-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KCh9eikstqenL0P8zgM9w54a6o+89kkTfMJzILw8GGU2+ZFABHcQns+jmJkZL266 0n59vbG7bmoGgLEKFEltRw== 0000320321-99-000057.txt : 19990302 0000320321-99-000057.hdr.sgml : 19990302 ACCESSION NUMBER: 0000320321-99-000057 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990301 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SEAGULL ENERGY CORP CENTRAL INDEX KEY: 0000320321 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 741764876 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 001-08094 FILM NUMBER: 99554689 BUSINESS ADDRESS: STREET 1: 1001 FANNIN STE 1700 STREET 2: 1001 FIRST CITY TOWER CITY: HOUSTON STATE: TX ZIP: 77002-6714 BUSINESS PHONE: 7139514700 MAIL ADDRESS: STREET 1: 1001 FANNIN, SUITE 1700 STREET 2: 1001 FIRST CITY TOWER CITY: HOUSTON STATE: TX ZIP: 77002-6714 FORMER COMPANY: FORMER CONFORMED NAME: SEAGULL PIPELINE CORP DATE OF NAME CHANGE: 19830815 10-K/A 1 AMENDED FORM 10-K FOR 1998 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K/A Amendment No. 1 (Mark One) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 1-8094 SEAGULL ENERGY CORPORATION (Exact name of registrant as specified in its charter) Texas 74-1764876 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 1001 Fannin, Suite 1700 Houston, Texas 77002-6714 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (713) 951-4700 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered Common Stock, par value $.10 per share New York Stock Exchange Preferred Stock Purchase Rights New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. As of February 9, 1999, the aggregate market value of the outstanding shares of Common Stock of the Company held by non-affiliates (based on the closing price of these shares on the New York Stock Exchange) was approximately $362,502,000. As of February 9, 1999, 64,158,444 shares of Common Stock, par value $0.10 per share, were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Document Part of Form 10-K Proxy Statement for Annual Meeting PART III of Shareholders to be held in June 1999 ================================================================================ SEAGULL ENERGY CORPORATION This Amendment No. 1 relates only to Part II, Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operations. Index Page
Part II Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations......................................... 23 Part IV Signatures...................................................................... 85
(i) SEAGULL ENERGY CORPORATION Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion is intended to assist in an understanding of the financial position and results of operations of Seagull for each of the periods indicated. The accompanying Consolidated Financial Statements contain detailed information that should be referred to in conjunction with the following discussion.
CONSOLIDATED HIGHLIGHTS (Amounts in Thousands) Year Ended December 31, ----------------------------------------------------- 1998 1997 1996 --------------- --------------- --------------- Revenues: Oil and gas operations................................... $ 332,579 $ 453,648 $ 419,595 Alaska transmission and distribution..................... 93,592 95,719 97,616 --------------- --------------- --------------- $ 426,171 $ 549,367 $ 517,211 =============== =============== =============== Operating profit (loss): Oil and gas operations................................... $ (99,544) $ 106,983 $ 97,192 Alaska transmission and distribution..................... 23,143 22,588 25,781 Corporate................................................ (21,803) (19,095) (19,530) --------------- --------------- --------------- $ (98,204) $ 110,476 $ 103,443 =============== =============== =============== Net income (loss)........................................... $ (96,696) $ 49,130 $ 28,961 Net cash provided by operating activities before changes in operating assets and liabilities......................... $ 147,184 $ 249,587 $ 220,543 Net cash provided by operating activities................... $ 148,718 $ 262,749 $ 258,439
During 1998, the oil prices realized by Seagull dropped 37%, from 1997's $17.34 per barrel to $10.93 per barrel. These low oil prices in 1998 represent the lowest oil prices received in a number of years and were a major contributing factor to the $46 million, or 35%, decrease in oil revenues from 1997 to $85 million for the year ended December 31, 1998. Additionally, domestic natural gas prices decreased 12% from $2.34 per Mcf in 1997 to $2.05 per Mcf for 1998. This gas price decrease and a 6% decrease in domestic gas production combined to create a $46 million decrease in domestic natural gas revenues. These decreases in oil and gas prices in combination with other key factors led to significant decreases in revenues, operating profit, net income and net cash provided by operating activities as compared to 1997. The other key items affecting 1998 results include the following: o Seagull recorded noncash charges of $78 million in the third quarter of 1998 related to the impairment of the Company's oil and gas assets and nonstrategic pipeline assets; o Oil and gas reserves decreased from 217 MMBOE to 204 MMBOE at December 31, 1997 and 1998, respectively; 23 SEAGULL ENERGY CORPORATION o Substantial increases in exploration charges for 1998 versus 1997 due to increases in dry hole expenses and leasehold impairments; o The sale of the Company's Canadian oil and gas operations in October 1997; o One-time compensation costs of approximately $6 million associated with the retirement of Barry J. Galt and the appointment of James T. Hackett as the Company's Chief Executive Officer; and o Income tax benefit of 29% of the loss before taxes for 1998, reflecting primarily the tax benefits of the impairment of long-lived assets and one-time compensation matters, versus 1997's tax expense of 43% of earnings before taxes. During 1997, as a result of the addition of Seagull's Egyptian properties and an increase in domestic gas prices, Seagull's net income improved by $20 million to $49 million in 1997 versus 1996 and cash flow provided by operating activities before changes in operating assets and liabilities improved $29 million to $250 million for 1997. The increase in net income and cash flow was concentrated in the O&G segment.
