-----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, Wuo1PbDXOiJ9yphYqnSb+3kY1P8vGdJrsHCxKCdFNe+g/NoKBfKfbrjVr47vm7Fc tHAmn/1NFFqArsYNuGwv/w== 0000007332-98-000016.txt : 19980817 0000007332-98-000016.hdr.sgml : 19980817 ACCESSION NUMBER: 0000007332-98-000016 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980814 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOUTHWESTERN ENERGY CO CENTRAL INDEX KEY: 0000007332 STANDARD INDUSTRIAL CLASSIFICATION: NATURAL GAS TRANSMISSION & DISTRIBUTION [4923] IRS NUMBER: 710205415 STATE OF INCORPORATION: AR FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-08246 FILM NUMBER: 98690391 BUSINESS ADDRESS: STREET 1: 1083 SAIN ST STREET 2: P O BOX 1408 CITY: FAYETTEVILLE STATE: AR ZIP: 72702-1408 BUSINESS PHONE: 5015211141 FORMER COMPANY: FORMER CONFORMED NAME: ARKANSAS WESTERN GAS CO DATE OF NAME CHANGE: 19790917 10-Q 1 FORM 10-Q FOR THE PERIOD ENDED JUNE 30, 1998 =========================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------------- FORM 10-Q (Mark one) [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 1998 ------------- or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______ to _______ Commission file number 1-8246 SOUTHWESTERN ENERGY COMPANY (Exact name of registrant as specified in its charter) Arkansas 71-0205415 (State of incorporation (I.R.S. Employer or organization) Identification No.) 1083 Sain Street, P.O. Box 1408, Fayetteville, Arkansas 72702-1408 (Address of principal executive offices, including zip code) (501) 521-1141 (Registrant's telephone number, including area code) No Change (Former name, former address and former fiscal year; if changed since last report) 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 twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes: X No: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Class Outstanding at August 5, 1998 ---------------------------- ---------------------------- Common Stock, Par Value $.10 24,882,534 =========================================================================== - 1 - PART I FINANCIAL INFORMATION - 2 - SOUTHWESTERN ENERGY COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited) ASSETS
June 30, December 31, 1998 1997 --------- --------- ($ in thousands) Current Assets Cash $ 1,976 $ 4,603 Accounts receivable 24,187 45,752 Income taxes receivable - 3,074 Inventories, at average cost 19,358 20,465 Under-recovered purchased gas costs, net - 9,428 Other 4,041 4,633 --------- --------- Total current assets 49,562 87,955 --------- --------- Investments 12,676 7,039 --------- --------- Property, Plant and Equipment, at cost Gas and oil properties, using the full cost method 729,285 708,094 Gas distribution systems 216,073 212,779 Gas in underground storage 24,054 23,748 Other 25,643 25,319 --------- --------- 995,055 969,940 Less: Accumulated depreciation, depletion and amortization 458,395 366,638 --------- --------- 536,660 603,302 --------- --------- Other Assets 12,785 12,570 --------- --------- Total Assets $ 611,683 $ 710,866 ========= =========
The accompanying notes are an integral part of the financial statements. - 3 - SOUTHWESTERN ENERGY COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited) LIABILITIES AND SHAREHOLDERS' EQUITY
June 30, December 31, 1998 1997 --------- --------- ($ in thousands) Current Liabilities Current portion of long-term debt $ 3,071 $ 3,071 Accounts payable 28,083 29,903 Taxes payable 4,900 3,893 Interest payable 2,353 2,569 Customer deposits 5,153 5,307 Over-recovered purchased gas costs, net 149 - Other 4,242 4,246 --------- --------- Total current liabilities 47,951 48,989 --------- --------- Long-Term Debt, less current portion above 259,071 296,472 --------- --------- Other Liabilities Deferred income taxes 114,270 139,256 Other 4,432 4,584 --------- --------- 118,702 143,840 --------- --------- Commitments and Contingencies Shareholders' Equity Common stock, $.10 par value; authorized 75,000,000 shares, issued 27,738,084 shares 2,774 2,774 Additional paid-in capital 21,444 21,475 Retained earnings 194,702 230,669 Less: Common stock in treasury, at cost 2,863,080 shares in 1998 and 2,904,519 shares in 1997 31,895 32,357 Unamortized cost of 107,998 restricted shares in 1998 and 90,375 restricted shares in 1997, issued under stock incentive plan 1,066 996 --------- --------- 185,959 221,565 --------- --------- Total Liabilities and Shareholders' Equity $ 611,683 $ 710,866 ========= =========
