C>
$0.69 - 1.00 1,252 7.2 $1.00 863 $1.00
$1.75 - 2.56 2,493 7.0 2.24 1,933 2.22
$2.72 - 4.13 270 3.6 3.81 224 3.99
</TABLE>
The weighted average fair value of options granted during 1996, 1997
and 1998 was $0.59, $1.51 and $1.46, respectively. There were no options granted
in the first quarter of 1999. The fair value of the options granted was
estimated on the date of grant using the Black-Scholes option-pricing model with
the following assumptions: weighted average risk-free interest rate of 6.8% for
1996, 6.4% for 1997 and 5.2% for 1998; an expected volatility of 60% for 1996
and 1997 and 78% for 1998; expected life of five years and no dividend yield for
all three years.
The Company applies Accounting Principles Board Opinion No. 25 and
related Interpretations in accounting for stock option and purchase plans.
Accordingly, no compensation cost has been recognized for the stock option
plans. Had compensation cost been recognized based upon the fair market value at
the grant dates for awards under those plans consistent with the method of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based
compensation", the Company's net loss and earnings per share for the years ended
December 31, 1996, 1997, 1998 and the three month period ended March 31, 1999,
would have been as reflected in the pro forma amounts indicated below:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
1996 1997 1998 MARCH 31, 1999
----------- ---------- ---------- ----------------
<S> <C> <C> <C> <C>
Net income (loss) before
extraordinary item (in thousands)................ $ (14,512) $ 1,319 $ (57,708) $ (11,079)
Loss per common share
before extraordinary item........................ (.21) (.03) (.49) (.10)
Net income (loss)
(in thousands)................................... (31,542) $ 1,319 $ (57,708) $ (11,079)
Loss per common share................................ (.40) (.03) (.49) (.10)
</TABLE>
ESOP/401K. Kelley Oil established the ESOP effective January 1, 1984
for the benefit of substantially all of its employees. No ESOP contributions
were made in 1996. Effective September 1, 1996, the ESOP was amended to include
a 401(k) feature whereby the Company is obligated to make matching contributions
up to 6% of each employee's salary. The plan also provides for additional
discretionary contributions. For the years ended 1996, 1997, 1998 and the
periods ended March 31, 1998 (unaudited) and 1999, the Company made matching
contributions totaling $0.1 million, $0.2 million, $0.3 million, $58,000 and
$67,000, respectively.
18
<PAGE> 78
NOTE 7 - INCOME TAXES
The following table sets forth a reconciliation of the statutory
federal income tax for the years ended December 31, 1996, 1997 and 1998 and for
the three month period ended March 31, 1999:
(IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months
ended
March 31,
1996 1997 1998 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Income (loss) before income taxes ...... $ (28,965) $ 1,951 $ (57,007) $ (10,986)
----------- ----------- ----------- -----------
Income tax expense (benefit)
computed at statutory rates ......... (9,848) 663 (19,382) (3,735)
Increase in valuation allowance ..... 16,322 301 16,272 5,297
Adjustment to net operating loss
carryforward and other ............ (7,209) (1,459) 2,463 (1,778)
Permanent differences:
Nondeductible expenses .............. 735 708 700 216
Other-net ........................... -- (213) (53) --
----------- ----------- ----------- -----------
Tax expense (benefit) ............. $ -- $ -- $ -- $ --
=========== =========== =========== ===========
</TABLE>
No federal income taxes were paid for the years ended December 31,
1996, 1997 and 1998 or for the three months ended March 31, 1998 (unaudited) and
1999.
The Company's deferred tax position reflects the net tax effects of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax reporting.
Significant components of the deferred tax liabilities and assets are as
follows:
(IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months
ended
March 31,
1996 1997 1998 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Deferred tax liabilities:
Tax over book depletion, depreciation and
capitalization methods on oil and gas properties ..... $ -- $ -- $ -- $ --
Deferred tax assets:
Book over tax depletion, depreciation and
capitalization method on oil and gas properties ......... 42,696 32,210 43,730 44,096
Net operating loss carryforwards ........................ 62,179 72,992 77,741 82,672
Charitable contribution carryforwards ................... 78 52 54 54
Alternative minimum tax credit carryforwards ............ 21 21 21 21
Valuation allowance ..................................... (104,974) (105,275) (121,546) (126,843)
----------- ----------- ----------- -----------
Total deferred tax assets ............................... -- -- -- --
----------- ----------- ----------- -----------
Net deferred tax liability .............................. $ -- $ -- $ -- $ --
=========== =========== =========== ===========
</TABLE>
19
<PAGE> 79
Net Operating Loss Carryforwards and Alternative Minimum Tax Credits.
As of December 31, 1998, the Company had cumulative net operating loss
carryforwards ("NOL") for federal income tax purposes of approximately $228
million, which expire in 2000 through 2018, and net operating loss carryforwards
for alternative minimum tax purposes of approximately $218 million, which expire
in 2008 through 2018. Due to previous ownership changes, future utilization of
the net operating loss carry forwards will be limited by Internal Revenue Code
section 382.
NOTE 8 - RELATED PARTY TRANSACTIONS
The 1994 DDP. In February 1994, the 1994 DDP completed a public
offering of 20.9 million units of its limited and general partner interests at
$3.00 per unit. As of March 31, 1999, the Company owned 19.2 million units
(91.9%) in the 1994 DDP, together with its 3.94% general partner interest.
The 1994 DDP's partnership agreement provides that any contributions of
the partners not used or committed to be used for drilling activities during the
two-year period from the commencement of operations through February 29, 1996
(the "Commitment Period") shall be distributed to the partners on a pro rata
basis as a return of capital. In 1997, Kelley Oil reduced the estimate for
Committed Expenditures to $58.0 million based on the amount of committed capital
actually used and committed or allocated to drilling activities by the end of
the Commitment Period. In accordance with the 1994 DDP's partnership agreement,
the 1994 DDP distributed the Outside Share of uncommitted capital to its
unitholders other than Kelley Oil aggregating $0.3 million in March 1996 and
$0.1 million in July 1997.
The 1992 DDP. During November 1992, the 1992 DDP completed a public
offering of 16.0 million units of limited and general partner interests at $3.00
per unit. As of March 31, 1999, Kelley Oil owned 13.4 million units (83.7%) in
the 1992 DDP, together with its 3.94% general partner interest. As of March 31,
1999, the 1992 DDP was indebted to Kelley Oil for loans aggregating $2.3 million
($0.4 million, net of intercompany eliminations). The Company recorded interest
income on this indebtedness of $10,000 in the first three months of 1999, net of
intercompany eliminations.
Reimbursements from Affiliated Programs. The Company is reimbursed for
administrative and overhead expenses incurred in connection with the management
and administration of each of these affiliated programs. Such amounts, net of
intercompany eliminations, aggregated $0.2 million, $0.1 million, $21,000,
$24,000 and $18,000 in 1996, 1997, 1998, and the three months ended March 31,
1998 (unaudited) and 1999, respectively.
Interest on DDP Commitments. During 1996, 1997, 1998, the first three
months of 1998 (unaudited) and 1999, the Company paid or accrued interest at a
market rate in the amounts, net of intercompany elimination, of $91,000,
$11,000, zero, zero and zero, respectively, on deferred subscription commitments
to DDPs.
Advisory Fees. In connection with the Contour Transaction, the Company
entered into an agreement (the "Advisory Agreement") with Bessemer Partners &
Co. ("BPCO"), an affiliate of Bessemer, providing for the engagement of BPCO to
provide the Company with financial advisory services. Under the Advisory
Agreement, BPCO has assisted the Company in arranging a new credit facility and
negotiating the related agreements and is assisting the Company in restructuring
its current capital structure. For its services under the Advisory Agreement,
BPCO received an advisory fee of $2.0 million at the closing of the Contour
Transaction and $500,000 in each of December 1996, 1997 and 1998, and will
receive an additional $500,000 in each December of 1999, 2000 and 2001. In
addition, BPCO is entitled to reimbursement of expenses incurred in connection
with rendering advisory services. The Company also has agreed to indemnify BPCO
and its affiliates against certain liabilities under the Advisory Agreement.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
Significant Customers. Substantially all of the Company's receivables
are due from a limited number of natural gas transmission companies and other
gas purchasers. During 1998 and the three month period ended March 31, 1999,
natural gas sales to three purchasers accounted for 48%, 22% and 18% and
20
<PAGE> 80
50%, 25% and 17%, respectively, of the Company's total sales. To date, this
concentration has not had a material adverse effect on the consolidated
financial condition of the Company.
Litigation. As previously disclosed, following Kelley Oil's
announcement of the initial proposal for the Consolidation in August 1994, four
separate lawsuits were filed against Kelley Oil and its directors relating to
the Consolidation. In November 1994, Kelley Oil entered into a memorandum of
understanding with the plaintiffs in three of the lawsuits, providing for a
proposed settlement based on a revised Consolidation proposal negotiated by a
special committee of Kelley Oil's non-management directors and the settling
plaintiffs. A stipulation and agreement of compromise, settlement and release
reflecting the terms of the proposed settlement was filed in the United States
District Court for the Southern District of Texas on November 23, 1994. At a
hearing held on the same date, the court approved the Consolidation of all four
lawsuits and the certification of a Unitholder class requested by the settling
parties. On March 3, 1995, following a hearing on the fairness of the
settlement, the court entered a final order approving the settlement, dismissing
the consolidated lawsuits with prejudice and reducing the award of attorneys'
fees and disbursements contemplated by the stipulation to $1.5 million, plus
interest from March 3, 1995 through the payment date. On April 29, 1997, the
U.S. Court of Appeals for the Fifth Circuit affirmed the final judgement and
order of the District Court. On August 4, 1997, the Company made a cash payment
of $1.7 million which included $0.2 million of interest.
The Company is involved in various claims and lawsuits incidental to
its business. In the opinion of management, the ultimate liability thereunder,
if any, will not have a material effect on the financial statements of the
Company.
Restructuring Expenses. In 1996, the Company incurred restructuring
expenses of $4.3 million associated primarily with staff reductions, related
severance settlements and reorganization costs. Accrued expenses on the balance
sheet include $0.9 million, $0.2 million and $0.1 million at December 31, 1997
and 1998 and March 31, 1999, respectively, related to the unpaid portion of
these charges.
Leases. The Company leases office space and equipment under operating
leases with options to renew. Rental expenses related to these leases for the
years ended December 31, 1996, 1997 and 1998 and for the three month periods
ended March 31, 1998 (unaudited) and 1999 were $1.3 million, $0.8 million, $0.6
million, $0.1 million and $0.2 million, respectively. For the balance of the
lease terms, minimum rentals are as follows:
(IN THOUSANDS)
<TABLE>
<S> <C>
1999.................................................................... $ 667
2000.................................................................... 636
2001 ................................................................... 341
2002 ................................................................... 39
2003.................................................................... 7
-------
Total................................................................... $ 1,690
=======
</TABLE>
The terms of the Company's office space lease provide that the Company
may terminate its rental obligation upon six months notice and incurring a
maximum obligation of $0.2 million.
NOTE 10 - HEDGING ACTIVITIES
The Company periodically uses forward sales contracts, natural gas
price swap agreements, natural gas basis swap agreements and options to reduce
exposure to downward price fluctuations on its natural gas production. The
Company does not engage in speculative transactions. During 1998, the Company
used price and basis swap agreements. Price swap agreements generally provide
for the Company to receive or make counterparty payments on the differential
between a fixed price and a variable indexed price for natural gas. Basis swap
agreements generally provide for the Company to receive or make counterparty
payments on the differential between a variable indexed price and the price it
receives from the sale of natural gas production, and are used to hedge against
unfavorable price movements in the relationship between such variable indexed
price and the price received for such production. Gains and losses realized by
the Company from hedging activities are included in oil and gas revenues and
average sales prices in the period that the related production is sold. The
Company's hedging activities also
21
<PAGE> 81
cover the oil and gas production attributable to the interest in such production
of the public unitholders in its subsidiary partnerships.
Through natural gas price swap agreements, the Company hedged
approximately 49% and 66% of its natural gas production for 1998 and the three
month period ended March 31, 1999, respectively, at average NYMEX quoted prices
of $2.31 per Mmbtu and $2.27 per Mmbtu, respectively, before transaction and
transportation costs. As of December 31, 1998, 5,400,000 Mmbtus of natural gas
production for 1999 has been hedged by natural gas price swap agreements at an
average NYMEX quoted price of $2.36 per Mmbtu before transaction and
transportation costs. As of March 31, 1999, 5,630,000 Mmbtus of natural gas
production for April through October 1999 has been hedged by natural gas price
swap agreements at an average NYMEX quoted price of $2.03 per Mmbtu before
transaction and transportation costs. As of December 31, 1998, 16,380,000
Mmbtu's of natural gas production for 1999 has been hedged by natural gas basis
swap agreements. As of March 31, 1999, 10,980,000 Mmbtus of natural gas
production for April through September 1999 has been hedged by natural gas basis
swap agreements. Hedging activities increased revenues by approximately $3.5
million in 1998 and $2.5 million in the first quarter of 1999, as compared to
estimated revenues had no hedging activities been conducted. At December 31,
1998, the unrealized gain on the Company's existing hedging instruments for
future production months in 1999 approximated $2.5 million. As of March 31,
1999, the unrealized loss on the Company's existing hedging instruments for the
future production months in 1999 approximated $1.4 million.
The credit risk exposure from counterparty nonperformance on natural
gas forward sales contracts and derivative financial instruments is generally
the amount of unrealized gains under the contracts. The Company has not
experienced counterparty nonperformance on these agreements and does not
anticipate any in future periods.
22
<PAGE> 82
NOTE 11 - GUARANTOR FINANCIAL STATEMENTS
Kelley Oil Corporation, a wholly-owned subsidiary of the Company and
Kelley Operating Company Ltd., an indirect wholly-owned partnership of the
Company are guarantors of the Company's Series B and Series D 10 3/8 % Senior
Subordinated Notes due 2006. The following guarantor consolidating condensed
financial statements present:
1. Consolidating condensed balance sheets as of December 31, 1997 and
1998 and March 31, 1999, consolidating condensed statements of
income (loss) for each of the years ended December 31, 1996, 1997
and 1998 and for the three month periods ended March 31, 1998
(unaudited) and 1999 and consolidating condensed statements of
cash flows for each of the years ended December 31, 1996, 1997 and
1998 and for the three month periods ended March 31, 1998
(unaudited) and 1999.