OIL AND GAS OPERATIONS (Amounts in Thousands) Year Ended December 31, --------------------------------------------------------- 1998 1997 1996 --------------- ---------------- ---------------- Revenues: Natural gas..................................... $ 225,055 $ 298,223 $ 298,235 Oil and NGL..................................... 84,866 131,096 90,779 Pipeline and marketing.......................... 22,658 24,329 30,581 --------------- ---------------- ---------------- 332,579 453,648 419,595 --------------- ---------------- ---------------- Production expenses.................................. 110,426 115,713 102,158 Pipeline and marketing expenses...................... 27,178 28,670 24,091 Exploration charges.................................. 59,787 42,085 50,772 Depreciation, depletion and amortization............. 156,905 160,197 145,382 Impairment of long-lived assets...................... 77,827 - - --------------- ---------------- ---------------- Operating profit (loss).............................. $ (99,544) $ 106,983 $ 97,192 =============== ================ ================
Exploration and Production Revenue -- The decline in commodity prices was the significant factor in the 27% decrease in revenues for the O&G segment to $333 million for 1998. The 12% gas price decrease and a 6% decrease in domestic gas production combined to create a $46 million decrease in domestic natural gas revenues. While the declining oil prices mentioned previously were the primary factor for the decrease in oil revenues, this was slightly offset by a 13% increase in oil and NGL production in the U.S. and Egypt combined as Seagull realized additional contributions from several new domestic wells and three Egyptian concessions Qarun, where additional facilities became operational during mid-1997; East Beni 24 SEAGULL ENERGY CORPORATION Suef, where production began in mid-1998; and West Abu Gharadig, which was purchased in late 1997. In 1997, the O&G segment showed a $34 million increase in revenues to $454 million and a $10 million increase in operating profit to $107 million. This 8% increase in O&G revenues was principally due to stronger natural gas prices in nearly all areas of the Company's production operations and increases in international oil and gas production, excluding Canada which was sold in October 1997. The effect of stronger gas prices and international liquids production was partially offset by a decline in oil prices in all areas other than Tatarstan, particularly Egypt where the price decreased 15% from 1996 to 1997, and a decrease in pipeline and marketing revenues. In October 1997, the Company sold its Canadian oil and gas operations, which had revenues of approximately $26 million and $34 million and income (loss) before income taxes of approximately $6 million and $(5) million for the years ended December 31, 1997 and 1996, respectively. Pipeline and Marketing -- Pipeline and marketing revenues declined $1.7 million for the year ended 1998 as compared to 1997 due primarily to lower revenues related to the Company's gas gathering and processing facilities caused by the lower natural gas prices in 1998 as compared to 1997. This decrease in revenues was partially offset by an increase in marketing revenues due to higher margins realized and by a decrease in the related cost of gas, resulting in a constant operating margin from 1997 to 1998. Pipeline and marketing revenues declined from $31 million in 1996 to $24 million in 1997 with the absence of the higher margins created from the high volatility in the natural gas markets during early 1996, partially offset by an increase in revenues related to the Company's gas gathering and processing facilities. This increase in gas gathering and processing revenues was substantially offset by an increase in the related cost of gas. A decision to dispose of the pipeline assets was made in September 1998. At that time, the Company also announced its intentions to exit its third-party marketing business and to explore alternatives for marketing its equity production, including outsourcing. Subsequent to year-end, Seagull entered into an agreement with a third-party to buy substantially all of the Company's domestic production. With the elimination of the pipeline and marketing function, Seagull was able to reduce staff by approximately 25 employees and effectively closed all derivative financial positions prior to December 31, 1998. Income and costs related to the Company's commodity hedging activities were recognized in oil and gas revenues when the commodities were produced. The Company recorded $1 million, $10 million, and $9 million for 1998, 1997 and 1996, respectively, in costs related to equity hedging activities, including costs related to the monetary production payment hedges of approximately $1 million, $3 million and $4 million in 1998, 1997 and 1996, 25 SEAGULL ENERGY CORPORATION respectively. The Company also recorded hedging costs related to third-party marketing activities of $5 million in costs, $3 million in costs and $0.5 million in income for 1998, 1997 and 1996, respectively.
