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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
SCHEDULE 13E-4
(AMENDMENT NO. 3)
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)
8 1/2% CONVERTIBLE SUBORDINATED DEBENTURES DUE 2000
7 7/8% CONVERTIBLE SUBORDINATED NOTES DUE 1999
(Titles of Classes of Securities)
487-736-AA8
487-736-AB6
(CUSIP Numbers of Classes 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
APRIL 19, 1999
(Date Tender Offer First Published,
Sent or Given to Security Holders)
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This Amendment No. 3 (this "Amendment") supplements and amends the
information set forth in an Issuer Tender Offer Statement on Schedule 13E-4
filed with the Securities and Exchange Commission on April 19, 1999 and amended
on May 7, 1999 and May 10, 1999 (as further amended hereby, this "Schedule
13E-4") relating to the offer by Kelley Oil & Gas Corporation, a Delaware
corporation (the "Company"), to purchase up to $26.9 million principal amount of
the Company's 8 1/2% Convertible Subordinated Debentures due April 1, 2000 (the
"8 1/2% Debentures") and $34.1 million principal amount of the Company's 7 7/8%
Convertible Subordinated Notes due December 15, 1999 (the "7 7/8% Notes", and
together with the 8 1/2% Debentures the "Securities"), at an aggregate purchase
price of approximately $36.0 million, plus accrued and unpaid interest thereon
to the date of repurchase, upon the terms and subject to the conditions set
forth in the Offer to Purchase dated April 19, 1999 (the "Offer to Purchase"),
and in the related Letters of Transmittal (the "Letters of Transmittal"; the
Offer to Purchase and the Letters of Transmittal, collectively, as amended or
supplemented from time to time, the "Offer"). On May 7, 1999, the Company issued
a press release (the "Press Release") to waive the minimum-tender condition of
the Offer. The Offer to Purchase, the Letters of Transmittal and the Press
Release are filed herewith as Exhibits (a)(1), (a)(2), (a)(3) and (a)(11)
hereto. This amendment reflects a change to the "Fees and Expenses" section of
the Offer to Purchase appearing on page 26 of the Offer to Purchase.
The following items are amended to read in their entirety as follows:
ITEM 9. MATERIAL TO BE FILED AS EXHIBITS.
Except as indicated otherwise, each of the following documents was
previously filed with this Schedule 13E-4.
(a) (1)* Form of Offer to Purchase dated April 19, 1999, as amended.
(2) Form of Letter of Transmittal for the 8 1/2% Debentures dated
April 19, 1999; together with Guidelines for Certification of Taxpayer
Identification Number on Substitute Form W-9.
(3) Form of Letter of Transmittal for the 7 7/8% Notes dated April 19,
1999, together with Guidelines for Certification of Taxpayer Identification
Number on Substitute Form W-9.
(4) Form of Notice of Guaranteed Delivery for the 8 1/2% Debentures.
(5) Form of Notice of Guaranteed Delivery for the 7 7/8% Notes.
(6) Form of Letter to Brokers, Dealers, Commercial Banks, Trust
Companies, and Other Nominees dated April 19, 1999 for the 8 1/2%
Debentures.
(7) Form of Letter to Brokers, Dealers, Commercial Banks, Trust
Companies and Other Nominees dated April 19, 1999 for the 7 7/8% Notes.
(8) Form of Letter to Clients for use by Brokers, Dealers, Commercial
Banks, Trust Companies, and Other Nominees dated April 19, 1999 for the
8 1/2% Debentures.
(9) Form of Letter to Clients for use by Brokers, Dealers, Commercial
Banks, Trust Companies and Other Nominees dated April 19, 1999 for the
7 7/8% Notes.
(10) Supplement to Offer to Purchase.
(11) Press Release of the Company dated May 7, 1999.
(b) Not applicable.
(c) Not applicable.
(d) Not applicable.
(e) Not applicable.
(f) Not applicable.
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* Filed herewith
1
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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 May 12, 1999
KELLEY OIL & GAS CORPORATION
By: /s/ RICK G. LESTER
----------------------------------
Rick G. Lester,
Chief Financial Officer
2
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EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
Except as indicated otherwise, each of the following documents was
previously filed with this Schedule 13E-4.
<S> <C>
(a)(1)* -- Form of Offer to Purchase dated April 19, 1999.
(2) -- Form of Letter of Transmittal for the 8 1/2% Debentures
dated April 19, 1999; together with Guidelines for
Certification of Taxpayer Identification Number on
Substitute Form W-9.
(3) -- Form of Letter of Transmittal for the 7 7/8% Notes dated
April 19, 1999, together with Guidelines for
Certification of Taxpayer Identification Number on
Substitute Form W-9.
(4) -- Form of Notice of Guaranteed Delivery for the 8 1/2%
Debentures.
(5) -- Form of Notice of Guaranteed Delivery for the 7 7/8%
Notes.
(6) -- Form of Letter to Brokers, Dealers, Commercial Banks,
Trust Companies, and Other Nominees dated April 19, 1999
for the 8 1/2% Debentures.
(7) -- Form of Letter to Brokers, Dealers, Commercial Banks,
Trust Companies and Other Nominees dated April 19, 1999
for the 7 7/8% Notes.
(8) -- Form of Letter to Clients for use by Brokers, Dealers,
Commercial Banks, Trust Companies, and Other Nominees
dated April 19, 1999 for the 8 1/2% Debentures.
(9) -- Form of Letter to Clients for use by Brokers, Dealers,
Commercial Banks, Trust Companies and Other Nominees
dated April 19, 1999 for the 7 7/8% Notes.
(10) -- Supplement to Offer to Purchase.
(11) -- Press Release of the Company dated May 7, 1999.
</TABLE>
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* Filed herewith
<PAGE> 1
EXHIBIT (A)(1)
KELLEY OIL & GAS CORPORATION
OFFER TO PURCHASE FOR CASH UP TO
$26,856,000 PRINCIPAL AMOUNT OF ITS
8 1/2% CONVERTIBLE SUBORDINATED DEBENTURES DUE 2000
CUSIP 487-736-AA8
AND
$34,147,000 PRINCIPAL AMOUNT OF ITS
7 7/8% CONVERTIBLE SUBORDINATED NOTES DUE 1999
CUSIP 487-736-AB6
AT $590 FOR EACH $1,000 PRINCIPAL AMOUNT OF DEBENTURES
OR NOTES TENDERED, PLUS ACCRUED AND UNPAID INTEREST THEREON
THIS OFFER WILL EXPIRE AT 12:01 A.M., NEW YORK CITY TIME, ON SATURDAY, MAY 15,
1999 UNLESS EXTENDED (SUCH DATE, AS THE SAME MAY BE EXTENDED, THE "EXPIRATION
DATE"). HOLDERS OF SECURITIES (AS DEFINED BELOW) MUST VALIDLY TENDER THEIR
SECURITIES ON OR PRIOR TO THE EXPIRATION DATE IN ORDER TO RECEIVE THE PURCHASE
PRICE (AS DEFINED BELOW). TENDERED SECURITIES MAY BE WITHDRAWN AT ANY TIME PRIOR
TO THE EXPIRATION DATE. THE OFFER IS CONDITIONED UPON A MINIMUM OF $55.0 MILLION
PRINCIPAL AMOUNT OF SECURITIES BEING TENDERED AND NOT WITHDRAWN AND ALSO IS
SUBJECT TO CERTAIN OTHER CONDITIONS. SEE "THE OFFER -- CERTAIN CONDITIONS OF THE
OFFER".
KELLEY OIL & GAS CORPORATION, a Delaware corporation (the "Company"),
hereby invites the holders (collectively, "Holders" and each a "Holder") of its
8 1/2% Convertible Subordinated Debentures due April 1, 2000 (the "8 1/2%
Debentures") and its 7 7/8% Convertible Subordinated Notes due December 15, 1999
(the "7 7/8% Notes" and with the 8 1/2% Debentures, the "Securities") to tender
up to all of the outstanding principal amount of Securities to the Company at a
price equal to $590 per $1,000 principal amount of Securities tendered, plus
accrued and unpaid interest through the date of payment (the "Purchase Price"),
upon the terms and subject to the conditions set forth herein and in the Letter
of Transmittal. References herein to the "Letter of Transmittal" refer to the
accompanying Letter of Transmittal relating to the 8 1/2% Debentures or to the
accompanying Letter of Transmittal relating to the 7 7/8% Notes, as applicable.
This Offer to Purchase and the Letter of Transmittal together constitute the
"Offer".
The Company will pay the Purchase Price for all Securities validly tendered
and not withdrawn upon the terms and subject to the conditions of the Offer.
THE BOARD OF DIRECTORS OF THE COMPANY HAS APPROVED THE OFFER AND BELIEVES
THE OFFER IS FAIR TO HOLDERS OF SECURITIES FROM A FINANCIAL POINT OF VIEW.
HOWEVER, THIS BELIEF DOES NOT CONSTITUTE A RECOMMENDATION TO ANY HOLDER
REGARDING THE OFFER, AND EACH HOLDER MUST MAKE THE DECISION WHETHER TO TENDER
SECURITIES AND, IF SO, THE PRINCIPAL AMOUNT OF SECURITIES TO TENDER. THIS OFFER
IS BEING MADE TO ALL HOLDERS.
THIS TRANSACTION HAS NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE 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.
(cover page continues)
------------------------
THE DEALER MANAGER FOR THE OFFER IS:
JEFFERIES & COMPANY, INC.
The Date of this Offer to Purchase is April 19, 1999
<PAGE> 2
Under no circumstances will any interest be payable because of any delay in
the transmission of funds to Holders of Securities. Subject to applicable
securities laws and the terms set forth in the Offer, the Company reserves the
right (i) to waive any and all conditions to the Offer, (ii) to extend or to
terminate the Offer or (iii) otherwise to amend the Offer in any respect.
Notwithstanding any other provision of the Offer, the Company's obligation
to accept for payment, and to pay for, Securities validly tendered pursuant to
the Offer is conditioned upon numerous conditions, including the Company
receiving a minimum $55.0 million principal amount of Securities validly
tendered and not withdrawn and receipt by the Company of the net proceeds from
the Phillips Transaction (as defined herein) and the Senior Secured Offering (as
defined herein). The Company may waive any of the conditions of the Offer, in
whole or in part, at any time and from time to time. See "The Offer -- Certain
Conditions of the Offer".
SEE "RISK FACTORS" BEGINNING ON PAGE 9, "CERTAIN UNITED STATES FEDERAL
INCOME TAX CONSEQUENCES" BEGINNING ON PAGE 24, AND "ANNEX D -- RISK FACTORS" FOR
DISCUSSIONS OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED IN EVALUATING THE
OFFER.
If the Offer is withdrawn or otherwise not completed, the Purchase Price
will not be paid or become payable to Holders who have validly tendered their
Securities in connection with the Offer.
Any questions or requests for assistance may be directed to the Information
Agent or the Dealer Manager at their respective addresses and telephone numbers
set forth below. Requests for additional copies of this Offer to Purchase, the
Letter of Transmittal, the Notice of Guaranteed Delivery and other related
documents may be directed to the Information Agent. Beneficial owners may also
contact their broker, dealer, commercial bank or trust company for assistance
concerning the Offer.
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
THE DEALER MANAGER FOR THE OFFER IS:
JEFFERIES & COMPANY, INC.
909 Fannin Street, Suite 3100
Houston, Texas 77010
(713) 658-1100
Attention: Todd A. Dittmann
ii
<PAGE> 3
TABLE OF CONTENTS
<TABLE>
<S> <C>
IMPORTANT INFORMATION REGARDING THE OFFER................... 2
ADDITIONAL INFORMATION...................................... 2
CAUTION AS TO FORWARD-LOOKING STATEMENTS.................... 3
SUMMARY OF THE OFFER........................................ 4
INTRODUCTION................................................ 5
General................................................... 5
Fairness of the Offer to Holders.......................... 6
The Company............................................... 6
Current Industry Conditions and Liquidity Concerns........ 7
Reasons for the Offer..................................... 8
RISK FACTORS................................................ 9
THE OFFER................................................... 12
Amount of Securities...................................... 12
Procedures for Tendering Securities....................... 12
Withdrawal Rights......................................... 15
Purchase of Securities and Payment of Purchase Price...... 15
Certain Conditions of the Offer........................... 16
SOURCE AND AMOUNT OF FUNDS.................................. 17
CERTAIN INFORMATION CONCERNING THE COMPANY.................. 18
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION...... 20
INTERESTS OF DIRECTORS AND OFFICERS; TRANSACTIONS AND
ARRANGEMENTS CONCERNING SECURITIES........................ 24
EFFECTS OF THE OFFER ON THE MARKET FOR SECURITIES;
REGISTRATION UNDER THE EXCHANGE ACT....................... 24
CERTAIN LEGAL MATTERS; REGULATORY APPROVALS................. 24
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES....... 24
EXTENSION OF THE OFFER; TERMINATION; AMENDMENT.............. 25
FEES AND EXPENSES........................................... 26
MISCELLANEOUS............................................... 27
GLOSSARY.................................................... 28
ANNEXES
ANNEX A -- Business and Properties........................ A-1
ANNEX B -- Selected Consolidated Financial Data........... B-1
ANNEX C -- Management's Discussion and Analysis of
Financial Condition and Results of
Operations..................................... C-1
ANNEX D -- Risk Factors................................... D-1
ANNEX E -- Description of the Senior Secured Notes........ E-1
ANNEX F -- Financial Statements........................... F-1
</TABLE>
1
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IMPORTANT INFORMATION REGARDING THE OFFER
Any Holder wishing to tender all or any part of his, her or its Securities
should either: (a) complete and sign a Letter of Transmittal (or a facsimile
thereof) in accordance with the instructions in the Letter of Transmittal and
either mail or deliver it with any required signature guarantee or an Agent's
Message (as defined below) and any other required documents to Norwest Bank
Minnesota, National Association (the "Depositary"), and either mail or deliver
the certificates for such tendered Securities to the Depositary (with all such
other documents) or tender such Securities pursuant to the procedure for
book-entry delivery set forth under "The Offer -- Procedures for Tendering
Securities"; or (b) request a broker, dealer, commercial bank, trust company, or
other nominee to effect the transaction for such Holder. Holders having
Securities registered in the name of a broker, dealer, commercial bank, trust
company or other nominee must contact that broker, dealer, commercial bank,
trust company or other nominee if they desire to tender their Securities.
Any Holder who desires to tender Securities and whose certificates for such
Securities cannot be delivered to the Depositary or who cannot comply with the
procedure for book-entry transfer or whose other required documents cannot be
delivered to the Depositary, in any case, by the expiration of the Offer must
tender such Securities pursuant to the guaranteed delivery procedure set forth
under "The Offer -- Procedures for Tendering Securities".
The Depository Trust Company ("DTC") has authorized DTC participants that
hold Securities on behalf of beneficial owners of Securities through DTC to
tender their Securities 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 under "The
Offer -- Procedures for Tendering Securities" or (ii) transmit their acceptance
to DTC through the DTC Automated Tender Offer Program ("ATOP"), for which the
transaction will be eligible, and follow the procedure for book-entry transfer
set forth under "The Offer -- Procedures for Tendering Securities". A beneficial
owner of Securities that are held of record by a custodian bank, depositary,
broker, trust company or other nominee must instruct such Holder to tender the
Securities on the beneficial owner's behalf. A Letter of Instructions is
included in the materials provided along with this Offer to Purchase, which may
be used by a beneficial owner in this process to give such instructions. See
"The Offer -- Procedures for Tendering Securities".
Additional copies of this Offer to Purchase, the Letter of Transmittal and
other tender offer materials may be obtained from the Information Agent and will
be furnished at the Company's expense. Questions and requests for assistance may
be directed to the Information Agent at its address and telephone number set
forth on the back cover of this Offer to Purchase. Holders may also contact
their local broker, dealer, commercial bank, trust company or other nominee for
assistance concerning the Offer.
ADDITIONAL INFORMATION
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 Securities and Exchange Commission (the "Commission")
relating to its 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.
2
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CAUTION AS TO FORWARD-LOOKING STATEMENTS
Statements contained in this Offer to Purchase, including the Annexes
hereto, and related materials 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), relating to matters such as the fairness of the Offer
to Holders of Securities, the Company's ability to repay its debt obligations as
they mature, including obligations under the Securities, anticipated operating
and financial performance, business prospects, developments and results of the
Company that are forward-looking in nature are "forward-looking statements".
Actual performance, prospects, developments and results may differ materially
from any or all anticipated performance, prospects, developments and results
included in such forward-looking statements 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 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 9 of this Offer to Purchase and in Annex D.
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" and in Annex D.
3
<PAGE> 6
SUMMARY OF THE OFFER
This general summary is solely for the convenience of the Holders of the
Securities and is qualified in its entirety by reference to the full text and
more specific details in this Offer to Purchase and the related Letter of
Transmittal.
Principal Amount of
Securities to be
Purchased................ Up to $26,856,000 principal amount of 8 1/2%
Debentures and $34,147,000 principal amount of
7 7/8% Notes.
Purchase Price............. Upon the terms and subject to the conditions of the
Offer, $590 per $1,000 principal amount of
Securities validly tendered and not withdrawn, plus
accrued and unpaid interest thereon.
Minimum Amount of
Securities To be Tendered
and Other Conditions to
the Offer................ Completion of the Offer is subject to the Company
receiving a minimum of $55.0 million principal
amount of Securities being tendered and not
withdrawn and receipt by the Company of the net
proceeds from the Phillips Transaction and the
Senior Secured Offering. The Offer also is subject
to certain other conditions. See "The
Offer -- Certain Conditions of the Offer".
How to Tender Securities... See "The Offer -- Procedures for Tendering
Securities". Call the Information Agent or consult
your broker for assistance.
Transfer Tax............... None, if payment is made to the registered holder.
Expiration Date............ Saturday, May 15, 1999, at 12:01 a.m., New York
City time, unless the Offer is extended by the
Company.
Payment Date............... As soon as practicable after the expiration of the
Offer.
Position of the Company and
its Board of Directors..... The Board of Directors of the Company has approved
the Offer and believes it is fair to Holders of
Securities from a financial point of view as
described herein. Neither the Company nor its Board
of Directors makes any recommendation to any Holder
as to whether to tender or refrain from tendering
Securities. The Offer is being made to all Holders
of Securities. See "Introduction -- Fairness of the
Offer to Holders".
Withdrawal Rights.......... Tendered Securities may be withdrawn at any time
prior to the expiration of the Offer (12:01 a.m.,
New York City time, on Saturday, May 15, 1999, or
such later date to which the Offer is extended by
the Company). See "The Offer -- Withdrawal Rights".
For Further Developments... Call the Information Agent or consult your broker.
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 SECURITIES 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
PURCHASE 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.
4
<PAGE> 7
INTRODUCTION
GENERAL
The Company hereby invites the Holders of its 8 1/2% Debentures and its
7 7/8% Notes to tender up to all of the outstanding principal amount of
Securities to the Company at a price equal to $590 per $1,000 principal amount
of Securities tendered, plus accrued and unpaid interest through the date of
payment, upon the terms and subject to the conditions set forth herein and in
the Letter of Transmittal.
The Offer is part of a series of measures that the Company is pursuing to
alleviate the severe credit and liquidity problems it is currently experiencing.
The Company is making the Offer at this time and at the Purchase Price because:
- The Company is in default under its existing credit facility, and the
Offer is an important component of the Company's plan to address this
default.
- The Company's independent auditors have issued a "going concern" opinion
on the Company's 1998 financial statements indicating the Company's
liquidity issues and difficulties in meeting certain loan agreement
covenants raise substantial doubt about the Company's ability to continue
as a going concern.
- Receipt by the Company of the net proceeds from the Phillips Transaction
and the Senior Secured Offering are subject to numerous conditions. The
Company's ability to satisfy these conditions is dependent upon
completion of the Offer.
- If the Offer is not completed, the Company may not be able to meet its
financial obligations with respect to its outstanding indebtedness. In
such event, the Company will be required to restructure its debt
obligations, including the Securities at amounts that may be below the
Purchase Price, or seek protection under the federal bankruptcy laws.
There is currently $262.6 million in principal amount of indebtedness
that is senior to the Securities. Holders of such indebtedness will have
priority over the Holders of the Securities in a bankruptcy proceeding.
- The indentures governing the Company's indebtedness that are senior to
the Securities restrict the amount that the Company may apply to the
retirement or repurchase of the Securities.
The Offer also allows a participating Holder the opportunity to receive a
significant cash payment that a Holder may not otherwise receive, given the
Company's current financial condition, illiquidity of the Securities and
depressed industry conditions as well as the significant amount of indebtedness
that is senior in right of payment to the Securities. To the extent a Holder
elects to not tender Securities pursuant to the Offer and the Offer is
completed, the reduced amount of outstanding Securities may result in further
reduced trading activity, which could adversely affect the market for the
Securities. Such non-tendering Holder also would remain subject to the risk that
the Company's financial condition and depressed industry conditions would make
it unable to fulfill its repayment obligations with respect to the Securities at
maturity. See "-- The Company", "-- Current Industry Conditions and Liquidity
Concerns" and "-- Reasons for the Offer" below for additional discussion of
these issues and other issues that should be considered by Holders when
determining whether to tender pursuant to the Offer.
THE OFFER IS CONDITIONED UPON A MINIMUM OF $55.0 MILLION PRINCIPAL AMOUNT
OF SECURITIES BEING TENDERED AND NOT WITHDRAWN AND ALSO IS SUBJECT TO CERTAIN
OTHER CONDITIONS. SEE "THE OFFER -- CERTAIN CONDITIONS OF THE OFFER".
SEE "RISK FACTORS" BEGINNING ON PAGE 9, "CERTAIN FEDERAL INCOME TAX
CONSEQUENCES" BEGINNING ON PAGE 24 AND "ANNEX D -- RISK FACTORS" FOR DISCUSSIONS
OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED IN EVALUATING THE OFFER.
5
<PAGE> 8
FAIRNESS OF THE OFFER TO HOLDERS
The Board of Directors believes that, in light of the Company's current
circumstances and current industry conditions, the terms of the Offer are fair
from a financial point of view to the Holders. In support of the Board's belief
that the terms of the Offer are fair from a financial point of view to the
Holders, the Board relied, without independent verification, on the accuracy and
completeness of all the financial and other information available to them. The
Board's belief is necessarily based upon the market, economic, financial and
other conditions as they exist and can be evaluated only as of the date hereof,
and any change in such conditions may impact this belief. The Board expresses no
opinion as to the price at which either the 8 1/2% Debentures or the 7 7/8%
Notes will trade at any time. The Board's belief speaks only as of the date
hereof and does not constitute a recommendation to any Holder of Securities as
to whether such Holder should accept the terms of the Offer.
In support of this belief, the Board of Directors took into account a
variety of considerations, the most significant of which are outlined below.
- Going Concern. The Company's independent auditors issued their opinion on
the Company's 1998 financial statements indicating the Company's
liquidity issues and difficulties in meeting certain loan agreement
covenants raise substantial doubt about the Company's ability to continue
as a going concern.
- Liquidation. The Board believes that if the Offer and the Phillips
Transaction are not consummated, and the funds from the Senior Secured
Offering are not released to the Company, the Company could be forced to
liquidate its assets, which could result in the Holders receiving less
than the Purchase Price for the Securities.
- Current and Historical Market Prices. The Company believes that the
8 1/2% Debentures and the 7 7/8% Notes have traded, to the extent a
market has been available, at a significant discount from their principal
amounts. The Offer allows a participating Holder the opportunity to
receive a significant cash payment that a Holder may not otherwise
receive, particularly given the lack of a liquid trading market for the
Securities.
- Debt Ratings. The debt rating for the Securities was recently downgraded
to "Ca" by Moody's Investor Services, Inc. ("Moody's"), which, according
to Moody's published rating definitions, implies such securities are
"speculative in a high degree" and "often in default".
- Book Value. At December 31, 1998, the Company had a stockholders' deficit
of $66.9 million.
The Board did not receive any report, opinion or appraisal from an outside
party relating to the Purchase Price or the fairness of the Purchase Price to
Holders of the Securities. The Offer was approved by the Board of Directors of
the Company at a meeting held April 18, 1999.
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 have historically
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 December 31, 1998, the Company had approximately $320
million of long-term debt ($262.6 million of which is senior by its terms to the
Securities), and proved reserves with a PV-10 Value of $234 million at January
1, 1999. Approximately 90% of the Company's reserves are natural gas and 64% are
proved developed. 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.
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For additional information concerning the Company, see "Annex A -- Business
and Properties", "Annex B -- Selected Consolidated Financial Data", "Annex
C -- Management's Discussion and Analysis of Financial Condition and Results of
Operations", "Annex D -- Risk Factors", and "Annex F -- Financial Statements".
CURRENT INDUSTRY CONDITIONS AND LIQUIDITY CONCERNS
During 1998 and 1999, the oil and natural gas industry has experienced a
worldwide excess of supply over demand for oil and natural gas resulting in
sharply reduced prices. As a result, the Company experienced drastically reduced
profitability and cash flows which, in turn, created significant liquidity
problems. As discussed in Note 4 to the financial statements included in Annex F
to this Offer to Purchase, although the Company was in compliance with the debt
covenants of its existing bank credit facility (the "Credit Facility") at
December 31, 1998, the Company was not in compliance 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 the Company's other debt obligations being accelerated. A total of
$111.5 million in borrowings and $1.5 million in letters of credit were
outstanding under the Credit Facility at December 31, 1998. The indebtedness
under the Credit Facility is secured by substantially all of the oil and natural
gas assets of the Company. In addition, repayment of the $34.1 million
outstanding principal amount of the 7 7/8% Notes is scheduled to be made in
December 1999 and repayment of the $26.9 million principal amount of the 8 1/2%
Debentures is scheduled to be made in April 2000. These uncertainties raise
substantial doubt about the Company's ability to continue its operations as a
going concern and make the scheduled repayments of the Securities at their
maturities. 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 (the "Phillips Transaction"). As a result of this transaction,
the Company will (1) receive an $83 million cash payment (subject to
post-closing adjustments), (2) retain 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) retain 25% of its
working interest in the Cotton Valley formation. In addition, the Company will
be relieved of significant future operating, exploration and development costs.
Proceeds from the Phillips Transaction will be used to fund a portion of the
Purchase Price to be paid upon the completion of the Offer. The closing of the
Phillips Transaction is subject to the parties obtaining required consents and
meeting substantial closing requirements. See "Annex D -- Risk Factors --
Uncertainties Regarding the Phillips Transaction".
The Company also has closed into escrow an offering (the "Senior Secured
Offering") of $135,000,000 principal amount of its 14% Senior Secured Notes due
2003, maturing at 105% of their stated maturity amount (the "Senior Secured
Notes"). The gross proceeds from the sale of the Senior Secured Notes initially
have been placed into an escrow account (the "Escrow") along with
unauthenticated and unissued Senior Secured Notes. If the Phillips Transaction
is consummated and other conditions are met on or before May 17, 1999, the Notes
will be issued to the investors in the Senior Secured Offering and the net
proceeds of the Senior Secured Offering (together with proceeds earned by
investment of the Escrow) will be released to the Company. If such conditions
are not met on or before May 17, 1999, the Senior Secured Notes will not be
issued and the amounts in the Escrow (including proceeds earned by investment of
the Escrow) will be refunded together with an amount to be paid by the Company
to the Escrow equal to the amount of interest that would have accrued on the
Senior Secured Notes had the Senior Secured Notes been issued at the time of
funding of the Escrow, less the proceeds earned by investment of the Escrow. The
principal terms and conditions of the Senior Secured Notes are summarized in
"Annex E -- Description of the Senior Secured Notes".
The net proceeds to the Company from the Senior Secured Offering are
expected to be approximately $126.8 million. The majority of the net proceeds
will be used to repay outstanding indebtedness under the Credit Facility. The
repayment of outstanding indebtedness under the Credit Facility will terminate
the Company's ability to make further borrowings under the Credit Facility, and
the Company is not likely to be
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able to borrow additional amounts in the future under another credit facility.
The Company intends to use the remainder of the net proceeds of the Senior
Secured Offering for additional working capital and for general corporate
purposes.
REASONS FOR THE OFFER
The Company is making the Offer at this time and for the Purchase Price
because:
- The Company is in default under its Credit Facility due to its failure to
comply with covenants relating to maintenance of interest coverage
ratios. In addition, the "going concern" qualification in the Company's
independent auditors' opinion on the Company's 1998 financial statements
is a default under the Credit Facility. Both events allow the lenders
under the Credit Facility to accelerate the Company's repayment
obligations of $111.5 million. The Company is currently negotiating to
obtain waivers for these defaults through May 17, 1999, at which time the
Company intends to repay the outstanding borrowings under the Credit
Facility with the proceeds received from the Senior Secured Offering.
- The Company's independent auditors have issued a "going concern" opinion
on the Company's 1998 financial statements indicating the Company's
liquidity issues and difficulties in meeting certain loan agreement
covenants raises substantial doubt about the Company's ability to
continue as a going concern. The issuance of an audit opinion on the
Company's March 31, 1999 financial statements without a going concern
qualification is a condition precedent to the receipt by the Company of
the net proceeds from the Senior Secured Offering currently held in
escrow. The Company believes completion of the Offer is necessary for the
issuance of such unqualified opinion.
- Successful completion of the Phillips Transaction and release of the net
proceeds from the Senior Secured Offering are subject to numerous
conditions. The Company's ability to satisfy these conditions is
dependent upon successful completion of the Offer.
(i) Completion of the Phillips Transaction is contingent upon the
Company refinancing its debt obligations under the Credit Facility.
(ii) The Company's ability to refinance its Credit Facility obligations
is contingent upon release to the Company of the net proceeds from
the Senior Secured Offering that are being held in escrow.
(iii) Release of the proceeds to the Company from the Senior Secured
Offering is subject to successful completion of the Phillips
Transaction and the Company's receipt an audit opinion on its
March 31, 1999 financial statements without a going concern
qualification as described above.
- If the Offer is not completed, the Company may not be able to meet its
financial obligations with respect to its debt obligations, including its
obligations to repay outstanding principal of the Securities at their
maturities. In such event, the Company will be required to restructure
its debt obligations, including the Securities at levels that may be
below the Purchase Price, or to seek protection under the federal
bankruptcy laws. There is currently $262.6 million in principal amount of
indebtedness that is senior to the Securities. Holders of such
indebtedness will have priority over the Holders of the Securities in a
bankruptcy proceeding.
- The indentures governing the Company's indebtedness that are senior to
the Securities restrict the amount that the Company may apply to the
retirement or repurchase of the Securities.