2. Kelley Oil & Gas Corporation (the "Parent"), combined Guarantor
Subsidiaries and combined Non-Guarantor Subsidiaries, all with
their investments in subsidiaries accounted for using the equity
method.
3. Elimination entries necessary to consolidate the Parent and all of
its subsidiaries.
23
<PAGE> 83
CONSOLIDATING CONDENSED BALANCE SHEET
DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
ASSETS:
Current assets ........................ $ 427,445 $ 212,780 $ 18,926 $ (632,293) $ 26,858
Property and equipment, net ........... -- 276,744 17,698 (829) 293,613
Other non-current assets, net ......... (141,957) 24,418 -- 119,670 2,131
------------- ------------- ------------- ------------- -------------
Total assets ........................ $ 285,488 $ 513,942 $ 36,624 $ (513,452) $ 322,602
============= ============= ============= ============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT:
Current liabilities ................... $ 4,926 $ 657,128 $ 12,279 $ (632,293) $ 42,040
Long-term debt ........................ 286,183 -- -- -- 286,183
Stockholders' deficit ................. (5,621) (143,186) 24,345 118,841 (5,621)
------------- ------------- ------------- ------------- -------------
Total liabilities and
stockholders' deficit ........... $ 285,488 $ 513,942 $ 36,624 $ (513,452) $ 322,602
============= ============= ============= ============= =============
</TABLE>
CONSOLIDATING CONDENSED BALANCE SHEET
DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
ASSETS:
Current assets ........................ $ 424,609 $ 212,946 $ 10,859 $ (620,163) $ 28,251
Property and equipment, net ........... -- 243,927 14,008 (1,480) 256,455
Other non-current assets, net ......... (165,642) 18,611 -- 148,522 1,491
------------- ------------- ------------- ------------- -------------
Total assets ........................ $ 258,967 $ 475,484 $ 24,867 $ (473,121) $ 286,197
============= ============= ============= ============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT:
Current liabilities ................... $ 38,406 $ 641,113 $ 6,281 $ (620,164) $ 65,636
Long-term debt ........................ 287,500 -- -- -- 287,500
Stockholders' deficit ................. (66,939) (165,629) 18,586 147,043 (66,939)
------------- ------------- ------------- ------------- -------------
Total liabilities and
stockholders' deficit ........... $ 258,967 $ 475,484 $ 24,867 $ (473,121) $ 286,197
============= ============= ============= ============= =============
</TABLE>
24
<PAGE> 84
CONSOLIDATING CONDENSED BALANCE SHEET
MARCH 31, 1999
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
ASSETS:
Current assets ........................ $ 422,192 $ 206,289 $ 8,166 $ (610,670) $ 25,977
Property and equipment, net ........... -- 239,052 13,589 (1,677) 250,964
Other non-current assets, net ......... (168,126) 18,476 -- 150,948 1,298
------------- ------------- ------------- ------------- -------------
Total assets ........................ $ 254,066 $ 463,817 $ 21,755 $ (461,399) $ 278,239
============= ============= ============= ============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT:
Current liabilities ................... $ 44,032 $ 631,533 $ 3,310 $ (610,670) $ 68,205
Long-term debt ........................ 287,959 -- -- -- 287,959
Stockholders' deficit ................. (77,925) (167,716) 18,445 149,271 (77,925)
------------- ------------- ------------- ------------- -------------
Total liabilities and
stockholders' deficit ............... $ 254,066 $ 463,817 $ 21,755 $ (461,399) $ 278,239
============= ============= ============= ============= =============
</TABLE>
25
<PAGE> 85
CONSOLIDATING CONDENSED STATEMENT OF INCOME (LOSS)
FOR THE YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenues ................................. $ -- $ 39,248 $ 24,784 $ (1,749) $ 62,283
Costs and expenses ....................... (22,397) (39,293) (13,150) 623 (74,217)
Equity in earnings of subsidiaries ....... 10,463 11,634 -- (22,097) --
Extraordinary item ....................... (17,030) -- -- -- (17,030)
------------- ------------- ------------- ------------- -------------
Net income (loss) ........................ $ (28,964) $ 11,589 $ 11,634 $ (23,223) $ (28,964)
============= ============= ============= ============= =============
</TABLE>
CONSOLIDATING CONDENSED STATEMENT OF INCOME (LOSS)
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenues ................................. $ 8 $ 57,064 $ 19,508 $ (442) $ 76,138
Costs and expenses ....................... (27,196) (36,975) (10,329) 313 (74,187)
Equity in earnings of subsidiaries ....... 29,139 9,179 -- (38,318) --
------------- ------------- ------------- ------------- -------------
Net income (loss) ........................ $ 1,951 $ 29,268 $ 9,179 $ (38,447) $ 1,951
============= ============= ============= ============= =============
</TABLE>
CONSOLIDATING CONDENSED STATEMENT OF INCOME (LOSS)
FOR THE YEAR ENDED DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenues ................................. $ (18) $ 69,958 $ 9,715 $ -- $ 79,655
Costs and expenses ....................... (33,893) (94,457) (7,742) (570) (136,662)
Equity in earnings (loss)
of subsidiaries ........................ (23,096) 1,973 -- 21,123 --
------------- ------------- ------------- ------------- -------------
Net income (loss) ........................ $ (57,007) $ (22,526) $ 1,973 $ 20,553 $ (57,007)
============= ============= ============= ============= =============
</TABLE>
26
<PAGE> 86
CONSOLIDATING CONDENSED STATEMENT OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1998
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenues ................................. $ (18) $ 19,962 $ 3,194 $ (67) $ 23,071
Expenses ................................. (8,260) (17,940) (1,940) 246 (27,894)
Equity in earnings of subsidiaries ....... 3,455 1,254 -- (4,709) --
------------- ------------- ------------- ------------- -------------
Net income (loss) ........................ $ (4,823) $ 3,276 $ 1,254 $ (4,530) $ (4,823)
============= ============= ============= ============= =============
</TABLE>
CONSOLIDATING CONDENSED STATEMENT OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenues ................................. $ -- $ 13,732 $ 1,990 $ (54) $ 15,668
Expenses ................................. (8,701) (16,684) (1,125) (144) (26,654)
Equity in earnings (loss) of subsidiaries (2,285) 865 -- 1,420 --
------------- ------------- ------------- ------------- -------------
Net income (loss) ........................ $ (10,986) $ (2,087) $ 865 $ 1,222 $ (10,986)
============= ============= ============= ============= =============
</TABLE>
27
<PAGE> 87
CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) ..................... $ (28,964) $ 11,589 $ 11,634 $ (23,223) $ (28,964)
Non-cash income (loss)
adjustments ......................... 10,133 12,280 6,542 23,223 52,178
Changes in operating assets
and liabilities ..................... (31,460) 26,767 (9,259) -- (13,952)
------------- ------------- ------------- ------------- -------------
Net cash provided by (used in)
operating activities ................ (50,291) 50,636 8,917 -- 9,262
------------- ------------- ------------- ------------- -------------
INVESTING ACTIVITIES:
Capital expenditures .................. -- (35,203) (12,398) -- (47,601)
Acquisition of oil and gas
properties .......................... -- (11,594) -- -- (11,594)
Proceeds from sale of properties ...... -- 3,811 1,992 -- 5,803
------------- ------------- ------------- ------------- -------------
Net cash used in investing
activities ............................ -- (42,986) (10,406) -- (53,392)
------------- ------------- ------------- ------------- -------------
FINANCING ACTIVITIES:
Net payments on long term
borrowings .......................... -- (8,500) -- -- (8,500)
Proceeds from sale of notes,
net ................................. 120,938 -- -- -- 120,938
Debenture conversion costs ............ (1,100) -- -- -- (1,100)
Proceeds from sale of
common stock, net ................... 43,998 -- -- -- 43,998
Retirement of senior notes ............ (113,488) -- -- -- (113,488)
------------- ------------- ------------- ------------- -------------
Net cash provided by (used in)
financing activities ................ 50,348 (8,500) -- -- 41,848
------------- ------------- ------------- ------------- -------------
Increase (decrease) in cash and
cash equivalents .................... 57 (850) (1,489) -- (2,282)
Cash and cash equivalents,
beginning of period ................. 1 3,654 2,697 -- 6,352
------------- ------------- ------------- ------------- -------------
Cash and cash equivalents, end of
period ................................ $ 58 $ 2,804 $ 1,208 $ -- $ 4,070
============= ============= ============= ============= =============
</TABLE>
28
<PAGE> 88
CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income ................................ $ 1,951 $ 29,268 $ 9,179 $ (38,447) $ 1,951
Non-cash income (loss) adjustments ........ (24,842) 16,880 5,098 38,447 35,583
Changes in operating assets
and liabilities ......................... (97,813) 105,584 (5,701) -- 2,070
------------- ------------- ------------- ------------- -------------
Net cash provided by (used in)
operating activities ...................... (120,704) 151,732 8,576 -- 39,604
------------- ------------- ------------- ------------- -------------
INVESTING ACTIVITIES:
Capital expenditures ...................... -- (51,592) (1,548) -- (53,140)
Acquisition of oil and gas properties ..... -- (111,135) -- -- (111,135)
Capital contributed to partnerships ....... -- (5,819) -- 5,819 --
Distributions from partnerships ........... -- 14,014 -- (14,014) --
------------- ------------- ------------- ------------- -------------
Net cash used in investing activities ........ -- (154,532) (1,548) (8,195) (164,275)
------------- ------------- ------------- ------------- -------------
FINANCING ACTIVITIES:
Net proceeds on long term borrowings ...... 97,800 -- -- -- 97,800
Proceeds from sale of common stock, net ... 27,545 -- -- -- 27,545
Distributions to partners ................. -- -- (14,014) 14,014 --
Capital contributed by partners ........... -- -- 5,819 (5,819) --
Dividends on preferred stock .............. (4,582) -- -- -- (4,582)
------------- ------------- ------------- ------------- -------------
Net cash provided by (used in) financing
activities ................................ 120,763 -- (8,195) 8,195 120,763
------------- ------------- ------------- ------------- -------------
Increase (decrease) in cash
and cash equivalents ...................... 59 (2,800) (1,167) -- (3,908)
Cash and cash equivalents,
beginning of period ....................... 58 2,804 1,208 -- 4,070
------------- ------------- ------------- ------------- -------------
Cash and cash equivalents,
end of period ............................. $ 117 $ 4 $ 41 $ -- $ 162
============= ============= ============= ============= =============
</TABLE>
29
<PAGE> 89
CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) ......................... $ (57,007) $ (22,526) $ 1,973 $ 20,553 $ (57,007)
Non-cash income (loss) adjustments ........ 28,109 70,144 3,687 (20,553) 81,387
Changes in operating assets
and liabilities ......................... 3,869 (7,976) 2,029 -- (2,078)
------------- ------------- ------------- ------------- -------------
Net cash provided by (used in)
operating activities ...................... (25,029) 39,642 7,689 -- 22,302
------------- ------------- ------------- ------------- -------------
INVESTING ACTIVITIES:
Capital expenditures ...................... -- (56,579) -- -- (56,579)
Proceeds from sale of property ............ -- 17,363 -- -- 17,363
Distributions from partnerships ........... -- 7,730 -- (7,730) --
------------- ------------- ------------- ------------- -------------
Net cash used in investing activities ........ -- (31,486) -- (7,730) (39,216)
------------- ------------- ------------- ------------- -------------
FINANCING ACTIVITIES:
Payments on long term borrowings .......... (118,900) -- -- -- (118,900)
Net proceeds on long term borrowings ...... 119,100 -- -- -- 119,100
Redemption on subordinated notes .......... (228) -- -- -- (228)
Proceeds from sale of common stock ........ 273 -- -- -- 273
Proceeds from conversion of preferred ..... (2) -- -- -- (2)
Proceeds from sale of common stock, net ... 29,526 -- -- -- 29,526
Distributions to partners ................. -- -- (7,730) 7,730 --
Dividends on preferred stock .............. (4,582) -- -- -- (4,582)
------------- ------------- ------------- ------------- -------------
Net cash provided by (used in) financing
activities ................................ 25,187 -- (7,730) 7,730 25,187
------------- ------------- ------------- ------------- -------------
Increase (decrease) in cash
and cash equivalents ...................... 158 8,156 (41) -- 8,273
Cash and cash equivalents,
beginning of period ....................... 117 4 41 -- 162
------------- ------------- ------------- ------------- -------------
Cash and cash equivalents,
end of period ............................. $ 275 $ 8,160 $ -- $ -- $ 8,435
============= ============= ============= ============= =============
</TABLE>
30
<PAGE> 90
CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1998
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income ................................ $ (4,823) $ 3,276 $ 1,254 $ (4,530) $ (4,823)
Non-cash income adjustments ............... (2,061) 11,041 879 4,530 14,389
Changes in operating assets
and liabilities ......................... 3,721 (3,848) 247 -- 120
------------- ------------- ------------- ------------- -------------
Net cash provided by (used in)
operating activities ...................... (3,163) 10,469 2,380 -- 9,686
------------- ------------- ------------- ------------- -------------
INVESTING ACTIVITIES:
Capital expenditures ...................... -- (12,675) (206) -- (12,881)
Capital contributed to partnerships ....... -- -- -- -- --
Distributions from partnerships ........... -- 2,202 -- (2,202) --
------------- ------------- ------------- ------------- -------------
Net cash used in investing activities ........ -- (10,473) (206) (2,202) (12,881)
------------- ------------- ------------- ------------- -------------
FINANCING ACTIVITIES:
Net proceeds on long term borrowings ...... 34,100 -- -- -- 34,100
Net payments on long term borrowings ...... (30,800) -- -- -- (30,800)
Redemption of notes ....................... (228) -- -- -- (228)
Proceeds from sale of common stock, net ... 1 -- -- -- 1
Distributions to partners ................. -- -- (2,202) 2,202 --
Capital contributed by partners ........... -- -- -- -- --
Dividends on preferred stock .............. -- -- -- -- --
------------- ------------- ------------- ------------- -------------
Net cash provided by (used in) financing
activities ................................ 3,073 -- (2,202) 2,202 3,073
------------- ------------- ------------- ------------- -------------
Decrease in cash and cash equivalents ........ (90) (4) (28) -- (122)
Cash and cash equivalents,
beginning of period ....................... 117 4 41 -- 162
------------- ------------- ------------- ------------- -------------
Cash and cash equivalents,
end of period ............................. $ 27 $ -- $ 13 $ -- $ 40
============= ============= ============= ============= =============
</TABLE>
31
<PAGE> 91
CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) ......................... $ (10,986) $ (2,087) $ 865 $ 1,222 $ (10,986)
Non-cash income (loss) adjustments ........ 3,517 9,835 433 (1,222) 12,563
Changes in operating assets
and liabilities ......................... 7,188 (4,370) (297) -- 2,521
------------- ------------- ------------- ------------- -------------
Net cash provided by (used in)
operating activities ...................... (281) 3,378 1,001 -- 4,098
------------- ------------- ------------- ------------- -------------
INVESTING ACTIVITIES:
Capital expenditures ...................... -- (5,823) -- -- (5,823)
Proceeds from sale of property ............ -- -- -- -- --
Distributions from partnerships ........... -- 1,001 -- (1,001) --
------------- ------------- ------------- ------------- -------------
Net cash used in investing activities ........ -- (4,822) -- (1,001) (5,823)
------------- ------------- ------------- ------------- -------------
FINANCING ACTIVITIES:
Net payments on long term borrowings ...... -- -- -- -- --
Proceeds from sale of notes, net .......... -- -- -- -- --
Redemption of subordinated notes .......... -- -- -- -- --
Proceeds from sale of common stock, net ... -- -- -- -- --
Proceeds from conversion of
preferred stock ......................... -- -- -- -- --
Distributions to partners ................. -- -- (1,001) 1,001 --
Dividends on preferred stock .............. -- -- -- -- --
------------- ------------- ------------- ------------- -------------
Net cash provided by (used in) financing
activities ................................ -- -- (1,001) 1,001
------------- ------------- ------------- ------------- -------------
Increase (Decrease) in cash and cash
equivalents ............................... (281) (1,444) -- -- (1,725)
Cash and cash equivalents,
beginning of period ....................... 275 8,160 -- -- 8,435
------------- ------------- ------------- ------------- -------------
Cash and cash equivalents,
end of period ............................. $ (6) $ 6,716 $ -- $ -- $ 6,710
============= ============= ============= ============= =============
</TABLE>
32
<PAGE> 92
NOTE 12 - SUPPLEMENTARY FINANCIAL AND OPERATING INFORMATION ON OIL AND GAS
EXPLORATION, DEVELOPMENT AND PRODUCTION ACTIVITIES (UNAUDITED)
This footnote provides unaudited information required by Statement of
Financial Accounting Standards No. 69, "Disclosures about Oil and Gas Producing
Activities".