PRODUCTION AND UNIT PRICE BY AREA Net Daily Production Unit Price ----------------------------------------- ----------------------------------------- Year Ended December 31, Year Ended December 31, ----------------------------------------- ----------------------------------------- 1998 1997 1996 1998 1997 1996 ----------- ---------- ----------- ----------- ----------- ---------- Gas Sales(*): Domestic............... 285 303 318 $2.05 $ 2.34 $ 2.17 Canada (sold in 1997).. - 37 58 - 1.63 1.32 Cote d'Ivoire.......... 9 6 4 1.59 1.93 1.77 Indonesia and other.... 8 11 12 2.23 3.18 3.36 ----------- ---------- ----------- ----------- ----------- ---------- 302 357 392 $2.04 $ 2.29 $ 2.08 =========== ========== =========== =========== =========== ========== Oil and NGL Sales(*): Domestic.............. 5,025 4,830 4,264 $11.41 $17.60 $19.03 Canada (sold in 1997). - 665 985 - 16.46 16.77 Egypt................. 10,965 9,268 3,565 11.92 18.26 21.56 Cote d'Ivoire......... 986 1,653 1,395 10.51 19.34 20.04 Tatarstan............. 4,099 4,143 3,053 7.67 14.26 13.98 Indonesia and other... 196 152 147 13.38 19.31 19.58 ----------- ---------- ----------- ----------- ------------ ---------- 21,271 20,711 13,409 $10.93 $17.34 $18.50 =========== ========== =========== =========== ============ ==========
(*) Natural gas is stated in MMcf and $ per Mcf. Oil and NGLs are stated in Bbl and $ per Bbl. Production Expenses -- Production expenses for 1998 decreased $5 million from 1997's $116 million, primarily due to the sale of the Company's Canadian operations in October 1997, partially offset by increases in production expenses in Egypt. Production expenses increased to $4.22 per BOE for 1998 from $3.95 per BOE for 1997. Production expenses for 1997 increased approximately $14 million over 1996, primarily due to the increased production associated with the Company's Egyptian operations and increased domestic operating expenses. This increase in production expenses associated with the Company's domestic operations was the primary reason for the $0.40 per BOE increase in production expense per equivalent unit of production to $3.95 per BOE for 1997 over 1996. Increased production taxes as natural gas prices increased, a change in the mix of producing properties and an increase in transportation expenses were the major contributing factors to the increase in domestic operating expenses during 1997. Exploration Charges -- In comparison to 1997, exploration charges for 1998 were approximately $18 million higher for the year primarily due to increases in dry hole expense and impairment of leaseholds, both domestically and on certain of the Company's Egyptian concessions. 26 SEAGULL ENERGY CORPORATION Exploration charges declined $8.7 million for the year ended 1997 as compared to 1996 due to decreases in dry hole costs, domestically and in Canada, and in G&G expense, primarily in Cote d'Ivoire. Depreciation, Depletion and Amortization -- The decrease in depreciation, depletion and amortization ("DD&A") expense to $157 million for 1998 from $160 million for the prior year is primarily due to the decrease in domestic gas production and the sale of the Company's Canadian operations, partially offset by increased oil production in Egypt and an increase in the DD&A expense per equivalent unit of production related to the Company's Egyptian operations. The downward revision of reserves in the Egyptian concessions previously discussed and the sale of Canadian properties, which had an average DD&A expense of approximately $3.00 per BOE, combined to increase DD&A expense per equivalent unit of production for oil and gas producing activities to $5.93 per BOE from $5.42 per BOE for 1998 and 1997, respectively. DD&A expense per equivalent unit of production increased to $5.42 per BOE in 1997 from $4.98 per BOE in 1996 and combined with the increase in Egyptian production to produce a 10% increase in DD&A expense for the O&G segment. A change in the mix of the properties being produced internationally was the primary factor for the increase, partially offset by a decrease in DD&A expense related to Canadian oil and gas properties. Noncash Impairments -- During the third quarter of 1998, the Company recorded noncash impairment charges of $74 million related to its oil and gas assets located in Egypt. The impairments of the oil and gas assets were primarily a result of disappointing well performance, much lower oil and natural gas prices and a lack of any perceived significant near-term improvement in oil prices that led to a reduction in reserves at Seagull's East Zeit, South Hurghada and East Beni Suef concessions. The oil and gas impairment tests were based upon estimates of future cash flows using an initial crude oil price of approximately $11 per barrel, escalated by quoted forward market prices when available and moderate escalation thereafter. There are no future cash flows from gas, as there is no gas production from these assets. Future cash flows at September 30, 1998 were based upon the Company's estimate of proved reserves. No probable and possible reserves were taken into consideration in this particular circumstance because they were not justified by economic conditions, actual or planned drilling. During this quarter, the Company also decided to dispose of nonstrategic pipeline assets, which resulted in an additional noncash impairment of $4 million related to those assets. The impairment reflected the difference between the recorded book value of the pipeline assets and the net realizable value expected to be received upon disposal of the assets. 27 SEAGULL ENERGY CORPORATION CAPITAL SPENDING AND OIL AND GAS RESERVES
OIL AND GAS OPERATIONS CAPITAL EXPENDITURES AND ACQUISITIONS (Amounts in Thousands) Year Ended December 31, ---------------------------------------------------------- 1998 1997 1996 ------------------ ------------------ ----------------- Capital Expenditures: Lease acquisitions................................ $ 40,718 $ 23,141 $ 12,986 Exploration....................................... 83,526 95,681 77,774 Development....................................... 132,331 137,806 108,763 ------------------ ------------------ ----------------- 256,575 256,628 199,523 Other oil and gas operations...................... 788 885 228 ------------------ ------------------ ----------------- Total oil and gas operations...................... $ 257,363 $ 257,513 $ 199,751 ================== ================== ================= Acquisitions of oil and gas properties............... $ 126,895 $ 17,665 $ 90,867 ================== ================== =================