The accompanying notes are an integral part of the financial statements. - 4 - SOUTHWESTERN ENERGY COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
Quarter Ended Six Months Ended June 30, June 30, 1998 1997 1998 1997 ---------- ---------- ---------- ---------- ($ in thousands, except per share amounts) Operating Revenues Gas sales $ 32,412 $ 32,180 $ 95,294 $ 101,442 Gas marketing 19,504 14,020 34,705 28,023 Oil sales 2,575 3,667 5,344 7,683 Gas transportation and other 1,843 1,377 3,947 3,015 ---------- ---------- ---------- --------- 56,334 51,244 139,290 140,163 ---------- ---------- ---------- --------- Operating Costs and Expenses Gas purchases - utility 3,983 4,993 22,670 27,276 Gas purchases - marketing 19,054 13,602 33,326 26,714 Operating and general 16,612 14,388 31,741 28,736 Depreciation, depletion and amortization 12,399 11,543 25,438 23,829 Write-down of oil and gas properties 66,383 - 66,383 - Taxes, other than income taxes 1,738 1,629 3,644 3,425 ---------- ---------- ---------- --------- 120,169 46,155 183,202 109,980 ---------- ---------- ---------- --------- Operating Income (Loss) (63,835) 5,089 (43,912) 30,183 ---------- ---------- ---------- --------- Interest Expense 4,010 3,745 8,188 7,731 ---------- ---------- ---------- --------- Other Income (Expense) (1,103) (1,296) (1,976) (2,373) ---------- ---------- ---------- --------- Income (Loss) Before Provision for Income Taxes (68,948) 48 (54,076) 20,079 ---------- ---------- ---------- --------- Income Tax Provision (Benefit) Current (1,418) (243) 3,888 6,298 Deferred (25,472) 262 (24,978) 1,433 ---------- ---------- ---------- --------- (26,890) 19 (21,090) 7,731 ---------- ---------- ---------- --------- Net Income (Loss) $ (42,058) $ 29 $ (32,986) $ 12,348 ========== ========== ========== ========== Basic Earnings (Loss) Per Share ($1.70) $ .00 ($1.33) $ .50 ====== ===== ====== ===== Weighted Average Common Shares Outstanding 24,859,789 24,736,398 24,851,447 24,728,318 ========== ========== ========== ========== Dilutive Earnings (Loss) Per Share $(1.70) $ .00 $(1.33) $ .50 ====== ===== ====== ===== Dilutive Weighted Average Common Shares Outstanding 24,859,789 24,834,804 24,851,447 24,855,471 ========== ========== ========== ========== Dividends Declared Per Share Payable 8/5/98 and 8/5/97 $ .06 $ .06 $ .06 $ .06 ===== ===== ===== =====
The accompanying notes are an integral part of the financial statements. - 5 - SOUTHWESTERN ENERGY COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six Months Ended June 30, 1998 1997 -------- -------- ($ in thousands) Cash Flows From Operating Activities Net income (loss) $(32,986) $ 12,348 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion and amortization 25,578 23,969 Write-down of oil and gas properties 66,383 - Deferred income taxes (24,978) 1,433 Equity in loss of partnership 1,706 2,014 Change in assets and liabilities: Decrease in accounts receivable 21,565 17,102 Decrease in income taxes receivable 4,751 11,584 Decrease in inventories 1,107 1,111 (Increase) decrease in under-recovered purchased gas costs 9,577 (5,878) Increase (decrease) in accounts payable (1,820) 719 Net change in other current assets and liabilities (452) (190) -------- -------- Net cash provided by operating activities 70,431 64,212 -------- -------- Cash Flows From Investing Activities Capital expenditures (26,414) (41,482) Investment in partnership (7,343) (2,496) (Increase) decrease in gas stored underground (306) 2,228 Other items 1,386 563 -------- -------- Net cash used in investing activities (32,677) (41,187) -------- -------- Cash Flows From Financing Activities Decrease in revolving long-term debt (37,400) (78,900) Issuance of long-term debt - 60,000 Cash dividends (2,981) (2,966) -------- -------- Net cash used in financing activities (40,381) (21,866) -------- -------- Increase (decrease) in cash (2,627) 1,159 Cash at beginning of year 4,603 2,297 -------- -------- Cash at end of period $ 1,976 $ 3,456 ======== ========