Capitalized Costs. Capitalized costs and accumulated depreciation,
depletion and amortization relating to the Company's oil and gas producing
activities, all of which are conducted within the continental United States, are
summarized below.
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Unevaluated properties ..................................... $ 12,521 $ 49,854 $ 38,293
Properties subject to amortization ......................... 338,794 463,263 496,686
---------- ---------- ----------
Capitalized costs .......................................... 351,315 513,117 534,979
Accumulated depreciation, depletion and amortization ....... (194,367) (221,729) (280,640)
---------- ---------- ----------
Net capitalized costs ...................................... $ 156,948 $ 291,388 $ 254,339
========== ========== ==========
</TABLE>
Costs Incurred. Costs incurred in oil and gas property acquisition,
exploration and development activities are summarized below.
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Property acquisition costs:
Proved .................................................. $ 11,594 $ 73,190 $ 2,338
Unproved (1) ............................................ 2,160 40,997 1,405
Exploration costs .......................................... 5,438 9,525 25,414
Development costs .......................................... 41,790 40,713 27,875
---------- ---------- ----------
Total costs incurred .................................... $ 60,982 $ 164,425 $ 57,032
========== ========== ==========
</TABLE>
(1) Includes $40 million in unproved assets acquired from SPR on December
1, 1997.
33
<PAGE> 93
Reserves. The following table summarizes the Company's net ownership
interests in estimated quantities of proved oil and gas reserves and changes in
net proved reserves, all of which are located in the continental United States,
for the years ended December 31, 1996, 1997 and 1998. Reserves estimates
contained below were prepared by H.J. Gruy & Associates, Inc. ("Gruy"),
independent petroleum engineers.
<TABLE>
<CAPTION>
CRUDE OIL, CONDENSATE
AND NATURAL GAS LIQUIDS NATURAL GAS
(MBBLS) (MMCF)
-------------------------------------- --------------------------------------
1996 1997 1998 1996 1997 1998
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Proved developed and undeveloped reserves:
Beginning of year ................ 1,387 1,466 2,953 196,273 297,634 354,867
Revisions of previous estimates .. (89) 106 (79) (30,519) 21,831 (31,674)
Purchases of reserves in place ... 57 1,351 -- 30,844 51,712 --
Extensions and discoveries ....... 477 256 3,082 128,692 13,892 9,512
Sale of reserves in place ........ (134) -- (287) (4,190) -- (13,589)
Production ....................... (232) (226) (375) (23,466) (30,202) (35,557)
---------- ---------- ---------- ---------- ---------- ----------
End of year ...................... 1,466 2,953 5,294 297,634 354,867 283,559
========== ========== ========== ========== ========== ==========
Proved developed reserves
at end of year ................... 977 2,432 1,981 173,465 257,800 188,824
========== ========== ========== ========== ========== ==========
</TABLE>
Standardized Measure. The following table of the Standardized Measure
of Discounted Future Net Cash Flows concerning the standardized measure of
future cash flows from proved oil and gas reserves are presented in accordance
with Statement of Financial Accounting Standards No. 69. As prescribed by this
statement, the amounts shown are based on prices and costs at the end of each
period, and assume continuation of existing economic conditions. Future income
taxes are based on year-end statutory rates, adjusted for operating loss
carryforwards and tax credits. A discount factor of 10% was used to reflect the
timing of future net cash flow. Extensive judgments are involved in estimating
the timing of production and the costs that will be incurred throughout the
remaining lives of the fields. Accordingly, the estimates of future net revenues
from proved reserves and the present value thereof may not be materially correct
when judged against actual subsequent results. Further, since prices and costs
do not remain static, and no price or cost changes have been considered, and
future production and development costs are estimates to be incurred in
developing and producing the estimated proved oil and gas reserves, the results
are not necessarily indicative of the fair market value of estimated proved
reserves, and the results may not be comparable to estimates disclosed by other
oil and gas producers.
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Future cash inflows ............................................. $ 1,099,089 $ 930,357 $ 643,473
Future production costs ......................................... (113,178) (196,048) (159,378)
Future development costs ........................................ (81,932) (106,123) (93,321)
Future income tax expenses ...................................... (162,887) (37,050) (1,627)
----------- ----------- -----------
Future net cash flows ....................................... 741,092 591,136 389,147
10% annual discount for estimating timing of cash flows ......... (307,321) (227,249) (155,677)
----------- ----------- -----------
Standardized measure of discounted future net cash flows .... $ 433,771 $ 363,887 $ 233,470
=========== =========== ===========
</TABLE>
The standardized measure of discounted future net cash flows as of
December 31, 1996, 1997 and 1998 was calculated using prices in effect as of
those dates, which averaged $25.18, $16.93 and $10.81, respectively, per barrel
of oil and $3.66, $2.49 and $2.07, respectively, per Mcf of natural gas.
34
<PAGE> 94
Change in Standardized Measure. Changes in standardized measure of
future net cash flows relating to proved oil and gas reserves are summarized
below.
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Changes due to current year operations:
Sales of oil and gas, net of production costs ................ $ (48,307) $ (62,080) $ (57,940)
Sale of reserves in place .................................... (6,836) -- (15,424)
Extensions and discoveries ................................... 192,174 21,945 20,097
Purchases of reserves in place ............................... 11,594 91,034 --
Future development costs incurred ............................ 24,500 21,806 9,218
Changes due to revisions in standardized variables:
Prices and production costs .................................. 159,292 (243,851) (94,569)
Revisions of previous quantity estimates ..................... (50,594) 25,345 (29,853)
Estimated future development costs ........................... 3,254 (17,413) (29,240)
Income taxes ................................................. (82,831) 69,489 (14,110)
Accretion of discount ........................................ 17,575 51,818 24,903
Production rates (timing) and other .......................... 42,898 (27,977) 56,501
------------ ------------ ------------
Net increase (decrease) .................................... 262,719 (69,884) (130,417)
Beginning of year ............................................ 171,052 433,771 363,887
------------ ------------ ------------
End of year ................................................ $ 433,771 $ 363,887 $ 233,470
============ ============ ============
</TABLE>
Sales of oil and gas, net of production costs, are based on historical
pre-tax results. Extensions and discoveries, purchases of reserves in place and
the changes due to revisions in standardized variables are reported on a pre-tax
discounted basis, while the accretion of discount is presented after tax.
Extensions and discoveries include proved undeveloped reserves attributable to
Kelley Oil's interests in drill sites assigned to DDPs.
NOTE 13 - QUARTERLY RESULTS (UNAUDITED)
<TABLE>
<CAPTION>
1997 1998
---------------------------------------- -----------------------------------------
1ST 2ND 3RD 4TH (1) 1ST 2ND 3RD 4TH(2)
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
--------- -------- ------- ------- --------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues.............................. $ 18,947 16,178 17,105 23,634 $ 23,047 21,162 18,630 16,311
Operating profit...................... 7,368 4,892 6,121 8,367 3,245 (1,251) (85) (26,087)
Net income (loss)..................... 1,703 (1,248) 59 1,437 (4,823) (9,433) (8,411) (34,340)
Basic and diluted income
(loss) per common share........... $ 0.01 (0.02) (0.01) -- $ (0.05) (0.08) (0.08) (0.28)
</TABLE>
(1) Reflects the acquisition of SPR on December 1, 1997.
(2) Reflects non-cash impairment charges against the carrying value of proved
and unproved oil and natural gas properties under SFAS 121 (see Note 2).
35
<PAGE> 95
SECTION B. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following information should be read in conjunction with the
information contained in the Financial Statements of the Company included
elsewhere in this Report.
GENERAL
Introduction. Kelley Oil & Gas Corporation and its consolidated
subsidiaries (the "Company") are engaged in oil and natural gas exploration,
development, production and acquisition. The Company's 1998 operational
activities were focused primarily on exploiting its north Louisiana properties
and exploration activities on its south Louisiana acreage. In 1998, the Company
drilled or participated in drilling 47 gross (21.2 net) development wells and 15
gross (5.8 net) exploratory wells of which 46 gross (20.7 net) and 8 gross (2.5
net), respectively, were completed as producing wells. The Company's most
significant event was the drilling of the Harry S. Bourg #1 discovery well in
Terrebonne Parish, Louisiana which added 21.4 bcfe of proved reserves to the
Company's reserve base at year-end. The Company has a 50% working interest in
this well. In the first three months of 1999, the Company participated in
drilling 2 gross (0.5 net) wells, both of which were completed in the first
quarter of 1999.
General Conditions of the Oil and Natural Gas Industry and Commodity
Prices. Through the first quarter of 1999, the prices of oil and natural gas
during recent months have fallen sharply and continue to reflect the volatility
of commodity prices and the industry generally. The Company cannot predict
future prices of oil and natural gas. Although both oil and natural gas prices
have recovered, should prices decline, the Company's results of operations and
liquidity could be adversely impacted. The success of the Company is in part
dependent on factors outside the control of the Company, but which directly
affect the financial condition of the Company, including capital market
conditions and highly volatile oil and natural gas prices. Due to recent
industry conditions, the Company, as others within the industry, has been
required to reconsider its capital expenditures budgets, which could adversely
impact production levels, and to evaluate various financing and strategic
alternatives.
Hedging Activities. The Company periodically uses forward sales
contracts, natural gas price swap agreements, natural gas basis swap agreements
and options to reduce exposure to downward price fluctuations on its natural gas
production. The Company does not engage in speculative transactions. During
1998, the Company used price and basis swap agreements. Price swap agreements
generally provide for the Company to receive or make counterparty payments on
the differential between a fixed price and a variable indexed price for natural
gas. Basis swap agreements generally provide for the Company to receive or make
counterparty payments on the differential between a variable indexed price and
the price it receives from the sale of natural gas production, and are used to
hedge against unfavorable price movements in the relationship between such
variable indexed price and the price received for such production. Gains and
losses realized by the Company from hedging activities are included in oil and
gas revenues and average sales prices in the period that the related production
is sold. The Company's hedging activities also cover the oil and gas production
attributable to the interest in such production of the public unitholders in its
subsidiary partnerships.
Through natural gas price swap agreements, the Company hedged
approximately 49% and 66% of its natural gas production for 1998 and the three
month period ended March 31, 1999, respectively, at average NYMEX quoted prices
of $2.31 per Mmbtu and $2.27 per Mmbtu, respectively, before transaction and
transportation costs. As of December 31, 1998, 5,400,000 Mmbtus of natural gas
production for 1999 has been hedged by natural gas price swap agreements at an
average NYMEX quoted price of $2.36 per Mmbtu before transaction and
transportation costs. As of March 31, 1999, 5,630,000 Mmbtus of natural gas
production for April through October 1999 has been hedged by natural gas price
swap agreements at an average NYMEX quoted price of $2.03 per Mmbtu before
transaction and transportation costs. As of December 31, 1998, 16,380,000
Mmbtu's of natural gas production for 1999 has been hedged by natural gas basis
swap agreements. As of March 31, 1999, 10,980,000 Mmbtus of natural gas
production for April through September 1999 has been hedged by natural gas basis
swap agreements. Hedging activities increased revenues by approximately $3.5
million in 1998 and $2.5 million in the first quarter of 1999, as compared to
estimated revenues had no hedging activities been conducted. At December 31,
1998, the unrealized gain on the Company's existing hedging instruments for
future production
36
<PAGE> 96
months in 1999 approximated $2.5 million. As of March 31, 1999, the unrealized
loss on the Company's existing hedging instruments for the future production
months in 1999 approximated $1.4 million.
The credit risk exposure from counterparty nonperformance on natural
gas forward sales contracts and derivative financial instruments is generally
the amount of unrealized gains under the contracts. The Company has not
experienced counterparty nonperformance on these agreements and does not
anticipate any in future periods.