Capital expenditures in 1998, excluding acquisitions, remained unchanged from 1997. The absence of the Company's Canadian operations, which had expenditures of $13 million in 1997, and a decline in Egyptian capital expenditures were offset by increased expenditures related to the Company's domestic operations. Spending outside North America in 1998 totaled $87 million, of which $28 million was for exploration, $48 million for exploitation and $11 million for leasehold acquisitions. Seagull participated in the drilling of 38 exploratory wells during 1998, of which 12 were successful. Another 10 exploratory wells were in progress at year-end. Of the successes, seven were in the U.S., four in Egypt and one in Cote d'Ivoire. O&G capital expenditures increased to $257 million in 1997, up 29% from $200 million in 1996. Spending outside North America totaled $103 million, of which $43 million was for exploration and $60 million for exploitation. On June 1, 1998, the Company completed the purchase of the stock of BRG Petroleum, Inc. and its related partnership interests for $103 million in cash, net of cash acquired of $2 million and noncash deferred tax liabilities of $25 million. The assets acquired include proved oil and gas reserves of 102 Bcfe. BRG operated approximately 70 percent of its 600 oil and gas wells located in approximately 140 fields. At year-end 1998, daily production from these acquired properties averaged approximately 20 MMcf of gas and 450 barrels of oil and natural gas liquids. The most significant of these assets are concentrated in East Texas, primarily in Freestone, Upshur, Rusk and Nacogdoches counties. During the fourth quarter of 1998, Seagull sold some of its less strategic E&P properties and various nonstrategic pipeline assets. The sale of these assets, and the additional pipeline asset sales expected to occur in early 1999, were steps taken to reduce debt and focus the Company's attention on assets within core areas. Prior to the sales, daily production from the E&P properties sold averaged approximately 18 MMcf of gas and 480 barrels of oil and natural gas liquids. The total reserves sold associated with these properties was approximately 10 MMBOE. The pipeline 28 SEAGULL ENERGY CORPORATION assets contributed $3 million, $5 million and $4 million in revenues for the years ended December 31, 1998, 1997 and 1996, respectively, but did not have a material effect on operating profit for any of these periods. Through drilling and proved property acquisitions, the Company replaced 90% of its production during 1998, including downward revisions of 11 MMBOE, at a cost of $16.32 per BOE and 158% of its production over the five-year period ended December 31, 1998 at a cost of $6.86 per BOE. Seagull's proved oil and gas reserves decreased from 217 MMBOE at year-end 1997 to 204 MMBOE at December 31, 1998, because of reserve declines due to lower commodity prices, disappointing well performance in certain Egyptian concessions and the nonstrategic property sales, partially offset by the 17 MMBOE purchased from BRG Petroleum. The standardized measure of discounted future net cash flows before taxes for Seagull's proved oil and gas reserves, calculated based on Securities and Exchange Commission criteria, decreased to $776 million at December 31, 1998 compared with $1.2 billion at the end of 1997. This decrease was primarily the result of significantly lower year-end commodity prices at December 31, 1998 compared to December 31, 1997. Year-end calculations were made using an average price of $9.06 and $15.41 per Bbl for oil, condensate and NGL and $2.03 and $2.42 per Mcf for gas for 1998 and 1997, respectively. The Company's average realized prices for the year ended December 31, 1998 were $10.93 per Bbl for oil, condensate and NGL and $2.04 per Mcf for gas. The Company's average realized prices for the month ended January 31, 1999 were $9.63 per Bbl for oil, condensate and NGL and $1.79 per Mcf for gas. Because the disclosure requirements for discounted future net cash flows are standardized by the SEC, significant changes can occur in these estimates based upon oil and gas prices in effect at year-end. The above estimates should not be viewed as an estimate of fair market value. See Note 17 to Consolidated Financial Statements. OUTLOOK As the O&G segment represents the majority of the Company's operations, continued depressed commodity prices will have a significant negative impact on the Company's total operating results. Oil prices in particular have reached multi-year lows in some markets in recent months and gas prices for the current winter season have been lower than in recent winters. Faced with continued depressed oil prices, if the OEI merger is completed, Seagull and New Ocean plan to spend significantly less on capital expenditures in 1999. Capital expenditures will focus on contractually obligated expenditures and drilling results that will yield immediate cash flow opportunities. With this decrease in capital expenditures, the Company may not be able to replace reserves or maintain production at current levels. 29 SEAGULL ENERGY CORPORATION
ALASKA TRANSMISSION AND DISTRIBUTION (Amounts in Thousands Except Degree Days) Year Ended December 31, -------------------------------------------------------- 1998 1997 1996 ---------------- --------------- --------------- Revenues............................................. $ 93,592 $ 95,719 $ 97,616 Cost of gas sold..................................... 41,232 43,684 42,600 ---------------- --------------- --------------- Gross margin......................................... 52,360 52,035 55,016 Operations and maintenance expense................... 20,688 21,079 21,045 Depreciation, depletion and amortization............. 8,529 8,368 8,190 ---------------- --------------- --------------- Operating profit..................................... $ 23,143 $ 22,588 $ 25,781 ================ =============== =============== Operating Data: Degree days (*)................................... 10,026 9,727 10,975