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RISK FACTORS
Holders should consider carefully the following factors, as well as the
other information contained in this Offer to Purchase, including the Annexes
hereto, in evaluating the Offer. In particular, Holders should carefully
consider the additional risk factors relating to an investment in the Company
that are discussed in "Annex D -- Risk Factors".
SUBSTANTIAL LEVERAGE; INABILITY TO SERVICE DEBT; LACK OF LIQUIDITY AND
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. The Company anticipates that it will fund
its debt service payments with the net cash proceeds of the Senior Secured
Offering remaining after retirement of the Credit Facility (assuming full
participation in a required offer by the Company to redeem up to $35 million in
stated principal amount of Senior Secured Notes at 104% of their stated
maturity) and cash flow from operations and proceeds from the Phillips
Transaction remaining after purchasing tendered Securities pursuant to the
Offer. 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 does not
receive the net proceeds from the Phillips Transaction and the Senior Secured
Offering, 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 or seek protection under the federal bankruptcy laws.
The indenture governing the Senior Secured Notes (the "Indenture") places
substantial limitations on the ability of the Company to pay in full its
subordinated debt obligations coming due within the next twelve months,
including the 7 7/8% Notes and 8 1/2% Debentures. The Company can provide no
assurance that it will be able to repay or redeem such subordinated debt
obligations prior to maturity or raise capital from sources permitted under the
Indenture to repay or refinance such subordinated debt obligations. The failure
of the Company to repurchase, repay or otherwise refinance its subordinated debt
obligations at or before maturity will result in a default under the indentures
governing those subordinated debt obligations, which in turn would result in
defaults under indentures governing the Company's other subordinated debt
obligations and under the Indenture. This could result in all of the Company's
long-term debt being declared immediately due and payable. In that circumstance,
the Company would have no choice but to seek protection under federal bankruptcy
laws. This could substantially hinder, delay or prevent the holders of the
Securities from being repaid in full or at all. There is currently $262.6
million in indebtedness that is senior by its terms to the Securities. Holders
of such senior indebtedness would have priority over Holders in a bankruptcy
proceeding.
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. Following receipt of the proceeds from the Senior
Secured Offering and application of the net proceeds, the Company is not likely
to have access to a revolving credit facility to supplement its cash needs.
Following receipt of the proceeds from the Senior Secured Offering and the
Phillips Transaction and completion of the Offer, the Company will continue to
have significant debt outstanding and will continue to be subject to various
commodity and economic factors beyond its control, which 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 "Annex C -- Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Liquidity and Capital
Resources".
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RESTRICTIVE DEBT COVENANTS
The Company is subject to a number of significant covenants that, among
other things, restrict the ability of the Company to pay amounts due under the
Securities, dispose of assets, incur additional indebtedness, repay other
indebtedness, incur liens, enter into certain investments or acquisitions,
repurchase or redeem capital stock, 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, including honoring its obligations
to repay the outstanding principal of the Securities at their maturities.
In this regard, even if the Offer is completed and the proceeds from the
Senior Secured Offering and Phillips Transaction are received by the Company,
there can still be no assurance that the Company will be able to repay in full
the outstanding principal amounts of Securities held by non-tendering Holders.
The Indenture currently prohibits the Company from using proceeds in excess of
$36 million from the Senior Secured Offering, future operating cash flow or
asset sales to repurchase subordinated debt such as the Securities. Therefore,
any attempt by the Company to repay the aggregate principal amounts of the
Securities remaining outstanding at maturity could result in a default under the
Senior Secured Notes, which could result in acceleration of the Company's
repayment obligations thereunder.
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 current prices for
oil and natural gas, 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
The trading volume of the Securities historically has been very limited. To
the extent that Securities are tendered and accepted for payment pursuant to the
Offer, the trading market for Securities that remain outstanding could be even
more limited than historical levels. The extent of the market for the Securities
and the availability of market quotations will depend upon the number of Holders
of the Securities remaining at such time, the interest in maintaining a market
in the Securities on the part of securities firms and other factors. As a
result, there can be no assurance that any trading market for the Securities
will exist after consummation of the Offer.
A debt security with a smaller outstanding principal amount available for
trading (a smaller "float") may command a lower price than would a comparable
debt security with a greater float. Therefore, the market price for Securities
that are not tendered and purchased in the Offer may be affected adversely to
the extent that the principal amount of Securities purchased pursuant to the
Offer reduces the float. A reduced float also may make the trading price of
Securities that are not purchased in the Offer more volatile.
RISKS ASSOCIATED WITH MAINTAINING AN INVESTMENT IN THE COMPANY
Holders should consider the risks associated in maintaining an investment
in the Company when determining whether to tender Securities pursuant to the
Offer. Such risks, in addition to the factors enumerated above, include those
associated with (i) depletion of reserves and necessity of successful
exploration and development; (ii) uncertainties in estimating reserves and
future net cash flow; (iii) volatility of oil, natural gas and natural gas
liquid prices; (iv) operating hazards and uninsured risks; (v) government laws
and regulations; (vi) hedging transactions entered into by the Company; (vii)
competition; (viii) dependence on key personnel; and (ix) control by a principal
stockholder. Each of these risk factors is described in more detail in "Annex
D -- Risk Factors".
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FRAUDULENT CONVEYANCE AND RELATED CONSIDERATIONS
Although the standards will vary depending on the law of the jurisdiction
applied, in general, if a court were to find that, at the time the holders of
Securities received payments of the Purchase Price either (i) the Company paid
such amounts, or incurred the related indebtedness or made other related
distributions, with the intent of hindering, delaying or defrauding creditors,
or (ii) the Company (a) received less than fair consideration or a reasonably
equivalent value for paying such amounts, or for incurring the related
indebtedness or making other related distributions and (b) either (x) was
insolvent or rendered insolvent by reason of the distribution, payment or loan
of such amounts, the incurrence of such indebtedness or such related
distributions or payments, (y) was engaged in a business for which its remaining
assets constituted unreasonably small capital, or (z) was acting with the intent
or belief that it would incur debts beyond its ability to repay such debts as
they matured (as the foregoing terms are defined in or interpreted under
applicable federal and state fraudulent conveyance statutes), then such court
may find that such payments involved the incurring of obligations or the
transfers of interests in property deemed to be a fraudulent conveyance under
applicable law. To the extent such payments were deemed to be a fraudulent
conveyance, there is a risk that such payments would be avoided and that
consenting and tendering holders of Securities would be ordered by a court to
turn over to the Company, or to a fund for the benefit of the creditors of the
Company or to judgment creditors of the Company, as the case may be, some or all
of the portion of the consideration paid to Holders for their Securities.
The measure of insolvency for purposes of the foregoing will vary depending
on the law of the jurisdiction that is being applied. Generally, however, a
corporation would be considered insolvent if the present fair saleable value of
its assets were less than the amount that would be required to pay its probable
liabilities on its existing debts as they become absolute and matured. There can
be no assurance as to what standard a court would use to determine whether the
Company was "solvent" in connection with such payments or as to whether,
whatever standard was used, the Company would be found to have been solvent in
such connection.
Separate and apart from any fraudulent conveyance challenge, any payments
made to holders in consideration for their tendering of their Securities also
may be subject to challenge as a preference if such payments (a) are made within
90 days prior to a bankruptcy filing by the Company, (b) are made when the
Company is insolvent and (c) permit the holders to receive more than they
otherwise might receive in a liquidation under applicable bankruptcy laws. If
such payments were deemed to be a preference, the full amount of such payments
could be recovered by the Company as debtor in possession or the trustee in
bankruptcy, and Holders would be restored to their previous position as holders
of Securities.
The Company believes that the payments made for the Securities tendered
pursuant to the Offer are being made for proper purposes and in good faith.
CONDITIONS TO CONSUMMATION OF THE OFFER AND RELATED RISKS
The consummation of the Offer is subject to the satisfaction or waiver of
numerous conditions, including the receipt of the net proceeds from the Phillips
Transaction and the Senior Secured Offering. See "The Offer -- Certain
Conditions of the Offer". There can be no assurance that such conditions will
occur or that, in the event the Offer is not consummated, the market value and
liquidity of the Securities will not be materially adversely affected.
THE PURCHASE PRICE IS AT A DISCOUNT TO THE PRINCIPAL AMOUNT OF THE SECURITIES
Although the Offer allows participating Holders an opportunity to receive a
significant cash payment for the Securities, the Purchase Price to be paid in
cash for validly tendered Securities pursuant to the Offer is $590 for each
$1,000 principal amount of Securities tendered, which represents a discount to
the principal amount of the Securities. A Holder who holds the Securities until
maturity would be entitled to receive payment of the full principal amount,
assuming the Company has the financial means to make such payment. Certain risks
associated with the Company's ability to repay the entire principal amount of
the Securities at their maturity, including the substantial amount of debt that
is senior in right of payment to the Securities, are discussed above.
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THE OFFER
AMOUNT OF SECURITIES
Upon the terms and subject to the conditions of the Offer, the Company will
purchase up to $26.9 million principal amount of 8 1/2% Debentures and $34.1
million principal amount of 7 7/8% Notes, constituting all of the issued and
outstanding principal amount of Securities, or such lesser number of Securities
subject to the minimum thresholds discussed below, as are validly tendered (and
not withdrawn, as described under "-- Withdrawal Rights") prior to the
Expiration Date (as defined below) at a price equal to $590 per each $1,000
principal amount of Securities validly tendered and not withdrawn, plus accrued
and unpaid interest to the date of purchase. The term "Expiration Date" means
12:01 a.m. New York City time, on Saturday, May 15, 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; Termination; Amendment" for a description of the
Company's right to extend, delay, terminate, or amend the Offer.
THE OFFER IS CONDITIONED UPON A MINIMUM OF $55.0 MILLION PRINCIPAL AMOUNT
OF SECURITIES BEING TENDERED AND NOT WITHDRAWN AND ALSO IS SUBJECT TO CERTAIN
OTHER CONDITIONS. SEE "-- CERTAIN CONDITIONS OF THE OFFER".
This Offer to Purchase and the related Letter of Transmittal will be mailed
to record holders of Securities and will be furnished to brokers, banks, and
similar persons whose names, or the names of whose nominees, appear on the
Company's debenture holder and noteholder lists or, if applicable, who are
listed as participants in a clearing agency's security position listing for
subsequent transmittal to beneficial owners of Securities.
PROCEDURES FOR TENDERING SECURITIES
Proper Tender of Securities. For Securities to be validly tendered pursuant
to the Offer: (a) the certificates for such Securities (or confirmation of
receipt of such Securities 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 Purchase; 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 a member of a recognized signature
guarantee or medallion program within the meaning of Rule 17Ad-15 under the
Securities Exchange Act of 1934, as amended (the "Exchange Act") (an "Eligible
Institution"), unless: (i) this Letter of Transmittal is signed by the
registered holders(s) of the Securities (which term, for purposes of this
document, shall include any participant in the Book-Entry Transfer Facility
whose name appears on a security position listing as the owner of Securities)
tendered herewith and such holder(s) have not completed the box entitled
"Special Payment Instructions" or the box entitled "Special Delivery
Instructions" on this Letter of Transmittal; or (ii) such Securities are
tendered for the account of an Eligible Institution. See Instruction 1 of the
Letter of Transmittal. If a certificate for Securities is registered in the name
of a person other than the person executing a Letter of Transmittal, or if
payment is to be made, or Securities not purchased or 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, payment for Securities tendered and accepted for payment
pursuant to the Offer will be made only after timely receipt by the Depositary
of certificates for such Securities (or a timely confirmation of a book-entry
transfer of such Securities into the Depositary's account at the Book-Entry
Transfer Facility as
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<PAGE> 15
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
SECURITIES, 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 TIMELY DELIVERY.
Book-Entry Delivery. The Depositary will establish an account with respect
to the Securities for purposes of the Offer at the Book-Entry Transfer Facility
(i.e., DTC) within two business days after the date of this Offer to Purchase,
and any financial institution that is a participant in the Book-Entry Transfer
Facility's system may make book-entry delivery of the Securities by causing such
Facility to transfer Securities into the Depositary's account in accordance with
such Book-Entry Transfer Facility's procedures for transfer. Although delivery
of Securities may be effected through a book-entry transfer into the
Depositary's account at the Book-Entry Transfer Facility, either: (i) a properly
completed and duly executed Letter of Transmittal (or a manually signed
facsimile thereof) with any required signature guarantees or an Agent's Message,
and any other required documents must, in any case, be transmitted to and
received by the Depositary at its address set forth on the back cover of this
Offer to Purchase prior to the Expiration Date; or (ii) the guaranteed delivery
procedure described below must be followed. The confirmation of a book-entry
transfer of Securities into the Depositary's account at the Book-Entry Transfer
Facility as described above is referred to herein as "confirmation of a
book-entry transfer".
DELIVERY OF DOCUMENTS TO THE BOOK-ENTRY TRANSFER FACILITY DOES NOT
CONSTITUTE DELIVERY TO THE DEPOSITARY.
The term "Agent's Message" means a message transmitted by the Book-Entry
Transfer Facility to, and received by, the Depositary and forming a part of a
confirmation of a book-entry transfer which states that such Book-Entry Transfer
Facility has received an express acknowledgment from the participant in such
Book-Entry Transfer Facility tendering the Securities that such participant has
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.
Guaranteed Delivery. Holders whose Securities certificates are not
immediately available, who cannot deliver their Securities 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
Securities 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 Securities in proper form for transfer by delivery, or a confirmation
of a book-entry transfer into the Depositary's account at the Book-Entry
Transfer Facility of all Securities 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 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.
United States Federal Income Tax Backup Withholding. Under the United
States federal income tax backup withholding rules, unless an exemption applies
under the applicable law and regulations, 31% of the gross proceeds payable to a
Holder or other payee pursuant to the Offer must be withheld and remitted to the
United States Treasury, unless the Holder or other payee provides its taxpayer
identification number (employer identification number or social security number)
to the Depositary and certifies that such number
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<PAGE> 16
is correct. Therefore, each tendering Holder must complete and sign the
Substitute Form W-9 included as part of the Letter of Transmittal so as to
provide the information and certification necessary to avoid backup withholding,
unless such Holder otherwise establishes to the satisfaction of the Depositary
that it is not subject to backup withholding. Certain Holders (including, among
others, all corporations and certain foreign Holders) are not subject to these
backup withholding requirements. To prevent possible erroneous backup
withholding, an exempt holder must enter its correct taxpayer identification
number in Part I of Substitute Form W-9, certify that such Holder is not subject
to backup withholding in Part 2 of such form, and sign and date the form. See
the Guidelines for Certification of Taxpayer Identification Number of Substitute
Form W-9 enclosed with Letter of Transmittal for additional instructions. Such
statements may be obtained from the Depositary. See Instruction 9 of the Letter
of Transmittal. Holders are urged to consult their own tax advisors regarding
the application of United States federal income tax withholding
TO PREVENT UNITED STATES FEDERAL INCOME TAX BACKUP WITHHOLDING EQUAL TO 31%
OF THE GROSS PAYMENTS MADE TO HOLDERS FOR SECURITIES PURCHASED PURSUANT TO THE
OFFER, EACH HOLDER WHO DOES NOT OTHERWISE ESTABLISH AN EXEMPTION FROM SUCH
WITHHOLDING MUST PROVIDE THE DEPOSITARY WITH THE HOLDER'S CORRECT TAXPAYER
IDENTIFICATION NUMBER AND PROVIDE CERTAIN OTHER INFORMATION BY COMPLETING THE
SUBSTITUTE FORM W-9 INCLUDED WITH THE LETTER OF TRANSMITTAL.
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 Securities; Waiver of Defects; No
Obligation to Give Notice of Defects. All questions as to the number of
Securities to be accepted and the validity, form, eligibility (including time of
receipt), and acceptance of any tender of Securities 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 Securities that it determines in its reasonable judgment are
not in appropriate form or the acceptance for payment of or payments for which
maybe unlawful. The Company also reserves the absolute right in its sole
discretion to waive any of the conditions of the Offer or any defect or
irregularity in any tender with respect to any particular Securities or any
particular Holder. No tender of Securities 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, the Information
Agent, 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 Securities 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 Securities being tendered within the meaning of Rule 14e-4
promulgated by the Commission under the Exchange Act; and (b) the tender of such
Securities complies with Rule 14e-4. It is a violation of Rule 14e-4 for a
person, directly or indirectly, to tender Securities 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) Securities tendered
or; (y) other securities convertible into or exchangeable or exercisable for the
Securities tendered and will acquire such Securities for tender by conversion,
exchange, or exercise and; (ii) will deliver or cause to be delivered such
Securities 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 Securities 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.
14
<PAGE> 17
CERTIFICATES FOR SECURITIES, 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 Securities pursuant to the
Offer are irrevocable. Securities 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, Securities tendered pursuant to
the Offer and not accepted by the Company for payment may be withdrawn at any
time after 12:00 midnight, New York City time, on June 7, 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 Purchase. 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 Securities), the number of Securities tendered,
and the number of Securities to be withdrawn. If the certificates for Securities
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 Securities to
be withdrawn, and the signature on the notice of withdrawal must be guaranteed
by an Eligible Institution (except in the case of Securities tendered by an
Eligible Institution). If Securities have been tendered pursuant to the
procedure for book-entry transfer set forth in -- Procedures for Tendering
Securities, 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 Securities 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 reasonable 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 Securities withdrawn will
thereafter be deemed not tendered for purposes of the Offer, unless such
withdrawn Securities are validly retendered prior to the Expiration Date by
again following one of the procedures described under "-- Procedures for
Tendering for Securities".
If the Company extends the Offer, is delayed in its purchase of Securities,
or is unable to purchase Securities 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 Securities on behalf of the Company,
and such Securities may not be withdrawn except to the extent tendering Holders
are entitled to withdrawal rights as described herein.
PURCHASE OF SECURITIES AND PAYMENT OF PURCHASE PRICE
For purposes of the Offer, the Company will be deemed to have accepted for
payment (and therefore purchased) Securities that are validly tendered and not
only when, as, and if it gives oral or written notice to the Depositary its
acceptance of such Securities for payment pursuant to the Offer. Notwithstanding
anything in this Offer to Purchase or in the Letter of Transmittal to the
contrary, the Company's obligation to pay the Purchase Price, however, is
contingent upon the Company's receipt of the net proceeds from the Phillips
Transaction and the Senior Secured Offering.
Upon the terms and subject to the conditions of the Offer, the Company will
purchase the Securities and pay the Purchase Price for all of the Securities
accepted for payment pursuant to the Offer as soon as practicable after the
Expiration Date. In all cases, payment for Securities tendered and not withdrawn
and accepted for payment pursuant to the Offer will be made, but only after
timely receipt by the Depositary of certificates for Securities (or of a timely
confirmation of a book-entry transfer of such Securities into the Depositary's
account at the Book-Entry Transfer Facility), a properly completed and duly
executed Letter of Transmittal (or manually signed facsimile thereof) and any
other required documents.
15
<PAGE> 18
The Company will pay for Securities purchased pursuant to the Offer by
depositing the aggregate Purchase Price therefor with the Depositary, which will
act as agent for tendering Holders for the purpose of receiving payment from the
Company and transmitting payment to the tendering Holders.
The Company will pay or cause to be paid all transfer taxes, if any,
payable on the transfer to it of Securities purchased pursuant to the Offer. If,
however, payment of the Purchase Price is to be made to, or (in the
circumstances permitted by the Offer) if unpurchased Securities are to be
registered in the name of, any person other than the registered Holder(s), or if
tendered certificates are registered in the name of any person other than the
person(s) signing the Letter of Transmittal, the amount of all transfer taxes,
if any (whether imposed on the registered Holder(s) or such other person or
otherwise) payable on account of the transfer to such person will be deducted
from the Purchase Price unless satisfactory evidence of the payment of the
transfer taxes, or exemption therefrom, is submitted. See Instruction 7 of the
Letter of Transmittal.
THE COMPANY MAY BE REQUIRED TO WITHHOLD AND REMIT TO THE IRS 31% OF THE
GROSS PROCEEDS PAID TO ANY TENDERING HOLDER OR OTHER PAYEE WHO FAILS TO COMPLETE
FULLY, SIGN, AND RETURN TO THE DEPOSITARY THE SUBSTITUTE FORM W-9 INCLUDED IN
THE LETTER OF TRANSMITTAL. SEE "CERTAIN UNITED STATES FEDERAL INCOME TAX
CONSEQUENCES".
CERTAIN CONDITIONS OF THE OFFER
The Company's obligation to accept for payment a tendered security is
contingent upon, among other things, it receiving a minimum of $55.0 million in
principal amount of Securities being validly tendered and not withdrawn. The
Company's obligation to accept tenders of Securities and pay the Purchase Price
is also contingent upon it receiving the net proceeds from the Phillips
Transaction and the Senior Secured Offering.
In addition, notwithstanding any other provision of the Offer, the Company
shall not be required to accept for payment, purchase, or pay for any Securities
tendered, and may terminate or amend the Offer, or may postpone the acceptance
for payment of, or the purchase of and the payment for Securities tendered,
subject to Rule 13e-4(f) under the Exchange Act, if at any time on or after
April 19, 1999, 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 payment or payment:
(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 Securities 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 payment of, or payment
for, some or all of the Securities 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 payment or pay for some or all of the
Securities; (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
16
<PAGE> 19
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
Securities (other than the Offer), 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 Notes, 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 Securities, or any new group shall have been formed that
beneficially owns more than 5% of the outstanding Securities; 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.
SOURCE AND AMOUNT OF FUNDS
The Company will finance the payment of the Purchase Price for Securities
tendered in the Offer from a portion of the proceeds received from the Phillips
Transaction and from cash on hand. None of the net proceeds from the Senior
Secured Offering will be utilized to purchase Securities.
\
17
<PAGE> 20
CERTAIN INFORMATION CONCERNING THE COMPANY
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 Offer, the consummation of the Phillips Transaction and receipt of
the net proceeds from the Senior Secured Offering and the application of the
proceeds therefrom (assuming full participation in the Company's required offer
to purchase $35 million of Senior Secured Notes at 104% of their stated
principal amount). The historical financial information for the years ended
December 31, 1996, 1997 and 1998 is derived from the financial statements
included in Annex F. The unaudited pro forma data are derived from the Unaudited
Pro Forma Consolidated Financial Information included elsewhere in this Offer to
Purchase. The unaudited pro forma income statement data and other financial data
give effect to the Offer, the consummation of the Phillips Transaction, the
receipt of the net proceeds from the Senior Secured Offering and the application
of the proceeds therefrom (assuming full participation in the Company's required
offer to purchase $35 million of Senior Secured Notes at 104% of their stated
principal amount) as if they occurred on January 1, 1998. The unaudited pro
forma balance sheet data as of December 31, 1998 give effect to the Offer, the
consummation of the Phillips Transaction, the receipt by the Company of the net
proceeds from the Senior Secured Offering and the application of the proceeds
therefrom (assuming full participation in the Company's required offer to
purchase $35 million of Senior Secured Notes at 104% of their stated principal
amount) as if they occurred on December 31, 1998. The pro forma financial
information presented below is unaudited and is not necessarily indicative of
financial results that would have occurred had the Offer, the consummation of
the Phillips Transaction and the receipt by the Company of the net proceeds from
the Senior Secured Offering and the application of the proceeds therefrom
(assuming full participation in the Company's required offer to purchase $35
million of Senior Secured Notes at 104% of their stated principal amount)
occurred on January 1, 1998 (for income statement data) or December 31, 1998
(for balance sheet data) and should not be viewed as indicative of operations in
future periods. This information should be read in conjunction with "Unaudited
Pro Forma Consolidated Financial Information", included elsewhere herein, "Annex
C -- Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Annex F -- Financial Statements".
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
PRO FORMA
1996 1997 1998 1998
-------- -------- -------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Oil and gas revenues............................... $ 60,854 $ 75,864 $ 79,150 $ 55,338
Interest and other income.......................... 1,429 274 505 1,139
Gain on sale of oil and gas properties............. -- -- -- 28,315
-------- -------- -------- --------
Total revenues................................ 62,283 76,138 79,655 84,792
-------- -------- -------- --------
Production expenses................................ 10,709 10,955 19,878 17,022
Exploration expenses............................... 5,438 5,433 12,034 12,034
General and administrative expenses................ 8,953 6,875 7,077 7,077
Interest and other debt expenses................... 24,401 25,071 33,333 39,902
Restructuring expenses............................. 4,276 -- -- --
Depreciation, depletion and amortization........... 20,440 25,853 38,602 33,032
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) $(50,013)
======== ======== ======== ========
OTHER DATA:
Ratio of Earnings to Fixed Charges(2).............. N/A 1.1x N/A N/A
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
------------------------
HISTORICAL PRO FORMA
----------- ----------
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET AND RELATED DATA:
Cash and cash equivalents................................... $ 8,435 $ 36,794
Total assets................................................ 286,197 264,518
PV-10 Value(3).............................................. 234,284 N/A
Long-term debt, including current maturities................ 319,751 259,323
Long-term debt senior to the Securities, including current
maturities................................................ 262,597 251,097
Stockholders' deficit....................................... (66,939) (28,190)
</TABLE>
18
<PAGE> 21
- ---------------
(1) Reflects non-cash impairment charges against the carrying value of proved
and unproved oil and natural gas properties under SFAS 121. See "Annex
C -- Management's Discussion and Analysis of Financial Condition and Results
of Operations" and Note 2 to the Financial Statements contained in "Annex
F -- Financial Statements".
(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 and $0.2 million for the years ended
December 31, 1996, 1997 and 1998, respectively, plus fixed charges. Fixed
charges consist of interest expense and other debt expenses. For the years
ended December 31, 1996 and 1998, earnings were insufficient to cover fixed
charges by $12.8 million and $57.2 million, respectively, and $50.2 million
for the year ended December 31, 1998, Pro Forma.
(3) PV-10 Value is not necessarily indicative of actual future cash flows. See
"Annex D -- Risk Factors -- Uncertainties in Estimating Reserves and Future
Net Cash Flows" and "Glossary".
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 included in "Annex F -- 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
"Annex D -- Risk Factors -- Uncertainties in Estimating Reserves and Future
Net Cash Flows" and "Glossary".
(2) Includes the effects of the Company's hedging activities.
19
<PAGE> 22
UNAUDITED PRO FORMA
CONSOLIDATED FINANCIAL INFORMATION
The following unaudited pro forma consolidated statement of operations for
the year ended December 31, 1998 gives effect to the Offer, consummation of the
Phillips Transaction and receipt by the Company of the net proceeds from the
Senior Secured Offering and the application of the proceeds therefrom (assuming
full participation in the Company's required offer to purchase $35 million of
Senior Secured Notes at 104% of their stated principal amount) as if each had
occurred on January 1, 1998. The following unaudited pro forma consolidated
balance sheet as of December 31, 1998 gives effect to the Offer, consummation of
the Phillips Transaction and receipt by the Company of the net proceeds from the
Senior Secured Offering and the application of the proceeds therefrom (assuming
full participation in the Company's required offer to purchase $35 million of
Senior Secured Notes at 104% of their stated principal amount) as if each had
occurred on December 31, 1998. The unaudited pro forma consolidated balance
sheet as of December 31, 1998 and statement of operations for the year ended
December 31, 1998 are based upon the Financial Statements included in "Annex
F -- 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 Offering 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. See footnote 3 to the Pro
Forma Statement 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 "Annex
C -- Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Annex F -- Financial Statements".
20
<PAGE> 23
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
UNAUDITED PRO FORMA
CONSOLIDATED BALANCE SHEET
AS OF DECEMBER 31, 1998
ASSETS
<TABLE>
<CAPTION>
ADJUSTMENTS
--------------------------------------
SENIOR
SECURED PHILLIPS
HISTORICAL OFFERING TRANSACTION OFFER PRO FORMA
---------- --------- ----------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents........................ $ 8,435 $ 15,250(1) $ 46,600(4) $(33,491)(8) $ 36,794
Accounts receivable.............................. 18,071 18,071
Accounts receivable -- drilling programs......... 624 624
Prepaid expenses and other current assets........ 1,121 1,121
--------- --------- -------- -------- ---------
Total current assets........................... 28,251 15,250 46,600 (33,491) 56,610
--------- --------- -------- -------- ---------
Unproved properties.............................. 38,293 38,293
Properties subject to amortization............... 496,686 (54,685)(5) 442,001
Pipelines and other transportation assets, at
cost........................................... 1,582 1,582
Furniture, fixtures and equipment................ 3,554 3,554
--------- --------- -------- -------- ---------
Total property and equipment................... 540,115 (54,685)(5) 485,430
--------- --------- -------- -------- ---------
Less: Accumulated depreciation, depletion and
amortization................................... (283,660) (283,660)
--------- --------- -------- -------- ---------
Total property and equipment, net.............. 256,455 (54,685)(5) 201,770
--------- --------- -------- -------- ---------
Other non-current assets, net.................... 1,491 6,786(2) (2,139)(6) 6,138
--------- --------- -------- -------- ---------
Total assets............................. $ 286,197 $ 22,036 $(10,224) $(33,491) $ 264,518
========= ========= ======== ======== =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Accounts payable and accrued expenses............ $ 33,113 $ 33,113
Accounts payable -- drilling programs............ 272 272
Current portion of long-term debt................ 32,251 $(27,491)(8) 4,760
--------- --------- -------- -------- ---------
Total current liabilities...................... 65,636 (27,491) 38,145
--------- --------- -------- -------- ---------
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................ 150,662 150,662
8 1/2% Convertible Subordinated Debentures....... 25,338 (21,437)(8) 3,901
--------- --------- -------- -------- ---------
Total long-term debt........................... 287,500 23,500 (35,000) (21,437) 254,563
--------- --------- -------- -------- ---------
Total liabilities........................ 353,136 23,500 (35,000) (48,928) 292,708
--------- --------- -------- -------- ---------
Preferred stock.................................. 2,600 2,600
Common stock..................................... 1,260 1,260
Additional paid-in capital....................... 300,653 300,653
Retained earnings................................ (371,452) (1,464)(2) 24,776(7) 15,437(9) (332,703)
--------- --------- -------- -------- ---------
Total stockholders' deficit.............. (66,939) (1,464) 24,776 15,437 (28,190)
--------- --------- -------- -------- ---------
Total liabilities and stockholders'
deficit................................ $ 286,197 $ 22,036 $(10,224) $(33,491) $ 264,518
========= ========= ======== ======== =========
</TABLE>
- ---------------
(1) To record the cash proceeds from the Senior Secured Offering in excess of
the repayment of the Credit Facility.