RESULTS OF OPERATIONS
The following table sets forth certain operating data regarding
net production, average sales prices, production expenses and revenues
associated with the Company's oil and natural gas operations for the periods
indicated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------------
1998 1999
------------ ------------
<S> <C> <C>
NET PRODUCTION DATA:
Oil and other liquid hydrocarbons (Mbbls) ........................... 102 82.8
Natural gas (Mmcf) .................................................. 10,165 7,247
Natural gas equivalent (Mmcfe) ...................................... 10,777 7,744
AVERAGE SALES PRICE PER UNIT:
Oil and other liquid hydrocarbons (per Bbl) ......................... $ 14.26 $ 11.63
Natural gas (per Mcf) ............................................... 2.12 1.97
Natural gas equivalent (per Mcfe) ................................... 2.13 1.97
COST PER MCFE:
Lifting costs ....................................................... $ .34 $ .59
Severance and ad valorem taxes ...................................... .12 .10
General and administrative expenses ................................. .18 .18
Depreciation, depletion and amortization (oil and gas activities) ... 1.00 1.20
Interest expense, excluding accretion and amortization .............. .62 .96
</TABLE>
The Company's oil and gas revenues of $15.5 million for the first
quarter of 1999 decreased 33% compared to $23.0 million in the same period of
1998 as a result of a decrease in natural gas production (29%), decreased oil
production (19%), lower natural gas prices (7%) and lower oil prices (18%).
Interest and other income increased from $0.02 million in the first
quarter of 1998 to $0.2 million in the first quarter of 1999 due to higher
average cash balances in the current period.
Production expenses for the first quarter of 1999 increased 8% to $5.3
million from $4.9 million in the same period last year, primarily due to higher
workover expenses on Gulf of Mexico properties partially offset by lower current
period severance and ad valorem taxes. Lifting costs (production expenses less
severance and ad valorem taxes) per Mmcfe for the first quarter of 1999
increased 74% compared to the first quarter of 1998, primarily due to the higher
workover expenses and a decrease in production volumes.
Exploration expenses totaled $1.4 million in the first quarter of 1999
and $2.1 million in the corresponding period of 1998, a decrease of 33%, due to
lower dry hole and seismic expenses of $0.7 million and $0.3 million,
respectively, partially offset by higher lease rental expenses.
General and administrative ("G&A") expenses of $1.4 million in the
first quarter of 1999 decreased 26% compared to $1.9 million in the
corresponding period last year. On a unit basis, G&A expenses of $0.18 per Mcfe
were level with the corresponding period in 1998 reflecting the lower G&A
expenses offset by a decline in production volumes.
37
<PAGE> 97
Interest and other debt expenses of $8.7 million in the first quarter
of 1999 increased 7% from $8.1 million in the same period of 1998. The increase
in interest expense resulted primarily from higher average debt levels during
the current period. In addition to its 1999 interest expense of $7.4 million,
the Company recorded non-cash charges in the first quarter of 1999 of $0.5
million for amortization of debt issuance costs, $0.3 million for accretion of
note discount and $0.5 million for accretion of debt valuation discount.
Depreciation, depletion and amortization ("DD&A") expense decreased 8%
from $10.9 million in the first quarter of 1998 to $10.0 million in the current
period, primarily as a result of lower first quarter 1999 production partially
offset by an increase in the units-of-production DD&A rate for oil and gas
activities from $1.00 per Mcfe in the first quarter 1998 to $1.20 per Mcfe in
the current period. This increase in rate was primarily a result of negative
reserve revisions at year end 1998.
The Company recognized a net loss of $11 million in the first quarter
of 1999 and a net loss of $4.8 million in the same period last year. The reasons
for the decline in earnings are described in the foregoing discussion.
The results of operations for the quarter ended March 31, 1999 are not
necessarily indicative of results to be expected for the full year.
Years Ended December 31, 1998 and 1997. The Company's oil and gas
revenues of $79.2 million for 1998 increased 4% compared to $75.9 million in
1997 primarily as a result of an increase in gas production 18%, partially
offset by lower oil prices (32%) and gas prices (8%). The increase in gas
production is primarily due to the Company's SPR acquisition and drilling
activities in north Louisiana.
Interest and other income increased from $0.3 million in 1997 to $0.5
million in 1998 primarily due to business interruption insurance proceeds
related to hurricane disruptions on offshore properties.
Production expenses for 1998 increased 81% to $19.9 million from $11.0
million in the prior year, resulting primarily from the SPR properties acquired
during the fourth quarter of 1997 and higher current period workover expenses.
Higher-cost production from the Gulf of Mexico properties acquired in the SPR
acquisition contributed to a 78% increase in lifting costs (production expenses
less ad valorem and severance taxes) per Mcfe to $0.41 in 1998 as compared to
$0.23 in 1997.
Exploration expenses increased 122% from $5.4 million in 1997 to $12.0
million in 1998 due to increased dry hole, seismic and unproved property
abandonment expenses and higher overhead allocated to exploration activities.
General and administrative expenses of $7.1 million in 1998 increased
3% compared to $6.9 million last year. On a unit of production basis, general
and administrative expenses were $0.19 per Mcfe in 1998 compared to $0.22 per
Mcfe in 1997.
Interest and other debt expenses of $33.3 million in 1998 increased 33%
from $25.1 million in 1997. The increase in interest expense resulted primarily
from higher average debt levels during the current period due to increased
borrowings under the Credit Facility and issuance of the Series C Notes. In
addition to its 1998 interest expense of $28.1 million, the Company recorded
non-cash charges in 1998 of $2.2 million for amortization of debt issuance
costs, $1.0 million for accretion of note discount and $2.0 million for
accretion of debt valuation discount.
Depreciation, depletion and amortization ("DD&A") expense increased 49%
from $25.9 million in 1997 to $38.6 million in 1998, as a result of higher 1998
production levels and an increase in the units-of-production DD&A rate for oil
and gas activities from $0.80 per Mcfe in 1997 to $1.01 in 1998.
In 1998, under Statement of Financial Accounting Standards No. 121
("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of", the Company recognized noncash impairment
charges of $25.7 million against the carrying values of its proved and unproved
oil and gas
38
<PAGE> 98
properties, aggregating $21.6 million and $4.1 million, respectively, for the
year ended December 31, 1998 (see "Property Impairment under SFAS No. 121" in
the "Notes to Consolidated Financial Statements").
The Company recognized a net loss of $(57.0) million in 1998 and net
income of $2.0 million in the prior year. The reasons for the earnings changes
are described in the foregoing discussion.
Years Ended December 31, 1997 and 1996. The Company's oil and gas
revenues of $75.9 million for 1997 increased 25% compared to $60.9 million in
1996 primarily as a result of an increase in gas production (29%), partially
offset by lower oil prices (13%) and gas prices (1%). The increase in gas
production is primarily due to the Company's drilling activities in north
Louisiana and the addition of one month of production from the SPR properties
partially offset by the sale of one-half of its interest in 23 wells and related
facilities in the Houma Embayment in Terrebonne Parish, Louisiana in the fourth
quarter of 1996.
Interest and other income decreased 79% from $1.4 million in 1996 to
$0.3 million in 1997 primarily due to higher 1996 interest income resulting from
invested funds received from the sale of common stock in February 1996 and gains
on the sale of assets recognized in 1996.
Production expenses for 1997 increased 3% to $11.0 million from $10.7
million in the prior year, primarily reflecting higher overall production
levels. On a unit basis, lifting costs (production expenses less ad valorem and
severance taxes) decreased to $0.23 per Mcfe in 1997 compared to $0.31 per Mcfe
in 1996, primarily reflecting lower average costs on north Louisiana production,
which is increasing in proportion to other higher cost production.
Exploration expenses remained constant from 1996 to 1997 at $5.4
million. Increased dry hole expenses were offset by a reduction in lease rental
expense reflecting the joint exploration agreement effective December 1996 in
south Louisiana with Williams.
General and administrative expenses of $6.9 million in 1997 decreased
23% compared to $9.0 million in 1996, reflecting efficiencies obtained in the
realignment of the workforce. This decrease is somewhat offset by a reduction in
1997 in the level of general and administrative expenses either being
capitalized or allocated to exploration expense. On a unit basis, general and
administrative expenses were $0.22 per Mcfe in 1997 compared to $0.36 per Mcfe
in 1996.
Interest and other debt expenses of $25.1 million in 1997 increased 3%
from $24.4 million in 1996. The increase in interest expense resulted primarily
from higher average debt levels during the current period and the payment of
interest associated with the settlement of a lawsuit. These were partially
offset by lower interest rates under the 10 3/8% Senior Subordinated Notes than
under the 13 1/2% Senior Notes retired in October 1996, and lower debt
amortization expenses as a result of the refinancing of the 13 1/2% Senior Notes
and the bank credit facility. See "Liquidity and Capital Resources." In addition
to its 1997 interest expense of $20.9 million, the Company recorded non-cash
charges in 1997 of $1.3 million for amortization of debt issuance costs, $0.9
million for accretion of note discount and $2.0 million for accretion of debt
valuation discount.
Restructuring expense in 1996 was $4.3 million. There was no
restructuring expense in 1997.
Depreciation, depletion and amortization ("DD&A") expense increased 27%
from $20.4 million in 1996 to $25.9 million in 1997, primarily as a result of
higher 1997 production levels. The units-of-production DD&A rate for oil and gas
activities was $0.80 per Mcfe in both 1996 and 1997.
The Company recognized net income of $2.0 million in 1997 and a net
loss before extraordinary item of $(11.9) million in the prior year. The reasons
for the earnings improvement are described in the foregoing discussion.
39
<PAGE> 99
LIQUIDITY AND CAPITAL RESOURCES
During 1998 and through the first quarter of 1999, the oil and gas
industry experienced a worldwide excess of supply over demand for oil and
natural gas resulting in sharply reduced prices. As a result, many companies in
the oil and gas industry, including Kelley Oil & Gas Corporation ("the
Company"), experienced reduced profitability and cash flows which, in turn,
created significant liquidity problems. To address these liquidity issues, the
Company has taken the measures discussed in the following paragraphs.
In April 1999, the Company entered into an Exploration and Development
Agreement with Phillips Petroleum Company ("Phillips") relating to certain of
the Company's interests in the Bryceland, West Bryceland and Sailes fields in
north Louisiana. Pursuant to the agreement, the Company (1) received an $83
million cash payment (subject to certain post-closing adjustments), (2) retained
a 42 Bcf, 8-year volumetric overriding royalty interest and a 1% override on the
excess of production above such royalty interest and (3) retained 25% of its
working interest in the Cotton Valley formation. In addition, Phillips, will at
its risk and expense, operate, develop, exploit and explore the properties
thereby relieving the Company of significant operating, exploration and
development costs in the future. The effective date of the transaction was May
1, 1999 and it closed on May 17, 1999. The Company anticipates recognition of a
gain ranging from approximately $24 million to $28 million in the second quarter
of 1999. The Company has not completed its analysis of the specific costs of the
oil and gas properties and related accumulated depreciation, depletion and
amortization being sold, and accordingly, the gain is subject to further
adjustment.
In April 1999, the Company negotiated a private offering of $135
million principal amount, 14% Senior Secured Notes (the "Notes"). The Notes are
secured by a first lien on substantially all of the Company's proved oil and
natural gas properties remaining after the sale to Phillips and guaranteed by
three entities wholly-owned by the Company. With the consummation of the
Phillips transaction, the Company is obligated to offer to repurchase $35
million principal amount of the Notes at a repurchase price equal to 104% of the
principal amount, plus accrued and unpaid interest to the date of the repurchase
within 30 days of such closing.
In April 1999, the Company began an offer to purchase ("Offer to
Purchase") the outstanding principal amounts of its 7 7/8% Convertible
Subordinated Notes due December 15, 1999 and its 8 1/2% Convertible Subordinated
Debentures due April 1, 2000 (collectively, the "Securities") at a price equal
to $590 per $1,000 principal amount. On May 17, 1999, the Company funded the
repurchase of $46.1 million of the Securities through the Offer to Purchase and
will recognize an extraordinary gain of approximately $18.9 million in the
second quarter of 1999.
The net proceeds from the combination of these transactions and cash on
hand were used by the Company to repay all borrowings outstanding under its
Credit Facility of $115.5 million plus accrued interest, to fund cash collateral
for a $1.5 million letter of credit, and to fund the repurchase of $46.1 million
of Securities under the Offer to Purchase, all at May 17, 1999. The remaining
net proceeds and cash flow from operations will be used to repurchase up to
$35 million of Notes at 104% of their principal amount and for general corporate
purposes.
While industry conditions cannot be predicted with certainty and are
dependent upon a number of commodity and economic factors which are beyond the
company's control, the Company believes that the cash on hand subsequent to the
consummation of the above transactions and the recent increase in oil and
natural gas prices, if continued, will sustain its operations over the
short-term. However, the Company will continue to have significant debt
outstanding and limited ability to incur further indebtedness, which, combined
with industry conditions beyond its control, may adversely affect its financial
condition, results of operations and cash flows.
Liquidity. Net cash provided by operating activities, before working
capital adjustments, during the first three months of 1999 aggregated $1.6
million. Funds used in investing activities were comprised of capital
expenditures of $5.8 million. As a result of these activities, cash and cash
equivalents decreased from $8.4 million at December 31, 1998 to $6.7 as of March
31, 1999. As of March 31, 1999, the Company had a working capital deficit of
$42.2 million, compared to a working capital deficit of $37.4 million at the end
of 1998.
40
<PAGE> 100
Capital Resources. At March 31, 1999, $111.5 million of borrowings and
$1.5 million of letters of credit were outstanding under the Credit Facility. In
April 1999, the Company borrowed an additional $4 million under the Credit
Facility, raising its total outstanding borrowings to $115.5 million as of April
30, 1999. The Company's typical monthly cash flow cycle is such that the Company
usually receives a substantial portion of its proceeds from operations near the
end of each month. Accordingly, outstanding balances under the Credit Facility
may be higher on any given day during the month than at the end of the month.
After the Company paid all amounts outstanding under the Credit
Facility, the Credit Facility was terminated and the Company is not likely to
have access to a revolving credit facility to supplement its cash needs. The
terms of the Notes and subordinated obligations significantly limit the ability
of the Company to incur additional funded indebtedness. Accordingly, the Company
anticipates that it will be required to meet its obligations during the
remainder of 1999 from the net proceeds of the transactions described above,
cash on hand and cash flows from operations. While the Company anticipates that
it will be able to meet its obligations in 1999, there can be no assurance that
it will be able to do so.
The Company had $327.9 million principal amount of debt outstanding as
of March 31, 1999 ($321 million recorded on the balance sheet), requiring $29.8
million in annual cash interest payments. The Company's outstanding $2.625
Convertible Exchangeable Preferred Stock (the "Preferred Stock") is cumulative,
requiring dividends to accumulate, currently at the rate of $4.6 million
annually, and carries liquidation preferences over the Common Stock totaling
$49.8 million at March 31, 1999, including dividend arrearages. The Company has
not declared the quarterly dividend of $0.65625 per preferred share for February
1, 1998, May 1, 1998, August 1, 1998, November 1, 1998, February 1, 1999 and May
1, 1999, aggregating approximately $6.8 million, covering six quarters. Further
dividends are restricted under the Company's indentures governing its 10 3/8%
Senior Subordinated Notes and its 14% Senior Secured Notes. If the Company does
not pay dividends on the Preferred Stock for a period of six quarters, whether
or not consecutive, the holders of the Preferred Stock, as a group, have the
right to elect two additional directors to the Company's Board of Directors.