(*) A measure of weather severity calculated by subtracting the mean temperature for each day from 65 degrees Fahrenheit. More degree days equate to colder weather. Operating profit of the Alaska transmission and distribution segment of the Company is primarily a function of the weather in the Anchorage, Alaska area during the winter heating season. Cold weather equates to higher gas volumes delivered, resulting in increased profits. This relationship between operating profit and degree days held true in 1998 and 1997 as the percentage change in operating profit (2% increase in 1998 versus 1997 and 12% decrease in 1997 versus 1996) was approximately equal to the percentage change in degree days (3% increase in 1998 and 11% decrease in 1997). OUTLOOK Even though its activities may be somewhat different from the Company's other O&G-oriented activities, management expects ENSTAR Alaska's stable cash flows and activities to continue to contribute to Seagull's goals and financial stability. Future operating profit for this segment will be affected by weather, regulatory action and customer growth in ENSTAR Alaska's service area. The 1998 degree days were 3% under the previous 30-year average degree days. The Company expects customer growth to continue at a modest 2% to 3% rate. During the 1998 summer construction season, approximately 67 miles of new distribution pipelines were installed to connect some 3,000 new customers (a 3% increase in customers over 1997). ENSTAR Alaska purchases all of its natural gas under long-term contracts in which the price is indexed to changes in the price of crude oil futures contracts. However, because ENSTAR Alaska's sales prices are adjusted to include the projected cost of its natural gas, there has been and is expected to be little or no impact on margins derived from ENSTAR Alaska's gas sales as a result of fluctuations in commodity prices due to worldwide political events and changing market conditions. Currently, ENSTAR Alaska's supply source is confined to the Cook Inlet area. During 1997, two of the Cook Inlet area's major suppliers filed for regulatory approval to export certain quantities of gas to overseas liquified natural gas markets. ENSTAR Alaska has filed as an intervenor in these proceedings and is actively working with regulatory authorities to ensure that the future gas supply needs of its customers are met. 30 SEAGULL ENERGY CORPORATION OTHER General and administrative ("G&A") expense increased from $16 million to $18 million for 1998 primarily due to the $6 million in one-time compensation charges, partially offset by decreases in G&A expense from compensation plans that are tied directly to the market price of Seagull's common stock. The closing price of Seagull's common stock was $6.31 and $20.63 at December 31, 1998 and 1997, respectively. After excluding the effects of provisions for litigation ($4.5 million in 1997 for a proposed settlement and $3 million in 1996 covering several minor settlements), general and administrative expenses decreased from $14.4 million in 1996 to $11.6 million in 1997. This decrease in G&A expenses from 1996 to 1997 was primarily due to efficiencies realized as a result of the Global merger and a decline in expenses associated with compensation plans that are tied directly to the market price of Seagull's common stock. In November 1997, the Company, NorAm Gas Transmission Company and Arkansas Western Gas Company signed a settlement proposal regarding certain litigation. The final settlement was signed in 1998 and was substantially the same as the initial settlement proposal. The payments to NorAm and other parties settled complex litigation over contract terms, conditions and conduct for the period October 1, 1994 to the date of the settlement. Interest expense increased only slightly from $38.5 million for 1997 to $39.2 million for 1998. Despite the increase in outstanding long-term debt from $469 million at December 31, 1997 to $583 million at December 31, 1998, average debt outstanding, and therefore interest expense, was approximately the same for each of the years. Interest expense declined from $45 million in 1996 to $39 million for 1997 through utilization of the proceeds from the sale of the Company's Canadian operations in late 1997 to repay amounts outstanding under the Company's existing credit facilities. Interest cost capitalized as property, plant and equipment amounted to approximately $7 million, $7 million and $3 million in 1998, 1997 and 1996, respectively. The Company and Global Natural Resources, Inc. completed a merger in October 1996, which was accounted for as a pooling-of-interests. As a result of the merger, expenses of $10 million ($9 million after taxes) representing investment banking fees, legal, accounting and other expenses were recorded. 31 SEAGULL ENERGY CORPORATION Gain on sales of assets in 1997 is primarily comprised of pre-tax gains of approximately $12 million related to the sale of the Company's Canadian oil and gas operations. Seagull's tax expense changed from approximately 43% of earnings before taxes for the year ended December 31, 1997 to an approximate 29% benefit for 1998, reflecting primarily the tax benefits of the impairment of long-lived assets and one-time compensation matters. Seagull's effective tax rate for 1997 of 43% decreased from the effective tax rate of 47% for 1996 primarily due to an income tax benefit associated with the gain on the sale of the Company's Canadian operations. OUTLOOK In the current low commodity price environment, Seagull has begun implementing cost cutting measures, such as the elimination of the pipeline and marketing function and an additional reduction of approximately 100 employees, approximately 11% of total employees, in January 1999. These personnel reductions are expected to generate an annual savings of approximately $14 million, excluding severance costs of $6 million. In addition, Seagull and OEI are developing plans to integrate their operations immediately after the merger to take full advantage of the benefits and synergies the merger will create. Seagull and OEI believe that New Ocean's organizational structure will allow for substantial overhead cost savings through the consolidation of duplicative corporate and field offices and staff. LIQUIDITY AND CAPITAL RESOURCES Seagull's capital resources primarily consist of a revolving credit facility (the "Revolving Credit Facility") with a maximum commitment of $500 million, $350 million of senior, unsecured debt and money market facilities with three U.S. banks with a combined maximum commitment of $110 million. The major changes in these obligations are as follows: o The repurchase of $50 million of senior debt in the third quarter of 1998, financed through additional borrowings under the Revolving Credit Facility; o The purchase of the BRG properties for $103 million in the second quarter of 1998, financed through additional borrowings under the Revolving Credit Facility; and o The issuance of $150 million of senior notes, due 2027, in September 1997. At December 31, 1998, there was $175 million borrowed under the Revolving Credit Facility and $307 million of the unused commitment was immediately available. The Revolving Credit Facility contains certain covenants and restrictive provisions, including