The accompanying notes are an integral part of the financial statements. - 6 - SOUTHWESTERN ENERGY COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 1. BASIS OF PRESENTATION The financial statements included herein are unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods. The Company's accounting policies are summarized in the 1997 Annual Report to Shareholders, Notes to Financial Statements. Certain reclassifications have been made to the June 30, 1997, financial statements in order to conform with the 1998 presentation. These reclassifications had no effect on previously reported net income. 2. OIL AND GAS PROPERTIES The Company utilizes the full cost method of accounting for costs related to its oil and natural gas properties. Under this method, all such costs (productive and nonproductive) are capitalized and amortized on an aggregate basis over the estimated lives of the properties using the units-of-production method. These capitalized costs are subject to a ceiling test, however, which limits such pooled costs to the aggregate of the present value of future net revenues attributable to proved gas and oil reserves discounted at 10 percent plus the lower of cost or market value of unproved properties. Such capitalized costs do not include costs related to unevaluated properties. At June 30, 1998, the Company's unamortized costs of oil and gas properties exceeded this ceiling amount by approximately $40.5 million (net of taxes) due to lower oil and gas prices and the transfer of previously unevaluated property costs to the amortizable portion of the full cost pool. As a result, the Company recognized a $40.5 million non-cash charge to earnings in the quarter ended June 30, 1998, by recording a write-down of its oil and gas properties of $66.4 million and a related reduction in the provision for deferred income taxes of $25.9 million. 3. EARNINGS PER SHARE The Company has adopted Financial Accounting Standards Board Statement No. 128. "Earnings Per Share" (SFAS No. 128). Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding during each year. The diluted earnings per share calculation adds to the weighted average number of common shares outstanding the incremental shares that would have been outstanding assuming the exercise of dilutive stock options. The impact of the adoption of SFAS No. 128 had no effect on reported earnings per share for the three month and six month periods ended June 30, 1998 and 1997. - 7 - 4. COMPREHENSIVE INCOME In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS No. 130), establishing standards for reporting and display of comprehensive income and its components in financial statements. SFAS No. 130 defines comprehensive income as the total of net income and all other nonowner changes in equity. The Company had no nonowner changes in equity other than net income during the six months ended June 30, 1998 and 1997. 5. DERIVATIVE AND 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 No. 133). SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999. A company may also implement the statement as of the beginning of any fiscal quarter after issuance (that is, fiscal quarters beginning June 16, 1998 and thereafter). SFAS No. 133 cannot be applied retroactively and must be applied to (a) derivative instruments and (b) certain derivative instruments embedded in hybrid contracts that were issued, acquired, or substantively modified after December 31, 1997 (and, at the company's election, before January 1, 1998). The Company has not yet quantified the impacts of adopting SFAS No. 133 on its financial statements, nor has it determined the timing of or method of adoption. However, it should be noted that SFAS No. 133 could increase volatility in future reported earnings and other comprehensive income. 6. DIVIDEND PAYABLE A dividend of $.06 per share was declared July 8, 1998, payable August 5, 1998. - 8 - 7. INTEREST AND INCOME TAXES PAID The following table provides interest and income taxes paid during each period presented.