(2) To record the debt issuance costs associated with the Senior Secured
Offering and the writeoff of the remaining capitalized issuance costs
associated with the Credit Facility.
(3) To record the aggregate stated principal amount of the Senior Secured Notes
issued in the Senior Secured Offering and the application of a portion of
the net proceeds from the Senior Secured Offering 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 of Senior Secured Notes at 104% of the principal amount.
(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, accordingly, the reduction of Properties
subject to amortization is presented net of estimated accumulated
depreciation, depletion and amortization.
21
<PAGE> 24
(6) To record the writeoff of debt issuance costs associated with the repurchase
of Senior Secured Notes after consummation of the Phillips Transaction.
(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................... $28,315
Writeoff of a proportionate amount of debt issuance
costs associated with the repurchase of the Senior
Secured Notes.......................................... (2,139)
Extraordinary loss on the repurchase of the Senior
Secured Notes.......................................... (1,400)
-------
Net gain................................................ $24,776
=======
</TABLE>
(8) To record the repurchase, net of deferred debt expenses, of the minimum
number, estimated to be $55 million, of tendered subordinated debt pursuant
to the Offer to Purchase.
(9) The pro forma adjustment to retained earnings resulting from the Offer
includes the following:
<TABLE>
<S> <C>
Extraordinary gain resulting from the extinguishment of
subordinated debt...................................... $19,045
Writeoff of a proportionate amount of debt issuance
costs associated with the subordinated debt............ (2,510)
Commissions............................................. (1,098)
-------
Net gain................................................ $15,437
=======
</TABLE>
22
<PAGE> 25
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
UNAUDITED PRO FORMA
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
ADJUSTMENTS
------------------------------------
SENIOR
SECURED PHILLIPS
HISTORICAL OFFERING TRANSACTION OFFER PRO FORMA
---------- -------- ----------- ------- ---------
(IN THOUSANDS)
<S> <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............ 28,315(5) 28,315
-------- -------- -------- ------- --------
Total revenues.................................. 79,655 370 4,767 84,792
-------- -------- -------- ------- --------
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) $(4,476)(9) 39,902
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) (4,476) 134,805
-------- -------- -------- ------- --------
Loss before income taxes.......................... (57,007) (16,159) 18,677 4,476 (50,013)
Income taxes......................................
-------- -------- -------- ------- --------
Net loss(10)...................................... (57,007) (16,159) 18,677 4,476 (50,013)
Preferred stock dividends......................... (4,550) (4,550)
-------- -------- -------- ------- --------
Net loss applicable to common stock............... $(61,557) $(16,159) $ 18,677 $ 4,476 $(54,563)
======== ======== ======== ======= ========
</TABLE>
- ---------------
(1) To record interest income on the net cash proceeds from the Senior Secured
Offering in excess of the repayment of the Credit Facility.
(2) The pro forma adjustment to interest expense includes the following:
<TABLE>
<S> <C>
Senior Secured Notes........................................ $21,172
Amortization of Senior Secured Offering costs............... 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 will receive an $83
million cash payment, retain a 42 Bcfe volumetric overriding royalty
interest (VORI) and retain 25% of its interest in the Cotton Valley
formation. This agreement will also 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 2007
---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Bcf........................................... 2.29 4.22 9.60 7.78 6.35 3.66 4.63 3.64 0.37
</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 Senior Secured
Notes at 104% of the 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 buy-back of
Senior Secured Notes triggered by the Phillips Transaction.
(8) To record the reduction in depreciation, depletion and amortization
pursuant to the Phillips Transaction.
(9) The pro forma adjustment to interest expense includes the following:
<TABLE>
<S> <C>
7 7/8% Convertible Subordinated Notes....................... $(2,421)
8 1/2% Convertible Subordinated Debentures.................. (2,055)
-------
$(4,476)
=======
</TABLE>
(10) Net loss from continuing operations excludes the extraordinary loss of
$3,539, including the writeoff of $2,139 of debt issuance costs, from the
repurchase of $35 million of Senior Secured Notes at 104% of principal
amount; and the extraordinary gain of $15,437 from the repurchase of a
minimum number, estimated to be $55 million, of the outstanding amount of
the 7 7/8% Convertible Subordinated Notes and 8 1/2% Convertible
Subordinated Debentures, including the writeoff of $2,510 of debt issuance
costs.
23
<PAGE> 26
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 Securities 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 Securities during the 40 business
days prior to the date hereof.
EFFECTS OF THE OFFER ON THE MARKET FOR SECURITIES;
REGISTRATION UNDER THE EXCHANGE ACT
The Company's purchase of Securities pursuant to the Offer will reduce the
number of Securities that might otherwise be traded publicly and may reduce the
number of noteholders.
The 8 1/2% Debentures are 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 purchase of 8 1/2% Debentures pursuant to the Offer may will result in
the 8 1/2% Debentures 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 Securities 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 Securities 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 payment of or payment for Securities 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 payment and
pay for Securities are subject to certain conditions. See "The Offer -- Certain
Conditions of the Offer".
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following is a general summary of certain federal income tax
consequences of the sale of Securities to the Company pursuant to the Offer. The
discussion is based on the Internal Revenue Code of 1986, as amended (the
"Code"), temporary and final Treasury regulations promulgated thereunder,
judicial decisions and administrative rulings, all of which are subject to
change. The following does not address the federal income tax consequences to
all categories of Holders of Securities that may be subject to special rules
(e.g., foreign holders, insurance companies, financial institutions, dealers in
securities or currencies, tax-exempt organizations and persons holding
Securities as part of a hedging or conversion transaction or a straddle), nor
does it address the federal income tax consequences to persons who do not hold
the Securities as "capital assets" within the meaning of Section 1221 of the
Code (generally, property held for investment). Any person who is considering
tendering Securities should consult his tax advisor regarding federal, state,
local and foreign income and other tax consequences of tendering the Securities.
Sale of Securities Pursuant to the Offer
The receipt of cash for the Securities pursuant to the Offer will be a
taxable transaction. In general, subject to the market discount rules and other
issues discussed below, a Holder of Securities will recognize capital gain or
loss at the time such Holder's Securities are purchased by the Company in an
amount equal to
24
<PAGE> 27
the difference between the Purchase Price received (except to the extent
attributable to accrued interest on the Securities) and the Holders's tax basis
in the Securities purchased. Such gain or loss will be a long-term capital gain
or loss if the Holder has held the Securities for a period in excess of one
year, except to the extent of accrued interest on the Securities, which
generally will be taxed as ordinary income. Holders should consult their tax
advisors with respect to rules under the Code which may limit any tax deduction
for capital losses.
A Holder who purchased his Securities at "market discount" (i.e., at a
price below their face amount) may be subject to certain recharacterization
rules with respect to the gain, if any, recognized on a sale of the Securities
pursuant to the Offer. In general, under the market discount rules, any gain
recognized on the sale of Securities pursuant to the Offer will be treated as
interest income (rather than capital gain) to the extent of the accrued market
discount (unless the Holder had previously elected to include such market
discount in income as it accrued).
Backup Withholding
In order to avoid backup withholding, a Holder of Securities (other than an
exempt Holder) whose tendered Securities are accepted for payment must provide
the Depositary (as payor) with his correct taxpayer identification number,
which, in the case of a Holder who is an individual, is his social security
number, or otherwise establish a basis for exemption from backup withholding.
The Depositary will be required to file information returns with the Internal
Revenue Service reporting the gross proceeds of the Offer to nonexempt Holders.
Exempt Holders (including, among others, all corporations and certain foreign
individuals and entities) are not subject to these backup withholding and
reporting requirements. To prevent backup withholding, each nonexempt Holder
must provide his correct taxpayer identification number by completing the
applicable form provided in the Letter of Transmittal, certifying that the
taxpayer identification number provided is correct (or that such Holder is
awaiting a taxpayer identification number) and that (i) the Holder has not been
notified by the Internal Revenue Service that he is subject to backup
withholding as a result of failure to report all interest or dividends or (ii)
the Internal Revenue Service has notified the Holder that he is no longer
subject to backup withholding.
If the Depositary is not provided with the correct taxpayer identification
number and certificate of no loss of exemption from backup withholding or other
adequate basis for exception, the Holder may be subject to a $50 penalty imposed
by the Internal Revenue Service, and gross proceeds of the Offer paid to the
Holder may be subject to a 31% backup withholding tax. Any amount withheld under
these rules will be creditable against the Holder's federal income tax
liability, and if withholding results in an overpayment of taxes, a refund may
be applied for.
THE TAX DISCUSSION SET FORTH ABOVE IS INCLUDED FOR GENERAL INFORMATION
ONLY. EACH HOLDER IS URGED TO CONSULT SUCH HOLDER'S OWN TAX ADVISOR TO DETERMINE
THE PARTICULAR TAX CONSEQUENCES TO HIM, HER OR IT OF THE OFFER, INCLUDING THE
APPLICABILITY AND EFFECT OF STATE, LOCAL, AND FOREIGN TAX LAWS.
EXTENSION OF THE OFFER; TERMINATION; AMENDMENT
The Company expressly reserves the right, in its reasonable 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
payment of, and payment for, any Securities 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 reasonable discretion, to
terminate the Offer and not accept for payment or pay for any Securities not
theretofore accepted for payment or paid for or, subject to applicable law, to
postpone payment for Securities 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 payment for Securities which it has accepted for payment is limited by
25
<PAGE> 28
Rule 13e-4(f)(5) promulgated under the Exchange Act, which requires that the
Company must pay the consideration offered or return the Securities 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 in
Section 6 shall have occurred or shall be deemed by the Company to have
occurred, to amend the Offer in any respect (including, without limitation, by
decreasing or increasing the consideration offered in the Offer to holders of
Securities or by decreasing or increasing the number of Notes 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 noteholders in a manner reasonably designed to inform noteholders 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 making a 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 securities 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
Securities or the number of Securities 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 Norwest Bank Minnesota, National
Association. The Information Agent for the Offer is D.F. King & Company, Inc.
The Company also has retained Jefferies & Company, Inc. to act as Dealer Manager
in connection with the Offer and to advise it with respect to the Offer,
including the appropriate terms from the Company's perspective. Jefferies &
Company, Inc. will receive a usual and customary fee in consideration for its
services as Dealer Manager. The Dealer Manager reserves the right to pay a
negotiated commission to brokers or dealers for soliciting tenders of Securities
pursuant to the Offer. The Company will indemnify the Dealer Manager against
certain liabilities and expenses in connection therewith, including liabilities
under the federal securities laws. Jefferies & Company, Inc. expects in the
future to provide investment banking services to the Company and acted as
Initial Purchaser (and was compensated as such) in connection with the Senior
Secured Offering.
All deliveries, correspondence and questions sent or presented to the
Depositary, the Information Agent or Dealer Manager relating to the Offer should
be directed to one of the addresses or telephone numbers set forth in this Offer
to Purchase.
The Information Agent and the Dealer Manager may contact holders of
Securities by any available means, including mail, telephone, facsimile and
personal interviews, regarding the Offer and may request brokers, dealers,
commercial banks, trust companies and other nominees to forward this Offer to
Purchase and related materials to beneficial owners of Securities.
Requests for information or additional copies hereof or the Letter of
Transmittal should be directed to the Information Agent or the Dealer Manager.
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.
26
<PAGE> 29
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 Securities 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 Securities 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.
The Company will pay or cause to be paid all stock transfer taxes, if any,
on its purchase of Securities except as otherwise provided in Instruction 7 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 Securities 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 in Section 9 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 PURCHASE 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
April 19, 1999
27
<PAGE> 30
GLOSSARY
3-D seismic. (Three-Dimensional Seismic) Seismic reflections from the
subsurface used to map strata in three dimensions.
Bbl. One stock tank barrel, or 42 U.S. Gallons liquid volume, used herein
in reference to oil or other liquid hydrocarbons.
Bcf. One billion cubic feet of natural gas.
Bcfe. One billion cubic feet of natural gas equivalent (see Mcfe for
equivalency).
Condensate. A hydrocarbon mixture that becomes liquid and separates from
natural gas when the natural gas is produced.
Development costs. The costs incurred in preparing proved reserves for
production, i.e., costs incurred to obtain access to proved reserves and to
provide facilities for extracting, treating, gathering, and storing oil and
natural gas, but not including exploration costs.
Development well. A well drilled within the proved area of an oil or
natural gas reservoir to the depth of a stratigraphic horizon known to be
productive.
EBITDAX. Income before extraordinary items, interest expense and other debt
expenses, income taxes, exploration costs, restructuring expense, depletion,
depreciation, amortization, and impairment of oil and natural gas properties
expenses.
Estimated future net cash flows. The estimated net cash flows expected to
be derived upon production and sale from proved oil and natural gas reserves at
a date indicated. Estimated future net cash flows are computed after giving
effect to estimated future development and production costs at a date indicated
and assuming the continuation of existing economic conditions. The calculation
does not take into account the effect of various cash outlays, including general
and administrative costs and interest expense, and does not give effect to
estimated future income taxes.
Exploration costs. Costs incurred in exploring property. Exploration
involves identifying areas that may warrant examination and examining specific
areas, including drilling exploratory wells.
Gross acres. The total number of acres in which a working interest is
owned.
Gross wells. The total number of wells in which a working interest is
owned.
Lease operating expenses. The expenses of lifting oil and natural gas from
a producing formation to the surface, and the transportation and marketing
thereof, constituting part of the current operating expenses of a working
interest, and also including labor, superintendence, supplies, repairs,
maintenance, allocated overhead costs, ad valorem taxes and other expenses
incidental to production, but not including severance taxes or capital costs.
MBbls. One thousand barrels of oil or other liquid hydrocarbons.
Mcf. One thousand cubic feet of natural gas.
Mcfe. One thousand cubic feet of natural gas equivalent (converting one
barrel of oil to six Mcf of natural gas based on commonly accepted rough
equivalency of energy content).
MMBtu. One million British Thermal Units, a standard measure of energy
content.
Mmcf. One million cubic feet of natural gas.
Mmcfe. One million cubic feet of natural gas equivalent (see Mcfe for
equivalency).
Net acres. The sum of acres determined by adding the products of gross
acres in which there is an interest multiplied by the fractional working
interests of Kelley therein.
Net wells. The sum of the fractional working interests owned by Kelley in
gross wells.
28
<PAGE> 31
NYMEX. New York Mercantile Exchange.
PV-10 Value or present value of estimated future net cash flows. An
estimate of the present value of the estimated future net cash flows is
calculated by discounting estimated future net cash flows before income taxes at
an annual rate of 10%, in accordance with Commission practice, to determine
their "present value". The present value is shown to indicate the effect of time
on the value of the revenue stream and should not be construed as being the fair
market value of the properties. Estimates of future net cash revenues are made
using oil and natural gas prices and costs at the date indicated and held
constant for the life of the reserves.
Producing well or productive well. A well that is producing oil or natural
gas or that is capable of producing commercial quantities without further
capital expenditure.
Production expenses. Lease operating expenses plus severance taxes.
Proved developed reserves. Proved developed reserves are those quantities
of oil, natural gas and natural gas liquids that, upon analysis of geological
and engineering data, can be expected with reasonable certainty to be
recoverable in the future from known oil and natural gas reservoirs under
existing economic and operating conditions. This classification includes those:
(a) which are expected to be recovered from currently open and producing zones
under continuation of existing equipment and operating methods (proved developed
producing reserves); and (b) which consist of (i) reserves from wells that have
been completed and tested but are not yet producing due to lack of market or
minor completion problems that reasonably can be expected to be corrected, and
(ii) reserves currently behind pipe in existing wells which reasonably can be
expected to be productive due to both the well log characteristics and analogous
production in the immediate vicinity of the well (proved developed nonproducing
reserves).
Proved reserves. Proved reserves are those estimated quantities of oil,
natural gas and other hydrocarbon liquids which, by analysis of geological and
engineering data, can be estimated with reasonable certainty to be commercially
recoverable in future years from known reservoirs and under current economic
conditions, operating methods and government regulations.
Proved undeveloped reserves. Proved undeveloped reserves are reserves that
are expected to be recovered from (a) new wells on undrilled acreage, (b)
deepening existing wells to a different reservoir or (c) where a relatively
large expenditure is required to (i) recomplete an existing well or (ii) install
production or transportation facilities for primary or improved recovery
projects.
Reserves to production ratio. Calculated by dividing the total proved
reserves as of a specific date by production for the twelve-month period
immediately preceding such date. This term is sometimes referred to as "average
reserve life" (in years) or "estimated reserve life" (in years) by industry
participants or followers.
Working interest. The interest in an oil and natural gas property (normally
a leasehold interest) that gives the owner the right to drill, produce and
conduct oil and natural gas operations on the property and to a share of
production, subject to all royalties, overriding royalties and other burdens and
to all costs of exploration, development and operations and all risks in
connection therewith.
29
<PAGE> 32
ANNEX A
BUSINESS AND PROPERTIES
See "Glossary" in the Offer to Purchase for the definitions at certain
common oil and gas terms utilized in this Annex A.
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 have historically
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 January 1, 1999, the Company had a PV-10 Value of $234
million. Approximately 90% of the Company's reserves are natural gas and 64% are
proved developed. 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.
The Company continues to experience development and exploration success,
achieving in 1998 a 98% success rate on development activities and an overall
success rate of 87% on the drilling of 62 total wells. The Company expects to
spend $10-$12 million on lower-risk drilling in 1999, substantially all of which
is discretionary.
The Company has entered into an exploration and development agreement with
Phillips Petroleum Company ("Phillips") relating to certain of its interests in
the Bryceland, West Bryceland and Sailes fields in north Louisiana (the
"Phillips Transaction"). 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. If the Company consummates the Phillips
Transaction, substantially more funds will be available for the Company's
drilling activities. The consummation of such transaction is subject to
substantial closing conditions, and the release of the proceeds from the
Company's Senior Secured Offering (as defined in the Offer to Purchase) is
conditioned on the closing of the Phillips Transaction. There is no assurance
that the Company will complete the Phillips Transaction as currently
contemplated or at all. See "Annex D -- Risk Factors -- Uncertainties Regarding
the Phillips Transaction".
COMPETITIVE STRENGTHS
The Company believes that it has the following competitive strengths.
Balanced Portfolio of Drilling Opportunities. The Company holds a balanced
portfolio of lower-risk development properties and higher-impact exploratory
prospects. The Company's development properties provide it with cash flow to
help support its operations and capital expenditure budget, and its exploratory
prospects offer the potential for larger reserves and greater production.
Operational Efficiencies. Substantially all of the Company's proved
reserves and a majority of its operating activities are concentrated in
Louisiana and in the shallow waters of the Gulf of Mexico. The Company believes
that this geographic focus has enabled its operating personnel to develop
expertise by concentrating on areas with similar operating and technical
characteristics. Moreover, the concentration of properties operated by the
Company enables it to achieve cost and operational efficiencies.
A-1
<PAGE> 33
Long-Lived Proved Reserves. The Company's proved reserves in north
Louisiana (which currently constitute 74% of the Company's estimated proved
reserves) are long-lived and support cash flow through their low lease operating
expenses and development costs. The Company's reserves to production ratio in
north Louisiana was approximately 9.4:1 as of January 1, 1999. The Company
believes the relatively long lives and low costs of its north Louisiana wells
provide a solid base from which to pursue its acquisition and exploration
strategy. The Company's overall reserves to production ratio was approximately
8.3:1 as of January 1, 1999.
High Operating Margins. The Company's oil and natural gas reserves are
located close to pipeline transportation and key market locations and,
therefore, generally command more favorable wellhead prices. In addition,
production from the Company's south Louisiana properties generally is sold at a
premium to NYMEX prices due to a higher BTU content. The Company's production
and general and administrative expenses for 1998 were $0.53 and $0.19 per Mcfe,
respectively, resulting in a cash operating margin of $1.38 per Mcfe.
Effective Use of Technology. The Company applies advanced technology to
lower the risks and costs of exploration and development activities. The Company
constantly re-evaluates and refines its 3-D seismic databases to improve
drilling results. These databases cover over 1,300 square miles, including all
presently identified exploration prospects. The Company has invested in
computer-aided exploration and development hardware and software and has an
experienced technical staff, including seven engineers, five geologists and
three geophysicists.
Experienced and Proven Management Team. The Company's senior management
team, assembled since February 1996, has extensive experience in the oil and
natural gas industry. In addition, the Company has adopted employee incentive
programs designed to align the interests of management and investors.
BUSINESS STRATEGY
The Company's strategy is to increase reserves, production and cash flow in
a cost-effective manner, primarily through a program of balanced development and
exploration activities in its current areas of operation.
Improve Liquidity. Receipt by the Company of the net proceeds from of the
Senior Secured Offering and the Phillips Transaction will provide the Company
with additional liquidity. The Company has historically funded its operations
primarily through cash flow from operations and borrowings. As a result of the
Senior Secured Offering, the Company's ability to incur additional indebtedness
will be substantially limited and thus, in the current environment of depressed
oil and natural gas prices, the Company will rely on cash on hand, cash flow
from operations and asset sales to fund oil and natural gas development and
exploitation activities and acquisitions.
Complete Strategic Transactions. The Company plans to complete sales of
certain oil and natural gas assets and similar transactions to provide
additional liquidity for redeployment in development and exploration projects,
which the Company expects will increase cash flow, proved reserves and
production. Consistent with this strategy, the Company has entered into an
exploration and development agreement regarding the Phillips Transaction.
Focus Capital Expenditures. Following the receipt by the Company of the net
proceeds from Senior Secured Offering and Phillips Transaction and to the extent
capital is available, the Company intends to focus its capital expenditures on
the development of its existing south Louisiana properties, on the continued
development of its north Louisiana properties (other than those properties that
may be a part of the Phillips Transaction) and on exploratory drilling. By
focusing on development projects in its core areas of operation, the Company
expects to increase its current levels of production with reduced levels of
capital expenditures.
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. Before the Consolidation in 1995, Kelley Partners and
developmental drilling partnership subsidiaries of Kelley Oil
A-2
<PAGE> 34
("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 Kelley, 2.4 million shares of Kelley's $2.625
convertible exchangeable preferred stock ("Preferred Stock") and 2.2 million
shares of cumulative convertible preferred stock ("ESOP Preferred Stock") held
by Kelley's Employee Stock Ownership Plan (the "ESOP"). As a result of the
Consolidation, Kelley Oil became a wholly-owned subsidiary of Kelley, 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
Kelley for financial accounting purposes. In 1996, Kelley Partners was merged
into Kelley and each of the then outstanding shares of ESOP Preferred Stock was
redeemed for one share of Kelley'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 Contour 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 (a) amended
its Certificate of Incorporation to increase its authorized Common Stock from
100 million shares to 200 million shares, (b) entered into employment agreements
with John F. Bookout and other new executives elected by the Company's Board of
Directors, (c) reduced the size of its Board to seven members and reconstituted
the Board with three continuing directors and four designees of Contour and (d)
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 (located in east Texas) acquired from SPR.
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
A-3
<PAGE> 35
(20.7 net) were completed as producing wells. At year-end 1998, 156 locations
included in the Gruy 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 in west Texas. 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" in the
Offer to Purchase and "Annex D -- 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 (a) 600 square miles,
a major portion of its existing leaseholdings in Terrebonne and LaFourche
Parishes, in south Louisiana, (b) 50 square miles offshore Texas and (c) 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 Company 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 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".
<TABLE>
<CAPTION>
PROVED RESERVES AT JANUARY 1, 1999
----------------------------------------------- PRODUCTION
PRESENT VALUE FOR THE
OF ESTIMATED YEAR ENDED DECEMBER 31, 1998
FUTURE NET -----------------------------
GAS CASH GAS
OIL GAS EQUIVALENT FLOWS(1)(2) 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................................ 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>
A-4
<PAGE> 36
- ---------------
(1) The estimates were prepared in accordance with Commission 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 12 to the Financial
Statements.
(2) Before the effects of income taxes. See "Glossary" in the Offer to Purchase.
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 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. 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. See "Annex D-- Risk Factors -- Uncertainties Regarding
the Phillips Transaction".
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 reserves in this region are 64% proved
developed, and its wells are typically drilled to a maximum depth of
approximately 10,500 feet. The Company's reserves to production ratio in north
Louisiana is approximately 9.4:1. 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 and added gross average reserves per well of
2.4 Bcfe. At December 31, 1998, the Company was operating 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, which was completed in the first quarter of 1999.
The Company's weighted average working interest in these properties based on
estimated proved reserves is approximately 51%.
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. Production from the Company's south Louisiana properties generally
receives premium wellhead prices because of the 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 was operating an aggregate of 23 gross (13.4 net) wells and
was drilling 1 gross (0.50 net) well in this region, which was completed in the
first quarter of 1999. The Company's weighted average working interest in these
properties based on estimated proved reserves 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.
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%.
A-5
<PAGE> 37
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 on their south Louisiana
properties. However, the Company's participation in drilling these wells is in
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.
ESTIMATED PROVED RESERVES
The following table sets forth the estimated quantities of proved and
proved developed reserves of oil (including condensate and natural gas liquids)
and natural gas owned by the Company for each of the three years in the period
ended December 31, 1998, which were prepared by Gruy.
<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 table above were prepared
in accordance with Commission 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
A-6
<PAGE> 38
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 the Offer to Purchase 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 this Offer to Purchase will ultimately
be produced or that the proved undeveloped reserves set forth in this Offer to
Purchase 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. 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 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. Actual results will differ, and are likely to differ
materially, from the results estimated. Accordingly, Holders are cautioned not
to place undue reliance on the reserve data included in this Offer to Purchase.
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 Commission.
A-7
<PAGE> 39
PRODUCTION, PRICE AND COST HISTORY
The following table sets forth certain production data, average sales
prices, average production expenses and general and administrative 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
Financial Statements included in "Annex F--Financial Statements".
<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)(1).............................. 2.30 2.27 2.09
Natural gas equivalent (per Mcfe)(1).................. 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
</TABLE>
- ---------------
(1) Includes the effects of the Company's hedging activities.
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 natural 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 oil or natural gas is
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.
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 natural 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 natural gas wells and 70 gross (11.5 net) productive oil
wells (including producing wells and wells capable of production).
A-8
<PAGE> 40
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 0.72
Dry.......................................... -- -- -- -- -- --
-- ----- -- ----- -- -----
Total................................... -- -- -- -- 2 0.72
== ===== == ===== == =====
Development wells:
Oil.......................................... 1 0.03 -- -- -- --
Natural gas.................................. 65 31.63 82 34.96 43 20.68
Dry.......................................... 3 1.74 -- -- 1 0.46
-- ----- -- ----- -- -----
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 0.46
-- ----- -- ----- -- -----
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 0.50 7 3.22
-- ----- -- ----- -- -----
Total................................... -- -- 10 4.00 13 5.03
== ===== == ===== == =====
Development wells:
Oil.......................................... -- -- -- -- 3 0.04
Natural gas.................................. -- -- -- -- -- --
Dry.......................................... -- -- -- -- -- --
-- ----- -- ----- -- -----
Total................................... -- -- -- -- 3 0.04
== ===== == ===== == =====
Total south Louisiana and other:
Producing.................................... -- -- 9 3.50 9 1.85
Dry.......................................... -- -- 1 0.50 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 well.
MARKETING OF OIL AND NATURAL GAS
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 oil, condensate and natural gas liquids generally
are made at prices related to posted field prices.
A-9
<PAGE> 41
In addition to marketing the Company's natural gas production, the Company
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 "Annex C--Management's Discussion and
Analysis of Financial Condition and Results of Operations" and in Note 10 to the
Financial Statements included in "Annex F-- 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 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 are mortgaged to secure the Credit Facility and,
following the Offering, will be mortgaged to secure the Notes. In addition, the
Company's properties 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.
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 is 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.
A-10
<PAGE> 42
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 Oil and Natural Gas. Sales of oil, natural gas
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 Products is affected by the ability to transport and cost of
transporting Products to market. Under applicable laws, the Federal Energy
Regulatory Commission ("FERC") regulates the construction of natural gas
pipeline facilities and the rates for transportation of Products in interstate
commerce.
The Company's sales of natural gas are affected by the availability, terms
and cost of pipeline transportation. The price and terms for access to pipeline
transportation remain subject to extensive federal and state regulation. Several
major regulatory changes have been implemented by Congress and the FERC from
1985 to the present that affect the economics of natural gas production,
transportation and sales. In addition, the FERC is continually proposing and
implementing new rules and regulations affecting these segments of the natural
gas industry, most notably natural gas transmission companies, that remain
subject to the FERC's jurisdiction. The FERC's more recent proposals may affect
the availability of interruptible transportation service on interstate
pipelines. These initiatives may also affect the intrastate transportation of
gas under certain circumstances. The stated purpose of many of these regulatory
changes is to promote competition among the various sectors of the natural gas
industry and these initiatives generally reflect more light-handed regulation of
the natural gas industry. The ultimate impact of the complex rules and
regulations issued by the FERC since 1985 cannot be predicted. In addition, some
aspects of these regulatory developments have not become final but are still
pending judicial and FERC final decisions. The Company cannot predict what
further action the FERC will take on these matters. However, the Company does
not believe that it will be affected by any action taken materially differently
than other natural gas producers, gatherers and marketers with which it
competes.
The Outercontinental Shelf Lands Act (the "OCSLA") requires that all
pipelines operating on or across the Outer Continental Shelf (the "OCS") provide
open-access, non-discriminatory service. Although the FERC has opted not to
impose regulations under Order No. 509, in which the FERC implemented the OCSLA,
on gatherers and other non-jurisdictional entities, the FERC has retained the
authority to exercise jurisdiction over those entities if necessary to permit
non-discriminatory access to service on the OCS.
Effective as of January 1, 1995, the FERC implemented regulations
establishing an indexing system for transportation rates for oil that could
increase the cost of transporting oil to the purchaser. The Company does not
believe that these regulations affect it any differently than other oil
producers and marketers with which it competes.