limitations on the incurrence of additional debt or liens, the declaration or payment of dividends and the repurchase 32 SEAGULL ENERGY CORPORATION or redemption of capital stock and the maintenance of certain financial ratios. Under the most restrictive of these provisions, approximately $130 million was available for payment of cash dividends on common stock or to repurchase common stock as of December 31, 1998. During the third quarter of 1998, the Company repurchased in open market transactions approximately $50 million in aggregate principal amount of its 8 5/8% Senior Subordinated Notes due 2005. These purchases were funded using borrowings under the Credit Facility. In connection with this repurchase, the Company recorded an after-tax extraordinary loss of $1 million, or $0.02 per basic and diluted share. At current interest rates under the Revolving Credit Facility, the Company expects to save approximately $1.6 million in annual interest expense by refinancing the $50 million of Senior Subordinated Notes under the Revolving Credit Facility. On June 1, 1998, the Company completed the purchase of the stock of BRG Petroleum, Inc. and its related partnership interests for $103 million in cash, excluding cash acquired of $2 million and noncash deferred tax liabilities of $25 million. The Company funded this acquisition through its existing credit facility. On September 30, 1997, Seagull issued $150 million of senior notes (the "1997 Senior Notes") at a public offering price of 99.544% of face value. The 1997 Senior Notes have a coupon of 7 1/2% and mature September 15, 2027. The 1997 Senior Notes are not redeemable prior to maturity and are not subject to any sinking fund. The net proceeds of approximately $146 million were used to repay existing debt and for general corporate purposes. The 1997 Senior Notes represent unsecured obligations of the Company and rank pari passu with all other unsecured, unsubordinated obligations of the Company. The Company has money market facilities with three U.S. banks with a combined maximum commitment of $110 million. These lines of credit bear interest at rates made available by the banks at their option and may be canceled at either Seagull's or the banks' option. There was $48 million outstanding under these money market facilities at December 31, 1998, included in accounts and notes payable.
CAPITAL EXPENDITURES AND ACQUISITIONS (Amounts in Thousands) Year Ended December 31, ---------------------------------------------------------- 1998 1997 1996 ------------------ ------------------ ----------------- Capital Expenditures: Oil and gas operations............................ $ 257,363 $ 257,513 $ 199,751 Alaska transmission and distribution.............. 9,626 9,607 9,287 Corporate......................................... 8,308 4, 8,488 4,424 ------------------ ------------------ ----------------- $ 275,297 $ 275,608 $ 213,462 ================== ================== ================= Acquisitions......................................... $ 129,276 $ 17,665 $ 104,420 ================== ================== =================
33 SEAGULL ENERGY CORPORATION Combined with the Company's long-term goal to grow its reserve base through its drilling efforts and complementary strategic acquisitions, a strong balance sheet is also a specific objective of management. In its present low commodity price environment, Seagull began a series of nonstrategic properties sales in late 1998. In 1997, Seagull also reduced its borrowings under existing bank facilities by $133 million with a portion of the proceeds from the sale of the Company's Canadian operations. During the fourth quarter of 1998, Seagull sold some of its less strategic E&P properties located away from its various core assets. During the third quarter of 1998, the Company also decided to liquidate its nonstrategic pipeline assets. As of December 31, 1998, approximately 25% of these pipeline assets had been sold. The E&P and pipeline sales generated approximately $53 million in net proceeds. Seagull is in final negotiations to sell the remaining 75% of the pipeline assets. OUTLOOK After the merger with OEI, New Ocean will have higher levels of debt and interest expense than Seagull on a stand-alone basis. This increased debt level will require the use of a substantial portion of New Ocean's cash flow to pay interest and principal on New Ocean's debt. Within the low commodity price environment, New Ocean anticipates substantially reduced capital expenditures and expects to keep capital expenditures at a level below cash flow from operations. New Ocean will have higher levels of debt and interest expense than Seagull on a stand-alone basis. The following table compares debt and leverage for Seagull and New Ocean, based on December 31, 1998 information, giving pro forma effect to the merger in the case of New Ocean:
Seagull New Ocean ------------------ ------------------ Total Debt.............................................................. $590 million $1,939 million Debt/capitalization ratio............................................... 52% 67%
The increase in total indebtedness and leverage of the combined company after the merger may have a negative impact on New Ocean's ability to realize the expected benefits of the merger, including a possible downgrade in the credit rating of the combined company. In this regard, Standard & Poor's has announced that, because of the higher leverage of the combined company and the current uncertain commodity price environment, upon completion of the merger, it will reduce Seagull's corporate credit and senior unsecured debt ratings from "BBB-" to "BB+," with a stable outlook. 