Capital Commitments. The Company's 1999 capital expenditure budget
provides for $10 million to be expended on development drilling primarily in
north and south Louisiana and $5 million to be expended on exploratory prospects
primarily in south Louisiana, the shallow waters of the Gulf of Mexico, Texas
and New Mexico. In the first three months of 1999, the Company participated in
drilling 2 gross (.5 net) wells, both of which wells were completed in the first
quarter of 1999. As of the end of the first quarter of 1999, the Company was
participating in the drilling of 3 gross (.7 net) wells.
Year 2000. The Company has instigated reviews and evaluations in
response to Year 2000 issues. These issues involve the potential disruption to
systems, processes, and business practices that may occur if system hardware and
software utilized by the Company, its vendors, and customers are unable to
process year 2000 data. The planning phase is completed and the Company is
nearing completion of internal corrective measures.
The Company is working closely with its information systems and
technology vendors to install updated software, where appropriate, that will be
Year 2000 compliant. Currently, more than 90% of the critical Year 2000 internal
systems issues have been tested and corrected. The remainder are expected to be
installed and tested by the end of the third quarter of 1999.
The Company has identified those vendors and others that it believes
provide material services or are vital to its business. Discussions with these
companies to determine their Year 2000 readiness are expected to be completed in
the second quarter 1999. By mid-year 1999 the Company plans to have completed
its Year 2000 review and implemented necessary corrective measures.
The cost of reviewing and implementing corrective measures for Year
2000 issues to date has not been material to the Company and has been limited to
use of Company and vendor personnel for review and implementation of corrective
measures. The Company expects the remainder of the Year 2000 review and
corrective measures to not involve significant costs.
Based on assessments to date and compliance plans in progress, nothing
has come to the attention of management to cause it to believe that Year 2000
issues, including the cost of implementing corrective measures,
41
<PAGE> 101
will have an adverse material impact on the business or operations of the
Company. Nevertheless, as indicated above, achieving Year 2000 readiness is
subject to risk and uncertainties, especially regarding third parties, and there
can be no assurance the Company will not be adversely affected by Year 2000
issues.
The foregoing statements are intended to be and are hereby designated
"Year 2000 Readiness Disclosures" within the meaning of the Year 2000
Information and Readiness Act.
Inflation and Changing Prices. Oil and natural gas prices, as with most
commodities, are highly volatile, have fluctuated during recent years and
generally have not followed the same pattern as inflation.
42
<PAGE> 102
SECTION C. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is exposed to market risk from changes in interest rates
and commodity prices. The Company has used its Credit Facility and uses its
Senior and Subordinated debt instruments to finance a significant portion of its
operations (see Note 1). The Company's exposure to market risk for interest rate
changes related to its Credit Facility variable rate debt (see Note 1). In the
normal course of business the Company enters into hedging transactions,
including natural gas price and basis swap agreements, to mitigate its exposure
to commodity price movements, but not for trading or speculative purposes. In
the first three months of 1999, the Company used price and basis swap agreements
to reduce exposure to downward price fluctuations for its natural gas
production. For debt obligations the table below presents principal cash flows
and weighted average interest rates by year of maturity. For natural gas price
and basis swap agreements, the table presents notional amounts in Mmbtu's and
weighted average prices for contracts in place at March 31, 1999. The
information presented below should be read in conjunction with Note 4 and Note
10 to the Consolidated Financial Statements (amounts in thousands otherwise
indicated).
<TABLE>
<CAPTION>
MATURITY DATE
------------------------------------------------------------- FAIR VALUE
1999 2000 2001 2002 2003 THEREAFTER TOTAL @ 3/31/99
----------- ----------- --------- --------- -------- ---------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Variable Debt:
Credit Facility
(Maturity) 6.78%(1)........... $ 111,500 $ 111,500 $ 111,500
Fixed Debt:
13.50% (Maturity)............. $ 435 435 435
7.88% (Maturity).............. 34,147 34,147 20,147
8.50% (Maturity).............. 26,856 26,856 15,845
10.38% (Maturity)............. $ 155,000 155,000 97,650
----------- ----------- ---------- ----------- ---------
Total Maturity................... $ 34,582 $ 138,356 $ 155,000 $ 327,938 $ 245,577
=========== =========== ========== =========== =========
Blended weighted
average interest rate......... 7.95% 8.5% 10.38%
Commodity price
derivatives:
Price swaps:
Notional amounts
(Mmbtu's) ................ 5,630,000
Weighted average price........ $ 2.03
Fair value at 3/31/99(2)...... $ (1,050)
Basis swaps:
Notional amounts
(Mmbtu's) ................ 10,980,000
Margin differential(3)........ $ (.03)
Fair value at 3/31/99(2)...... $ (335)
</TABLE>
(1) Reflects the weighted average interest rate on borrowings outstanding at
March 31, 1999.
(2) Represents estimated amounts to settle the contracts at March 31, 1999.
(3) Estimated weighted average margin differential at March 31, 1999.
43
<PAGE> 103
FORWARD-LOOKING STATEMENTS
Statements contained in this Report and other materials filed or to be
filed by the Company with the Securities and Exchange Commission (as well as
information included in oral or other written statements made or to be made by
the Company or its representatives) that are forward-looking in nature are
intended to be "forward-looking statements" within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, relating to matters such as anticipated
operating and financial performance, business prospects, developments and
results of the Company. Actual performance, prospects, developments and results
may differ materially from any or all anticipated results due to economic
conditions and other risks, uncertainties and circumstances partly or totally
outside the control of the Company, including rates of inflation, oil and
natural gas prices, uncertainty of reserve estimates, rates and timing of future
production of oil and gas, exploratory and development activities, acquisition
risks, changes in the level and timing of future costs and expenses related to
drilling and operating activities and those risk factors described on pages 13,
14 and 15 of the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1998.
Words such as "anticipates," "believes," "expects," "estimates,"
"projects" and similar expressions are intended to identify forward-looking
statements. Forward-looking statements include the risk factors described in the
Company's Form 10-K mentioned above.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT
NUMBER: EXHIBIT
27 Financial Data Schedule (included only in the
electronic filing of this document).
(b) Reports on Form 8-K:
No reports on Form 8-K were filed by the Registrant during the
first quarter of 1999.
44
<PAGE> 104
SIGNATURES
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.
KELLEY OIL & GAS CORPORATION
Date: May 18, 1999 By: /s/ Rick G. Lester
----------------------------------
Rick G. Lester
Chief Financial Officer
(Duly Authorized Officer)
(Principal Accounting Officer)
45
<PAGE> 1
CUSIP 487906-20-8
KELLEY OIL & GAS CORPORATION
LETTER OF TRANSMITTAL
TO TENDER ITS
$2.625 CONVERTIBLE EXCHANGEABLE PREFERRED STOCK
PURSUANT TO THE OFFER TO EXCHANGE
DATED JUNE 28, 1999.
THE OFFER WILL EXPIRE AT 12:01 A.M., NEW YORK CITY TIME, ON TUESDAY, JULY 27,
1999 UNLESS EXTENDED (SUCH DATE, AS THE SAME MAY BE EXTENDED, THE "EXPIRATION
DATE"). HOLDERS OF PREFERRED STOCK (AS DEFINED BELOW) MUST VALIDLY TENDER THEIR
PREFERRED STOCK ON OR PRIOR TO THE EXPIRATION DATE IN ORDER FOR THEIR PREFERRED
STOCK TO BE EXCHANGED PURSUANT TO THIS OFFER. TENDERED SHARES OF PREFERRED STOCK
MAY BE WITHDRAWN AT ANY TIME PRIOR TO THE EXPIRATION DATE.
The Depositary for the Offer is:
CHASEMELLON SHAREHOLDER SERVICES, L.L.C.
<TABLE>
<S> <C> <C>
BY REGISTERED OR BY OVERNIGHT COURIER BY HAND DELIVERY
CERTIFIED MAIL: OR IN PERSON:
ChaseMellon Shareholder ChaseMellon Shareholder ChaseMellon Shareholder
Services, L.L.C. Services, L.L.C. Services, L.L.C.
Post Office Box 3301 85 Challenger Road -- 120 Broadway, 13th Floor
South Hackensack, NJ 07606 Mail Drop -- Reorg New York, NY 10271
Attn: Reorganization Department Ridgefield Park, NJ 07660 Attn: Reorganization Department
Attn: Reorganization Department
</TABLE>
BY FACSIMILE:
(201) 296-4293
CONFIRM FACSIMILE BY TELEPHONE
(201) 296-4860
The Information Agent is:
D.F. King & Co., Inc.
77 Water Street
New York, New York 10005
Bankers and Brokers Call Collect:
(212) 269-5550
or
All Others Call Toll-Free:
(800) 488-8095
DELIVERY OF THIS LETTER OF TRANSMITTAL TO AN ADDRESS OTHER THAN AS SET
FORTH ABOVE OR TRANSMISSION OF THIS LETTER OF TRANSMITTAL VIA FACSIMILE TO A
NUMBER OTHER THAN AS SET FORTH ABOVE DOES NOT CONSTITUTE A VALID DELIVERY. THE
INSTRUCTIONS CONTAINED HEREIN SHOULD BE READ CAREFULLY BEFORE THIS LETTER OF
TRANSMITTAL IS COMPLETED.
<PAGE> 2
The undersigned acknowledges that he or she has received the Offer to
Exchange dated June 28, 1999 (the "Offer to Exchange"), of Kelley Oil & Gas
Corporation (the "Company") and this Letter of Transmittal (the "Letter of
Transmittal"), which together constitute the Company's offer (the "Offer") to
exchange 15 shares of its Common Stock, par value $.01 per share ("Common
Stock"), for each outstanding share of the Company's $2.625 Convertible
Exchangeable Preferred Stock, par value $1.50 per share ("Preferred Stock")
validly tendered. The term "Expiration Date" shall mean 12:01 a.m. New York City
time, on Tuesday, July 27, 1999, unless the Offer is extended as provided in the
Offer to Exchange, in which case the term "Expiration Date" shall mean the
latest date and time to which the Offer is extended. Capitalized terms used but
not defined herein shall have the same meaning given them in the Offer to
Exchange.
The Letter of Transmittal is to be completed by holders of Preferred Stock
either (i) if the Preferred Stock is forwarded herewith or (ii) if tender of
Preferred Stock is to be made by book-entry transfer to an account maintained by
(the "Depositary") at The Depository Trust Company ("DTC") pursuant to the
procedures set forth in "The Offer--Procedures for Tendering Preferred Stock" in
the Offer to Exchange.
Holders of Preferred Stock whose certificates (the "Certificates") for such
Preferred Stock are not immediately available or who cannot deliver their
Certificates and all other required documents to the Depositary prior to 12:01
a.m., New York City time, on the Expiration Date or who cannot complete the
procedures for book-entry transfer prior to such time on the Expiration Date
must tender their Preferred Stock according to the guaranteed delivery
procedures set forth in "The Offer--Procedures for Tendering Preferred
Stock--Guaranteed Delivery" in the Offer to Exchange. See Instruction 1.
Delivery of documents to DTC does not constitute delivery to Depositary.
THE OFFER IS NOT BEING MADE TO (NOR WILL TENDERS OF PREFERRED STOCK BE
ACCEPTED FROM OR ON BEHALF OF) HOLDERS IN ANY JURISDICTION IN WHICH THE MAKING
OR ACCEPTANCE OF THE OFFER OR SOLICITATION WOULD NOT BE IN COMPLIANCE WITH THE
LAWS OF SUCH JURISDICTION.
The term "Holder" with respect to the Offer means any person in whose name
shares of Preferred Stock are registered on the books of the Company or any
other person who has obtained a properly completed bond power from the
registered holder. The undersigned has completed, executed and delivered this
Letter of Transmittal to indicate the action the undersigned desires to take
with respect to the Offer. Holders who wish to tender their shares of Preferred
Stock must complete this Letter of Transmittal in its entirety.
-2-
<PAGE> 3
PLEASE READ THIS ENTIRE LETTER OF TRANSMITTAL CAREFULLY
BEFORE COMPLETING THIS LETTER OF TRANSMITTAL
ALL TENDERING HOLDERS COMPLETE THIS BOX
DESCRIPTION OF OUTSTANDING PREFERRED STOCK TENDERED
<TABLE>
<S> <C> <C> <C> <C>
------------------------------------------------------------------------------------------------------------------------
DESCRIPTION OF OUTSTANDING PREFERRED STOCK TENDERED
------------------------------------------------------------------------------------------------------------------------
NUMBER OF SHARES NUMBER OF SHARES NUMBER OF BENEFICIAL
NAME AND ADDRESS OF OF PREFERRED STOCK OF PREFERRED STOCK HOLDERS FOR WHOM
REGISTERED HOLDER (ATTACH ADDITIONAL TENDERED OUTSTANDING PREFERRED
(PLEASE FILL IN IF BLANK) CERTIFICATE NUMBERS* LIST IF NECESSARY) (IF LESS THAN ALL)** STOCK IS HELD
------------------------------------------------------------------------------------------------------------------------
$
------------------------------------------------------------------------------------------------------------------------
$
------------------------------------------------------------------------------------------------------------------------
$
------------------------------------------------------------------------------------------------------------------------
Total Amount Tendered: $
------------------------------------------------------------------------------------------------------------------------
* Need not be completed by book-entry holders.