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
A-11
<PAGE> 43
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. The
MMS has promulgated regulations requiring offshore production facilities located
on the OCS to meet stringent engineering and construction specifications. The
MMS also has regulations restricting the flaring or venting of natural gas, and
has proposed to amend such regulations to prohibit the flaring of liquid
hydrocarbons and oil without prior authorization. Similarly, the MMS has
promulgated other regulations governing plugging and abandonment of wells
located offshore and the removal of all production facilities. To cover the
various obligations of lessees on the OCS, the MMS generally requires that
lessees have a substantial net worth or post bonds or other acceptable
assurances that such obligations will be met. Under certain circumstances, the
MMS may require any Company operations on federal leases to be suspended or
terminated. Any such suspension or termination could materially and adversely
affect the Company's financial condition, cash flows and operations. 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 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 ("CAA"); the Oil Pollution Act of
1990("OPA"); the Federal Water Pollution Control Act("FWPCA"); the Resource
Conservation and Recovery Act ("RCRA"); the Toxic Substances Control Act; and
the Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"), and the various state and local environmental laws, and the
regulations adopted pursuant to such laws, governing the discharge of materials
into the environment or the disposal of waste materials, or otherwise relating
to the protection of the environment apply to the Company's operations. In
particular, the Company's drilling, development and production operations, its
activities in connection with storage and transportation of 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 remediate, 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 will be 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
A-12
<PAGE> 44
maintains insurance, which may provide some protection against certain types of
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 OPA also requires certain
categories of responsible parties to maintain evidence of financial
responsibility to cover liabilities related to a crude oil spill. 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 U.S. 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 CAA requirements 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 subject to a substantial portion of RCRA's requirements because
the Company's operations generate minimal quantities of hazardous wastes.
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 where hazardous
substances have been released 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 the corrective action or remediation requirements imposed by 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. The Company could also be subject to other
damage claims by governmental authorities or third parties related to such
contamination.
A-13
<PAGE> 45
MANAGEMENT
Set forth below are the names, ages and positions of the current executive
officers and directors of Kelley as of April 1, 1999. All directors are elected
for a term of one year and serve until their successors are duly elected and
qualified. All executive officers hold office until their successors are duly
appointed and qualified or their earlier resignation or removal.
<TABLE>
<S> <C>
John F. Bookout.......................... President, Chief Executive Officer and
Chairman of the Board
Dallas D. Laumbach....................... Senior Vice President -- Exploration and
Production
Rick G. Lester........................... Senior Vice President and Chief Financial
Officer
John J. Conklin, Jr. .................... Director
Ralph P. Davidson........................ Director
Adam P. Godfrey.......................... Director
William J. Murray........................ Director
Ogden M. Phipps.......................... Director
Ward W. Woods............................ Director
</TABLE>
John F. Bookout, age 76, has served Kelley as Chairman of the Board,
President and Chief Executive Officer since February 1996 in connection with the
Contour Transaction. He had served as Chairman of the Board and President of
Contour Production Company ("CPC") since its formation in 1993. Before joining
CPC as a founder, Mr. Bookout served in positions of increasing responsibility
for 38 years at Shell Oil Company, starting in 1950 as a geologist and
culminating as President, Chief Executive Officer and a director from 1976
through June 1988. From 1988 through 1993, he served as a member of the
Supervisory Board of Royal Dutch Petroleum. He currently serves on the board of
trustees of the United States Counsel for International Business and various
civic and educational bodies.
Dallas D. Laumbach, age 62, has served as Senior Vice
President -- Exploration and Production of Kelley since February 1996. He served
as Senior Vice President of Contour from December 1993 to February 1996. Before
joining Contour, Mr. Laumbach served in positions of increasing responsibility
at Shell Oil Company, concluding as Manager -- Business Development within the
exploration and production segment.
Rick G. Lester, age 47, was elected Senior Vice President and Chief
Financial Officer of Kelley by the Board in October 1998. Previously, he was
Vice President and Chief Financial Officer of Domain Energy Corporation from
1996 until 1998 and was with Tenneco Inc. from 1981 to 1996.
John J. Conklin, Jr., age 68, has served as a director of Kelley or its
predecessor since November 1993. Mr. Conklin has been a private investor since
his retirement in 1989 as a senior partner of Conklin, Cahill & Co., a member
firm of the New York Stock Exchange, where he was active for over 35 years. He
has also served as a member of the Board of Governors of the New York Stock
Exchange, the Board of Directors of the New York Futures Exchange and the
National Market Advisory Board.
Ralph P. Davidson, age 71, served as Chairman of the Board of Kelley from
October 1995 through February 1996 and has served as a director of Kelley or its
predecessor since November 1993. Mr. Davidson provides consulting services to
nonprofit organizations as President of Davidson Associates. From 1980 through
1987, he was Chairman of the Board of Time, Inc., where he spent 21 years with
Time Magazine in various executive capacities. Mr. Davidson is a member of the
Board of Trustees of Phoenix House, the National Council for Adoption, the
Emeritus Foundation and The American University in Bulgaria.
Adam P. Godfrey, age 36, has served as a director of Kelley since March 19,
1998, and, since January 1, 1998, he has been the sole shareholder and president
of a corporation that serves as a manager of the limited liability company that
is the general partner of Bessemer Holdings, L.P. ("Bessemer") and other
affiliated investment partnerships including the investment partnerships that
comprise the BH Group (the "BH Group"). The BH Group owns a majority of the
membership interests in Contour. Mr. Godfrey is also
A-14
<PAGE> 46
the sole shareholder and president of a corporation that is a general partner of
Bessemer Partners & Co. ("BPC"), an affiliate of Bessemer. From July 1993 to
December 1997, Mr. Godfrey was a principal with BPC, and a member of the general
partner of Bessemer. Mr. Godfrey is a director of several private companies
William J. Murray, age 84, has served as a director of Kelley or its
predecessor since March 1984. Mr. Murray has been an independent petroleum
consultant for more than the past five years. He served on the Texas Railroad
Commission for 16 years, during six of which he served as Chairman. Mr. Murray
currently serves on a number of industry committees, including as Chairman of
the Industry Advisory Committee on Natural Gas Ratable Take and Chairman of the
Industry Voluntary Allocation Committee.
Ogden M. Phipps, age 58, has served as a director of Kelley since his
election in February 1996. He was Chairman of the Board of BSC from 1982 through
1994 and of The Bessemer Group, Incorporated ("BGI") from 1991 through 1994. Mr.
Phipps continues to serve as a director of BSC and BGI and is also a manager of
Bessemer Securities, LLC ("BSLLC"). BSC is the principal limited partner of
Bessemer. BSC and BSLLC are principal limited partners in another partnership in
the BH Group. He also serves as a director of several private companies and an
officer and director of several nonprofit organizations.
Ward W. Woods, age 56, has served as a director of Kelley since his
election in February 1996. Since 1989, he has been the sole stockholder and
president of corporations that serve as the managing general partner or
principal manager of the general partner of Bessemer and other affiliated
investment partnerships including those comprising the BH Group. He is also the
sole stockholder and president of a corporation that is a managing general
partner of BPC. Mr. Woods is the President and Chief Executive Officer of BSLLC
and BSC (which he joined in 1989). He is a director of Boise Cascade Corporation
and several private companies.
CERTAIN TRANSACTIONS
Pursuant to the Contour Transaction, Contour purchased 48.0 million newly
issued shares of Common Stock on February 15, 1996, for $48.0 million and an
option to purchase an additional 27.0 million shares of Common Stock for $27.0
million, which option was exercised December 1, 1997 to fund a portion of the
purchase price of the SPR Acquisition. In connection with the Contour
Transaction, the Company granted certain registration rights to Contour with
respect to Common Stock held or acquired by Contour.
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 credit facilities and negotiating the related
agreements and is assisting the Company in restructuring its 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.
It is the policy of the Company to structure any transactions between the
Company and its officers, directors, principal stockholders or other affiliates
only on terms no less favorable to the Company than terms that could be obtained
on an arms-length basis from unrelated parties and only upon approval by a
majority of the Company's independent and disinterested directors.
A-15
<PAGE> 47
ANNEX B
SELECTED CONSOLIDATED FINANCIAL DATA
The following tables present selected consolidated financial data for the
Company, which for 1996, 1997 and 1998 are derived from the Financial Statements
included in "Annex F -- Financial Statements." The historical financial
information for the year ended December 31, 1995 reflects the Consolidation (as
defined herein) in February 1995. The financial information for periods prior to
the Consolidation reflects Kelley Oil's (as defined in "Annex A -- Business and
Properties") historical results of operations. The impact of the acquisition of
the SPR Properties (as defined herein) is reflected in the selected financial
data as of December 1, 1997. This information should be read in conjunction with
"Annex C -- Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Annex F -- Financial Statements".
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1994 1995 1996 1997 1998
-------- --------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<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.................... -- -- -- -- --
-------- --------- -------- -------- --------
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
OTHER FINANCIAL DATA:
Ratio of earnings to fixed
charges(4)........................... N/A N/A N/A 1.1x N/A
CASH FLOW DATA:
Net cash (used in) provided by
operating activities................. $ (1,672) $ (1,806) $ 9,262 $ 39,604 $ 22,302
Net cash used in investing
activities........................... (44,976) (43,224) (53,392) (164,275) (39,216)
Net cash provided by financing
activities........................... 44,944 42,114 41,848 120,763 25,187
BALANCE SHEET DATA:
Cash and cash equivalents.............. $ 9,268 $ 6,352 $ 4,070 $ 162 $ 8,435
Total assets........................... 106,513 151,342 189,227 322,602 286,197
Long term debt, including current
maturities........................... 39,713 164,980 184,253 286,183 319,751
Stockholders' equity (deficit)......... 45,180 (45,568) (30,535) (5,621) (66,939)
Property and equipment, net............ 74,912 128,642 158,468 293,613 256,455
</TABLE>
B-1
<PAGE> 48
- ---------------
(1) Reflects non-cash impairment charges against the carrying value of proved
and unproved oil and natural gas properties under SFAS 121. See "Annex
C -- Management's Discussion and Analysis of Financial Condition and Results
of Operations" and Note 2 to the Financial Statements contained in "Annex
F -- 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
"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.
(4) For purposes of computing the ratio of earnings to fixed charges, earnings
consist of pre-tax income from continuing operations, excluding interest
income of $0.8 million, $0.6 million, $0.9 million, $0.2 million and $0.2
million for the years ended December 31, 1994, 1995, 1996, 1997 and 1998,
respectively, plus fixed charges. Fixed charges consist of interest expense
and other debt expenses. For the years ended December 31, 1994, 1995, 1996
and 1998, earnings were insufficient to cover fixed charges by $25.8
million, $211.9 million, $12.8 million and $57.2 million, respectively.
B-2
<PAGE> 49
ANNEX C
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 Annex F -- Financial Statements included elsewhere
in this Offer to Purchase. See "Glossary" in the Offer to Purchase for the
definitions of certain common oil and gas terms used in this Annex C.
GENERAL
Introduction. The Company is 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 during 1998 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 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 have adversely impacted, and
could continue to adversely impact, the Company's results of operations and
liquidity. The success of the Company is substantially 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 expenditure budget, 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
natural 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
natural 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 had 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's 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.
C-1
<PAGE> 50
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
Years Ended December 31, 1998 and 1997. The Company's oil and natural 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 natural gas production (18%),
partially offset by lower oil prices (32%) and gas prices (8%). The increase in
natural gas production was primarily due to the Company's 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 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 fourth
quarter of 1997 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 per Mcfe 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 in 1997. On a units-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 1998 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 natural gas activities from $0.80 per Mcfe in 1997 to $1.00 per Mcfe 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 121" in Note 2
to the 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 natural 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 natural gas production (29%),
partially offset by lower oil prices (13%) and natural gas prices (1%). The
increase in natural gas production was primarily due to the Company's drilling
activities in north Louisiana and the addition of one month of production from
properties acquired in the fourth quarter of 1997, which was 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.
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<PAGE> 51
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 increased 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 Production, Gulf Coast Company.
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 was 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 units-of-production 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 1997 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.
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 natural 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 the
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's 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 natural 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 natural gas
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<PAGE> 52
industry, including the Company, experienced reduced profitability and cash
flows which, in turn, created significant liquidity problems. As discussed in
Note 4 to the Financial Statements included in "Annex F--Financial Statements",
although the Company was in compliance with the 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 the Credit Facility being declared
immediately due and payable, the Credit Facility being terminated and the
payment of other subordinated obligations being accelerated. In addition,
repayment of the $34.1 million outstanding principal amount of 7 7/8% Notes is
scheduled to be made in December 1999 and repayment of the $26.9 million
principal amount of 8 1/2% Debentures is scheduled to be made in April 2000.
These uncertainties raise substantial doubt about the Company's ability to
continue its operations as a going concern and make the scheduled repayments of
the Securities at their maturities. 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 agreement relating to the
Phillips Transaction. As a result of this transaction, the Company will (1)
receive an $83 million cash payment (subject to post-closing adjustments), (2)
retain 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) retain 25% of its working interest in the Cotton Valley
formation. In addition, the Company will be relieved of significant future
operating, exploration and development costs. Closing of the Phillips
Transaction is subject to the parties obtaining required consents and meeting
substantial closing requirements. In addition, the majority of the proceeds of
the Senior Secured Offering will be used to repay all amounts outstanding under
the Credit Facility, and the remainder of the proceeds will be used for
additional working capital for general corporate purposes, including to pay
interest on subordinated debt, and may be used to redeem or otherwise retire
outstanding convertible subordinated debt. Following receipt of the net proceeds
from the Senior Secured Offering, 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.
The Company believes that both completion of the Phillips Transaction and
receipt of the net proceeds from the Senior Secured Offering will occur; however
there can be no assurance that such events will occur. If the Phillips
Transaction and the Senior Secured Offering are consummated, the Company
believes the net cash proceeds from the Phillips Transaction and the Senior
Secured Offering, 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 will continue to be subject to various
commodity and economic factors beyond its control which may adversely affect its
results of operation and financial condition. In addition, the Indenture places
substantial limitations on the ability of the Company to pay its subordinated
obligations as they mature, including the Securities. Failure to pay such
obligations could have material adverse consequences for the Company. See "Risk
Factors -- Substantial Leverage; Inability to Service Debt; Lack of Liquidity;
Substantial Capital Requirements" in the Offer to Purchase.
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 primarily 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 and 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 was primarily a result of the reclassification of the 7 7/8% convertible
subordinated notes, which are redeemable on December 15, 1999, to current
portion of long-term debt.
C-4
<PAGE> 53
The following table sets forth on an unaudited basis net cash provided by
operating activities before working capital adjustments and net cash used in
investing activities.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1996 1997 1998
------- --------- -------
(IN THOUSANDS)
<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)
</TABLE>
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 December 1997 in connection with a larger asset
purchase. The properties were producing approximately 4.5 Mmcfe per day. See
"-- Capital Resources".
Capital Resources. The 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. 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 (a) an
increase in the margin borrowing rate to 250 basis points over LIBOR, (b) a
reduction in the grace periods available under certain default provisions, (c) 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 (d) 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, 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 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 and the Credit Facility
could be terminated. The
C-5
<PAGE> 54
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 4 to the
Financial Statements included in "Annex F--Financial Statements" for further
discussion. The Series C Notes were sold pursuant to Rule 144A under the
Securities Act. The Company 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 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 of the Offering
remaining after the repayment of other obligations, and with proceeds from oil
and natural gas property sales. The Company can provide no assurance that such
transactions will be completed or that, if completed, will provide sufficient
proceeds to repay this outstanding long-term debt. See "Risk
Factors -- Substantial Leverage; Inability to Service Debt; Lack of Liquidity;
Substantial Capital Requirements" included in the Offer to Purchase.
Capital Commitments. The Company expects to spend $10 million to $12
million on lower-risk drilling in 1999, substantially all of which is
discretionary. However, the Company's ability to fund its planned 1999 capital
expenditures will depend on the actual amount of cash flow from operations and
proceeds from oil and natural gas property sales. In addition, the Indenture
will limit the Company's capital expenditures. To the extent additional funding
is available, the Company may, subject to the limitations in the Indenture,
spend additional amounts on development and exploration activities.
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, both of which have since been completed as producing 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 the Company's 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 a
material adverse impact on the business or operations of the Company.
Nevertheless, as
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<PAGE> 55
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 received by the
Company during the periods indicated.
<TABLE>
<CAPTION>
AVERAGE AVERAGE
OIL PRICE GAS PRICE
($/BBL) ($/MCF)(1)
--------- ----------
<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>
- ---------------
(1) Includes the effects of the Company's hedging activities.
MARKET RISK DISCLOSURE
The Company is exposed to market risk from changes in interest rates and
commodity prices. The Company uses the Credit Facility and its 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 the 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 Financial Statements included in
"Annex F--Financial Statements".
<TABLE>
<CAPTION>
MATURITY DATE
------------------------------------------------------- FAIR VALUE
DEBT (DOLLARS IN THOUSANDS) 1999 2000 2001 2002 2003 THEREAFTER TOTAL 12/31/98
--------------------------- ----------- -------- -------- -------- -------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Variable:
Credit Facility 7.03%(1)
(Maturity).................. $111,500 $111,500 $111,500
Fixed:
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.
C-7
<PAGE> 56
ANNEX D
RISK FACTORS
The Company cautions that the following risk factors could affect its
actual financial condition and results of operations in the future.
UNCERTAINTIES REGARDING THE PHILLIPS TRANSACTION
The Company has entered into an exploration and development agreement
regarding the Phillips Transaction and intends to complete such transaction.
However, the consummation of such transaction is subject to substantial closing
conditions, including but not limited to (a) the absence of a material adverse
change since April 12, 1999 in the financial condition of the Company, including
but not limited to (i) any event of default on any material Company obligation
or agreement and (ii) any Commission filing that contains a qualified opinion of
the Company's independent auditors, (b) the receipt by the Company of financing
of at least $120 million that has been used to repay the Credit Facility in
full, (c) the accuracy of representations and warranties (including the
representation relating to the solvency of the Company) and the performance of
certain covenants and agreements, (d) the receipt of legal opinions and any
required consents, permits and waivers and (e) the absence of any pending of
threatened lawsuit, claim, action, proceeding or other investigation with
respect to the Phillips Transaction. The Company has failed to comply with
certain of these conditions and will seek a waiver of such conditions from
Phillips. However, there can be no assurance that the Company will ultimately be
able to consummate the Phillips Transaction. As such transaction is an integral
part of the Company's financial strategy, failure to consummate such transaction
could materially and adversely affect the Company's financial condition and its
ability to make its debt service payments, including repayments of the 7 7/8%
Notes and 8 1/2% Debentures at their respective maturities.
If the Company consummates the Phillips Transaction, substantially more
funds will be available for the Company's drilling activities. Consequently, the
Company would have the opportunity to focus more on exploratory drilling with a
higher reserve potential and a higher risk profile. The drilling of more
exploratory wells could result in a lower drilling success rate. There is no
assurance that the Company will be able to replace the proved reserves that are
the subject of the Phillips Transaction, if such transaction is completed, or
that any proved reserves will be discovered through exploratory drilling.
If the Company does not consummate the Phillips Transaction and receive the
proceeds therefrom, the Company will not receive the proceeds from the Senior
Secured Offering, which are held in escrow.
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 Purchase and the Annexes thereto 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
D-1
<PAGE> 57
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 Purchase and the Annexes thereto will ultimately be produced or that
the proved undeveloped reserves set forth in the Offer to Purchase and the
Annexes thereto 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. 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 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. 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 Purchase and the Annexes thereto.
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 prices 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 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),
D-2
<PAGE> 58
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 additional laws
and regulations will be adopted or the effect such changes may have on the
Company's business or financial condition. See "Annex A -- Business and
Properties -- Regulation".
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
"Annex A -- Business and Properties -- Regulation".
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 "Annex C -- Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Market Risk
Disclosure" and Note 10 to the Financial Statements, included in "Annex
F -- 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.
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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 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 the holders of
the Securities.
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ANNEX E
DESCRIPTION OF THE SENIOR SECURED NOTES
Proceeds from an offering of $135,000,000 aggregate principal amount of 14%
Senior Secured Notes due 2003 maturing at 105% of the stated principal amount
(the "Senior Secured Notes") has been placed in escrow. Upon release of the
escrow such notes will be issued under an indenture (the "Indenture") dated as
of April 15, 1999, among the Company, as issuer, Kelley Oil Corporation, Kelley
Operating Company, Ltd. and Concorde Gas Marketing, Inc., as initial Subsidiary
Guarantors, and Norwest Bank Minnesota, National Association, as trustee (the
"Trustee").
Capitalized terms not otherwise defined below or elsewhere in this
Description of the Notes have the meanings given to them in the Indenture, the
Offer to Purchase or the Annexes thereto. The definitions of certain capitalized
terms used in the summary are set forth below under "-- Certain Definitions." In
this description, the word "Company" refers to Kelley Oil & Gas Corporation and
not to any of its subsidiaries and "Holder" refers to a holder of the Senior
Secured Notes and not to a holder of the Securities.
CLOSING INTO ESCROW; LIABILITY OF COMPANY AND SUBSIDIARY GUARANTORS FOR SENIOR
SECURED NOTES
The unauthenticated and unissued Senior Secured Notes, the Subsidiary
Guarantees, the other Security Documents and the proceeds from the Senior
Secured Offering are currently held in escrow pursuant to an Escrow Agreement
(the "Escrow Agreement") dated as of April 16, 1999 among the Company, the
Subsidiary Guarantors, Norwest Bank Minnesota, National Association, as Escrow
Agent (the "Escrow Agent") and Norwest Bank Minnesota, National Association, as
securities intermediary. On April 16, 1999, the proceeds from the Offering of
the Notes were deposited into a securities account maintained by the Escrow
Agent at its corporate trust offices or at any securities intermediary selected
by the Escrow Agent having a combined capital and surplus of at least $250.0
million and having a long-term debt rating of at least "A3" by Moody's Investor
Service, Inc. and at least "A-" by Standard & Poor's Ratings Services styled the
"Kelley Oil Escrow Account" (such account being the "Escrow Account") which
shall be under the exclusive dominion and control of the Trustee. Investors in
the Offering received receipts ("Cash Secured Escrow Receipts") evidencing their
rights to the Escrow Account. All amounts on deposit in the Escrow Account shall
be treated as financial assets and cash funds on deposit in the Escrow Account
may be invested by the Escrow Agent, at the direction of the Company, in
short-term U.S. government treasury securities; provided, however, in no event
shall the Company have the right to withdraw funds or assets from the Escrow
Account except in compliance with the terms of the Escrow Agreement and all
assets credited to the Escrow Account shall be subject to a Lien in favor of the
Trustee for the benefit of the Initial Purchaser and the Holders.
The unauthenticated and unissued Senior Secured Notes, the Subsidiary
Guarantees and the other Security Documents are not, and shall not be deemed to
be, outstanding obligations of the Company and the Subsidiary Guarantors,
respectively, until such agreements and the proceeds from the Senior Secured
Offering are released from the Escrow Account and the Senior Secured Notes are
authenticated and issued pursuant to the terms thereof.
The Notes, the Subsidiary Guarantees and the other Security Documents and
the proceeds from the Offering shall be released from escrow and the Escrow
Agent shall deliver (i) to the Company the proceeds from the Senior Secured
Offering and (ii) to the Trustee the Senior Secured Notes duly authenticated,
the Subsidiary Guarantees and the other Security Documents, as contemplated by
the Indenture, upon receipt by the Escrow Agent of an officer's certificate from
each of the Company and from the Initial Purchaser setting forth that certain
conditions have been satisfied, including:
(A) the Phillips Transaction has been consummated, resulting in cash
proceeds to the Company of not less than $80.0 million minus any
non-material, usual and customary price adjustment for similar transactions
in the Oil and Gas Business;
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(B) the Company will deliver to the Trustee an independent auditors'
report from a firm of recognized national standing containing an
unqualified opinion without an explanatory paragraph for a going concern
consideration for their audit of the Company's consolidated financial
statements as of an interim date and for an interim period subsequent to
December 31, 1998;
(C) the Company, Jefferies & Company, Inc. (the "Initial Purchaser")
and the Trustee will exchange certain other customary closing documents;
(D) that no Default has occurred and is continuing under the
Indenture.
If (i) such conditions have not been met on or before May 17, 1999, or (ii)
the Company delivers to the Escrow Agent and the Trustee written notice that
such conditions will not be met by May 17, 1999, then (A) the proceeds from the
Senior Secured Offering (together with all interest earned on the principal of
the escrow fund) will be returned to the holders of Cash Secured Escrow
Receipts, (B) the Indenture, the unauthenticated and unissued Senior Secured
Notes, the Subsidiary Guarantees and the other Security Documents will be
canceled by the Trustee and returned by the Trustee to the Company, and (C) the
Company will pay to the Escrow Agent an amount equal to the interest that would
have accrued on the Senior Secured Notes had they been outstanding from and
after April 16, 1999 less interest earned on the principal of the escrow fund
for disbursement by the Escrow Agent to the purchasers of the Senior Secured
Notes.
GENERAL
Upon satisfaction of the release conditions, the Senior Secured Notes:
- will be senior secured obligations of the Company;
- will be secured by a first Lien, subject only to Permitted Liens, on
substantially all of the proved oil and natural gas reserves of the
Company;
- will rank equally in contractual right of payment with all of the
Company's current and future senior Indebtedness;
- will rank senior to all of the Company's current and future Subordinated
Obligations; and
- will be unconditionally guaranteed by the Subsidiary Guarantors (which
guarantees will be secured by a first Lien, subject only to Permitted
Liens, on substantially all of the proved oil and natural gas reserves of
each such Subsidiary Guarantor).
The Senior Secured Notes are limited to an aggregate stated principal
amount not to exceed the Borrowing Base, and will mature on April 15, 2003 at a
price of 105% of the stated principal amount thereof, with a partial quarterly
mandatory redemption. See "Mandatory Redemption." The Senior Secured Notes will
bear interest at 14% per annum from the Issue Date, payable semiannually to
Holders of record at the close of business on the April 1 or October 1
immediately preceding the interest payment date on April 15 and October 15 of
each year, commencing on October 15, 1999. Interest on overdue principal and (to
the extent permitted by law) on overdue installments of interest will accrue at
1% per annum in excess of such rate. Interest on the Senior Secured Notes will
be computed on the basis of a 360-day year of twelve 30-day months. Interest
shall accrue and be payable before and after the filing of a bankruptcy petition
at the rate and on the dates set forth above.
The Senior Secured Notes will be issued only in fully registered form,
without coupons, in denominations of $1,000 and any integral multiple of $1,000.
No service charge shall be made for any registration of transfer or exchange of
the Senior Secured Notes, but the Company may require payment of a sum
sufficient to cover any transfer tax or other similar governmental charge
payable in connection therewith.
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The proceeds of the Senior Secured Offering will be used to replace and
refinance the Indebtedness outstanding under the Credit Agreement when released
from escrow and will represent a modification, refunding, replacement and
refinancing of the Indebtedness currently outstanding under the Credit
Agreement.
SCHEDULED QUARTERLY REDEMPTION
On the 15th day of each January, April, July and October, commencing July
15, 2002, the Company will be obligated to redeem $2.0 million of the stated
principal amount of the Senior Secured Notes (expressed as an integral multiple
of $1,000) at a redemption price equal to 103% of the stated principal amount
thereof plus accrued and unpaid interest thereon to such date.
OPTIONAL REDEMPTION
Except as set forth in the following paragraph, the Senior Secured Notes
will not be redeemable at the option of the Company prior to April 15, 2001.
Thereafter, the Senior Secured Notes will be redeemable, at the Company's
option, in whole or in part, at any time or from time to time, upon not less
than 30 nor more than 60 days' prior notice mailed by first-class mail to each
Holder's registered address, at 105% (expressed as a percentage of stated
principal amount), plus accrued interest to the redemption date (subject to the
right of Holders of record on the relevant record date to receive interest due
on the relevant interest payment date), if redeemed on or after April 15, 2001.
In addition, at any time and from time to time prior to April 15, 2001, the
Company may redeem in the aggregate up to 35% of the original stated principal
amount of the Senior Secured Notes with the proceeds of one or more Equity
Offerings at a redemption price (expressed as a percentage of stated principal
amount) of 114% plus accrued interest to the redemption date (subject to the
right of Holders of record on the relevant record date to receive interest due
on the relevant interest payment date); provided, however, that either at least
65% of the original stated principal amount of the Senior Secured Notes must
remain outstanding after each such redemption or such redemption must retire the
Senior Secured Notes in their entirety and the redemption occurs within 60 days
after the consummation of such Equity Offering.
In the case of any partial redemption, selection of the Senior Secured
Notes for redemption will be made by the Trustee on a pro rata basis, by lot or
by such other method as the Trustee in its sole discretion shall deem to be fair
and appropriate, although no Senior Secured Note of $1,000 in original principal
amount or less shall be redeemed in part. If any Senior Secured Note is to be
redeemed in part only, the notice of redemption relating to such Senior Secured
Note shall state the portion of the principal amount thereof to be redeemed. A
new Senior Secured Note in principal amount equal to the unredeemed portion
thereof will be issued in the name of the Holder thereof upon cancellation of
the original Senior Secured Note.
SUBSIDIARY GUARANTEES
The Company's Obligations will be guaranteed (all such obligations
guaranteed by the Subsidiary Guarantors being herein called the "Guaranteed
Obligations" and each such Subsidiary Guarantee being herein called a
"Subsidiary Guarantee") by the Company's Restricted Subsidiaries (other than the
Programs), which are initially Kelley Oil Corporation, Kelley Operating Company,
Ltd. and Concorde Gas Marketing, Inc. (all such Restricted Subsidiaries being
the "Subsidiary Guarantors"). Substantially all of the Oil and Gas Assets of
each Subsidiary Guarantor will be pledged to secure its obligations under its
Subsidiary Guarantee. Each Subsidiary Guarantor's Subsidiary Guarantee will rank
equally in contractual right of payment with all of its current and future
senior Indebtedness, and senior to all of its current and future Subordinated
Obligations.
Each Subsidiary Guarantor, as primary obligor and not merely as surety,
will irrevocably and unconditionally guarantee, on a joint and several basis,
the performance and the punctual payment when due, whether at Stated Maturity,
by acceleration, by redemption or otherwise, of all the Obligations of the
Company under the Indenture and the Senior Secured Notes. Each Subsidiary
Guarantee will be limited in amount to an amount not to exceed the maximum
amount that can, after giving effect to all other contingent and fixed
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liabilities of the applicable Subsidiary Guarantor, be guaranteed by such
Subsidiary Guarantor without rendering such Subsidiary Guarantee voidable under
applicable law relating to fraudulent transfer or fraudulent conveyance or
similar laws affecting the rights of creditors generally. Each Subsidiary
Guarantor will agree to pay, in addition to the amount stated above, any and all
expenses (including reasonable counsel fees and expenses) incurred by the
Trustee and the Holders in enforcing any rights under the Subsidiary Guarantee
with respect to such Subsidiary Guarantor.