34 SEAGULL ENERGY CORPORATION FORWARD-LOOKING STATEMENTS MAY PROVE INACCURATE This document includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact included in this document, including, without limitation, statements regarding the financial position, business strategy, production and reserve growth and other plans and objectives for the future operations of Seagull or New Ocean are forward-looking statements. Although Seagull believes that such forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will in fact occur. Important factors could cause actual results to differ materially from those in the forward-looking statements. Forward-looking statements are subject to risks and uncertainties and include whether the merger with OEI is actually completed, information concerning cost savings from the merger, integration of the businesses of OEI and Seagull, general economic conditions and possible or assumed future results of operations of Seagull or New Ocean, estimates of oil and gas production and reserves, drilling plans, future cash flows, anticipated capital expenditures and management's strategies, plans and objectives as set forth herein. When used in this document, the words "believes," "expects," "anticipates," "intends" or similar expressions are intended to identify such forward-looking statements. The following important factors, in addition to those discussed elsewhere in this document could affect the future results of the energy industry in general, and Seagull and/or New Ocean after the merger in particular, and could cause those results to differ materially from those expressed in such forward-looking statements: o Risks incident to the drilling and operation of oil and gas wells; o Future production and development costs; o The effect of existing and future laws and regulatory actions; o The political and economic climate in the foreign jurisdictions in which Seagull conducts oil and gas operations; o The effect of changes in commodity prices, hedging activities and conditions in the capital markets; o A significant delay in the expected closing of the merger (or a failure to consummate the merger); and o Competition from others in the energy industry. ENVIRONMENTAL To date, compliance with applicable environmental and safety regulations by the Company has not required any significant capital expenditures or materially affected its business or earnings. The Company believes it is in substantial compliance with environmental and safety regulations and foresees no material expenditures in the future; however, the Company is unable 35 SEAGULL ENERGY CORPORATION to predict the impact that compliance with future regulations may have on capital expenditures, earnings and competitive position. YEAR 2000 Historically, most computer systems (including microprocessors embedded into field equipment and other machinery) utilized software that recognized a calendar year by its last two digits. Beginning in the year 2000, these systems will require modification to distinguish twenty-first century dates from twentieth century dates ("Year 2000 issues"). Accordingly, the Company has initiated a comprehensive plan to address the Year 2000 issues associated with its operations and business (the "Year 2000 plan"). Seagull's Board of Directors has been briefed about the Year 2000 problem generally and as it may affect Seagull. The Board has created a committee consisting of senior executives and a representative from the Board to oversee the adoption and implementation of the Year 2000 plan covering all of Seagull's business units. The plan has been developed with an aim towards taking reasonable steps to prevent Seagull's mission-critical functions from being impaired due to the Year 2000 problem. The plan includes several phases - (i) assessment of all of the Company's systems and technology; (ii) implementation and testing of modifications to or replacements of existing systems and technology, both financial and operational; (iii) communication with key business partners regarding Year 2000 issues; and (iv) contingency planning. In planning and developing the project, Seagull has considered both its information technology ("IT") and its non-IT systems. The term "computer equipment and software" includes systems that are commonly thought of as IT systems, including accounting, data processing, telephone systems, scanning equipment, and other miscellaneous systems. Non-IT systems include alarm systems, fax machines, monitors for field operations, and other miscellaneous systems. Both IT and non-IT systems may contain embedded technology, which complicates Seagull's Year 2000 identification, assessment, remediation, and testing efforts. Based upon its identification and assessment efforts to date, Seagull is in the process of replacing the computer equipment and software it currently uses to become Year 2000 compliant. In addition, in the ordinary course of replacing computer equipment and software, Seagull plans to obtain replacements that are Year 2000 compliant. During 1997, the Company utilized both internal and external resources to test, reprogram or replace many of its IT systems, primarily financial and operational software, for necessary modifications identified in its assessment of Year 2000 issues. As of the date of this filing, the Company estimates that approximately 80% of its Year 2000 plan related to these IT systems has been implemented and anticipates that the remainder of the plan, including any necessary remedial action, will be completed by June 30, 1999. During September 1998, 36 SEAGULL ENERGY CORPORATION the Company began utilizing internal and external resources to evaluate its vulnerability to Year 2000 issues related to its non-IT systems, primarily field operational systems and equipment. The Company is working with Stone & Webster to identify embedded chips that may need to be replaced or avoided. Stone & Webster is an internationally recognized engineering firm that has developed and maintains a database of systems that are susceptible to Year 2000 problems. The database comparisons that have been completed to date have not revealed any material problems. This effort should be completed by the end of the first quarter of 1999. Areas that will require contingency plans will be determined as part of these efforts relative to embedded chips and microcontrollers and as a result of our correspondence and meetings with key business partners. This effort should be completed by the end of the second quarter of 1999. The Company has also initiated formal communications with all of its key business partners to determine the extent to which the Company is vulnerable to those third parties' potential failure to remediate their own Year 2000 issues. Key business partners were identified in four categories of companies including: (a) major vendors and contractors (including banks and other financial service companies); (b) major customers; (c) utility companies; and (d) third party operators of major oil and gas properties. Questionnaires were sent to the Company's key business partners to confirm their Year 2000 activities and follow-up letters, telephone calls, and meetings are being used, as appropriate, to obtain additional information. During the fourth quarter of 1998, the Company began developing contingency plans for its financial and operational systems. Seagull's contingency plans are being designed to minimize the disruptions or other adverse effects resulting from Year 2000 incompatibilities regarding these systems, and to facilitate the early identification and remediation of Year 2000 problems that first