** All shares of Preferred Stock held shall be deemed tendered unless a lesser number is specified in this column.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
(BOXES BELOW TO BE CHECKED BY ELIGIBLE INSTITUTIONS ONLY)
[ ] CHECK HERE IF TENDERED SHARES OF PREFERRED STOCK ARE BEING DELIVERED
BY BOOK-ENTRY TRANSFER MADE TO THE ACCOUNT MAINTAINED BY THE
DEPOSITARY WITH DTC AND COMPLETE THE FOLLOWING (ONLY PARTICIPANTS IN
DTC MAY DELIVER SHARES OF PREFERRED STOCK BY BOOK-ENTRY TRANSFER (SEE
INSTRUCTION 1)):
Name of Tendering Institution:
DTC Account Number:
Transaction Code Number:
[ ] CHECK HERE AND ENCLOSE A PHOTOCOPY OF THE NOTICE OF GUARANTEED
DELIVERY IF TENDERED SHARES OF PREFERRED STOCK ARE BEING DELIVERED
PURSUANT TO A NOTICE OF GUARANTEED DELIVERY PREVIOUSLY SENT TO THE
DEPOSITARY AND COMPLETE THE FOLLOWING (SEE INSTRUCTION 5):
Name of Registered Holder(s):
Window Ticket Number (if any):
Date of Execution of Notice of Guaranteed Delivery:
Name of Institution which executed the notice of Guaranteed Delivery:
If Guaranteed Delivery is to be made by Book-Entry Transfer:
Name of Tendering Institution:
DTC Account Number:
Transaction Code Number:
-3-
<PAGE> 4
Ladies and Gentlemen:
The undersigned hereby tenders to the Company the above described shares of
Preferred Stock in exchange for 15 shares of Common Stock for each share of
Preferred Stock validly tendered.
Subject to and effective upon the acceptance for exchange of all or any
portion of the shares of Preferred Stock tendered herewith in accordance with
the terms and conditions of the Offer (including, if the Offer is extended or
amended, the terms and conditions of any such extension or amendment), the
undersigned hereby sells, assigns, transfers and conveys to the order of the
Company, all right, title and interest in and to such Preferred Stock as are
being tendered herewith. The undersigned hereby irrevocably constitutes and
appoints the Depositary as its agent and attorney-in-fact (with full knowledge
that the Depositary is also acting as agent of the Company in connection with
the Offer) with respect to the tendered Preferred Stock, with full power of
substitution (such power of attorney being deemed to be an irrevocable power
coupled with an interest), subject only to the right of withdrawal described in
the Offer to Exchange, to (i) deliver Certificates for Preferred Stock together
with all accompanying evidence of transfer and authenticity to, or upon the
order of the Company, upon receipt by the Depositary, as the undersigned's
agent, of the shares of Common Stock to be issued in exchange for the Preferred
Stock, (ii) present Certificates for such Preferred Stock for transfer, and to
transfer the Preferred Stock on the books of the Company, and (iii) receive for
the account of the Company all benefits and otherwise exercise all rights of
beneficial ownership of such Preferred Stock, all in accordance with the terms
and conditions of the Offer to Exchange.
THE UNDERSIGNED HEREBY REPRESENTS AND WARRANTS THAT THE UNDERSIGNED HAS
FULL POWER AND AUTHORITY TO TENDER, SELL, ASSIGN, TRANSFER AND CONVEY THE
PREFERRED STOCK TENDERED HEREBY AND THAT, WHEN THE SAME ARE ACCEPTED FOR
EXCHANGE, THE COMPANY WILL ACQUIRE GOOD, MARKETABLE AND UNENCUMBERED TITLE
THERETO, FREE AND CLEAR OF ALL LIENS, RESTRICTIONS, CHARGES AND ENCUMBRANCES,
AND THAT THE SHARES OF PREFERRED STOCK TENDERED HEREBY ARE NOT SUBJECT TO ANY
ADVERSE CLAIMS OR PROXIES. THE UNDERSIGNED WILL, UPON REQUEST, EXECUTE AND
DELIVER ANY ADDITIONAL DOCUMENTS DEEMED BY THE COMPANY OR THE DEPOSITARY TO BE
NECESSARY OR DESIRABLE TO COMPLETE THE SALE, ASSIGNMENT, TRANSFER AND CONVEYANCE
OF THE SHARES OF PREFERRED STOCK TENDERED HEREBY. THE UNDERSIGNED HAS READ AND
AGREES TO ALL OF THE TERMS OF THE OFFER TO EXCHANGE.
The name(s) and address(es) of the registered holder(s) of the Preferred
Stock tendered hereby should be printed above, if they are not already set forth
above, as they appear on the Certificates representing such Preferred Stock. The
Certificate number(s) and the Preferred Stock that the undersigned wishes to
tender should be indicated in the appropriate boxes above.
If any tendered shares of Preferred Stock are not exchanged pursuant to the
Offer for any reason, or if Certificates are submitted for more shares of
Preferred Stock than are tendered or accepted for exchange, Certificates for
such nonexchanged or nontendered shares of Preferred Stock will be returned (or,
in the case of shares of Preferred Stock tendered by book-entry transfer, such
shares of Preferred Stock will be credited to an account maintained at DTC)
without expense to the tendering Holder, as soon as practicable following the
withdrawal or rejection of tender or the expiration or termination of the Offer.
The undersigned understands that tender of shares of Preferred Stock
pursuant to any one of the procedures described in "The Offer--Procedures for
Tendering Preferred Stock" in the Offer to Exchange and in this Letter of
Transmittal, and the Company's acceptance for exchange of such tendered shares
of Preferred Stock, will constitute a binding agreement between the undersigned
and the Company upon the terms and subject to the conditions of the Offer. The
undersigned recognizes that, under certain circumstances set forth in the Offer
to Exchange, the Company may not be required to accept for exchange any of the
shares of Preferred Stock tendered hereby.
Unless otherwise indicated herein in the box entitled "Special Issuance
Instructions" below, the undersigned hereby directs that any shares of Preferred
Stock not tendered or accepted for exchange to be
-4-
<PAGE> 5
issued in the name(s) of the undersigned (or, in the case of shares of Preferred
Stock tendered by book-entry transfer, by credit to the account at DTC), and
that the shares of Common Stock to be issued in the Exchange be issued in the
name of the undersigned. Similarly, unless otherwise indicated herein in the box
entitled "Special Delivery Instructions," the undersigned hereby directs that
any shares of Preferred Stock not tendered or not accepted for exchange and the
shares of Common Stock to be issued in the Exchange be delivered to the
undersigned at the address shown below the undersigned's signature(s). In the
event that the "Special Issuance Instructions" box or the "Special Delivery
Instructions" box is, or both are, completed, the undersigned hereby requests
that any shares of Preferred Stock not tendered or not accepted for exchange to
be issued in the name(s) of, certificates for such shares of Preferred Stock to
be delivered to, and the shares of Common Stock to be issued in the Exchange be
delivered to, the person(s) at the address(es) so indicated, as applicable. The
undersigned recognizes that the Company has no obligation pursuant to the
"Special Issuance Instructions" box or "Special Delivery Instructions" box to
transfer any shares of Preferred Stock from the name of the registered holder(s)
thereof if the Company does not accept for exchange any of the so tendered.
Holders of Preferred Stock whose Preferred Stock is accepted for exchange
will not receive accrued dividends on such Preferred Stock for any period from
and after the exchange of such Preferred Stock pursuant to this Offer.
Except as stated in the Offer to Exchange, this tender is irrevocable.
-5-
<PAGE> 6
HOLDER(S) SIGN HERE
(SEE INSTRUCTIONS 2, 5 AND 6)
(NOTE: SIGNATURE(S) MUST BE GUARANTEED IF REQUIRED BY INSTRUCTION 2)
Must be signed by registered holder(s) exactly as name(s) appear(s) on
Certificate(s) for the Preferred Stock hereby tendered or on a security position
listing, or by any person(s) authorized to become the registered holder(s) by
endorsements and documents transmitted herewith (including such opinions of
counsel, certifications and other information as may be required by the Company
for the Preferred Stock to comply with the restrictions on transfer applicable
to the Preferred Stock). If signature is by an attorney-in-fact, trustee,
officer of a corporation or another acting in a fiduciary capacity or
representative capacity, please set forth the signer's full title. See
Instruction 5.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(SIGNATURE(S) OF HOLDER(S))
Dated
- ---------------------------------------------, 1999
Name(s):
- --------------------------------------------------------------------------------
(PLEASE PRINT)
Capacity (full title):
- --------------------------------------------------------------------------------
Address:
- --------------------------------------------------------------------------------
-------------------------------------------------------------------------
-------------------------------------------------------------------------
(INCLUDE ZIP CODE)
Area Code and Telephone Number:
- -------------------------------------------------------------------------------
Tax Identification or Social Security Number:
- ---------------------------------------------------------------------
GUARANTEE OF SIGNATURE(S)
(SEE INSTRUCTIONS 2 AND 5)
- --------------------------------------------------------------------------------
(AUTHORIZED SIGNATURE)
Dated
- ---------------------------------------------, 1999
Name of Firm:
- --------------------------------------------------------------------------------
(PLEASE PRINT)
Capacity (full title):
- --------------------------------------------------------------------------------
Address:
- --------------------------------------------------------------------------------
-------------------------------------------------------------------------
-------------------------------------------------------------------------
(INCLUDE ZIP CODE)
Area Code and Telephone Number:
- -------------------------------------------------------------------------------
-6-
<PAGE> 7
SPECIAL ISSUANCE INSTRUCTIONS
(SEE INSTRUCTIONS 2, 5 AND 6)
To be completed ONLY if certificates for shares of Preferred stock not
tendered or not accepted for exchange and/or the shares of Common Stock to be
issued in the Exchange are to be issued in the name of someone other than the
registered holder of the Preferred Stock whose name(s) appear(s) above, or if
shares of Preferred Stock are to be returned by credit to an account maintained
by DTC.
Issue
[ ] Common Stock issued in the Exchange and/or
[ ] Preferred Stock not tendered
to:
Name(s):
Address:
(INCLUDE ZIP CODE)
Area Code and Telephone Number:
Tax Identification or Social Security Number(s):
Credit unaccepted Preferred Stock tendered by book-entry transfer to the
following account at DTC:
-7-
<PAGE> 8
SPECIAL DELIVERY INSTRUCTIONS
(SEE INSTRUCTIONS 2, 5 AND 6)
To be completed ONLY if Certificates for shares of Preferred Stock not
tendered or not accepted for exchange and/or the shares of Common Stock to be
issued in the Exchange are to be sent to someone other than the registered
holder of the Preferred Stock whose name(s) appear(s) above, or to such
registered holder(s) at an address other than that shown above.
Mail
[ ] Common Stock issued in the Exchange and/or
[ ] Preferred Stock not tendered
to:
Name(s):
Address:
(INCLUDE ZIP CODE)
Area Code and Telephone Number:
Tax Identification or Social Security Number(s):
-8-
<PAGE> 9
INSTRUCTIONS
FORMING PART OF THE TERMS AND CONDITIONS OF THE OFFER
1. DELIVERY OF LETTER OF TRANSMITTAL AND CERTIFICATES, GUARANTEED DELIVERY
PROCEDURES. This Letter of Transmittal is to be completed either if (a)
Certificates are forwarded herewith or (b) tenders are to be made pursuant to
the procedures for tender by book-entry transfer set forth in "The
Offer--Procedures for Tendering Preferred Stock" in the Offer to Exchange.
Certificates for shares of Preferred Stock being tendered, or timely
confirmation of a book-entry transfer of such Preferred Stock into the
Depositary's account at DTC, as well as this Letter of Transmittal (or a
facsimile thereof), properly completed and duly executed, with any required
signature guarantees, and any other documents required by this Letter of
Transmittal, must be received by the Depositary at its address set forth herein
prior to 12:01 a.m., New York City time, on the Expiration Date.
Holders who wish to tender their Preferred Stock and (i) whose Preferred
Stock is not immediately available or (ii) who cannot deliver their Preferred
Stock, this Letter of Transmittal or any other required documents to the
Depositary prior to 12:01 a.m., New York City time, on the Expiration Date or
(iii) who cannot complete the procedures for delivery by book-entry transfer
prior to the Expiration Date may tender their Preferred Stock by properly
completing and duly executing a Notice of Guaranteed Delivery pursuant to the
guaranteed delivery procedures set forth in "The Offer--Procedures for Tendering
Preferred Stock--Guaranteed Delivery" in the Offer to Exchange. Pursuant to such
procedures: (i) such tender must be made by or through an Eligible Institution
(as defined below); (ii) a properly completed and duly executed Notice of
Guaranteed Delivery, substantially in the form made available by the Company,
must be received by the Depositary prior to 12:01 a.m., New York City time, on
the Expiration Date; and (iii) the Certificates (or a confirmation of book-entry
transfer of such Preferred Stock into the Depositary's account at the Book-Entry
Transfer Facility (as defined in the Offer to Exchange)) representing all
tendered Preferred Stock, in proper form for transfer, together with a Letter of
Transmittal (or facsimile thereof), properly completed and duly executed, with
any required signature guarantees and any other documents required by this
Letter of Transmittal, must be received by the Depositary within three New York
Stock Exchange trading days after the date the Depositary receives such Notice
of Guaranteed Delivery, all as provided in "The Offer--Procedures for Tendering
Preferred Stock--Guaranteed Delivery" in the Offer to Exchange.
The Notice of Guaranteed Delivery may be delivered by hand or mail or
transmitted by facsimile to the Depositary and, if required, must include a
guarantee by an Eligible Institution in the form set forth in such notice. See
Instruction 2 below. As used herein and in the Offer to Exchange, "Eligible
Institution" means a firm or other entity identified as an "eligible guarantor
institution" within the meaning of Rule 17Ad-15 under the Exchange Act,
including (as such terms are defined therein) (i) a bank; (ii) a broker, dealer,
municipal securities broker or dealer or government securities broker or dealer;
(iii) a credit union; (iv) a national securities exchange, registered securities
association or clearing agency; or (v) a savings association that is a
participant in a securities transfer association.
THE METHOD OF DELIVERY OF CERTIFICATES, THIS LETTER OF TRANSMITTAL AND ALL
OTHER REQUIRED DOCUMENTS IS AT THE OPTION AND SOLE RISK OF THE TENDERING HOLDER
AND THE DELIVERY WILL BE DEEMED MADE ONLY WHEN ACTUALLY RECEIVED BY THE
DEPOSITARY. IF DELIVERY IS BY MAIL, REGISTERED MAIL WITH RETURN RECEIPT
REQUESTED, PROPERLY INSURED, OR OVERNIGHT DELIVERY SERVICE IS RECOMMENDED. IN
ALL CASES, SUFFICIENT TIME SHOULD BE ALLOWED TO ENSURE TIMELY DELIVERY.
The Company will not accept any alternative, conditional or contingent
tenders. Each tendering holder, by execution of a Letter of Transmittal (or
facsimile thereof), waives any right to receive any notice of the acceptance of
such tender.