Each Subsidiary Guarantee is a continuing guarantee and shall (a) remain in
full force and effect until payment in full of all the Guaranteed Obligations,
(b) be binding upon the relevant Subsidiary Guarantor and (c) inure to the
benefit of and be enforceable by the Trustee, the Holders and their successors,
transferees and assigns as provided in the Indenture. See "-- Defaults."
Pursuant to the Indenture, any Subsidiary Guarantor may consolidate with,
merge with or into, or transfer all or substantially all its assets to any other
Person to the same extent the Company may consolidate with, merge with or into,
or transfer all or substantially all its assets to, any other Person; provided,
however, that if such Person is not the Company or a Subsidiary Guarantor, such
Subsidiary Guarantor's obligations under the Indenture and its Subsidiary
Guarantee must be expressly assumed by such other Person. However, upon the sale
or disposition (by merger or otherwise) of any Subsidiary Guarantor to a Person
(other than to the Company or a Subsidiary Guarantor) permitted by the
Indenture, such Subsidiary Guarantor will be released and relieved from all its
obligations under the Indenture and its Subsidiary Guarantee. See "-- Certain
Covenants -- Limitation on Sales of Assets and Subsidiary Stock."
SECURITY; RANKING
All of the Obligations and the Guaranteed Obligations will be secured by a
first Lien, subject only to Permitted Liens, on substantially all of the Oil and
Gas Assets of the Company and its Restricted Subsidiaries owned on the Issue
Date, and by a first Lien, subject only to Permitted Liens, on substantially all
of such Oil and Gas Assets acquired or developed thereafter; provided however
that, with respect to any property securing Acquired Indebtedness, the Company's
and each Subsidiary Guarantor's obligation to provide Liens to the Trustee on
such property will be limited to the extent that granting a Lien on such
property is not prohibited by the terms of the instruments creating such
Acquired Indebtedness (including any Refinancing thereof); and provided further
that such Lien, if not otherwise prohibited, may be inferior to the Lien
securing the Acquired Indebtedness. See "-- Certain Covenants -- Lien on
Additional Collateral." In addition, the Obligations will be secured by a first
priority Lien on the general partnership interests of the Company and the
Subsidiary Guarantors in the Programs.
The Oil and Gas Assets that will initially secure the Obligations and the
Guaranteed Obligations represent approximately 95% of the PV-10 Value of the Oil
and Gas Properties of the Company and Subsidiary Guarantors as of December 31,
1998. Approximately 10% of that value is represented by the general partnership
interests of the Company and the Subsidiary Guarantors in the Programs. A
substantial portion of these same assets currently serve as collateral for the
Credit Agreement, and the lending institutions thereunder will assign their
Liens securing the Credit Agreement to the Trustee, effective as of the Issue
Date, in connection with the refunding, replacement and refinancing of the
Indebtedness currently outstanding under the Credit Agreement contemplated
hereby.
If the Senior Secured Notes become due and payable prior to the Stated
Maturity or are not paid in full at the Stated Maturity, the Trustee may take
all actions it deems necessary or appropriate, including, but not limited to,
foreclosing upon the Collateral in accordance with the Indenture, the Security
Documents and applicable law. The proceeds received from the sale of any
Collateral that is the subject of a foreclosure or collection suit will be
applied first to pay the expenses of such foreclosure or suit and amounts then
payable to the Trustee and thereafter to pay the principal of and interest on
the Senior Secured Notes. The Trustee has the power to institute and maintain
such suits and proceedings as it may deem expedient to prevent impairment of, or
to preserve or protect its and the Holders' interest in, the Collateral.
The collateral release provisions of the Indenture will permit the release
of Collateral without substitution of collateral of equal value under certain
circumstances. See "-- Possession, Use and Release of Collateral."
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As secured obligations of the Company and the relevant Subsidiary
Guarantors, the Obligations and the Guaranteed Obligations, respectively, will
be senior to all of the Company's and the relevant Subsidiary Guarantor's
Subordinated Obligations and pari passu in contractual right of payment to all
of the Company's and the relevant Subsidiary Guarantor's other current and
future senior Indebtedness. The Senior Secured Notes and any Subsidiary
Guarantee will effectively, however, be senior as to other senior Indebtedness
on the basis of the Liens granted under the Indenture and the Security Documents
to the extent of the value of the Collateral.
Substantially all the operations of the Company are currently conducted
through its subsidiaries. Claims of creditors of any such subsidiaries which
have not executed a Subsidiary Guarantee, including trade creditors, secured
creditors and creditors holding guarantees issued by such subsidiaries, and
claims of preferred stockholders (if any) of such subsidiaries generally will
have priority with respect to the assets and earnings of such subsidiaries over
the claims of creditors of the Company and the Subsidiary Guarantors, including
the Holders. The Senior Secured Notes and each Subsidiary Guarantee, therefore,
will be effectively subordinated to creditors (including trade creditors) and
preferred stockholders (if any) of subsidiaries of the Company (other than the
relevant Subsidiary Guarantor). After giving pro forma effect to the Refinancing
of the Credit Agreement with the proceeds of the Senior Secured Offering, as of
December 31, 1998, the Company's subsidiaries (other than the Subsidiary
Guarantors) would have had no liabilities to any Person other than the Company
and its subsidiaries. Although the Indenture limits the incurrence of
Indebtedness and the issuance of preferred stock of certain of the Company's
subsidiaries, such limitation is subject to a number of significant
qualifications; moreover, the Indenture does not impose any limitation on the
incurrence by such subsidiaries of liabilities that are not considered
Indebtedness under the Indenture. See "-- Certain Covenants -- Limitation on
Indebtedness."
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CERTAIN DEFINITIONS
"Acquired Indebtedness" means Indebtedness of the Company or any of its
Restricted Subsidiaries of the types described under clauses (b)(5), (b)(7),
(b)(11) and (b)(12) of the covenant "Limitation on Indebtedness."
"Additional Assets" means (i) any property or assets (other than
Indebtedness and Capital Stock) used or useful in the Oil and Gas Business; (ii)
the Capital Stock of a Person that becomes a Restricted Subsidiary as a result
of the acquisition of such Capital Stock by the Company or another Restricted
Subsidiary or (iii) Capital Stock constituting a minority interest in any Person
that at such time is a Restricted Subsidiary; provided, however, that any such
Restricted Subsidiary described in clauses (ii) or (iii) above is primarily
engaged in the Oil and Gas Business.
"Adjusted Consolidated Net Tangible Assets" means (without duplication), as
of the date of determination, (a) the sum of (i) discounted future net revenues
from proved oil and gas reserves of the Company and its Restricted Subsidiaries
calculated in accordance with SEC guidelines before any state or federal income
taxes, as estimated in a reserve report prepared as of the end of the Company's
most recently completed fiscal year, which reserve report is prepared or
reviewed by independent petroleum engineers, as increased by, as of the date of
determination, the discounted future net revenues of (A) estimated proved oil
and gas reserves of the Company and its Restricted Subsidiaries attributable to
any material acquisition consummated since the date of such year-end reserve
report, and (B) estimated oil and gas reserves of the Company and its Restricted
Subsidiaries attributable to material extensions, discoveries and other
additions and upward determinations of estimates of proved oil and gas reserves
due to exploration, development or exploitation, production or other activities
conducted or otherwise occurring since the date of such year-end reserve report
which would, in the case of determinations made pursuant to clauses (A) and (B),
in accordance with standard industry practice, result in such additions or
revisions, in each case calculated in accordance with SEC guidelines (utilizing
the prices utilized in such year-end reserve report), and decreased by, as of
the date of determination, the discounted future net revenues of (C) estimated
proved oil and gas reserves of the Company and its Restricted Subsidiaries
produced or disposed of since the date of such year-end reserve report and (D)
reductions in the estimated oil and gas reserves of the Company and its
Restricted Subsidiaries since the date of such year-end reserve report
attributable to material downward determinations of estimates of proved oil and
gas reserves due to exploration, development or exploitation, production or
other activities conducted or otherwise occurring since the date of such
year-end reserve report which would, in the case of determinations made pursuant
to clauses (C) and (D), in accordance with standard industry practice, result in
such determinations, in each case calculated in accordance with SEC guidelines
(utilizing the prices utilized in such year-end reserve report); provided that,
in the case of each of the determinations made pursuant to clauses (A) through
(D), such increases and decreases shall be as estimated by the Company's
engineers, except that if as a result of such acquisitions, dispositions,
discoveries, extensions or revisions, there is a Material Change, then such
increases and decreases in the discounted future net revenue shall be confirmed
in writing by an independent petroleum engineer, (ii) the capitalized costs that
are attributable to oil and gas properties of the Company and its Restricted
Subsidiaries to which no proved oil and gas reserves are attributed, based on
the Company's books and records as of a date no earlier than the date of the
Company's latest annual or quarterly financial statements, (iii) the Net Working
Capital on a date no earlier than the date of the Company's latest annual or
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quarterly financial statements and (iv) the greater of (I) the net book value on
a date no earlier than the date of the Company's latest annual or quarterly
financial statements and (II) the appraised value, as estimated by independent
appraisers, of other tangible assets of the Company and its Restricted
Subsidiaries as of a date no earlier than the date of the Company's latest
audited financial statements (provided that the Company shall not be required to
obtain such an appraisal of such assets if no such appraisal has been
performed), minus (b) the sum of (i) minority interests, (ii) any gas balancing
liabilities of the Company and its Restricted Subsidiaries reflected in the
Company's latest audited financial statements, (iii) the discounted future net
revenue, calculated in accordance with SEC guidelines (utilizing the same prices
utilized in the Company's year-end reserve report), attributable to reserves
subject to participation interests, overriding royalty interests or other
interests of third parties, pursuant to participation, partnership, vendor
financing or other agreements then in effect, or which otherwise are required to
be delivered to third parties, (iv) the discounted future net revenues,
calculated in accordance with SEC guidelines (utilizing the same prices utilized
in the Company's year-end reserve report), attributable to reserves that are
required to be delivered to third parties to fully satisfy the obligations of
the Company and its Restricted Subsidiaries with respect to Volumetric
Production Payments on the schedules specified with respect thereto and (v) the
discounted future net revenues, calculated in accordance with SEC guidelines,
attributable to reserves subject to Dollar-Denominated Production Payments that,
based on the estimates of production included in determining the discounted
future net revenues specified in the immediately preceding clause (a)(i)
(utilizing the same prices utilized in the Company's year-end reserve report),
would be necessary to satisfy fully the obligations of the Company and its
Restricted Subsidiaries with respect to Dollar-Denominated Production Payments
on the schedules specified with respect thereto.
"Affiliate" of any specified Person means any other Person, directly or
indirectly, controlling or controlled by or under direct or indirect common
control with such specified Person. For the purposes of this definition,
"control" when used with respect to any Person means the power to direct the
management and policies of such Person, directly or indirectly, whether through
the ownership of voting securities, by contract or otherwise; and the terms
"controlling" and "controlled" have meanings correlative to the preceding. For
purposes of the provisions described under "-- Certain Covenants -- Limitation
on Restricted Payments," "-- Certain Covenants -- Limitation on Sales of Assets
and Subsidiary Stock" and "-- Certain Covenants -- Limitation on Affiliate
Transactions" only, "Affiliate" shall also mean any beneficial owner of Capital
Stock representing 5% or more of the total voting power of the Voting Stock (on
a fully diluted basis) of the Company or of rights or warrants to purchase such
Capital Stock (whether or not currently exercisable) and any Person who would be
an Affiliate of any such beneficial owner pursuant to the first sentence hereof.
Shareholders and Affiliates of Bessemer Securities Corporation ("BSC") that
would not be Affiliates of the Company other than by reason of being
shareholders or Affiliates of BSC and that neither in fact participate in the
management of any of BSC, Bessemer Partners & Co. ("Bessemer"), Bessemer
Holdings, L.P. ("Holdings") or the Company nor are controlled by BSC, Bessemer,
Holdings, the Company, or any of their respective Affiliates who in fact
participate in the management of any of BSC, Bessemer, Holdings or the Company,
shall not be deemed to be "Affiliates" of the Company.
"Asset Disposition" means any sale, lease, transfer or other disposition
(or series of related sales, leases, transfers or dispositions) by the Company
or any Restricted Subsidiary, including any disposition by means of a merger,
consolidation or similar transaction (each referred to for the purposes of this
definition as a "disposition"), of (i) any shares of Capital Stock of a
Restricted Subsidiary (other than directors' qualifying shares or shares
required by applicable law to be held by a Person other than the Company or a
Restricted Subsidiary), (ii) all or substantially all the assets of any division
or line of business of the Company or any Restricted Subsidiary or (iii) any
other assets of the Company or any Restricted Subsidiary outside of the ordinary
course of business of the Company or such Restricted Subsidiary. Notwithstanding
the preceding, none of the following shall be deemed to be an Asset Disposition:
(1) a disposition by a Restricted Subsidiary to the Company or by the Company or
a Restricted Subsidiary to a Wholly Owned Subsidiary, (2) the sale or transfer
(whether or not in the ordinary course of business) of oil and gas properties or
direct or indirect interests in real property; provided, however, that at the
time of such sale or transfer such properties do not have associated with them
any proved reserves, (3) the abandonment, farm-out, lease or sublease of
developed or undeveloped oil and gas properties in the ordinary course of
business, (4) the trade or exchange
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by the Company or any Restricted Subsidiary of any oil and gas property owned or
held by the Company or such Restricted Subsidiary for any oil and gas property
owned or held by another Person, provided that if any property so traded or
exchanged contains proved reserves, then the property received therefor contains
a reasonably equivalent value of proved reserves, (5) the trade or exchange by
the Company or any Restricted Subsidiary of any oil and gas property owned or
held by the Company or such Restricted Subsidiary for any Investment in equity
interests of a Person engaged in the Oil and Gas Business, provided that if any
property so traded or exchanged contains proved reserves, then (A) the Company's
or such Restricted Subsidiary's pro rata Investment in such Person shall
represent a reasonably equivalent value of proved reserves and (B) such Person
is or becomes by virtue of such Investment a Restricted Subsidiary or a
Permitted Joint Venture, or (6) the sale or transfer of hydrocarbons or other
mineral products or surplus or obsolete equipment all in the ordinary course of
business.
"Attributable Debt" in respect of a Sale/Leaseback Transaction means, as at
the time of determination, the present value (discounted at the interest rate
implicit in the Sale/Leaseback Transaction, compounded annually) of the total
obligations of the lessee for rental payments during the remaining term of the
lease included in such Sale/Leaseback Transaction (including any period for
which such lease has been extended).
"Available Borrowing Base" means, as of any date, the Borrowing Base minus
the outstanding principal amount of the Notes as of such date.
"Average Life" means, as of the date of determination, with respect to any
Indebtedness or Preferred Stock, the quotient obtained by dividing (i) the sum
of the products of numbers of years from the date of determination to the dates
of each successive scheduled principal payment of such Indebtedness or
redemption or similar payment with respect to such Preferred Stock multiplied by
the amount of such payment by (ii) the sum of all such payments.
"Board of Directors" means the Board of Directors of the Company or any
committee thereof duly authorized to act on behalf of such Board.
"Borrowing Base" means $135.0 million.
"Business Day" means each day which is not a Legal Holiday (as defined in
the Indenture).
"Capital Lease Obligations" means an obligation that is required to be
classified and accounted for as a capital lease for financial reporting purposes
in accordance with GAAP, and the amount of Indebtedness represented by such
obligation shall be the capitalized amount of such obligation determined in
accordance with GAAP; and the Stated Maturity thereof shall be the date of the
last payment of rent or any other amount due under such lease prior to the first
date upon which such lease may be terminated by the lessee without payment of a
penalty.
"Capital Stock" of any Person means any and all shares, interests, rights
to purchase, warrants, options, participations or other equivalents of or
interests in (however designated) equity of such Person, including any Preferred
Stock, but excluding any debt securities convertible into such equity and any
warrants or options granted to directors, officers or employees of the Company
in the ordinary course of business.
"Cash Balance Amount" means, as of any date, the amount equal to the
aggregate amount of cash and Temporary Cash Investments held by the Company and
its Restricted Subsidiaries as of the close of business on the immediately
preceding Business Day divided by 1.04, minus $5,000.000.
"Change of Control" means the occurrence of any of the following events:
(i) any "person" (as such term is used in Sections 13(d) and 14(d) of
the Exchange Act), other than one or more Permitted Holders, is or becomes
the beneficial owner (as defined in Rules 13d-3 and 13d-5 under the
Exchange Act, except that for purposes of this clause (i) such person shall
be deemed to have "beneficial ownership" of all shares that such person has
the right to acquire, whether such right is exercisable immediately or only
after the passage of time), directly or indirectly, of more than 35% of the
total voting power of the Voting Stock of the Company; provided, however,
that the Permitted Holders beneficially own (as defined in Rules 13d-3 and
13d-5 under the Exchange Act),
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directly or indirectly, in the aggregate a lesser percentage of the total
voting power of the Voting Stock of the Company than such other person and
do not have the right or ability by voting power, contract or otherwise to
elect or designate for election a majority of the Board of Directors (for
the purposes of this clause (i), such other person shall be deemed to
beneficially own any Voting Stock of a specified corporation held by a
parent corporation, if such other person is the beneficial owner (as
defined in this clause (i)), directly or indirectly, of more than 35% of
the voting power of the Voting Stock of such parent corporation and the
Permitted Holders beneficially own (as defined in this proviso), directly
or indirectly, in the aggregate a lesser percentage of the voting power of
the Voting Stock of such parent corporation and do not have the right or
ability by voting power, contract or otherwise to elect or designate for
election a majority of the board of directors of such parent corporation);
(ii) during any period of two consecutive years from and after the
Closing Date, individuals who at the beginning of such period constituted
the Board of Directors (together with any new directors whose election by
such Board of Directors or whose nomination for election by the
shareholders of the Company was approved by a vote of a majority of the
directors of the Company then still in office who were either directors at
the beginning of such period or whose election or nomination for election
was previously so approved) cease for any reason to constitute a majority
of the Board of Directors then in office; or
(iii) the merger or consolidation of the Company with or into another
Person or the merger of another Person with or into the Company, or the
sale of all or substantially all the assets of the Company to another
Person (other than a Person that is controlled by the Permitted Holders),
and, in the case of any such merger or consolidation, the securities of the
Company that are outstanding immediately prior to such transaction and
which represent 100% of the aggregate voting power of the Voting Stock of
the Company are changed into or exchanged for cash, securities or property,
unless pursuant to such transaction such securities are changed into or
exchanged for, in addition to any other consideration, securities of the
surviving corporation that represent immediately after such transaction, at
least a majority of the aggregate voting power of the Voting Stock of the
surviving corporation.
"Closing Date" means the date on which the Indenture is executed. See
"Closing into Escrow; Liability of the Company and the Subsidiary Guarantors on
the Notes."
"Code" means the Internal Revenue Code of 1986, as amended.
"Collateral" means, collectively, all of the property and assets
(including, without limitation, Trust Moneys) that are from time to time subject
to, or purported to be subject to, the Lien of the Indenture or any of the
Security Documents.
"Collateral Account" has the meaning given to it in the section described
herein under the heading "Possession, Use and Release of Collateral -- Deposit,
Use and Release of Trust Moneys."
"Collateral Maintenance Tender Offer Amount" means, with respect to any
Asset Disposition other than the Phillips Transaction, an amount equal to the
excess of (i) the outstanding principal balance of the Notes over (ii) quotient
obtained by dividing (a) the PV-10 Value of all of the Oil and Gas Assets of the
Company and its Restricted Subsidiaries immediately after giving effect to such
Asset Disposition by (b) 1.75.
"Consolidated Coverage Ratio" as of any date of determination means the
ratio of (i) the aggregate amount of EBITDA for the period of the most recent
four consecutive fiscal quarters ending at least 45 days prior to the date of
such determination to (ii) Consolidated Interest Expense for such four fiscal
quarters; provided, however, that (1) if the Company or any Restricted
Subsidiary has Incurred any Indebtedness since the beginning of such period that
remains outstanding or if the transaction giving rise to the need to calculate
the Consolidated Coverage Ratio is an Incurrence of Indebtedness, or both,
EBITDA and Consolidated Interest Expense for such period shall be calculated
after giving effect on a pro forma basis to such Indebtedness as if such
Indebtedness had been Incurred on the first day of such period and the discharge
of any other Indebtedness repaid, repurchased, defeased or otherwise discharged
with the proceeds of such new Indebtedness as if such discharge had occurred on
the first day of such period, (2) if the Company or any Restricted Subsidiary
has repaid, repurchased, defeased or otherwise discharged any Indebtedness since
the
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beginning of such period or if any Indebtedness is to be repaid, repurchased,
defeased or otherwise discharged on the date of the transaction giving rise to
the need to calculate the Consolidated Coverage Ratio, EBITDA and Consolidated
Interest Expense for such period shall be calculated on a pro forma basis as if
such discharge had occurred on the first day of such period and as if the
Company or such Restricted Subsidiary has not earned the interest income
actually earned during such period in respect of cash or Temporary Cash
Investments used to repay, repurchase, defease or otherwise discharge such
Indebtedness, (3) if since the beginning of such period the Company or any
Restricted Subsidiary shall have made any Asset Disposition (other than an Asset
Disposition involving assets having a fair market value of less than the greater
of one percent (1%) of Adjusted Consolidated Net Tangible Assets as of the end
of the Company's then most recently completed fiscal year and $2.0 million),
then EBITDA for such period shall be reduced by an amount equal to EBITDA (if
positive) directly attributable to the assets which are the subject of such
Asset Disposition for such period, or increased by an amount equal to EBITDA (if
negative), directly attributable thereto for such period and Consolidated
Interest Expense for such period shall be reduced by an amount equal to the
Consolidated Interest Expense directly attributable to any Indebtedness of the
Company or any Restricted Subsidiary repaid, repurchased, defeased or otherwise
discharged with respect to the Company and its continuing Restricted
Subsidiaries in connection with such Asset Disposition for such period (or, if
the Capital Stock of any Restricted Subsidiary is sold, the Consolidated
Interest Expense for such period directly attributable to the Indebtedness of
such Restricted Subsidiary to the extent the Company and its continuing
Restricted Subsidiaries are no longer liable for such Indebtedness after such
sale), (4) if since the beginning of such period the Company or any Restricted
Subsidiary (by merger or otherwise) shall have made an Investment in any
Restricted Subsidiary (or any Person which becomes a Restricted Subsidiary) or
an acquisition (including by way of lease) of assets, including any acquisition
of assets occurring in connection with a transaction requiring a calculation to
be made hereunder, EBITDA and Consolidated Interest Expense for such period
shall be calculated after giving pro forma effect thereto (including the
Incurrence of any Indebtedness) as if such Investment or acquisition occurred on
the first day of such period and (5) if since the beginning of such period any
Person (that subsequently became a Restricted Subsidiary or was merged with or
into the Company or any Restricted Subsidiary since the beginning of such
period) shall have made any Asset Disposition, any Investment or acquisition of
assets that would have required an adjustment pursuant to clause (3) or (4)
above if made by the Company or a Restricted Subsidiary during such period,
EBITDA and Consolidated Interest Expense for such period shall be calculated
after giving pro forma effect thereto as if such Asset Disposition, Investment
or acquisition occurred on the first day of such period. For purposes of this
definition, whenever pro forma effect is to be given to an acquisition or
disposition of assets, the amount of income or earnings relating thereto and the
amount of Consolidated Interest Expense associated with any Indebtedness
Incurred or repaid in connection therewith, the pro forma calculations shall be
determined in good faith by a responsible financial or accounting officer of the
Company. If any Indebtedness bears a floating rate of interest and is being
given pro forma effect, the interest of such Indebtedness shall be calculated as
if the rate in effect on the date of determination had been the applicable rate
for the entire period (taking into account any Interest Rate Agreement
applicable to such Indebtedness if such Interest Rate Agreement has a remaining
term in excess of 12 months).
"Consolidated Current Liabilities" as of the date of determination means
the aggregate amount of liabilities of the Company and its consolidated
Restricted Subsidiaries which may properly be classified as current liabilities
(including taxes accrued as estimated), on a consolidated basis, after
eliminating (i) all intercompany items between the Company and any Restricted
Subsidiary and (ii) all current maturities of long-term Indebtedness, all as
determined in accordance with GAAP consistently applied.
"Consolidated Interest Expense" means, for any period, the total interest
expense of the Company and its consolidated Restricted Subsidiaries for such
period, determined on a consolidated basis in accordance with GAAP, plus, to the
extent not included in such total interest expense, and to the extent incurred
by the Company or its Restricted Subsidiaries, without duplication, (i) interest
expense attributable to capital leases and imputed interest with respect to
Attributable Debt, (ii) capitalized interest, (iii) non-cash interest expenses,
(iv) commissions, discounts and other fees and charges owed with respect to
letters of credit and bankers' acceptance financing, (v) net costs (including
amortization of fees and upfront payments) associated with interest rate caps
and other interest rate and currency options that, at the time entered into,
resulted in
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the Company and its Restricted Subsidiaries being net payees as to future
payouts under such caps or options, and interest rate and currency swaps and
forwards for which the Company or any of its Restricted Subsidiaries has paid a
premium, (vi) Preferred Stock dividends in respect of all Preferred Stock held
by Persons other than the Company or a Wholly Owned Subsidiary, to the extent
that, by the terms of the Preferred Stock, failure to pay such dividends would
result in a bankruptcy of the issuer thereof and (vii) interest accruing on any
Indebtedness of any other Person to the extent such Indebtedness is Guaranteed
by the Company or any Restricted Subsidiary or secured by a Lien on assets of
the Company or any Restricted Subsidiary to the extent such Indebtedness
constitutes Indebtedness of the Company or any Restricted Subsidiary (whether or
not such Guarantee or Lien is called upon); provided, however, "Consolidated
Interest Expense" shall not include any (w) amortization of costs relating to
debt issuances (including the amortization of debt discount) other than the
amortization of debt discount related to the issuance of securities with an
original issue price of not more than 90% of the principal thereof, (x)
amortization of debt discount to the extent it relates to revaluations of
financial instruments recognized in connection with the Consolidation, and (y)
noncash interest expense Incurred in connection with interest rate caps and
other interest rate and currency options that, at the time entered into,
resulted in the Company and its Restricted Subsidiaries being either neutral or
net payors as to future payouts under such caps or options.
"Consolidated Net Income" means, for any period, the net income of the
Company and its consolidated Subsidiaries; provided, however, that there shall
not be included in such Consolidated Net Income: (i) any net income of any
Person (other than the Company) if such Person is not a Restricted Subsidiary,
except that (A) subject to the exclusion contained in clause (iv) below, the
Company's equity in the net income of any such Person for such period shall be
included in such Consolidated Net Income up to the aggregate amount of cash
actually distributed by such Person during such period to the Company or a
Restricted Subsidiary as a dividend or other distribution (subject, in the case
of a dividend or other distribution paid to a Restricted Subsidiary, to the
limitations contained in clause (iii) below) and (B) the Company's equity in a
net loss of any such Person for such period shall be included in determining
such Consolidated Net Income; (ii) any net income (or loss) of any Person
acquired by the Company or a Subsidiary in a pooling of interests transaction
for any period prior to the date of such acquisition; (iii) any net income of
any Restricted Subsidiary if such Restricted Subsidiary is subject to
restrictions, directly or indirectly, on the payment of dividends or the making
of distributions by such Restricted Subsidiary, directly or indirectly, to the
Company, except that (A) subject to the exclusion contained in clause (iv)
below, the Company's equity in the net income of any such Restricted Subsidiary
for such period shall be included in such Consolidated Net Income up to the
aggregate amount of cash actually distributed by such Restricted Subsidiary
during such period to the Company or another Restricted Subsidiary as a dividend
or other distribution (subject, in the case of a dividend or other distribution
paid to another Restricted Subsidiary, to the limitation contained in this
clause) and (B) the Company's equity in a net loss of any such Restricted
Subsidiary for such period shall be included in determining such Consolidated
Net Income; (iv) any gain or loss realized upon the sale or other disposition of
any assets of the Company or its consolidated Subsidiaries (including pursuant
to any sale-and-leaseback arrangement) which is not sold or otherwise disposed
of in the ordinary course of business and any gain or loss realized upon the
sale or other disposition of any Capital Stock of any Person; (v) extraordinary
gains or losses; and (vi) the cumulative effect of a change in accounting
principles.
"Consolidated Net Tangible Assets," as of any date of determination, means
the total amount of assets (less accumulated depreciation and amortization,
allowances for doubtful receivables, other applicable reserves and other
properly deductible items) which would appear on a consolidated balance sheet of
the Company and its consolidated Restricted Subsidiaries, determined on a
consolidated basis in accordance with GAAP, and after giving effect to purchase
accounting and after deducting therefrom Consolidated Current Liabilities and,
to the extent otherwise included, the amounts of: (i) minority interests in
consolidated Subsidiaries held by Persons other than the Company or a Restricted
Subsidiary; (ii) excess of cost over fair value of assets of businesses
acquired, as determined in good faith by the Board of Directors; (iii) any
revaluation or other write-up in book value of assets subsequent to the Issue
Date as a result of a change in the method of valuation in accordance with GAAP
consistently applied; (iv) unamortized debt discount and expenses and other
unamortized deferred charges, goodwill, patents, trademarks, service marks,
trade names, copyrights, licenses, organization or developmental expenses and
other intangible items; (v) treasury stock;
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(vi) cash set apart and held in a sinking or other analogous fund established
for the purpose of redemption or other retirement of Capital Stock to the extent
such obligation is not reflected in Consolidated Current Liabilities; and (vii)
Investments in and assets of Unrestricted Subsidiaries.
"Consolidated Net Worth" means the total of the amounts shown on the
balance sheet of the Company and its consolidated Subsidiaries, determined on a
consolidated basis in accordance with GAAP, as of the end of the most recent
fiscal quarter of the Company ending at least 45 days prior to the taking of any
action for the purpose of which the determination is being made, as (i) the par
or stated value of all outstanding Capital Stock of the Company plus (ii)
paid-in capital or capital surplus relating to such Capital Stock plus (iii) any
retained earnings or earned surplus less (A) any accumulated deficit and (B) any
amounts attributable to Disqualified Stock.
"Consolidation" means the conversion in 1994 of Capital Stock of Kelley Oil
and units in Kelley Oil & Gas Partners, Ltd., a Texas limited partnership, into
shares of common stock, Convertible Exchangeable Preferred Stock and cumulative
convertible stock of the Company.
"Convertible Exchangeable Preferred Stock" means the $2.625 Convertible
Exchangeable Preferred Stock of the Company.