manifest themselves after January 1, 2000. The failure to correct a material Year 2000 issue could result in an interruption in, or a failure of, certain normal business activities, resulting in a material, adverse affect on the Company's results of operations, liquidity and financial position. The Company's remediation efforts are expected to reduce significantly the Company's level of uncertainty about Year 2000 compliance and the possibility of interruptions of normal operations. However, there can be no guarantee that other companies' systems, on which the Company's systems rely, will be timely converted, or that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have a material adverse effect on the Company. Disruptions to the oil and gas transportation networks controlled by third-party carriers could result in reduced production volumes delivered to market. In addition, risks associated with foreign operations may increase with the uncertainty of Year 2000 compliance by foreign governments and their supporting infrastructures. The Company's Year 2000 task force members have been asked to investigate the compliance activities of certain third parties and foreign governments to determine the risks to the Company. This investigation is in progress. 37 SEAGULL ENERGY CORPORATION In a recent Securities and Exchange Commission release regarding Year 2000 disclosures, the Securities and Exchange Commission stated that public companies must disclose the most reasonably likely worst case Year 2000 scenario. Analysis of the most reasonably likely worst case Year 2000 scenarios Seagull may face leads to contemplation of the following possibilities which, though unlikely in some or many cases, must be included in any consideration of worst cases: widespread failure of electrical, gas, and similar supplies by utilities serving Seagull domestically and internationally; widespread disruption of the services of communications common carriers domestically and internationally; similar disruption to means and modes of transportation for Seagull and its employees, contractors, suppliers, and customers; significant disruption to Seagull's ability to gain access to, and remain working in, office buildings and other facilities; the failure of substantial numbers of Seagull's mission-critical information (computer) hardware and software systems, including both internal business systems and systems (such as those with embedded chips) controlling operational facilities such as onshore and offshore oil and gas rigs, oil and gas pipelines and gas plants domestically and internationally, the effects of which would have a cumulative material adverse impact on Seagull. Among other things, Seagull could face substantial claims by customers or loss of revenues due to service interruptions, inability to fulfill contractual obligations, inability to account for certain revenues or obligations or to bill customers accurately and on a timely basis, and increased expenses associated with litigation, stabilization of operations following mission-critical failures, and the execution of contingency plans. Seagull could also experience an inability by customers, traders, and others to pay, on a timely basis or at all, obligations owed to Seagull. Under these circumstances, the adverse effect on Seagull, and the diminution of Seagull's revenues, would be material, although not quantifiable at this time. Further in this scenario, the cumulative effect of these failures could have a substantial adverse effect on the economy, domestically and internationally. The adverse effect on Seagull, and the diminution of Seagull's revenues, from a domestic or global recession or depression is also likely to be material, although not quantifiable at this time. The total costs for the Year 2000 compliance review, evaluation, assessment and remediation efforts are not expected to be in excess of $1 million. Of this amount, approximately $0.3 million had been incurred as of December 31, 1998. ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes standards of accounting for and disclosures of derivative instruments and hedging activities. This statement is effective for fiscal years beginning after June 15, 1999. The Company has not yet determined the impact of this statement on the Company's financial condition or results of operations. 38 SEAGULL ENERGY CORPORATION SELECTED QUARTERLY FINANCIAL DATA Summarized quarterly financial data is as follows (amounts in thousands except per share data):
Quarter Ended ------------------------------------------------------------------------------- March 31 June 30 September 30 December 31 ------------------ ------------------ ------------------- ------------------ 1998: Revenues......................... $ 122,325 $ 103,529 $ 93,099 $ 107,218 Operating Profit (Loss) (2)...... $ 14,201 $ 5,575 $ (108,817) $ (9,163) Net Income (Loss) Before Extraordinary Item(2)......... $ 3,155 $ (1,051) $ (86,607) $ (11,162) Earnings (Loss) per Share Before Extraordinary Item: Basic.......................... $ 0.05 $ (0.02) $ (1.37) $ (0.18) Diluted(1)..................... $ 0.05 $ (0.02) $ (1.37) $ (0.18) Net Income (Loss) (2)............ $ 3,155 $ (1,051) $ (87,638) $ (11,162) Earnings (Loss) per Share: Basic.......................... $ 0.05 $ (0.02) $ (1.39) $ (0.18) Diluted(1)..................... $ 0.05 $ (0.02) $ (1.39) $ (0.18) 1997: Revenues......................... $ 159,573 $ 122,180 $ 120,655 $ 146,959 Operating Profit................. $ 46,606 $ 17,811 $ 13,456 $ 32,603 Net Income(3).................... $ 17,254 $ 2,621 $ 3,202 $ 26,053 Earnings per Share: Basic.......................... $ 0.27 $ 0.04 $ 0.05 $ 0.41 Diluted(1)..................... $ 0.27 $ 0.04 $ 0.05 $ 0.41 (1) Quarterly earnings (loss) per common share may not total to the full year per share amount, as the weighted average number of shares outstanding for each quarter fluctuated as a result of the assumed exercise of stock options. (2) Includes $78 million pre-tax noncash impairment of long-lived assets and $6 million one-time pre-tax compensation charges during the quarter ended September 30, 1998. (3) Includes $12 million pre-tax gain on sale of Canadian oil and gas operations during the quarter ended December 31, 1997.
39 SEAGULL ENERGY CORPORATION SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. By: /s/ William L. Transier William L. Transier, Executive Vice President and Chief Financial Officer (Principal Financial Officer) Date: March 1, 1999 By: /s/ Gordon L. McConnell Gordon L. McConnell, Vice President and Controller (Principal Accounting Officer) Date: March 1, 1999 85 -----END PRIVACY-ENHANCED MESSAGE-----