2. GUARANTEE OF SIGNATURES. No signature guarantee on this Letter of
Transmittal is required if:
(i) this Letter of Transmittal is signed by the registered holder
(which term, for purposes of this document, shall include any participant
in DTC whose name appears on a security position listing as the
-9-
<PAGE> 10
owner of the Preferred Stock) of Preferred Stock tendered herewith, unless
such holder has completed either the box entitled "Special Registration
Instructions" or the box entitled "Special Delivery Instructions" above, or
(ii) such Preferred Stock is tendered for the account of a firm that
is an Eligible Institution.
In all other cases, an Eligible Institution must guarantee the signature(s)
on this Letter of Transmittal. See Instruction 5.
3. INADEQUATE SPACE. If the space provided in the box captioned "Number of
Shares of Preferred Stock" is inadequate, the Certificate number(s) and/or the
number of shares of Preferred Stock and any other required information should be
listed on a separate signed schedule which is attached to this Letter of
Transmittal.
4. PARTIAL TENDERS AND WITHDRAWAL RIGHTS. If less than all the shares of
Preferred Stock evidenced by any Certificate submitted are to be tendered, fill
in the number of shares of Preferred Stock that are to be tendered in the box
entitled "Number of Shares of Preferred Stock Tendered (If Less Than All)." In
such case, the holder will receive new Certificate(s) for the remainder of the
shares of Preferred Stock promptly after the Expiration Date. All shares of
Preferred Stock represented by Certificates delivered to the Depositary will be
deemed to have been tendered unless otherwise indicated.
Except as otherwise provided herein, tenders of Preferred Stock may be
withdrawn at any time prior to 12:01 a.m., New York City time, on the Expiration
Date. In order for a withdrawal to be effective on or prior to that time, a
written or facsimile transmission of such notice of withdrawal must be timely
received by the Depositary at one of its addresses set forth above or in the
Offer to Exchange prior to 12:01 a.m., New York City time, on the Expiration
Date. Any such notice of withdrawal must (i) specify the name of the person
having deposited the Preferred Stock to be withdrawn (the "Depositor"), (ii)
identify the shares of Preferred Stock to be withdrawn (including the
certificate number(s) and number of such shares, or, in the case of Preferred
Stock transferred by book-entry transfer, the name and number of the account at
the Book-Entry Transfer Facility to be credited), (iii) be signed by the Holder
in the same manner as the original signature on the Letter of Transmittal by
which such Preferred Stock was tendered (including any required signature
guarantees) or be accompanied by documents of transfer sufficient to have the
Trustee with respect to the Preferred Stock register the transfer of such
Preferred Stock into the name of the person withdrawing the tender, (iv) specify
the name in which any such shares of Preferred Stock are to be registered, if
different from that of the Depositor and (v) if applicable because the shares of
Preferred Stock have been tendered pursuant to book-entry procedures, specify
the name and number of the participant's account at DTC to be credited, if
different from that of the Depositor. All questions as to the validity, form and
eligibility (including time of receipt) of such notices will be determined by
the Company, whose determination shall be final and binding on all parties. Any
Preferred Stock so withdrawn will be deemed not to have been validly tendered
for purposes of the Offer and the Common Stock will not be issued with respect
thereto unless the shares of Preferred Stock so withdrawn are validly tendered.
Properly withdrawn Preferred Stock may be retendered by following one of the
procedures described in "The Offer--Procedures for Tendering Preferred Stock" in
the Offer to Exchange at any time prior to the Expiration Date.
All questions as to the validity, form and eligibility (including time of
receipt) of such withdrawal notices will be determined by the Company, in its
sole discretion, whose determination shall be final and binding on all parties.
The Company, any affiliates or assigns of the Company, the Depositary, the
Information Agent or any other person shall not be under any duty to give any
notification of any irregularities in any notice of withdrawal or incur any
liability for failure to give any such notification. Any shares of Preferred
Stock which have been tendered but which are withdrawn will be returned to the
holder thereof without cost to such holder as soon as practicable after
withdrawal, rejection of tender or termination of the Offer.
5. SIGNATURES ON LETTER OF TRANSMITTAL, ASSIGNMENTS AND ENDORSEMENTS. If
this Letter of Transmittal is signed by the registered holder(s) of the shares
of Preferred Stock tendered hereby, the signature(s) must correspond exactly
with the name(s) as written on the face of the Certificate(s) without
alteration, enlargement or any change whatsoever.
If any of the shares of Preferred Stock tendered hereby are owned of record
by two or more joint owners, all such owners must sign this Letter of
Transmittal.
-10-
<PAGE> 11
If any tendered shares of Preferred Stock are registered in different
name(s) on several Certificates, it will be necessary to complete, sign and
submit as many separate Letters of Transmittal (or facsimiles thereof) as there
are different registrations of Certificates.
If this Letter of Transmittal or any Certificates or stock powers are
signed by trustees, executors, administrators, guardians, attorneys-in-fact,
officers of corporations or others acting in a fiduciary or representative
capacity, such person should so indicate when signing and, unless waived by the
Company, evidence satisfactory to the Company, in its sole discretion, of their
authority to so act must be submitted with this Letter of Transmittal.
When this Letter of Transmittal is signed by the registered owner(s) of the
shares of Preferred Stock listed and transmitted hereby, no endorsement(s) of
Certificate(s) or separate stock power(s) are required unless the shares of
Common Stock to be issued in the Exchange are to be issued in the name of a
person other than the registered holder(s). Signature(s) on such Certificate(s)
or stock power(s) must be guaranteed by an Eligible Institution.
If this Letter of Transmittal is signed by a person other than the
registered owner(s) of the shares of Preferred Stock listed, the Certificates
must be endorsed or accompanied by appropriate stock powers, signed by the
registered owner(s) exactly as the name or names of the registered owner(s)
appear(s) on the Certificates, and also must be accompanied by such opinions of
counsel, certifications and other information as the Company may require in
accordance with the restrictions on transfer applicable to the Preferred Stock.
Signatures on such Certificates or stock powers must be guaranteed by an
Eligible Institution.
If tendered shares of Preferred Stock are registered in the name of the
signer of the Letter of Transmittal and the shares of Common Stock to be issued
in the Exchange are to be issued (and any untendered shares of Preferred Stock
are to be reissued) in the name of the registered holder (including any
participant in The Depository Trust Company (also referred to as a book-entry
facility) whose name appears on a security listing as the owner of shares of
Preferred Stock), the signature of such signer need not be guaranteed. In any
other case, the tendered shares of Preferred Stock must be endorsed or
accompanied by written instruments of transfer in form satisfactory to the
Company and duly executed by the registered holder and the signature on the
endorsement or instrument of transfer must be guaranteed by a member firm of a
registered national securities exchange or of the National Association of
Securities Dealers, Inc., a commercial bank or trust company having an office or
correspondent in the United States or an "eligible guarantor institution" as
defined by Rule 17Ad-15 under the Securities Exchange Act of 1934, as amended.
6. SPECIAL PAYMENT AND DELIVERY INSTRUCTIONS. Except as set forth in this
Instruction 6, the Company will pay all transfer taxes, if any, applicable to
the exchange of the Preferred Stock pursuant to the Offer. If the shares of
Common Stock to be issued in the Exchange are to be issued in the name of a
person other than the signer of this Letter of Transmittal, or if shares of
Common Stock to be issued in the Exchange are to be issued are to be sent to
someone other than the signer of this Letter of Transmittal or to an address
other than that shown above, the appropriate boxes on this Letter of Transmittal
should be completed. Certificates for Preferred Stock not exchanged will be
returned by mail or, if tendered by book-entry transfer, by crediting the
account indicated above maintained at DTC. See Instruction 4.
7. IRREGULARITIES. The Company will determine, in its sole discretion, all
questions as to the form of documents, validity, eligibility (including time of
receipt), acceptance and withdrawal of tendered Preferred Stock, which
determination shall be final and binding on all parties. The Company reserves
the absolute right to reject any and all tenders determined by it not to be in
proper form or the acceptance of which, or purchase for, may, in the view of
counsel to the Company, be unlawful. The Company also reserves the absolute
right, subject to applicable law, to waive any of the conditions of the Offer
set forth in the Offer to Exchange under "The Offer--Certain Conditions of the
Offer" or defects, irregularities or conditions of tender as to particular
shares of Preferred Stock, whether or not similar conditions or irregularities
are waived in the case of other holders. The Company's interpretation of the
terms and conditions of the Offer (including this Letter of Transmittal and the
instructions hereto) will be final and binding on all parties. No tender of
shares of Preferred Stock will be deemed to have been validly made until all
irregularities with respect to such tender have been waived or cured within such
time as the Company shall determine. Although the Company intends
-11-
<PAGE> 12
to notify Holders of defects or irregularities with respect to tenders of shares
of Preferred Stock, neither the Company, any affiliate or assign of the Company
or the Depositary or Information Agent nor any person shall be under any duty to
give notification of any irregularities in tenders or incur any liability for
failure to give such notification. Any shares of Preferred Stock received by the
Depositary that are not properly tendered and as to which the defects or
irregularities have not been cured or waived will be returned by the Depositary
to the tendering Holders as soon as practicable following the Expiration Date.
8. QUESTIONS, REQUESTS FOR ASSISTANCE AND ADDITIONAL COPIES. Questions and
requests for assistance may be directed to the Depositary or Information Agent
at their addresses and telephone numbers set forth on the front of this Letter
of Transmittal. Additional copies of the Offer to Exchange, the Notice of
Guaranteed Delivery and the Letter of Transmittal may be obtained from the
Depositary or Information Agent or from your broker, dealer, commercial bank,
trust company or other nominee.
9. LOST, DESTROYED OR STOLEN CERTIFICATES. If any Certificate(s)
representing Preferred Stock have been lost, destroyed or stolen, the holder
should promptly notify the Depositary. The holder will then be instructed by the
Depositary as to the steps that must be taken in order to replace the
Certificate(s). This Letter of Transmittal and related documents cannot be
processed until the procedures for replacing lost, destroyed or stolen
Certificate(s) have been followed.
10. SECURITY TRANSFER TAXES. Holders who tender their Preferred Stock for
exchange will not be obligated to pay any transfer taxes in connection
therewith. If, however, certificates representing the shares of Preferred Stock
not tendered or accepted for exchange are to be delivered to, or are to be
issued in the name of, any person other than the person signing the Letter of
Transmittal, or if a transfer tax is imposed for any reason other than the
exchange of Preferred Stock in connection with the Offer, then the amount of any
such transfer tax (whether imposed on the registered holder or any other person)
will be payable by the tendering holder. If satisfactory evidence of payment of
such taxes or exemption therefrom is not submitted with this Letter of
Transmittal, the amount of such transfer taxes will be billed directly to such
tendering holder.
11. CONFLICTS. In the event of any conflict between the terms of the Offer
to Exchange and the terms of this Letter of Transmittal, the terms of the Offer
to Exchange will control.
IMPORTANT: THIS LETTER OF TRANSMITTAL (OR FACSIMILE THEREOF) AND ALL OTHER
REQUIRED DOCUMENTS MUST BE RECEIVED BY THE DEPOSITARY PRIOR TO 12:01 A.M., NEW
YORK CITY TIME, ON THE EXPIRATION DATE.
-12-
<PAGE> 13
CUSIP 487906-20-8
KELLEY OIL & GAS CORPORATION
OFFER TO EXCHANGE
15 SHARES OF COMMON STOCK FOR EACH SHARE OF
$2.625 CONVERTIBLE EXCHANGEABLE PREFERRED STOCK
PURSUANT TO THE OFFER TO EXCHANGE
DATED JUNE 28, 1999
THE OFFER WILL EXPIRE AT 12:01 A.M., NEW YORK CITY TIME, ON TUESDAY, JULY 27,
1999 UNLESS EXTENDED (SUCH DATE, AS THE SAME MAY BE EXTENDED, THE "EXPIRATION
DATE"). HOLDERS OF PREFERRED STOCK (AS DEFINED BELOW) MUST VALIDLY TENDER THEIR
PREFERRED STOCK ON OR PRIOR TO THE EXPIRATION DATE IN ORDER FOR THEIR PREFERRED
STOCK TO BE EXCHANGED PURSUANT TO THIS OFFER. TENDERED PREFERRED STOCK MAY BE
WITHDRAWN AT ANY TIME PRIOR TO THE EXPIRATION DATE.
To Brokers, Dealers, Commercial Banks,
Trust Companies and Other Nominees:
Kelley Oil & Gas Corporation, a Delaware corporation (the "Issuer"), is
offering, upon the terms and subject to the conditions set forth in the Offer to
Exchange dated June 28, 1999 (the "Offer to Exchange") and the accompanying
Letter of Transmittal enclosed herewith (which together constitute the "Offer"),
to exchange 15 shares of its Common Stock for each share of its $2.625
Convertible Exchangeable Preferred Stock ("Preferred Stock").
THE OFFER IS SUBJECT TO CERTAIN CONDITIONS. SEE "THE OFFER--CERTAIN
CONDITIONS OF THE OFFER" IN THE OFFER TO EXCHANGE.
Enclosed herewith for your information and forwarding to your clients are
copies of the following documents:
1. the Offer to Exchange dated June 28, 1999;
2. the Letter of Transmittal for your use and for the information of your
clients (facsimile copies of the Letter of Transmittal may be used to
tender Preferred Stock);
3. a form of letter which may be sent to your clients for whose accounts
you hold Preferred Stock registered in your name or in the name of your
nominee, with space provided for obtaining such clients' instructions
with regard to the issuance of the Common Stock; and
4. a Notice of Guaranteed Delivery.
YOUR PROMPT ACTION IS REQUESTED. PLEASE NOTE THAT THE OFFER WILL EXPIRE AT
12:01 A.M., NEW YORK CITY TIME, ON TUESDAY, JULY 27, 1999, UNLESS EXTENDED.
PLEASE FURNISH COPIES OF THE ENCLOSED MATERIALS TO THOSE OF YOUR CLIENTS FOR
WHOM YOU HOLD PREFERRED STOCK REGISTERED IN YOUR NAME OR IN THE NAME OF YOUR
NOMINEE AS QUICKLY AS POSSIBLE.
In all cases, the exchange of Preferred Stock pursuant to the Offer will be
made only after receipt by the Depositary of (a) certificates representing such
Preferred Stock, or a confirmation of a book-entry transfer into the
Depositary's account at the Book-Entry Transfer Facility (as defined in the
Offer to Exchange), as the case may be, (b) the Letter of Transmittal (or
facsimile thereof), properly completed and duly executed, or an Agent's Message
(as defined in the Offer to Exchange) and (c) any other required documents.