"Credit Agreement" means that certain Amended and Restated Credit Agreement
dated as of December 1, 1997 among the Company, Kelley Oil Corporation and
Kelley Operating Company, Ltd., as borrowers, Concorde Gas Marketing, Inc. and
certain other Persons, as guarantors, each of the lenders that is a signatory
thereto, and Chase Bank of Texas, National Association (formerly known as Texas
Commerce Bank National Association), as agent, and any related notes,
guarantees, collateral documents, instruments and agreements executed in
connection therewith, and in each case, as amended or modified prior to the
Issue Date.
"Credit Facilities" means, with respect to the Company or any Restricted
Subsidiary, one or more debt facilities (other than the Credit Agreement) or
commercial paper facilities with banks or other institutional lenders providing
for revolving credit loans, term loans, production payments, receivables
financings (including through the sale of receivables to such lenders or to
special purpose entities formed to borrow from such lenders against such
receivables) or letters of credit, in each case, as amended, restated, modified,
renewed, refunded, replaced or refinanced in whole or in part from time to time.
"Currency Agreement" means in respect of a Person any foreign exchange
contract, currency swap agreement or other similar agreement to which such
Person is a party or a beneficiary.
"Default" means any event which is, or after notice or passage of time or
both would be, an Event of Default.
"Phillips Transaction" means the transaction(s) contemplated by that
certain Exploration and Development Agreement dated as of April 12, 1999 between
the Company and Phillips Petroleum Company, as the same may be amended, but in
any event providing for cash proceeds to the Company equal to at least $80.0
million minus any non-material, usual and customary price adjustments for
similar transactions in the Oil and Gas Business.
"Disqualified Stock" means, with respect to any Person, any Capital Stock
to the extent that by its terms (or by the terms of any security into which it
is convertible or for which it is exchangeable) or upon the happening of any
event, it (i) matures or is mandatorily redeemable pursuant to a sinking fund
obligation or otherwise, (ii) is convertible or exchangeable for Indebtedness or
Disqualified Stock or (iii) is redeemable, in whole or in part, at the option of
the holder thereof, in each case described in the immediately preceding clauses
(i), (ii) or (iii), on or prior to the Stated Maturity of the Notes; provided,
however, that any Capital Stock that would not constitute Disqualified Stock but
for provisions thereof giving holders thereof the right to require such Person
to repurchase or redeem such Capital Stock upon the occurrence of an "asset
sale" or "change of control" occurring prior to the Stated Maturity of the Notes
shall not constitute Disqualified Stock if the "asset sale" or "change of
control" provisions applicable to such Capital Stock are not more favorable to
the holders of such Capital Stock than the provisions described under
"-- Certain Covenants -- Limitation on
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Sales of Assets and Subsidiary Stock" and "-- Certain Covenants -- Change of
Control"; provided further, however, that the Company's Convertible Exchangeable
Preferred Stock outstanding on the Issue Date shall not be deemed Disqualified
Stock.
"Dollar-Denominated Production Payments" means production payment
obligations recorded as liabilities in accordance with GAAP, together with all
undertakings and obligations in connection therewith.
"EBITDA" for any period means the sum of Consolidated Net Income, plus
Consolidated Interest Expense plus the following to the extent deducted in
calculating such Consolidated Net Income: (a) provision for taxes based on
income or profits, (b) depletion and depreciation expense, (c) amortization
expense, (d) exploration costs and (e) all other non-cash charges (excluding any
such non-cash charge to the extent that it represents an accrual of or reserve
for cash charges in any future period or amortization of a prepaid cash expense
that was paid in a prior period except such amounts as the Company determines in
good faith are nonrecurring), and less, to the extent included in calculating
such Consolidated Net Income and in excess of any costs or expenses attributable
thereto and deducted in calculating such Consolidated Net Income, the sum of (x)
the amount of deferred revenues that are amortized during such period and are
attributable to reserves that are subject to Volumetric Production Payments and
(y) amounts recorded in accordance with GAAP as repayments of principal and
interest pursuant to Dollar-Denominated Production Payments. Notwithstanding the
preceding, the provision for taxes based on the income or profits of, and the
depreciation and amortization and other non-cash charges of, a Subsidiary of the
Company shall be added to Consolidated Net Income to compute EBITDA only to the
extent (and in the same proportion) that the net income of such Subsidiary was
included in calculating Consolidated Net Income and only if a corresponding
amount would be permitted at the date of determination to be dividended to the
Company by such Subsidiary without prior approval (that has not been obtained)
pursuant to the terms of its charter and all agreements, instruments, judgments,
decrees, orders, statutes, rules and governmental regulations applicable to such
Subsidiary or its stockholders.
"Equity Offering" means a primary offering, whether public or private, of
shares of common stock of the Company.
"Excess Proceeds" has the meaning given such term in the covenant
"-- Limitation on Sales of Assets and Subsidiary Stock."
"Excess Proceeds Offer" has the meaning given such term in the covenant
"-- Limitation on Sales of Assets and Subsidiary Stock."
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Exchange Offer" has the meaning given such term in the section
"Registration Rights; Liquidated Damages."
"Exchange Notes" has the meaning given such term in the section
"Registration Rights; Liquidated Damages."
"GAAP" means generally accepted accounting principles in the United States
of America as in effect on the Issue Date, including those set forth in (i) the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants, (ii) statements and pronouncements of
the Financial Accounting Standards Board, (iii) such other statements by such
other entity as approved by a significant segment of the accounting profession,
and (iv) the rules and regulations of the SEC governing the inclusion of
financial statements (including pro forma financial statements) in periodic
reports required to be filed pursuant to Section 13 of the Exchange Act,
including opinions and pronouncements in staff accounting bulletins and similar
written statements from the accounting staff of the SEC.
"Guarantee" means, without duplication, any obligation, contingent or
otherwise, of any Person directly or indirectly guaranteeing any Indebtedness of
any other Person and any obligation, direct or indirect, contingent or
otherwise, of such Person (i) to purchase or pay (or advance or supply funds for
the purchase or payment of) such Indebtedness of such other Person (whether
arising by virtue of partnership arrangements, or by agreements to keep-well, to
purchase assets, goods, securities or services, to take-or-pay or to maintain
financial statement conditions or otherwise) or (ii) entered into for the
purpose of assuring in any other
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manner the obligee of such Indebtedness of the payment thereof or to protect
such obligee against loss in respect thereof (in whole or in part); provided,
however, that the term "Guarantee" shall not include endorsements for collection
or deposit in the ordinary course of business. The term "Guarantee" used as a
verb has a corresponding meaning. The term "Guarantor" shall mean any Person
Guaranteeing any obligation.
"Guaranteed Obligations" has the meaning given such term in the section
"Subsidiary Guarantees."
"Hedging Obligations" of any Person means the obligations of such Person
pursuant to any Oil and Gas Hedging Contract, Interest Rate Agreement or
Currency Agreement.
"Holder" or "Noteholder" means the Person in whose name a Note is
registered on the Registrar's books.
"Incur" means issue, assume, Guarantee, incur or otherwise become liable
for; provided, however, that any Indebtedness, Capital Stock or Lien of a Person
existing at the time such Person becomes a Subsidiary (whether by merger,
consolidation, acquisition or otherwise) shall be deemed to be Incurred by such
Subsidiary at the time it becomes a Subsidiary. The term "Incurrence" when used
as a noun shall have a correlative meaning. The accretion of principal of a
non-interest bearing or other discount security shall not be deemed the
Incurrence of Indebtedness.
"Indebtedness" means, with respect to any Person on any date of
determination (without duplication), (i) the principal of and premium (if any)
in respect of (A) indebtedness of such Person for money borrowed and (B)
indebtedness evidenced by notes, debentures, bonds or other similar instruments
for the payment of which such Person is responsible or liable; (ii) all Capital
Lease Obligations of such Person and all Attributable Debt in respect of
Sale/Leaseback Transactions entered into by such Person; (iii) all obligations
of such Person issued or assumed as the deferred purchase price of property
(which purchase price is due more than six months after the date of taking
delivery of title to such property), including all obligations of such Person
for the deferred purchase price of property under any title retention agreement
(but excluding trade accounts payable arising in the ordinary course of
business); (iv) all obligations of such Person for the reimbursement of any
obligor on any letter of credit, banker's acceptance or similar credit
transaction (other than obligations with respect to letters of credit securing
obligations (other than obligations described in (i) through (iii) above)
entered into in the ordinary course of business of such Person to the extent
such letters of credit are not drawn upon or, if and to the extent drawn upon,
such drawing is reimbursed no later than the tenth Business Day following
receipt by such Person of a demand for reimbursement following payment on the
letter of credit); (v) the amount of all obligations of such Person with respect
to the redemption, repayment or other repurchase of any Disqualified Stock or,
with respect to any Subsidiary of such Person the liquidation preference with
respect to, any Preferred Stock (but excluding, in each case, any accrued
dividends); (vi) all obligations of such Person relating to any Production
Payment or in respect of production imbalances (but excluding production
imbalances arising in the ordinary course of business); (vii) all obligations of
the type referred to in clauses (i) through (vi) of other Persons and all
dividends of other Persons for the payment of which, in either case, such Person
is responsible or liable, directly or indirectly, as obligor, guarantor or
otherwise, including by means of any Guarantee (including, with respect to any
Production Payment, any warranties or Guarantees of production or payment by
such Person with respect to such Production Payment but excluding other
contractual obligations of such Person with respect to such Production Payment);
(viii) all obligations of the type referred to in clauses (i) through (vii) of
other Persons secured by any Lien on any property or asset of such
first-mentioned Person (whether or not such obligation is assumed by such
first-mentioned Person), the amount of such obligation being deemed to be the
lesser of the value of such property or assets or the amount of the obligation
so secured and (ix) to the extent not otherwise included in this definition,
Hedging Obligations of such Person.
The "amount" or "principal amount" of Indebtedness at any time of
determination as used herein represented by: (1) any Capital Lease Obligation
shall be the amount determined in accordance with the definition thereof, (2)
any Interest Rate Agreements included in the definition of Permitted
Indebtedness shall be zero, (3) all other unconditional obligations shall be the
amount of the liability thereof determined in accordance with GAAP, and (4) all
other contingent obligations shall be the maximum liability at such date of such
Person.
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It is understood that none of the following shall constitute Indebtedness:
(i) indebtedness arising from agreements providing for indemnification or
adjustment of purchase price or from Guarantees securing any obligations of the
Company or any of its Subsidiaries pursuant to such agreements, incurred or
assumed in connection with the disposition of any business, assets or Subsidiary
of the Company, other than Guarantees or similar credit support by the Company
or any of its Subsidiaries of Indebtedness incurred by any Person acquiring all
or any portion of such business, assets or Subsidiary for the purpose of
financing such acquisition; (ii) any trade payables and other accrued current
liabilities incurred in the ordinary course of business as the deferred purchase
price of property; (iii) obligations arising from Guarantees to suppliers,
lessors, licensees, contractors, franchisees or customers incurred in the
ordinary course of business; (iv) obligations (other than express Guarantees of
indebtedness for borrowed money) in respect of Indebtedness of other Persons
arising in connection with (A) the sale or discount of accounts receivable, (B)
trade acceptances and (C) endorsements of instruments for deposit in the
ordinary course of business, (v) obligations in respect of performance bonds
provided by the Company or its Subsidiaries in the ordinary course of business
and refinancings thereof; (vi) obligations arising from the honoring by a bank
or other financial institution of a check, draft or similar instrument drawn
against insufficient funds in the ordinary course of business, provided,
however, that such obligation is extinguished within two business days of its
incurrence; and (vii) obligations in respect of any obligations under workers'
compensation laws and similar legislation.
"Initial Purchaser" means Jefferies & Company, Inc.
"Interest Rate Agreement" means any interest rate swap agreement, interest
rate cap agreement or other financial agreement or arrangement designed to
protect the Company or any Restricted Subsidiary against fluctuations in
interest rates.
"Investment" in any Person means any direct or indirect advance, loan
(other than advances to customers or joint interest partners or drilling
partnerships sponsored by the Company or any Restricted Subsidiary in the
ordinary course of business that are recorded as accounts receivable on the
balance sheet of the lender) or other extensions of credit (including by way of
Guarantee or similar arrangement) or capital contribution to (by means of any
transfer of cash or other property to others or any payment for property or
services for the account or use of others), or any purchase or acquisition of
Capital Stock, Indebtedness or other similar instruments issued by such Person.
For purposes of the definition of "Unrestricted Subsidiary," the definition of
"Restricted Payment" and the covenant described under "-- Certain
Covenants -- Limitation on Restricted Payments," (i) "Investment" shall include
the portion (proportionate to the Company's equity interest in such Subsidiary)
of the fair market value of the net assets of any Subsidiary of the Company at
the time that such Subsidiary is designated an Unrestricted Subsidiary;
provided, however, that upon a redesignation of such Subsidiary as a Restricted
Subsidiary, the Company shall be deemed to continue to have a permanent
"Investment" in an Unrestricted Subsidiary equal to an amount (if positive)
equal to (x) the Company's "Investment" in such Subsidiary at the time of such
redesignation less (y) the portion (proportionate to the Company's equity
interest in such Subsidiary) of the fair market value of the net assets of such
Subsidiary at the time of such redesignation; and (ii) any property transferred
to or from an Unrestricted Subsidiary shall be valued at its fair market value
at the time of such transfer, in each case as determined in good faith by the
Board of Directors.
"Issue Date" means the date on which the proceeds of the Notes are released
from escrow as provided under the heading "Closing in Escrow; Liability of
Company and Subsidiary Guarantors for Senior Secured Notes."
"Lien" means any mortgage, pledge, security interest, encumbrance, lien or
charge of any kind (including any conditional sale or other title retention
agreement or lease in the nature thereof).
"Liquidated Damages" has the meaning given such term in the section
"Registration Rights; Liquidated Damages."
"Limited Recourse Indebtedness" means, with respect to any Production
Payments, Indebtedness, the terms of which limit the liability of the Company
and its Restricted Subsidiaries solely to the hydrocarbons covered by such
Production Payments; provided, however, that no default with respect to such
Indebtedness
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would permit any holder of any other Indebtedness of the Company or any
Restricted Subsidiary to declare a default on such other Indebtedness or cause
the payment thereof to be accelerated or payable prior to its Stated Maturity.
"Material Change" means an increase or decrease (excluding changes that
result solely from changes in prices) of more than 15% during a fiscal quarter
in the discounted future net revenues from proved oil and gas reserves of the
Company and its Restricted Subsidiaries, calculated in accordance with clause
(a)(i) of the definition of Adjusted Consolidated Net Tangible Assets; provided,
however, that the following will be excluded from the calculation of Material
Change: (i) any acquisitions during the fiscal quarter of oil and gas reserves
that have been estimated by independent petroleum engineers and with respect to
which a report or reports of such engineers exist and (ii) any disposition of
properties existing at the beginning of such fiscal quarter that have been
disposed of in compliance with the covenant described under "-- Certain
Covenants -- Limitation on Sales of Assets and Subsidiary Stock."
"Minimum Reserve Amount" means, as of any date, an amount of Oil and Gas
Assets expressed as a volumetric equivalent equal to 180 Bcfe less the aggregate
of all revisions to reserves resulting from sales of reserves in place as
reflected in all Reserve Reports delivered pursuant to the Indenture.
"Mortgage" means mortgage (or deed of trust), assignment of production,
security agreement, fixture filing and financing statement granted by the
Company or any Subsidiary Guarantor for the benefit of the Trustee and the
Holders and pursuant to which one or more Liens on Oil and Gas Assets or
interests therein are created, as the same may be amended, supplemented or
modified from time to time in accordance with the terms thereof and of the
Indenture.
"Net Available Cash" from an Asset Disposition means cash payments received
therefrom (including any cash payments received by way of deferred payment of
principal pursuant to a note or installment receivable or otherwise, but only as
and when received, but excluding any other consideration received in the form of
assumption by the acquiring Person of Indebtedness or other obligations relating
to such properties or assets or received in any other noncash form) in each case
net of (i) all legal, title and recording tax expenses, commissions and other
fees (including financial and other advisory fees) and expenses incurred, and
all Federal, state, provincial, foreign and local taxes required to be accrued
as a liability under GAAP, as a consequence of such Asset Disposition, (ii) all
payments made on any Indebtedness which is secured by any assets subject to such
Asset Disposition, in accordance with the terms of any Lien upon or other
security agreement of any kind with respect to such assets, or which must by its
terms, or in order to obtain a necessary consent to such Asset Disposition, or
by applicable law, be repaid out of the proceeds from such Asset Disposition,
(iii) all distributions and other payments required to be made to minority
interest holders in Subsidiaries or joint ventures as a result of such Asset
Disposition and (iv) the deduction of appropriate amounts provided by the seller
as a reserve, in accordance with GAAP, against any liabilities associated with
the property or other assets disposed in such Asset Disposition and retained by
the Company or any Restricted Subsidiary after such Asset Disposition.
"Net Cash Proceeds," with respect to any issuance or sale of Capital Stock,
means the cash proceeds of such issuance or sale net of attorneys' fees,
accountants' fees, underwriters' or placement agents' fees, discounts or
commissions and brokerage, consultant and other fees actually incurred in
connection with such issuance or sale and net of taxes paid or payable as a
result thereof.
"Net Present Value" means, with respect to any proved hydrocarbon reserves,
the discounted future net revenues associated with such reserves, determined in
accordance with the rules and regulations (including interpretations thereof) of
the SEC in effect on the Closing Date.
"Net Working Capital" means (a) all current assets of the Company and its
Restricted Subsidiaries minus (b) all current liabilities of the Company and its
Restricted Subsidiaries, except current liabilities included in Indebtedness,
determined in accordance with GAAP.
"Obligations" means all obligations for principal, premium, interest,
penalties, fees, indemnifications, reimbursements, damages and other liabilities
payable under the Indenture and other documentation governing the Senior Secured
Notes.
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"Oil and Gas Assets" means all proved oil and gas reserves and natural gas
processing facilities of the Company and/or any Restricted Subsidiary.
"Oil and Gas Business" means the business of the exploration for, and
exploitation, development, acquisition, production, processing (but not
refining), marketing, storage and transportation of, hydrocarbons, and other
related energy and natural resource businesses.
"Oil and Gas Hedging Contract" means any oil and gas purchase or hedging
agreement, and other agreement or arrangement, in each case, that is designed to
provide protection against oil and gas price fluctuations.
"Permitted Business Investment" means any Investment made in the ordinary
course of, and of a nature that is or shall have become customary in, the Oil
and Gas Business as a means of actively exploiting, exploring for, acquiring,
developing, producing, processing, gathering, marketing or transporting oil and
gas through agreements, transactions, interests or arrangements which permit one
to share risks or costs, comply with regulatory requirements regarding local
ownership or satisfy other objectives customarily achieved through the conduct
of Oil and Gas Business jointly with third parties, including (i) ownership
interests in oil and gas properties, processing facilities, gathering systems or
ancillary real property interests and (ii) Investments in the form of or
pursuant to operating agreements, processing agreements, farm-in agreements,
farm-out agreements, development agreements, area of mutual interest agreements,
unitization agreements, pooling agreements, joint bidding agreements, service
contracts, joint venture agreements, partnership agreements (whether general or
limited), subscription agreements, stock purchase agreements and other similar
agreements with third parties.
"Permitted Holders" means (i) the members of Contour Production Company
L.L.C., a Delaware limited liability company ("Contour"), as of the Closing Date
(the "Contour Group"), (ii) Contour, so long as Contour is controlled (as
defined in the definition of "Affiliate" above), directly or indirectly, by the
Contour Group, (iii) officers, principals, employees, direct or indirect owners
or Affiliates of Persons described in clauses (i) or (ii), (iv) Persons who
beneficially own Voting Stock of the Company on the Closing Date and (v)
officers or employees of the Company or any of its Subsidiaries as of the
Closing Date.
"Permitted Investment" means an Investment by the Company or any Restricted
Subsidiary in (i) a Restricted Subsidiary or a Person that will, upon the making
of such Investment, become a Restricted Subsidiary; provided, however, that the
primary business of such Restricted Subsidiary is an Oil and Gas Business; (ii)
another Person if as a result of such Investment such other Person is merged or
consolidated with or into, or transfers or conveys all or substantially all its
assets to, the Company or a Restricted Subsidiary; provided, however, that such
Person's primary business is an Oil and Gas Business; (iii) Temporary Cash
Investments; (iv) receivables owing to the Company or any Restricted Subsidiary
if created or acquired in the ordinary course of business and payable or
dischargeable in accordance with customary trade terms; provided, however, that
such trade terms may include such concessionary trade terms as the Company or
any such Restricted Subsidiary deems reasonable under the circumstances; (v)
payroll, travel and similar advances to cover matters that are expected at the
time of such advances ultimately to be treated as expenses for accounting
purposes and that are made in the ordinary course of business; (vi) loans or
advances to employees made in the ordinary course of business; (vii) stock,
obligations or securities received in settlement of debts created in the
ordinary course of business and owing to the Company or any Restricted
Subsidiary or in satisfaction of judgments; (viii) any Person to the extent such
Investment represents the non-cash portion of the consideration received for an
Asset Disposition as permitted pursuant to the covenant described under
"-- Certain Covenants -- Limitation on Sales of Assets and Subsidiary Stock" and
(ix) Permitted Business Investments.
"Permitted Joint Venture" means any Person engaged in the Oil and Gas
Business in which the Company or a Restricted Subsidiary makes a Permitted
Business Investment and which cannot, by the terms of such Person's constituent
documents, Incur or Guarantee Indebtedness.
"Permitted Liens" means, with respect to any Person, (a) pledges or
deposits by such Person under worker's compensation laws, unemployment insurance
laws or similar legislation, or good faith deposits in
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connection with bids, tenders, contracts (other than for the payment of
Indebtedness) or leases to which such Person is a party, or deposits to secure
public or statutory obligations of such Person or deposits of cash or United
States government bonds to secure surety or appeal bonds to which such Person is
a party, or deposits as security for contested taxes or import duties or for the
payment of rent, in each case Incurred in the ordinary course of business; (b)
Liens imposed by law, such as carriers', warehousemen's and mechanics' Liens, in
each case for sums not yet due or being contested in good faith by appropriate
proceedings; (c) Liens for property taxes not yet subject to penalties for
non-payment or which are being contested in good faith and by appropriate
proceedings; (d) Liens in favor of issuers of surety bonds or letters of credit
issued pursuant to the request of and for the account of such Person in the
ordinary course of its business; provided, however, that such letters of credit
do not constitute Indebtedness; (e) minor survey exceptions, minor encumbrances,
easements or reservations of, or rights of others for, licenses, rights of way,
sewers, electric lines, telegraph and telephone lines and other similar
purposes, or zoning or other restrictions as to the use of real property or
Liens incidental to the conduct of the business of such Person or to the
ownership of its properties which were not Incurred in connection with
Indebtedness and which do not in the aggregate materially impair their use in
the operation of the business of such Person; (f) Liens securing Indebtedness
Incurred under clauses (b)(7) and (b)(11) of the covenant "Limitation on
Indebtedness"; provided, however, that the Lien may not extend to any other
property owned by such Person or any of its Subsidiaries at the time the Lien is
Incurred, and the Indebtedness secured by the Lien may not be Incurred more than
365 days after the later of the acquisition, completion of construction, repair,
improvement, addition or commencement of full operation of the property subject
to the Lien; (g) Liens securing Refinancing Indebtedness which is incurred to
Refinance any Indebtedness which has been incurred in accordance with the
provisions of this Indenture; provided, that: (1) such Liens are expressly
junior to the Liens securing the Obligations and the Subsidiary Guarantees, (2)
such Refinancing results in an improvement on a pro forma basis in the Company's
Consolidated Coverage Ratio, and (3) the instruments creating such Liens
expressly subject the foreclosure rights of the holders of the Indebtedness
being Refinanced to a stand-still of not less than 179 days; (h) Liens existing
on the Closing Date; (i) Liens on property or shares of Capital Stock of another
Person at the time such other Person becomes a Subsidiary of such Person;
provided, however, that such Liens are not created, incurred or assumed in
connection with, or in contemplation of, such other Person becoming such a
Subsidiary; provided further, however, that such Lien may not extend to any
other property owned by such Person or any of its Subsidiaries; (j) Liens on
property at the time such Person or any of its Subsidiaries acquires the
property, including any acquisition by means of a merger or consolidation with
or into such Person or a Subsidiary of such Person; provided, however, that such
Liens are not created, incurred or assumed in connection with, or in
contemplation of, such acquisition; provided further, however, that the Liens
may not extend to any other property owned by such Person or any of its
Subsidiaries; (k) Liens securing Indebtedness or other obligations of a
Subsidiary of such Person owing to such Person or a wholly owned Subsidiary of
such Person (or, in the case of the Company, to a Wholly Owned Subsidiary); (l)
Liens securing Hedging Obligations so long as such Hedging Obligations relate to
Indebtedness that is, and is permitted to be under the Indenture, secured by a
Lien on the same property securing such Hedging Obligations; (m) Liens arising
in the ordinary course of business in favor of the United States, any state
thereof, any foreign country or any department, agency, instrumentality or
political subdivision of any such jurisdiction, to secure partial, progress,
advance or other payments pursuant to any contract or statute; (n) Liens to
secure any Refinancing (or successive Refinancing) as a whole, or in part, of
any Indebtedness secured by any Lien referred to in the preceding clauses (f),
(g), (h), (i) and (j); provided, however, that (x) such new Lien shall be
limited to all or part of the same property that secured the original Lien (plus
improvements to or on such property) and (y) the Indebtedness secured by such
Lien at such time is not increased to any amount greater than the sum of (A) the
outstanding principal amount or, if greater, committed amount of the
Indebtedness described under clause (g), (f), (h), (i) or (j) at the time the
original Lien became a Permitted Lien and (B) an amount necessary to pay any
fees and expenses, including premiums, related to such Refinancing; (o) Liens
on, or related to, properties to secure all or part of the costs incurred in the
ordinary course of business of exploration, drilling, development or operation
thereof; (p) Liens on pipeline or pipeline facilities which arise out of
operation of law; (q) Liens reserved in oil and gas mineral leases for bonus or
rental payments and for compliance with the terms of such leases; (r) Liens
arising under partnership agreements, oil and gas leases, farm-out agreements,
division orders, contracts for the sale, purchase, exchange, transportation or
processing (but not the refining) of oil, gas
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or other hydrocarbons, unitization and pooling declarations and agreements,
development agreements, operating agreements, area of mutual interest
agreements, and other similar agreements which are customary in the Oil and Gas
Business; (s) Liens arising out of judgments or awards against such Person with
respect to which such Person shall then be proceeding with an appeal or other
proceedings for review; and (t) Liens arising pursuant to the Indenture or any
Security Document or otherwise securing the Obligations and/or the Subsidiary
Guarantees. Notwithstanding the preceding, (1) "Permitted Liens" will not
include any Lien described in clause (f), (i) or (j) above to the extent (A)
such Lien applies to any Additional Assets or Permitted Business Investment
acquired directly or indirectly from Net Available Cash pursuant to the covenant
described under "-- Certain Covenants -- Limitation on Sales of Assets and
Subsidiary Stock" and (B) the fair value of such Additional Assets or Permitted
Business Investment is less than the sum of (x) the amount of Indebtedness
secured by such Lien plus (y) the amount of Net Available Cash so invested in
such Additional Assets or Permitted Business Investment; (2) "Permitted Liens"
as such term relates to encumbrances on property constituting Collateral shall
not include Liens of the type described in clauses (a), (d), (h), (l) and (n)
(in so far as it relates to clause (h)); and (3) Liens Incurred pursuant to
clauses (f), (i) and (j) shall not secure Indebtedness in a principal amount at
any one time outstanding in excess of the greater of (A) $5.0 million or (B) an
amount equal to 33.33% of the fair market value of the property acquired (which
shall be deemed to be the PV-10 Value of any Oil and Gas Assets) subject of such
Lien as of the date such Lien is created or assumed.
"Person" means any individual, corporation, partnership, joint venture,
association, joint-stock company, trust, unincorporated organization, government
or any agency or political subdivision thereof or any other entity.
"Pledge Agreement" means that certain Pledge Agreement dated as of the
Issue Date pursuant to which the Capital Stock of the Programs owned by the
Company and its Restricted Subsidiaries is pledged to the Trustee for the
benefit of the Holders, as the same may be amended, modified or supplemented
from time to time.
"Preferred Stock," as applied to the Capital Stock of any Person, means
Capital Stock of any class or classes (however designated) which is preferred as
to the payment of dividends, or as to the distribution of assets upon any
voluntary or involuntary liquidation or dissolution of such Person, over shares
of Capital Stock of any other class of such Person.
"principal" of a Senior Secured Note means the principal of the Senior
Secured Note plus the premium, if any, payable on the Senior Secured Note which
is due or overdue or is to become due at the relevant time.
"Production Payments" means, collectively, Dollar-Denominated Production
Payments and Volumetric Production Payments.
"Programs" means Kelley Partners 1992 Development Drilling Program, a Texas
limited partnership, and Kelley Partners 1994 Development Drilling Program, a
Texas limited partnership, together with Kelley Partners 1992 Development
Drilling Joint Venture, a Texas general partnership, Kelley Partners 1994
Development Drilling Joint Venture, a Texas general partnership, and each of
their respective successors.
"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.
"Refinance" means, in respect of any Indebtedness, to refinance, extend,
renew, refund, repay, prepay, redeem, defease or retire, or to issue other
Indebtedness in exchange or replacement for, such Indebtedness (including an
Incurrence pursuant to clause (ii) of the first or third paragraph of the
covenant described under "-- Certain Covenants -- Merger and Consolidation").
"Refinanced" and "Refinancing" shall have correlative meanings.
"Refinancing Indebtedness" means Indebtedness that Refinances any
Indebtedness of the Company or any Restricted Subsidiary existing on the Closing
Date or Incurred in compliance with the Indenture including
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Indebtedness that Refinances Refinancing Indebtedness and Indebtedness that is
deemed to be Incurred at the time of a merger or consolidation pursuant to
clause (ii) of the first or third paragraph of the covenant described under
"-- Certain Covenants -- Merger and Consolidation," provided, however, that (i)
such Refinancing Indebtedness has a Stated Maturity no earlier than the Stated
Maturity of the Indebtedness being Refinanced, (ii) such Refinancing
Indebtedness has an Average Life at the time such Refinancing Indebtedness is
Incurred that is equal to or greater than the Average Life of the Indebtedness
being Refinanced and (iii) such Refinancing Indebtedness has an aggregate
principal amount (or if Incurred with original issue discount, an aggregate
issue price) that is equal to or less than the aggregate principal amount (or if
Incurred with original issue discount, the aggregate accreted value) then
outstanding or committed (plus fees and expenses, including any premium and
defeasance costs) under the Indebtedness being Refinanced; provided further,
however, that Refinancing Indebtedness shall not include (x) Indebtedness of a
Subsidiary (other than a Subsidiary Guarantor) that Refinances Indebtedness of
the Company or another Subsidiary or (y) Indebtedness of the Company or a
Restricted Subsidiary that Refinances Indebtedness of an Unrestricted
Subsidiary.