<PAGE> 14
Holders who wish to tender their shares of Preferred Stock and (i) whose
shares of Preferred Stock are not immediately available or (ii) who cannot
deliver their shares of Preferred Stock, the Letter of Transmittal or an Agent's
Message or any other documents required by the Letter of Transmittal to the
Depositary prior to the Expiration Date or (iii) who cannot complete the
procedures for book-entry transfer prior to the Expiration Date must tender
their shares of Preferred Stock according to the guaranteed delivery procedures
set forth under the caption "The Offer--Procedures for Tendering Preferred
Stock--Guaranteed Delivery" in the Offer to Exchange.
The Offer is not being made to, nor will tenders be accepted from or on
behalf of, holders of shares of Preferred Stock residing in any jurisdiction in
which the making of the Offer or acceptance thereof would not be in compliance
with the laws of such jurisdiction.
The Issuer will not make any payments to brokers, dealers or other persons
for soliciting acceptances of the Offer. The Issuer will, however, upon request,
reimburse you for customary clerical and mailing expenses incurred by you in
forwarding any of the enclosed materials to your clients. The Issuer will pay or
cause to be paid any transfer taxes payable on the transfer of shares of
Preferred Stock to it, except as otherwise provided in the Letter of
Transmittal.
Questions and requests for assistance with respect to the Offer or for
copies of the Offer to Exchange and Letter of Transmittal may be directed to the
Depositary or the Information Agent at their addresses set forth in the Offer to
Exchange.
Very truly yours,
KELLEY OIL & GAS CORPORATION
NOTHING CONTAINED HEREIN OR IN THE ENCLOSED DOCUMENTS SHALL CONSTITUTE YOU
OR ANY OTHER PERSON THE AGENT OF THE ISSUER OR ANY AFFILIATE THEREOF, OR
AUTHORIZE YOU OR ANY OTHER PERSON TO MAKE ANY STATEMENTS OR USE ANY DOCUMENT ON
BEHALF OF ANY OF THEM IN CONNECTION WITH THE OFFER OTHER THAN THE ENCLOSED
DOCUMENTS AND THE STATEMENTS CONTAINED THEREIN.
-2-
<PAGE> 15
CUSIP 487906-20-8
KELLEY OIL & GAS CORPORATION
OFFER TO EXCHANGE
15 SHARES OF COMMON STOCK FOR EACH SHARE OF
$2.625 CONVERTIBLE EXCHANGEABLE PREFERRED STOCK
PURSUANT TO THE OFFER TO EXCHANGE
DATED JUNE 28, 1999
THE OFFER WILL EXPIRE AT 12:01 A.M., NEW YORK CITY TIME, ON TUESDAY, JULY 27,
1999 UNLESS EXTENDED (SUCH DATE, AS THE SAME MAY BE EXTENDED, THE "EXPIRATION
DATE"). HOLDERS OF PREFERRED STOCK (AS DEFINED BELOW) MUST VALIDLY TENDER THEIR
PREFERRED STOCK ON OR PRIOR TO THE EXPIRATION DATE IN ORDER FOR THEIR PREFERRED
STOCK TO BE EXCHANGED PURSUANT TO THIS OFFER. TENDERED PREFERRED STOCK MAY BE
WITHDRAWN AT ANY TIME PRIOR TO THE EXPIRATION DATE.
TO OUR CLIENTS:
Enclosed for your consideration is an Offer to Exchange dated June 28, 1999
(the "Offer to Exchange") and a Letter of Transmittal (which together constitute
the "Offer") relating to the offer by Kelley Oil & Gas Corporation (the
"Issuer") to exchange 15 shares of its Common Stock for each share of its $2.625
Convertible Exchangeable Preferred Stock ("Preferred Stock").
The enclosed material is being forwarded to you as the beneficial owner of
Preferred Stock held by us for your account at benefit but not registered in
your name. A tender of any Preferred Stock may only be made by us as the
registered Holder pursuant to your instructions. Therefore, the Issuer urges
beneficial owners of Preferred Stock registered in the name of a broker, dealer,
commercial bank, trust company or other nominee to contact such Holder promptly
if they wish to tender Preferred Stock in the Offer.
Accordingly, we request instructions as to whether you wish us to tender
any or all such Preferred Stock held by us for your account or benefit, pursuant
to the terms and conditions set forth in the Offer to Exchange and Letter of
Transmittal. We urge you to read carefully the Offer to Exchange and Letter of
Transmittal before instructing us to tender your Preferred Stock.
Your instructions to us should be forwarded as promptly as possible in
order to permit us to tender Preferred Stock on your behalf in accordance with
the provisions of the Offer. The Offer expires at 12:01 a.m., New York City
time, on Tuesday, July 27, 1999, unless extended. The term "Expiration Date"
shall mean 12:01 a.m., New York City time, on Tuesday, July 27, 1999, unless the
Offer is extended as provided in the Offer to Exchange, in which case the term
"Expiration Date" shall mean the latest date and time to which the Offer is
extended. A tender of Preferred Stock may be withdrawn at any time prior to
12:01 a.m., New York City time, on the Expiration Date.
<PAGE> 16
Your attention is directed to the following:
1. The Offer is for the tender of each share of Preferred Stock for 15
shares of Common Stock. As of June 25, 1999, 1,733,628 shares of
Preferred Stock were outstanding.
2. The Offer is subject to certain conditions. See "The Offer--Certain
Conditions of the Offer" in the Offer to Exchange.
3. The Offer and withdrawal rights will expire at 12:01 a.m., New York
City time, on Tuesday, July 27, 1999, unless extended.
4. The Issuer has agreed to pay certain expenses of the Offer. Any
transfer taxes incident to the transfer of Preferred Stock from the
tendering Holder to the Issuer will be paid by the Issuer, except as
provided in the Offer to Exchange and the Letter of Transmittal. See
"Fees and Expenses" in the Offer to Exchange.
The Offer is not being made to, nor will tenders be accepted from or on
behalf of Holders of Preferred Stock, residing in any jurisdiction in which the
making of the Offer or acceptance thereof would not be in compliance with the
laws of such jurisdiction.
If you wish us to tender any or all of your Preferred Stock held by us for
your account or benefit, please do instruct us by completing, executing and
returning to us the attached instruction form. THE ACCOMPANYING LETTER OF
TRANSMITTAL IS FURNISHED TO YOU FOR INFORMATIONAL PURPOSES ONLY AND MAY NOT BE
USED BY YOU TO EXCHANGE PREFERRED STOCK HELD BY US AND REGISTERED IN OUR NAME
FOR YOUR ACCOUNT OR BENEFIT.
THIS MATERIAL RELATING TO THE OFFER IS BEING FORWARDED TO YOU AS THE
BENEFICIAL OWNER OF PREFERRED STOCK CARRIED BY US FOR YOUR ACCOUNT OR BENEFIT
BUT NOT REGISTERED IN YOUR NAME. A TENDER OF ANY SUCH PREFERRED STOCK WITH
RESPECT THERETO CAN BE MADE ONLY BY US AS THE REGISTERED HOLDER AND PURSUANT TO
YOUR INSTRUCTIONS. THE LETTER OF TRANSMITTAL IS FURNISHED TO YOU FOR YOUR
INFORMATION ONLY AND CANNOT BE USED BY YOU TO TENDER PREFERRED STOCK WITH
RESPECT TO SUCH PREFERRED STOCK, HELD BY US FOR YOUR ACCOUNT.
-2-
<PAGE> 17
INSTRUCTIONS
The undersigned acknowledge(s) receipt of your letter and the enclosed
material referred to therein relating to the Offer of Kelley Oil & Gas
Corporation.
This will instruct you to tender for exchange the aggregate number of
shares of Preferred Stock indicated below (or, if no aggregate principal amount
is indicated below, all shares of Preferred Stock) held by you for the account
or benefit of the undersigned, pursuant to the terms of and conditions set forth
in the Offer to Exchange and the Letter of Transmittal.
Number of Shares of Preferred Stock to be tendered:
________________________*
* I (we) understand that if I (we) sign this instruction form without indicating
an aggregate number of shares of Preferred Stock in the space above, all
shares of Preferred Stock held by you for my (our) account will be tendered.
----------------------------------------------------
----------------------------------------------------
Signature(s)
----------------------------------------------------
Capacity (full title) if signing in a
fiduciary or representative capacity
----------------------------------------------------
----------------------------------------------------
----------------------------------------------------
Name(s) and address, including zip code
Date:
----------------------------------------------------
Area Code and Telephone Number
----------------------------------------------------
Taxpayer Identification or Social Security No.
-3-
<PAGE> 1
CUSIP 487906-20-8
KELLEY OIL & GAS CORPORATION
NOTICE OF GUARANTEED DELIVERY
FOR TENDER OF ITS
$2.625 CONVERTIBLE EXCHANGEABLE PREFERRED STOCK
FOR 15 SHARES OF COMMON STOCK FOR EACH SHARE OF PREFERRED STOCK
PURSUANT TO THE OFFER TO EXCHANGE
DATED JUNE 28, 1999
THE OFFER WILL EXPIRE AT 12:01 A.M., NEW YORK CITY TIME, ON TUESDAY, JULY
27, 1999, UNLESS EXTENDED (SUCH DATE, AS THE SAME MAY BE EXTENDED, THE
"EXPIRATION DATE.") HOLDERS OF PREFERRED STOCK (AS DEFINED BELOW) MUST VALIDLY
TENDER THEIR PREFERRED STOCK ON OR PRIOR TO THE EXPIRATION DATE IN ORDER FOR
THEIR PREFERRED STOCK TO BE EXCHANGED PURSUANT TO THIS OFFER. TENDERED PREFERRED
STOCK MAY BE WITHDRAWN AT ANY TIME PRIOR TO THE EXPIRATION DATE.
The Depositary for the Offer is:
ChaseMellon Shareholder Services, L.L.C.
<TABLE>
<S> <C> <C>
BY REGISTERED OR BY OVERNIGHT COURIER HAND DELIVERY OR
CERTIFIED MAIL: IN PERSON:
ChaseMellon Shareholder ChaseMellon Shareholder ChaseMellon Shareholder
Services, L.L.C. Services, L.L.C. Services, L.L.C.
Post Office Box 3301 85 Challenger Road -- 120 Broadway, 13th Floor
New York, NY 10271 Mail Drop -- Reorg New York, NY 10271
Attn: Reorganization Department Ridgefield Park, NJ 07660 Attn: Reorganization Department
Attn: Reorganization Department
</TABLE>
BY FACSIMILE:
(201) 296-4293
CONFIRM FACSIMILE BY TELEPHONE
(201) 296-4860
The Information Agent is:
D.F. King & Co., Inc.
77 Water Street
New York, New York 10005
Banks and Brokers Call Collect:
(212) 269-5550
or
All Others Call Toll Free:
(800) 488-8095
DELIVERY OF THIS NOTICE OF GUARANTEED DELIVERY TO AN ADDRESS OTHER THAN AS
SET FORTH ABOVE OR TRANSMISSION OF THIS NOTICE OF GUARANTEED DELIVERY VIA
FACSIMILE TO A NUMBER OTHER THAN AS SET FORTH ABOVE WILL NOT CONSTITUTE A VALID
DELIVERY.
Ladies and Gentlemen:
The undersigned hereby tenders to Kelley Oil & Gas Corporation, a Delaware
corporation (the "Issuer"), upon the terms and subject to the conditions set
forth in the Offer to Exchange dated June 28, 1999 (as the same may be amended
or supplemented from time to time, the "Offer to Exchange"), and the related
Letter of Transmittal (which together constitute the "Offer"), receipt of which
is hereby acknowledged, the aggregate number of shares of Preferred Stock set
forth below pursuant to the guaranteed delivery procedures
<PAGE> 2
set forth in the Offer to Exchange under the caption "The Offer--Procedures for
Tendering Preferred Stock--Guaranteed Delivery". All capitalized terms used
herein but not defined shall have the meanings ascribed to them in the Offer to
Exchange.
The undersigned understands and acknowledges that the Offer will expire at
12:01 a.m., New York City time, on Tuesday, July 27, 1999, unless extended by
the Issuer. The term "Expiration Date" shall mean 12:01 a.m., New York City
time, on Tuesday, July 27, 1999, unless the Offer is extended as provided in the
Offer to Exchange, in which case the term "Expiration Date" shall mean the
latest date and time to which the Offer is extended.
SIGNATURE
x Date:
x Date:
Signature(s) of Registered Holder(s)
or Authorized Signatory
Area Code and Telephone Number:
Name(s):
(Please Print)
Capacity (full title, if signing in a fiduciary or
representative capacity):
----------------------------------------------------
Address:
Taxpayer Identification Number or
Social Security No.:
Aggregate Number of Shares of
Preferred Stock Tendered
Certificate Number(s) of
Preferred Stock (if available):
Aggregate Number of Shares of
Preferred Stock Represented by Certificate(s):
IF TENDERED PREFERRED STOCK WILL BE
DELIVERED BY BOOK-ENTRY TRANSFER,
PROVIDE THE DEPOSITORY TRUST COMPANY
("DTC") ACCOUNT NO. AND TRANSACTION
CODE (IF AVAILABLE):
Account No.:
Transaction No.:
-2-
<PAGE> 3
GUARANTEE OF DELIVERY
(NOT TO BE USED FOR SIGNATURE GUARANTEE)
The undersigned, a firm or other entity identified as an "eligible
guarantor institution" within the meaning of Rule 17Ad-15 promulgated under the
Securities Exchange Act of 1934, as amended, guarantees deposit with the
Depositary of a properly completed and executed Letter of Transmittal (or
facsimile thereof), or an Agent's Message, as well as the certificate(s)
representing all tendered shares of Preferred Stock in proper form for transfer,
or confirmation of the book-entry transfer of such shares of Preferred Stock
into the Depositary's account at DTC as described in the Offer to Exchange under
the caption "The Offer--Procedures for Tendering Preferred Stock--Guaranteed
Delivery" and other documents required by the Letter of Transmittal, all by
12:01 a.m., New York City time, on the third New York Stock Exchange trading day
following the Expiration Date.
Name of Eligible Institution:
Authorized
Signature
Address:
Name:
Title:
Date:
Area Code and Telephone
No.
NOTE: DO NOT SEND PREFERRED STOCK WITH THIS NOTICE OF GUARANTEED DELIVERY.
ACTUAL SURRENDER OF PREFERRED STOCK MUST BE MADE PURSUANT TO, AND BE ACCOMPANIED
BY, A PROPERLY COMPLETED AND DULY EXECUTED LETTER OF TRANSMITTAL AND ANY OTHER
REQUIRED DOCUMENTS.
-3-