"Registration Default" has the meaning given such term in the section
"Registration Rights; Liquidated Damages."
"Registration Rights Agreement" means the Registration Rights Agreement
dated the Closing Date but effective as of the Issue Date among the Issuer, the
Subsidiary Guarantors and the Initial Purchaser.
"Reserve Report" shall mean a reserve engineering report, setting forth, as
of the most recent January 1, April 1, July 1 and October 1, the oil and gas
reserves attributable to the Company's and its Restricted Subsidiaries' Oil and
Gas Assets included in the Collateral together with a projection of the rate of
production and future net income, severance and production taxes, operating
expenses and capital expenditures with respect thereto as of such date, based
upon the pricing assumptions consistent with SEC reporting requirements at the
time.
"Restricted Payment" with respect to any Person means (i) the declaration
or payment of any dividends or any other distributions of any sort in respect of
its Capital Stock (including any payment in connection with any merger or
consolidation involving such Person) or similar payment to the direct or
indirect holders of its Capital Stock (other than (x) dividends or distributions
payable solely in its Capital Stock (other than Disqualified Stock), (y)
dividends or distributions payable solely to the Company or a Restricted
Subsidiary, and (z) pro rata dividends or other distributions made by a
Subsidiary that is not a Wholly Owned Subsidiary to minority stockholders (or
owners of an equivalent interest in the case of a Subsidiary that is an entity
other than a corporation)), (ii) the purchase, redemption or other acquisition
or retirement for value of any Capital Stock of the Company held by any Person
or of any Capital Stock of a Restricted Subsidiary held by any Affiliate of the
Company (other than a Restricted Subsidiary), including the exercise of any
option to exchange any Capital Stock (other than into Capital Stock of the
Company that is not Disqualified Stock), (iii) the purchase, repurchase,
redemption, defeasance or other acquisition or retirement for value, prior to
scheduled maturity, scheduled repayment or scheduled sinking fund payment of any
Subordinated Obligations, (iv) the purchase, repurchase, redemption, defeasance
or other acquisition or retirement for value of the Company's 7 7/8% Convertible
Subordinated Notes due 1999 and the Company's 8 1/2% Convertible Subordinated
Notes due 2000, or (v) the making of any Investment in any Person (other than a
Permitted Investment).
"Restricted Subsidiary" means any Subsidiary of the Company that is not an
Unrestricted Subsidiary.
"Sale/Leaseback Transaction" means an arrangement relating to property now
owned or hereafter acquired whereby the Company or a Restricted Subsidiary
transfers such property to a Person and the Company or a Restricted Subsidiary
leases it from such Person.
"SEC" means the Securities and Exchange Commission.
"Securities Act" means the Securities Act of 1933, as amended.
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"Security Documents" means, collectively, the Mortgages, the Pledge
Agreement and all security agreements, mortgages, deeds of trust, collateral
assignments or other instruments evidencing or creating any security interests
in favor of the Trustee or any predecessor Trustee in all or any portion of the
Collateral, in each case as amended, supplemented or modified from time to time
in accordance with their terms and the terms of the Indenture.
"Shelf Registration Statement" has the meaning given such term in the
section "Registration Rights; Liquidated Damages."
"Significant Subsidiary" means any Restricted Subsidiary that would be a
"Significant Subsidiary" of the Company within the meaning of Rule 1-02 under
Regulation S-X promulgated by the SEC.
"Stated Maturity" means, with respect to any security, the date specified
in such security as the fixed date on which the final payment of principal of
such security is due and payable, including pursuant to any mandatory redemption
provision (but excluding any provision providing for the repurchase of such
security at the option of the holder thereof upon the happening of any
contingency unless such contingency has occurred).
"Subordinated Obligations" means any Indebtedness or Preferred Stock of the
Company or any Subsidiary Guarantor (whether outstanding on the Closing Date or
thereafter Incurred) which is subordinate or junior in right of payment to the
Senior Secured Notes or any Subsidiary Guarantee, as the case may be, pursuant
to a written agreement to that effect.
"Subsidiary" means, in respect of any Person, any corporation, association,
partnership or other business entity of which more than 50% of the total voting
power of shares of Capital Stock or other interests (including partnership
interests) entitled (without regard to the occurrence of any contingency) to
vote in the election of directors, managers or trustees thereof is at the time
owned or controlled, directly or indirectly, by (i) such Person, (ii) such
Person and one or more Subsidiaries of such Person or (iii) one or more
Subsidiaries of such Person. Unless otherwise indicated, references to
Subsidiaries in this Description of the Senior Secured Notes refers to
Subsidiaries of the Company.
"Temporary Cash Investments" means any of the following: (i) any investment
in direct obligations of the United States of America or any agency thereof or
obligations guaranteed by the United States of America or any agency thereof,
(ii) investments in time deposit accounts, certificates of deposit and money
market deposits maturing within 180 days of the date of acquisition thereof
issued by a bank or trust company which is organized under the laws of the
United States of America, any state thereof or any foreign country recognized by
the United States, and which bank or trust company has capital, surplus and
undivided profits aggregating in excess of $50.0 million (or the foreign
currency equivalent thereof) and has outstanding debt which is rated "A" (or
such similar equivalent rating) or higher by at least one nationally recognized
statistical rating organization (as used in the Securities Act and the Exchange
Act and the rules promulgated thereunder) or any money-market fund sponsored by
a registered broker dealer or mutual fund distributor, (iii) repurchase
obligations with a term of not more than 30 days for underlying securities of
the types described in clause (i) above entered into with a bank meeting the
qualifications described in clause (ii) above, (iv) investments in commercial
paper, maturing not more than 180 days after the date of acquisition, issued by
a Person (other than an Affiliate of the Company) organized and in existence
under the laws of the United States of America or any foreign country recognized
by the United States of America with a rating at the time as of which any
investment therein is made of "P-2" (or higher) according to Moody's Investors
Service, Inc. or "A-2" (or higher) according to Standard & Poor's Ratings
Services, and (v) investments in securities with maturities of six months or
less from the date of acquisition issued or fully guaranteed by any state,
commonwealth or territory of the United States of America, or by any political
subdivision or taxing authority thereof, and rated at least "A" by Standard &
Poor's Ratings Services or "A" by Moody's Investors Service, Inc.
"Trust Moneys" means all cash or Temporary Cash Investments received by the
Trustee:
(1) upon the release of Collateral from the Lien of the Indenture and the
Security Documents, including investment earnings thereon;
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(2) pursuant to the provisions of any Mortgage;
(3) as proceeds of any Asset Disposition or other sale or other disposition
of all or any part of the Collateral by or on behalf of the Trustee or
any collection, recovery, receipt, appropriation or other realization
of or from all or any part of the Collateral pursuant to the Indenture
or any of the Security Documents or otherwise; or
(4) for application under the Indenture as provided for in the Indenture or
the Security Documents, or whose disposition is not elsewhere
specifically provided for in the Indenture or in the Security
Documents; provided, however, that Trust Moneys shall not include any
property deposited with the Trustee pursuant to any Change of Control
offer, Excess Proceeds Offer or redemption or defeasance of any Notes.
"Unrestricted Subsidiary" means (i) any Subsidiary of the Company that at
the time of determination shall be designated an Unrestricted Subsidiary by the
Board of Directors in the manner provided below and (ii) any Subsidiary of an
Unrestricted Subsidiary. The Board of Directors may designate any Subsidiary of
the Company (including any newly acquired or newly formed Subsidiary) to be an
Unrestricted Subsidiary unless such Subsidiary is a Subsidiary Guarantor, such
Subsidiary or any of its Subsidiaries owns any Capital Stock or Indebtedness of,
or holds any Lien on any property of, the Company or any other Subsidiary of the
Company that is not a Subsidiary of the Subsidiary to be so designated;
provided, however, that the Subsidiary to be so designated has total assets of
$1,000 or less. The Board of Directors may designate any Unrestricted Subsidiary
to be a Restricted Subsidiary; provided, however, that immediately after giving
effect to such designation (x) the Company could Incur $1.00 of additional
Indebtedness under paragraph (a) of the covenant described under "-- Certain
Covenants -- Limitation on Indebtedness" and (y) no Default shall have occurred
and be continuing. Any such designation by the Board of Directors shall be
evidenced by the Company to the Trustee by promptly filing with the Trustee a
copy of the board resolution giving effect to such designation and an officers'
certificate certifying that such designation complied with the preceding
provisions.
"U.S. Government Obligations" means direct obligations (or certificates
representing an ownership interest in such obligations) of the United States of
America (including any agency or instrumentality thereof) for the payment of
which the full faith and credit of the United States of America is pledged and
which are not callable at the issuer's option.
"Volumetric Production Payments" means production payment obligations
recorded as deferred revenue in accordance with GAAP, together with all
undertakings and obligations in connection therewith.
"Voting Stock" of a Person means all classes of Capital Stock of such
Person then outstanding and normally entitled (without regard to the occurrence
of any contingency) to vote in the election of directors, managers or trustees
thereof.
"Wholly Owned Subsidiary" means a Restricted Subsidiary all the Capital
Stock of which (other than directors' qualifying shares and shares held by other
Persons to the extent such shares are required by applicable law to be held by a
Person other than the Company or a Restricted Subsidiary) is owned by the
Company or one or more Wholly Owned Subsidiaries.
CERTAIN COVENANTS
The Indenture contains covenants including, among others, the following:
Limitation on Indebtedness
(a) The Company shall not, and shall not permit any Restricted Subsidiary
to, Incur, directly or indirectly, any Indebtedness; provided, however, that the
Company or a Subsidiary Guarantor may Incur Indebtedness if, on the date of such
Incurrence and after giving effect thereto, the Consolidated Coverage Ratio
equals or exceeds (i) 2.0 to 1.0, if such Indebtedness is Incurred on or prior
to September 30, 1999, (ii) 2.25 to 1.0, if such Indebtedness is Incurred after
September 30, 1999 and on or prior to September 30, 2001, and (iii) 2.5 to 1.0
if such Indebtedness is Incurred after September 30, 2001.
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(b) Notwithstanding the preceding paragraph (a), the Company and any
Restricted Subsidiary may Incur the following Indebtedness:
(1) Indebtedness of the Company Incurred pursuant to any Credit
Facility, so long as the aggregate principal amount of all Indebtedness
outstanding under all Credit Facilities does not at any one time exceed the
then Available Borrowing Base;
(2) Indebtedness owed to and held by the Company or a Wholly Owned
Subsidiary; provided, however, that any subsequent issuance or transfer of
any Capital Stock which results in any such Wholly Owned Subsidiary ceasing
to be a Wholly Owned Subsidiary or any subsequent transfer of such
Indebtedness (other than to the Company or another Wholly Owned Subsidiary)
shall be deemed, in each case, to constitute the Incurrence of such
Indebtedness by the issuer thereof;
(3) the Senior Secured Notes and the Subsidiary Guarantees;
(4) Indebtedness outstanding on the Closing Date (other than
Indebtedness described in clause (1), (2) or (3) of this covenant);
(5) Indebtedness of a Restricted Subsidiary Incurred and outstanding
on or prior to the date on which such Restricted Subsidiary was acquired by
the Company (other than Indebtedness Incurred in connection with, or to
provide all or any portion of the funds or credit support utilized to
consummate, the transaction or series of related transactions pursuant to
which such Restricted Subsidiary became a Restricted Subsidiary or was
acquired by the Company); provided, however, that on the date of such
acquisition and after giving effect thereto, the Consolidated Coverage
Ratio equals or exceeds (i) 1.8 to 1.0, if such Indebtedness is Incurred on
or prior to September 30, 1999, (ii) 2.05 to 1.0, if such Indebtedness is
Incurred after September 30, 1999 and on or prior to September 30, 2001,
and (iii) 2.3 to 1.0, if such Indebtedness is Incurred after September 30,
2001;
(6) Refinancing Indebtedness in respect of Indebtedness Incurred
pursuant to paragraph (a) or pursuant to clause (3), (4) or (5) above,
clause (7) or (12) below; provided, however, that to the extent such
Refinancing Indebtedness directly or indirectly Refinances Indebtedness or
Preferred Stock of a Restricted Subsidiary described in clause (5), such
Refinancing Indebtedness shall be Incurred only by such Restricted
Subsidiary or the Company;
(7) Indebtedness of the Company or a Restricted Subsidiary represented
by Capital Lease Obligations, mortgage financings or purchase money
obligations, in each case Incurred for the purpose of financing all or any
part of the purchase price or cost of construction or improvement of
property used in its Oil and Gas Business and in each case Incurred no
later than 365 days after the date of such acquisition or the date of
completion of such construction or improvement; provided, however, that the
principal amount of any Indebtedness Incurred pursuant to this clause (7)
in any single calendar year shall not exceed $15.0 million;
(8) Indebtedness consisting of Interest Rate Agreements directly
related to Indebtedness permitted to be Incurred by the Company and its
Restricted Subsidiaries pursuant to the Indenture;
(9) Indebtedness under Oil and Gas Hedging Contracts and Currency
Agreements entered into in the ordinary course of business for the purpose
of limiting risks that arise in the ordinary course of business of the
Company;
(10) Indebtedness in respect of letters of credit issued for the
benefit of the Company or any of its Restricted Subsidiaries to the extent
they are issued in connection with the ordinary course of business of the
Company and its Restricted Subsidiaries, Incurred in an aggregate principal
amount which, when taken together with the principal amount of all other
Indebtedness Incurred pursuant to this clause (10) and then outstanding,
does not exceed $15.0 million;
(11) Indebtedness of the Company or a Restricted Subsidiary Incurred
to finance capital expenditures (or Refinancings thereof) in an aggregate
principal amount which, when taken together with the principal amount of
all other Indebtedness Incurred pursuant to this clause (11) and then
outstanding, does not exceed $10.0 million;
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(12) Indebtedness of the Company or a Restricted Subsidiary Incurred
for the purpose of financing all or any part of the cost of acquiring oil
and gas reserves of another Person (other than a Person that was,
immediately prior to such acquisition, a Subsidiary of the Company) engaged
in the Oil and Gas Business or all or substantially all the assets of such
a Person; provided, however, that on the date of such Incurrence and after
giving effect thereto, the Consolidated Coverage Ratio equals or exceeds
(i) 1.8 to 1.0, if such Indebtedness is Incurred on or prior to September
30, 1999, (ii) 2.05 to 1.0, if such Indebtedness is Incurred after
September 30, 1999 and on or prior to September 30, 2001, and (iii) 2.3 to
1.0 if such Indebtedness is Incurred after September 30, 2001; and
(13) Indebtedness in an aggregate principal amount which, together
with the principal amount of all other Indebtedness of the Company and its
Restricted Subsidiaries outstanding on the date of such Incurrence (other
than Indebtedness permitted by clauses (1) through (12) above or paragraph
(a)) does not exceed the greater of 6% of Adjusted Consolidated Net
Tangible Assets as of the end of the most recent fiscal year ending at
least 90 days prior to the date of such Incurrence and $15.0 million.
(c) Notwithstanding the preceding, the Company shall not Incur any
Indebtedness pursuant to the preceding paragraph (b) if the proceeds thereof are
used, directly or indirectly, to Refinance any Subordinated Obligations unless
such Indebtedness shall be subordinated to the Senior Secured Notes to at least
the same extent as such Subordinated Obligations; provided, however, that this
paragraph (c) shall not prohibit the Company from Refinancing any of its
Subordinated Obligations outstanding on the Closing Date.
(d) For purposes of determining compliance with the preceding covenant, (i)
in the event that an item of Indebtedness meets the criteria of more than one of
the types of Indebtedness described above, the Company, in its sole discretion,
will classify such item of Indebtedness and only be required to include the
amount and type of such Indebtedness in one of the above clauses and (ii) an
item of Indebtedness may be divided and classified in more than one of the types
of Indebtedness described above.
Limitation on Restricted Payments
(a) The Company shall not, and shall not permit any Restricted Subsidiary,
directly or indirectly, to make a Restricted Payment.
(b) The provisions of the preceding paragraph (a) shall not prohibit:
(i) any purchase, repurchase, redemption, defeasance or other
acquisition or retirement for value of Capital Stock or Subordinated
Obligations of the Company made by exchange for, or out of the proceeds of
the substantially concurrent sale of, Capital Stock of the Company (other
than Disqualified Stock and other than Capital Stock issued or sold to a
Subsidiary of the Company or an employee stock ownership plan or to a trust
established by the Company or any of its Subsidiaries for the benefit of
their employees);
(ii) any purchase, repurchase, redemption, defeasance or other
acquisition or retirement for value of Subordinated Obligations made by
exchange for, or out of the proceeds of the substantially concurrent sale
of, Indebtedness which the Company is permitted to Incur pursuant to the
covenant described under "-- Limitation on Indebtedness"; provided that
such Indebtedness is effectively junior to the Senior Secured Notes,
matures no less than 180 days after the Stated Maturity of the Senior
Secured Notes and does not result in an increase in the total amount of the
Company's Indebtedness;
(iii) the purchase, repurchase, redemption, defeasance or other
acquisition or retirement for value of Subordinated Obligations; provided
that the Company may not use the proceeds from the sale of the Senior
Secured Notes, any Excess Proceeds or the cash flows from operations
accumulated after the Issue Date to purchase, repurchase, redeem, defease,
acquire or retire for value any of the Subordinated Obligations under this
clause (iii) if the aggregate amount so purchased, repurchased, redeemed,
defeased, acquired or retired using any or all of the proceeds from the
sale of the Senior Secured Notes, any Excess Proceeds or the cash flows
from operations accumulated after the Issue Date would exceed the greater
of (1) $36.0 million and (2) the excess of the PV-10 Value of the Company's
and its
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Restricted Subsidiaries' Oil and Gas Assets, using 1998 year-end pricing
assumptions, over two times the aggregate stated principal amount of the
Senior Secured Notes then outstanding;
(iv) any purchase, repurchase, redemption, defeasance or other
acquisition or retirement for value of Subordinated Obligations made with
any Excess Proceeds remaining after an Excess Proceeds Offer in which the
Company purchased all Senior Secured Notes duly tendered thereunder;
provided, such purchase, repurchase, redemption, defeasance or other
acquisition or retirement for value occurs no sooner than 360 days after
the last Asset Disposition giving rise to an obligation to offer to
purchase such Subordinated Obligations; or
(v) Further Restricted Payments in an aggregate amount not to exceed
$5.0 million.
Limitation on Restrictions on Distributions from Restricted Subsidiaries
The Company shall not, and shall not permit any Restricted Subsidiary to,
create or otherwise cause or permit to exist or become effective any consensual
encumbrance or restriction on the ability of any Restricted Subsidiary (a) to
pay dividends or make any other distributions on its Capital Stock or pay any
Indebtedness owed to the Company or a Restricted Subsidiary, (b) to make any
loans or advances to the Company or a Restricted Subsidiary, (c) to transfer any
of its property or assets to the Company or a Restricted Subsidiary or (d) grant
to the Trustee a Lien on any of its Property, except: (i) any encumbrance or
restriction pursuant to an agreement in effect at or entered into on the Closing
Date; (ii) any encumbrance or restriction with respect to a Restricted
Subsidiary pursuant to an agreement relating to any Indebtedness Incurred by
such Restricted Subsidiary on or prior to the date on which such Restricted
Subsidiary was acquired by the Company (other than Indebtedness Incurred as
consideration in, or to provide all or any portion of the funds or credit
support utilized to consummate, the transaction or series of related
transactions pursuant to which such Restricted Subsidiary became a Restricted
Subsidiary or was acquired by the Company) and outstanding on such date; (iii)
any encumbrance or restriction pursuant to an agreement effecting a Refinancing
of Indebtedness Incurred pursuant to an agreement referred to in clause (i) or
(ii) of this covenant or this clause (iii) or contained in any amendment to an
agreement referred to in clause (i) or (ii) of this covenant or this clause
(iii); provided, however, that the encumbrances and restrictions with respect to
such Restricted Subsidiary contained in any such refinancing agreement or
amendment are no less favorable to the Senior Secured Noteholders than
encumbrances and restrictions with respect to such Restricted Subsidiary
contained in such agreements; (iv) any such encumbrance or restriction
consisting of customary nonassignment provisions in leases governing leasehold
interests to the extent such provisions restrict the transfer of the lease or
the property leased thereunder; (v) in the case of clause (c) above,
restrictions contained in security agreements or mortgages securing Indebtedness
of a Restricted Subsidiary to the extent such restrictions restrict the transfer
of the property subject to such security agreements or mortgages; (vi) any
restriction with respect to a Restricted Subsidiary imposed pursuant to an
agreement entered into for the sale or disposition of all or substantially all
the Capital Stock or assets of such Restricted Subsidiary pending the closing of
such sale or disposition; and (vii) in the case of clause (d) above,
restrictions contained in instruments related to or creating Permitted Liens
under clauses (f), (i), (j) and (n) of the definition of "Permitted Liens,"
provided such restrictions relate only to the property subject to such Permitted
Liens.
Limitation on Sales of Assets and Subsidiary Stock
(a) The Company will not, and will not cause or permit any of its
Restricted Subsidiaries to, consummate an Asset Disposition unless
(1) the Company or the applicable Restricted Subsidiary, as the case may
be, receives consideration at the time of such Asset Disposition at
least equal to the fair market value of the assets sold or otherwise
disposed of (as determined in good faith by the Company's Board of
Directors or senior management of the Company), and
(2) (A) at least 75% of the consideration received by the Company or such
Restricted Subsidiary, as the case may be, from such Asset Disposition
shall be in the form of cash or Temporary Cash Investments and is
received at the time of such disposition and (B) at least 15% of such
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consideration received if in a form other than cash or Temporary Cash
Investments is converted into or exchanged for cash or Temporary Cash
Investments within 90 days of such disposition.
In the event and to the extent that the Net Available Cash received by the
Company or any Restricted Subsidiary from one or more Asset Dispositions
occurring on or after the Closing Date in any period of 12 consecutive months
exceeds $5.0 million, then the Company shall (i) within 180 days after the date
such Net Available Cash so received exceeds such $5.0 million invest an amount
equal to such excess in Additional Assets or in one or more Permitted Joint
Ventures or Permitted Business Investments or (ii) apply an amount equal to such
excess (to the extent not applied pursuant to clause (i)) as provided in the
following paragraphs of this covenant. The amount of such excess Net Available
Cash required to be applied during the applicable period and not applied (or
designated by the Company as not to be so applied) as so required by the end of
such period shall constitute "Excess Proceeds."
Notwithstanding the foregoing paragraph, if the Company consummates the
Phillips Transaction, then the Company (i) shall, on a date which is not less
than 15 nor more than 30 days after the date on which the Phillips Transaction
is consummated, offer to purchase from all Holders an amount equal to
$35,000,000 (expressed as an integral multiple of $1,000) of the Senior Secured
Notes at a purchase price equal to 104% of the stated principal amount thereof
plus accrued and unpaid interest thereon to the date of purchase (subject to the
right of Holders on the relevant record date to receive interest on the relevant
interest payment date) and purchase any Senior Secured Notes tendered in
response to such offer (up to an amount equal to $35,000,000) and (ii) may use
the Net Available Cash received from the Phillips Transaction less an amount
equal to the amount required to repurchase Senior Secured Notes tendered in
response to the offer made under the immediately preceding clause (i) in a
manner contemplated by clause (b)(iii) of the covenant described under
"-- Limitation on Restricted Payments." Any remaining Net Available Cash
received from the Phillips Transaction and not used pursuant to the immediately
preceding clauses (i) and (ii) shall be applied in accordance with the
immediately preceding paragraph of this covenant.
Notwithstanding the foregoing two paragraphs, if the Company consummates
any Asset Disposition other than the Phillips Transaction, then the Company (i)
shall, on a date which is not less than 15 nor more than 30 days after the date
on which such Asset Disposition is consummated, offer to purchase from all
Holders an amount not less than the Collateral Maintenance Tender Offer Amount
(expressed as an integral multiple of $1,000) of the Senior Secured Notes at a
purchase price equal to 105% of the stated principal amount thereof plus accrued
and unpaid interest thereon to the date of purchase (subject to the right of
Holders on the relevant record date to receive interest on the relevant interest
payment date) and purchase any Senior Secured Notes tendered in response to such
offer (up to an amount equal to the Collateral Maintenance Tender Offer Amount);
and (ii) may use the Net Available Cash received from such Asset Disposition
less an amount equal to the amount required to repurchase Senior Secured Notes
tendered in response to the offer made under the immediately preceding clause
(i) in a manner contemplated by clause (b)(iii) of the covenant described under
"-- Limitation on Restricted Payments." Any remaining Net Available Cash
received from such Asset Disposition and not used pursuant to the immediately
preceding clauses (i) and (ii) shall be applied in accordance with the
immediately second preceding paragraph of this covenant.
If, as of the first day of any calendar month, the aggregate amount of
Excess Proceeds not theretofore subject to an Excess Proceeds Offer (as defined
below) totals at least $5.0 million, the Company must, not later than the
fifteenth Business Day of such month, make an offer (an "Excess Proceeds Offer")
to purchase from the Holders on a pro rata basis an aggregate stated principal
amount of Senior Secured Notes equal to the Excess Proceeds (rounded down to the
nearest multiple of $1,000) on such date, at a purchase price equal to 105% of
the stated principal amount of such Senior Secured Notes, plus, in each case,
accrued interest (if any) to the date of purchase (the "Excess Proceeds
Payment"). The Company will comply, to the extent applicable, with the
requirements of Section 14(e) of the Exchange Act and any other securities laws
or regulations thereunder in the event that such Excess Proceeds are received by
the Company under this covenant and the Company is required to repurchase Senior
Secured Notes as described above. To the extent that the provisions of any
securities laws or regulations conflict with the provisions of this covenant,
the
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Company shall comply with the applicable securities laws and regulations and
shall not be deemed to have breached its obligations under this covenant by
virtue thereof.
(b) In the event of the transfer of substantially all (but not all) the
property and assets of the Company as an entirety to a Person in a transaction
permitted by the covenant described under "-- Merger and Consolidation," the
Successor Company (as defined therein) shall be deemed to have sold the
properties and assets of the Company not so transferred for purposes of this
covenant, and shall comply with the provisions of this covenant with respect to
such deemed sale as if it were an Asset Disposition and the Successor Company
shall be deemed to have received Net Available Cash in an amount equal to the
fair market value (as determined in good faith by the Board of Directors) of the
properties and assets not so transferred or sold.
(c) All Net Available Cash shall constitute Trust Moneys and shall be
delivered by the Company to the Trustee and shall be deposited in the Collateral
Account in accordance with the Indenture.
Limitation on Affiliate Transactions
(a) The Company shall not, and shall not permit any Restricted Subsidiary
to, enter into or permit to exist any transaction (including the purchase, sale,
lease or exchange of any property, employee compensation arrangements or the
rendering of any service) with any Affiliate of the Company (an "Affiliate
Transaction") unless the terms thereof (1) are no less favorable to the Company
or such Restricted Subsidiary than those that could be obtained at the time of
such transaction in arm's-length dealings with a Person who is not such an
Affiliate, (2) if such Affiliate Transaction involves an amount in excess of
$1.0 million, are set forth in writing and has been approved by a majority of
the members of the Board of Directors having no personal stake in such Affiliate
Transaction or (3) if such Affiliate Transaction involves an amount in excess of
$10.0 million, have been determined by a nationally recognized investment
banking firm to be fair, from a financial standpoint, to the Company and its
Restricted Subsidiaries.
(b) The provisions of the preceding paragraph (a) shall not prohibit (i)
any sale of hydrocarbons or other mineral products or the entering into or
performance of Oil and Gas Hedging Contracts, gas gathering, transportation or
processing contracts or oil or natural gas marketing or exchange contracts, in
each case, entered into in the ordinary course of business, so long as the terms
of any such transaction are approved by a majority of the members of the Board
of Directors who are disinterested with respect to such transaction as being the
most favorable of at least (x) two bids, quotes or proposals, at least one of
which is from a Person that is not an Affiliate of the Company (in the event
that the Company determines in good faith that it is able to obtain only two
bids, quotes or proposals with respect to such transaction) or (y) three bids,
quotes or proposals, at least two of which are from Persons that are not
Affiliates of the Company (in all other circumstances), (ii) the sale to an
Affiliate of the Company of Capital Stock of the Company that does not
constitute Disqualified Stock, (iii) transactions contemplated by any employment
agreement or other compensation plan or arrangement entered into by the Company
or any of its Restricted Subsidiaries in the ordinary course of business and
consistent with industry practice, (iv) transactions between or among the
Company and its Restricted Subsidiaries, (v) Restricted Payments and Permitted
Investments that are permitted by the provisions of the Indenture described
above under the caption "-- Limitation on Restricted Payments," (vi) the
transactions described in "Annex A-- Business and Properties" under the caption
"Certain Transactions" and (vii) loans or advances to employees of the Company
or any Subsidiary in the ordinary course of business and approved by the
Company's Board of Directors in an aggregate principal amount not to exceed $1.0
million outstanding at any one time.
Change of Control
(a) Upon the occurrence of a Change of Control, each Holder shall have the
right to require that the Company repurchase such Holder's Senior Secured Notes
at a purchase price in cash equal to 101% of the stated principal amount thereof
plus accrued and unpaid interest, if any, to the date of purchase (subject to
the right of Holders on the relevant record date to receive interest on the
relevant interest payment date), in accordance with the terms contemplated in
paragraph (b) below.
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(b) Within 30 days following any Change of Control, the Company shall mail
a notice to each Holder with a copy to the Trustee stating: (1) that a Change of
Control has occurred and that such Holder has the right to require the Company
to purchase such Holder's Senior Secured Notes at a purchase price in cash equal
to 101% of the stated principal amount thereof plus accrued and unpaid interest,
if any, to the date of purchase (subject to the right of Holders on the relevant
record date to receive interest on the relevant interest payment date); (2) the
circumstances and relevant facts regarding such Change of Control (including
information with respect to pro forma historical income, cash flow and
capitalization after giving effect to such Change of Control); (3) the
repurchase date (which shall be no earlier than 30 days nor later than 60 days
from the date such notice is mailed); and (4) the instructions determined by the
Company, consistent with this covenant, that a Holder must follow in order to
have its Senior Secured Notes purchased.
(c) The Company shall comply, to the extent applicable, with the
requirements of Section 14(e) of the Exchange Act and any other securities laws
or regulations in connection with the repurchase of Senior Secured Notes
pursuant to this covenant. To the extent that the provisions of any securities
laws or regulations conflict with the provisions of this covenant, the Company
shall comply with the applicable securities laws and regulations and shall not
be deemed to have breached its obligations under this covenant by virtue
thereof.
The Change of Control purchase feature is a result of negotiations between
the Company and the Initial Purchaser. Management has no present intention to
engage in a transaction involving a Change of Control, although it is possible
that the Company would decide to do so in the future. Subject to the limitations
discussed below, the Company could, in the future, enter into certain
transactions, including acquisitions, refinancings or other recapitalizations,
that would not constitute a Change of Control under the Indenture, but that
could increase the amount of Indebtedness outstanding at such time or otherwise
affect the Company's capital structure or credit ratings. Restrictions on the
ability of the Company to incur additional Indebtedness are contained in the
covenants described under "-- Limitation on Indebtedness," "-- Limitation on
Liens" and "-- Limitation on Sale/Leaseback Transactions." Except for the
limitations contained in such covenants, however, the Indenture will not contain
any covenants or provisions that may afford Holders protection in the event of a
highly leveraged transaction.
The provisions under the Indenture relating to the Company's obligation to
make an offer to repurchase the Senior Secured Notes as a result of a Change of
Control may be waived or modified with the written consent of the Holders of a
majority in principal amount of the Senior Secured Notes.
The Company will not be required to make an offer to purchase the Senior
Secured Notes as a result of a Change of Control if a third party (i) makes such
offer in the manner, at the times and otherwise in compliance with the
requirements set forth in the Indenture relating to the Company's obligations to
make such an offer and (ii) purchases all Senior Secured Notes validly tendered
and not withdrawn under such an offer.
Limitation on the Sale or Issuance of Capital Stock of Restricted Subsidiaries
The Company shall not sell or otherwise dispose of any shares of Capital
Stock of a Restricted Subsidiary, and shall not permit any Restricted
Subsidiary, directly or indirectly, to issue or sell or otherwise dispose of any
shares of its Capital Stock except (i) to the Company or a Wholly Owned
Subsidiary, (ii) if, immediately after giving effect to such issuance, sale or
other disposition, the Company and its Restricted Subsidiaries would own less
than 20% of the Voting Stock of such Restricted Subsidiary and have no greater
economic interest in such Restricted Subsidiary, (iii) if, immediately after
giving effect to such issuance, sale or other disposition, the Company and its
Restricted Subsidiaries would own greater than 80% of the Voting Stock of such
Restricted Subsidiary and have no lesser economic interest in such Restricted
Subsidiary or (iv) to the extent such shares represent directors' qualifying
shares or shares required by applicable law to be held by a Person other than
the Company or Restricted Subsidiary; provided that in the case of clauses (ii)
and (iii), the Company complies with the provisions of the covenant "Limitation
on Sales of Assets and Subsidiary Stock." If the Company or a Restricted
Subsidiary shall dispose of all of the Capital Stock of any Subsidiary
Guarantor, such Subsidiary Guarantor shall be released from the obligations
under its Subsidiary Guarantee.
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Limitation on Liens
The Company will not, and will not cause or permit any of its Restricted
Subsidiaries to, directly or indirectly, create, incur, assume or permit or
suffer to exist or remain in effect any Liens other than Permitted Liens.
Limitation on Sale/Leaseback Transactions
The Company shall not, and shall not permit any Restricted Subsidiary to,
enter into any Sale/Leaseback Transaction with respect to any property unless
(i) the Company or such Restricted Subsidiary would be entitled to (A) Incur
Indebtedness in an amount equal to the Attributable Debt with respect to such
Sale/ Leaseback Transaction pursuant to the covenant described under
"-- Limitation on Indebtedness" and (B) create a Lien on such property securing
such Attributable Debt pursuant to the covenant described under "-- Limitation
on Liens," (ii) the net proceeds received by the Company or any Restricted
Subsidiary in connection with such Sale/Leaseback Transaction are at least equal
to the fair value (as determined by the Board of Directors) of such property and
(iii) the Company applies the proceeds of such transaction in compliance with
the covenant described under "-- Limitation on Sales of Assets and Subsidiary
Stock."
Future Subsidiary Guarantors
From and after the Issue Date, the Company shall cause each of its
Subsidiaries which is or becomes a Restricted Subsidiary (other than the
Programs) to issue a Subsidiary Guarantee for the benefit of the Holders.
Merger and Consolidation
The Company shall not consolidate with or merge with or into, or convey,
transfer or lease, in one transaction or a series of transactions, all or
substantially all its assets to, any Person, unless: (i) the resulting,
surviving or transferee Person (the "Successor Company") shall be a Person
organized and existing under the laws of the United States of America, any State
thereof or the District of Columbia and the Successor Company (if not the
Company) shall expressly assume, by an indenture supplemental thereto, executed
and delivered to the Trustee, in form satisfactory to the Trustee, all the
Obligations; (ii) immediately after giving effect to such transaction (and
treating any Indebtedness which becomes an obligation of the Successor Company
or any Subsidiary as a result of such transaction as having been Incurred by
such Successor Company or such Subsidiary at the time of such transaction), no
Default shall have occurred and be continuing, (iii) immediately after giving
effect to such transaction, the Successor Company would be able to Incur an
additional $1.00 of Indebtedness pursuant to paragraph (a) or, if applicable,
paragraph (b)(5), of the covenant described under "-- Limitation on
Indebtedness," (iv) immediately after giving effect to such transaction, the
Successor Company shall have Adjusted Consolidated Net Tangible Assets in an
amount that is not less than the Adjusted Consolidated Net Tangible Assets of
the Company immediately prior to such transaction; and (v) the Company shall
have delivered to the Trustee an officers' certificate and an opinion of
counsel, each stating that such consolidation, merger or transfer and such
supplemental indenture (if any) comply with the Indenture; provided, however,
that clauses (iii) and (iv) shall not be applicable to any such transaction
solely between the Company and any Restricted Subsidiary.
The Successor Company shall be the successor to the Company and shall
succeed to, and be substituted for, and may exercise every right and power of,
the Company under the Indenture, but the predecessor Company in the case of a
conveyance, transfer or lease of all or substantially all its assets shall not
be released from the obligation to pay the principal of and interest on the
Senior Secured Notes.
The Company will not permit any Subsidiary Guarantor to consolidate with or
merge with or into, or convey, transfer or lease, in one transaction or series
of transactions, all or substantially all its assets to any Person unless: (i)
the resulting, surviving or transferee Person shall expressly assume by a
supplemental indenture, in a form acceptable to the Trustee, all the obligations
of such Subsidiary Guarantor, if any, under its Subsidiary Guarantee; (ii)
immediately after giving effect to such transaction or transactions on a pro
forma basis (and, treating any Indebtedness which becomes an obligation of the
resulting, surviving or
E-29
<PAGE> 89
transferee Person as a result of such transaction as having been issued by such
Person at the time of such transaction), no Default shall have occurred and be
continuing; and (iii) the Company delivers to the Trustee an officers'
certificate and an opinion of counsel, each stating that such consolidation,
merger or transfer and such guaranty agreement, if any, complies with the
Indenture. Notwithstanding the preceding, upon any consolidation, merger,
conveyance, transfer or lease of all or substantially all its assets, a
Subsidiary Guarantor and its successor or transferee shall be released from all
of such Subsidiary Guarantor's obligations under the Indenture and its
Subsidiary Guarantee as described in the definition of "Guarantee."
SEC Reports
Notwithstanding that the Company may not at any time be subject to the
reporting requirements of Section 13 or 15(d) of the Exchange Act, the Company
shall file with the SEC and provide the Trustee and Noteholders with such annual
reports and such information, documents and other reports as are specified in
Sections 13 and 15(d) of the Exchange Act (excluding however information with
respect to benefit plans and long-term compensation arrangements) and applicable
to a U.S. corporation subject to such Sections, such information, documents and
other reports to be so filed and provided at the times specified for the filing
of such information, documents and reports under such Sections.
Limitation on Impairment of Lien
Neither the Company nor any of its Subsidiaries will take or omit to take
any action which action or omission would have the result of adversely affecting
or impairing the Lien in favor of the Trustee or any predecessor, on behalf of
itself and the Holders or the priority thereof, with respect to the Collateral,
and neither the Company nor any of its Subsidiaries shall grant to any Person,
or suffer any Person (other than the Company and its Restricted Subsidiaries) to
have (other than to the Trustee on behalf of the Trustee and the Holders) any
interest whatsoever in the Collateral other than Permitted Liens. Neither the
Company nor any of its Subsidiaries will enter into any agreement or instrument
that by its terms requires the proceeds received from any sale of Collateral to
be applied to repay, redeem, defease or otherwise acquire or retire any
Indebtedness, other than pursuant to the Indenture and the Security Documents.
Limitation on Conduct of Business
The Company will not, and will not permit any of its Restricted
Subsidiaries to, engage in the conduct of any business other than the Oil and
Gas Business.
Limitation on Capital Expenditures
During the period of eight fiscal quarters, commencing with the fiscal
quarter during which the Issue Date occurs, the Company will not, and will not
permit any of its Restricted Subsidiaries to, make any expenditures for fixed or
capital assets if, after giving effect thereto, the aggregate of all such
expenditures during any such fiscal quarter would exceed $5.0 million plus the
excess of EBITDA for such fiscal quarter over $12.5 million; provided that this
covenant will not limit expenditures for fixed or capital assets to the extent
such expenditures are made with the Net Cash Proceeds of any sale or issuance of
Capital Stock (other than Disqualified Capital Stock) of the Company (other than
sales or issuances to any of its Subsidiaries). Notwithstanding the foregoing,
(i) if any amount which the Company would have been permitted to spend during a
given fiscal quarter on fixed or capital assets under this covenant is not spent
during such fiscal quarter, the Company may spend such amounts during the next
succeeding fiscal quarter, and (ii) if the Company spends an amount in a given
fiscal quarter on fixed or capital assets which exceeds 120% of the maximum
amount permitted under this covenant for such fiscal quarter, such action shall
not be considered a breach of this covenant if the aggregate amount spent on
fixed and capital assets during such fiscal quarter and the next succeeding
fiscal quarter does not exceed the sum of the maximum permitted expenditures for
both such fiscal quarters.
E-30
<PAGE> 90
Lien on Additional Collateral
(a) If, after the Issue Date, the Company or any of its Restricted
Subsidiaries shall (i) acquire any Oil and Gas Assets or other assets as
non-cash consideration for any Asset Disposition or (ii) engage in successful
drilling and exploration activities resulting in the creation of material new
proved oil and gas reserves, then the Company shall, and shall cause each of its
Restricted Subsidiaries to, execute and file in the appropriate filing offices
additional Security Documents granting to the Trustee for the benefit of the
Holders a first Lien, subject only to Permitted Liens (or in the case of
property securing Acquired Indebtedness, to the extent not prohibited by the
terms of the instruments creating such Acquired Indebtedness, a junior Lien), as
is necessary or appropriate to ensure that the Lien of the Indenture and the
Security Documents covers substantially all of the PV-10 Value of such new
assets.
(b) Without limitation of clause (a), on the date any Oil and Gas Assets or
interests in a Permitted Joint Venture shall be acquired in exchange for or
replacement of any Collateral, the Company shall, and shall cause each of its
Restricted Subsidiaries to, execute and file in the appropriate filing offices
additional Security Documents granting to the Trustee, for the benefit of the
Holders, a first Lien, subject only to Permitted Liens (or in the case of
property securing Acquired Indebtedness, to the extent not prohibited by the
terms of the instruments creating such Acquired Indebtedness, a junior Lien), on
such portion of such assets as is necessary to ensure that the Lien of the
Indenture and the Security Documents covers substantially all of the PV-10 Value
of such assets received in exchange or trade or on such interests in such
Permitted Joint Venture.
(c) In connection with any Security Documents executed and filed under
clause (a) or (b), the Company shall also comply with the terms of the Trust
Indenture Act to the extent applicable.
(d) On March 15th in each year, beginning with March 15, 2000, the Company
shall review its and its Restricted Subsidiaries' Oil and Gas Assets as of the
preceding January 1st to ascertain whether substantially all of the PV-10 Value
of its and its Restricted Subsidiaries' Oil and Gas Assets as of such January
1st are then subject to the Lien of the Indenture and the Security Documents,
provided that to the extent Oil and Gas Assets secure Acquired Indebtedness, the
discounted future net revenues attributable to such Oil and Gas Assets may be
excluded from this calculation to the extent the instruments securing such
Acquired Indebtedness prohibit the Incurrence of a Lien on such assets. If
substantially all of the PV-10 Value of such assets are not then subject to the
Lien of this Indenture and the Security Documents, then the Company shall, and
shall cause its Restricted Subsidiaries, to execute and file in the appropriate
filing offices additional Security Documents granting to the Trustee for the
benefit of the Holders a first Lien, subject only to Permitted Liens (or in the
case of property securing Acquired Indebtedness, to the extent not prohibited by
the terms of instruments creating such Acquired Indebtedness, a junior Lien), as
is necessary or appropriate to encumber substantially all such assets.
Quarterly Reserve Engineering Reports; Reserve Redemption Event
Not later than the first day of each March, June, September and December of
each year commencing June 1, 1999, the Company shall furnish to the Trustee and
will make available to any Holder upon request a Reserve Report dated as of the
January 1, April 1, July 1 or October 1 immediately preceding such date. Each
such Reserve Report of each year shall be prepared (i) by certified independent
petroleum engineers or consultants or (ii) under the supervision of the chief
engineer of the Company and audited by such certified independent petroleum
engineers or consultant(s) of national standing in accordance with the Company's
reserve engineering practices as of the Issue Date.
If as of the date any Reserve Report under this covenant is delivered, the
Company reports that the volumetric equivalent of its and its Restricted
Subsidiaries' Oil and Gas Assets is less than the Minimum Reserve Amount (a
"Reserve Deficiency Event") then the Company shall, not later than the fifth
Business Day following such event, make an offer (a "Reserve Deficiency Offer")
to purchase from the Holders on a pro rata basis an aggregate stated principal
amount of Senior Secured Notes equal to the Cash Balance Amount (rounded down to
the nearest multiple of $1,000) on the date of such Reserve Deficiency Offer, at
a purchase price equal to 104% of the stated principal amount of such Senior
Secured Notes, plus, in each case, accrued interest (if any) to the date of
purchase (the "Reserve Deficiency Payment").
E-31
<PAGE> 91
If (i) within 90 days following such Reserve Deficiency Event, the Company
has not entered into one or more definitive agreements for one or more Asset
Dispositions, such that, after giving effect to any such Asset Disposition(s)
and the assumed redemption of the Senior Secured Notes following an Excess
Proceeds Offer under the covenant "-- Certain Covenants -- Limitation of Sale of
Assets and Subsidiary Stock," the PV-10 Value of the Oil and Gas Assets of the
Company and its Restricted Subsidiaries is greater than or equal to 1.75 times
the aggregate stated principal amount of the Senior Secured Notes then
outstanding or (ii) if within such period such ratio is not otherwise met
without the need for any such Asset Disposition, then the Company shall be
obligated on the 91st day following such Reserve Deficiency Event to offer to
redeem (a "Reserve Deficiency Redemption Offer") all of the Senior Secured Notes
then outstanding at a purchase price equal to 104% of the stated principal
amount of such Senior Secured Notes, plus, in each case, accrued interest (if
any) to the date of purchase.
The Company shall commence a Reserve Deficiency Offer or Reserve Deficiency
Redemption Offer with respect to the Senior Secured Notes by mailing a notice to
the Trustee and each Holder stating: (i) that such offer is being made pursuant
to this covenant and that all Senior Secured Notes validly tendered will be
accepted for payment on a pro rata basis; (ii) the purchase price and the date
of purchase (which shall be a Business Day no earlier than 30 days nor later
than 60 days from the date such notice is mailed) (the "Reserve Deficiency
Payment Date"); (iii) that any Senior Secured Note not tendered will continue to
accrue interest pursuant to its terms; (iv) that, unless the Company defaults in
the payment of the Reserve Deficiency Payment, any Senior Secured Notes accepted
for payment pursuant to the Reserve Deficiency Offer shall cease to accrue
interest on and after the Reserve Deficiency Payment Date; (v) that Holders
electing to have a Senior Secured Note purchased pursuant to such offer will be
required to surrender the Senior Secured Note, together with the form entitled
"Option of Holder to Elect Purchase" on the reverse side of the Senior Secured
Note completed, to the Paying Agent at the address specified in the notice prior
to the close of business on the Business Day immediately preceding the Reserve
Deficiency Payment Date; (vi) that Holders will be entitled to withdraw their
election if the Paying Agent receives, not later than the close of business on
the third Business Day immediately preceding the Reserve Deficiency Payment
Date, a telegram, facsimile transmission or letter setting forth the name of
such Holder, the principal amount of Senior Secured Notes delivered for purchase
and a statement that such Holder is withdrawing his election to have such Senior
Secured Notes purchased; and (vii) that Holders whose Notes are being purchased
only in part will be issued new Senior Secured Notes equal in principal amount
to the unpurchased portion of the Senior Secured Notes surrendered; provided
however, that each Senior Secured Note purchased and each new Senior Secured
Note issued shall be in a principal amount of $1,000 or integral multiples
thereof.
On the Reserve Deficiency Payment Date, the Company shall (A) accept for
payment on a pro rata basis Senior Secured Notes or portions thereof tendered
pursuant to the Reserve Deficiency Offer or Reserve Deficiency Redemption Offer,
(B) deposit with the Paying Agent money sufficient to pay the purchase price of
all Senior Secured Notes or portions thereof so accepted, and (C) deliver, or
cause to be delivered, to the Trustee all Senior Secured Notes or portions
thereof so accepted together with an Officers' Certificate specifying the Senior
Secured Notes or portions thereof so accepted for payment by the Company. The
Paying Agent shall promptly mail to the Holders of Senior Secured Notes so
accepted payment in an amount equal to the purchase price, and the Trustee shall
promptly authenticate and mail to such Holders a new Senior Secured Note equal
in principal amount to any unpurchased portion of the Senior Secured Note
surrendered; provided, however; that each note purchased and each new Senior
Secured Note issued shall be in a principal amount of $1,000 or integral
multiples thereof. The Company will publicly announce the results of the Reserve
Deficiency Offer or Reserve Deficiency Redemption Offer as soon as practicable
after the Reserve Deficiency Payment Date. For purposes of this covenant, the
Trustee shall act as the Paying Agent.
The Company will comply, to the extent applicable, with the requirements of
this covenant, of the Exchange Act and any other securities laws or regulations
thereunder in the event that a Reserve Deficiency Event occurs under this
covenant and the Company is required to repurchase Senior Secured Notes as
described above. To the extent that the provisions of any securities laws or
regulations conflict with the provisions of this covenant, the Company shall
comply with the applicable securities laws and regulations and shall not be
deemed to have breached its obligations under this covenant by virtue thereof.
E-32
<PAGE> 92
DEFAULTS
An Event of Default is defined in the Indenture as (i) a default in the
payment of interest on the Senior Secured Notes when due, continued for 20 days,
(ii) a default in the payment of principal of any Senior Secured Note when due
at its Stated Maturity, upon optional redemption, upon required repurchase, upon
declaration or otherwise, (iii) the failure by the Company to comply with its
obligations under "-- Certain Covenants -- Merger and Consolidation" above, (iv)
the failure by the Company to comply for 20 days after notice with any of its
obligations in the covenants described above under "-- Certain Covenants:
- -- Limitation on Indebtedness," "-- Limitation on Restricted Payments,"
"-- Limitation on Restrictions on Distributions from Restricted Subsidiaries,"
"-- Limitation on Sales of Assets and Subsidiary Stock" (other than a failure to
purchase Senior Secured Notes), "-- Limitation on Affiliate Transactions,"
"-- Limitation on the Sale or Issuance of Capital Stock of Restricted
Subsidiaries," "-- Change of Control" (other than a failure to purchase Notes),
"-- Limitation on Liens," "-- Limitation on Sale/Leaseback Transactions,"
"-- Future Subsidiary Guarantors," "-- SEC Reports," "-- Limitation on
Impairment of Lien," "-- Limitation on Capital Expenditures," or "-- Quarterly
Reserve Engineering Reports; Reserve Redemption Event," (other than a failure to
purchase Senior Secured Notes), (v) the failure by the Company or any Subsidiary
Guarantor to comply for 60 days after notice with its other agreements contained
in the Indenture or any Security Document, (vi) principal of, or interest on,
any Indebtedness of the Company or any Significant Subsidiary (other than
Limited Recourse Indebtedness) in excess of $10.0 million is not paid when due,
after giving effect to any applicable grace period, or any default shall occur
and be continuing under any Indebtedness of the Company or any Significant
Subsidiary (other than Limited Recourse Indebtedness) in excess of $10.0 million
and the maturity thereof is accelerated by the holders thereof (the "cross
acceleration provision"), (vii) certain events of bankruptcy, insolvency or
reorganization of the Company or a Significant Subsidiary (the "bankruptcy
provisions"), (viii) any judgment or decree for the payment of money in excess
of $10.0 million is rendered against the Company or a Significant Subsidiary,
remains outstanding for a period of 60 days following such judgment and is not
discharged, waived or stayed within 10 days after notice (the "judgment default
provision"), (ix) a Subsidiary Guarantee or any Security Document ceases to be
in full force and effect (other than in accordance with the terms of such
Subsidiary Guarantee or such Security Document) or the Company or a Subsidiary
Guarantor denies or disaffirms its obligations under any Security Document to
which it is a party or its Subsidiary Guarantee, as applicable, if such default
continues for a period of 10 days after notice thereof to the Company or (x) the
Company shall ultimately realize Net Available Cash from the Phillips
Transaction of less than $80.0 million minus any non-material, usual and
customary price adjustments for transactions similar to the Phillips Transaction
in the Oil and Gas Business. However, a default under clauses (iv), (v), (viii)
and (x) will not constitute an Event of Default until the Trustee or the Holders
of 25% in stated principal amount of the outstanding Senior Secured Notes
notifies the Company of the default and the Company does not cure such default
within the time specified after receipt of such notice.
If an Event of Default occurs and is continuing, the Trustee or the Holders
of at least 25% in principal amount of the outstanding Senior Secured Notes may
declare the principal of and accrued but unpaid interest on all the Senior
Secured Notes to be due and payable. Upon such a declaration, such principal and
interest shall be due and payable immediately. If an Event of Default relating
to certain events of bankruptcy, insolvency or reorganization of the Company or
any Significant Subsidiary occurs and is continuing, the principal of and
interest on all the Senior Secured Notes will ipso facto become and be
immediately due and payable without any declaration or other act on the part of
the Trustee or any Holders. Under certain circumstances, the Holders of a
majority in principal amount of the outstanding Notes may rescind any such
acceleration with respect to the Senior Secured Notes and its consequences.
Subject to the provisions of the Indenture relating to the duties of the
Trustee, if an Event of Default occurs and is continuing, the Trustee will be
under no obligation to exercise any of the rights or powers under the Indenture
at the request or direction of any of the Holders unless such Holders have
offered to the Trustee reasonable indemnity or security against any loss,
liability or expense. Except to enforce the right to receive payment of
principal or interest when due, no Holder may pursue any remedy with respect to
the Indenture, the Senior Secured Notes, any Subsidiary Guarantee or Security
Document unless (i) such Holder has
E-33
<PAGE> 93
previously given the Trustee notice that an Event of Default is continuing, (ii)
Holders of at least 25% in principal amount of the outstanding Senior Secured
Notes have requested the Trustee to pursue the remedy, (iii) such Holders have
offered the Trustee reasonable security or indemnity against any loss, liability
or expense, (iv) the Trustee has not complied with such request within 60 days
after the receipt thereof and the offer of security or indemnity and (v) the
Holders of a majority in principal amount of the outstanding Senior Secured
Notes have not given the Trustee a direction inconsistent with such request
within such 60-day period. Subject to certain restrictions, the Holders of a
majority in principal amount of the outstanding Notes are given the right to
direct the time, method and place of conducting any proceeding for any remedy
available to the Trustee or of exercising any trust or power conferred on the
Trustee. The Trustee, however, may refuse to follow any direction that conflicts
with law or the Indenture or that the Trustee determines is unduly prejudicial
to the rights of any other Holder of a Senior Secured Note or that would involve
the Trustee in personal liability.
The Indenture provides that if a Default occurs and is continuing and is
known to the Trustee, the Trustee must mail to each Holder notice of the Default
within 90 days after it occurs. Except in the case of a Default in the payment
of principal of or interest on any Senior Secured Note, the Trustee may withhold
notice if and so long as a committee of its trust officers determines that
withholding notice is not opposed to the interest of the Holders. In addition,
the Company is required to deliver to the Trustee, within 120 days after the end
of each fiscal year, an officers' certificate indicating whether the signers
thereof know of any Default that occurred during such fiscal year. The Company
also is required to deliver to the Trustee, within 30 days after the occurrence
thereof, written notice of any event which would constitute certain Defaults,
their status and what action the Company is taking or proposes to take in
respect thereto.
E-34
<PAGE> 94
ANNEX F
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES:
Independent Auditors' Report................................ F-2
Consolidated Balance Sheets -- December 31, 1997 and 1998... F-3
Consolidated Statements of Income (Loss) -- For the years
ended December 31, 1996, 1997 and 1998.................... F-4
Consolidated Statements of Cash Flows -- For the years ended
December 31, 1996,
1997 and 1998............................................. F-5
Consolidated Statements of Changes in Stockholders'
Deficit -- For the years ended December 31, 1996, 1997 and
1998...................................................... F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 95
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
F-2
<PAGE> 96
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 AND STOCKHOLDERS' DEFICIT
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.
F-3
<PAGE> 97
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.............................................. -- -- --
-------- -------- --------
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.
F-4
<PAGE> 98
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 year................ 6,352 4,070 162
--------- -------- --------
Cash and cash equivalents, end of year...................... $ 4,070 $ 162 $ 8,435
========= ======== ========
</TABLE>
See Notes to Consolidated Financial Statements.
F-5
<PAGE> 99
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.
F-6
<PAGE> 100
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 world-wide excess of
supply over demand for oil and natural gas resulting in sharply reduced prices.
As a result, many companies in the oil and natural gas industry, including the
Company, experienced reduced profitability and cash flows which, in turn,
created significant liquidity problems. As discussed in Note 4, 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
its 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 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 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
F-7
<PAGE> 101
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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 units-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 units-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
F-8
<PAGE> 102
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, 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.
F-9
<PAGE> 103
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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.
<TABLE>
<CAPTION>
(UNAUDITED)
------------------------
YEAR ENDED DECEMBER 31,
------------------------
1996 1997
---------- ----------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<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:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1998
-------- --------
(IN THOUSANDS)
<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.
F-10
<PAGE> 104
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, $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
F-11
<PAGE> 105
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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
F-12
<PAGE> 106
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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.
F-13
<PAGE> 107
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, 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 or limited
under various of the Company's debt instruments. 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.
F-14
<PAGE> 108
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 PRICE OPTIONS PRICE OPTIONS PRICE
------- -------- ------- -------- ------- --------
OPTIONS IN THOUSANDS
<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.
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
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF CONTRACTUAL LIFE EXERCISE EXERCISE
EXERCISE PRICE OPTIONS (YEARS) PRICE OPTIONS 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 APB 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 loss
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>
F-15
<PAGE> 109
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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:
<TABLE>
<CAPTION>
1996 1997 1998
-------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Income (loss) before income taxes..................... $(28,964) $ 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:
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ---------
(IN THOUSANDS)
<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.
F-16
<PAGE> 110
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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
F-17
<PAGE> 111
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<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.
F-18
<PAGE> 112
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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.
F-19
<PAGE> 113
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
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>
F-20
<PAGE> 114
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
F-21
<PAGE> 115
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
F-22
<PAGE> 116
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
F-23
<PAGE> 117
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
F-24
<PAGE> 118
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1996 1997 1998
--------- --------- ---------
(IN THOUSANDS)
<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.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1996 1997 1998
------- -------- -------
(IN THOUSANDS)
<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.
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
F-25
<PAGE> 119
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
were prepared by H.J. Gruy & Associates, Inc. ("Gruy"), independent petroleum
engineers. See "Risk Factors -- Uncertainties in Estimating Reserves and Future
Net Cash Flows" in the Offer to Purchase.
<TABLE>
<CAPTION>
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 cash
flows 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.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1997 1998
---------- --------- ---------
(IN THOUSANDS)
<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.
F-26
<PAGE> 120
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Change in Standardized Measure. Changes in standardized measure of future
net cash flows relating to proved oil and gas reserves are summarized below.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1996 1997 1998
-------- --------- ---------
(IN THOUSANDS)
<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 1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER(1) QUARTER QUARTER QUARTER QUARTER(2)
------- ------- ------- ---------- ------- ------- ------- ----------
<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).
F-27
<PAGE> 121
Facsimile copies of the Letter of Transmittal will be accepted from
Eligible Institutions. The Letter of Transmittal and certificates for Securities
and any other required documents should be sent or delivered by each
Securityholder 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:
Norwest Bank Minnesota, National Association
<TABLE>
<S> <C> <C>
BY REGISTERED OR BY HAND DELIVERY OR
CERTIFIED MAIL: OVERNIGHT COURIER: IN PERSON:
Norwest Bank Minnesota Norwest Bank Minnesota, Norwest Bank Minnesota,
National Association National Association National Association
Corporate Trust Operations Corporate Trust Operations Northstar East Bldg.
P.O. Box 1517 Norwest Center 608 2nd Ave. S.
Minneapolis, MN 55480-1517 Sixth and Marquette 12th Floor
Minneapolis, MN 55479-0113 Corporate Trust Services
Minneapolis, MN 55479-0113
</TABLE>
BY FACSIMILE:
(612) 667-4927
CONFIRM BY TELEPHONE
(612) 667-9764
Additional copies of the Offer to Purchase, the Letter of Transmittal, or
other tender offer materials may be obtained from the Information Agent and will
be furnished at the Company's expense. Questions and requests for assistance may
be directed to the Information Agent as set forth below. Holders may also
contact their local broker, dealer, commercial bank, trust company, or other
nominee for assistance concerning the Offer.
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