Three months Six months Periods Ended June 30 1998 1997 1998 1997 - --------------------------------------------------------------------------------------- (in thousands) Interest payments $9,280 $7,276 $9,781 $8,845 Income tax payments $2,342 $219 $2,342 $384
- 9 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following updates information as to the Company's financial condition provided in the Company's Form 10-K for the year ended December 31, 1997, and analyzes the changes in the results of operations between the three and six month periods ended June 30, 1998, and the comparable periods of 1997. RESULTS OF OPERATIONS The Company reported a net loss of $42.1 million, or $1.70 per share, for the second quarter of 1998, and a net loss of $33.0 million, or $1.33 per share, for the six months ended June 30, 1998, reflecting the impact of an after-tax, non-cash ceiling test write-down of its oil and gas properties of $40.5 million, or $1.63 per share. Excluding the write-down, the Company would have recognized a net loss for the three months ended June 30, 1998, of $1.6 million, or $.07 per share, down from net income of $29,000, or $.00 per share, for the same period in 1997. For the six months ended June 30, 1998, net income would have been $7.5 million, or $.30 per share, down from to $12.3 million, or $.50 per share, for the same period in 1997, primarily due to lower wellhead prices for both oil and gas. The Company utilizes the full cost method of accounting for costs related to its oil and natural gas properties. Under this method, all such costs (productive and nonproductive) are capitalized and amortized on an aggregate basis over the estimated lives of the properties using the units-of-production method. These capitalized costs are subject to a ceiling test, however, which limits such pooled costs to the aggregate of the present value of future net revenues attributable to proved gas and oil reserves discounted at 10 percent plus the lower of cost or market value of unproved properties. Such capitalized costs do not include costs related to unevaluated properties. At June 30, 1998, the Company's unamortized costs of oil and gas properties exceeded this ceiling amount by approximately $40.5 million (net of taxes) due to lower gas and oil prices and the transfer of previously unevaluated property costs to the amortizable portion of the full cost pool. As a result, the Company recognized a $40.5 million non-cash charge to earnings in the quarter ended June 30, 1998, by recording a write-down of its oil and gas properties of $66.4 million ($.19 per equivalent Mcf of existing proved reserves and $3.49 per equivalent Mcf produced in the first six months) and a related reduction in the provision for deferred income taxes of $25.9 million. The Company's full cost ceiling is evaluated at the end of each quarter. If gas and oil prices remain at the current low levels for a prolonged period, or other changes occur that affect terms of existing sales contracts, the Company may be required to reflect additional non-cash charges to earnings in future quarterly periods related to the Company's unamortized costs of oil and gas properties. The Company transferred approximately $27.2 million of previously unevaluated property costs to its amortizable full cost pool during the second quarter of 1998 in connection with the Company's semi-annual impairment review of its properties. A large portion of the costs - 10 - transferred were costs incurred over the past two years for 3-D seismic data, leasehold and lease options related to the Company's Henry project in south Louisiana. The final processed seismic data for this project was received in September, 1997. The review and interpretation of this data was completed during the second quarter of 1998. After the transfer of these costs, net unamortized costs for unevaluated properties excluded from the amortizable full cost pool at June 30, 1998, were approximately $47.1 million, down from $69.3 million at December 31, 1997. Excluding the impact of the write-down of oil and gas properties, results for the second quarter 1997 were unfavorably impacted by low oil prices, increased operating and general expenses, and higher depreciation, depletion and amortization expense. The following tables compare operating revenues and operating income (before the effects of the write-down of oil and gas properties) by business segment for the three and six month periods ended June 30, 1998 and 1997:
Quarter Ended Six Months Ended June 30, June 30, --------------------- -------------------- 1998 1997 1998 1997 ---- ---- ---- ---- (in thousands) Revenues Exploration and production $21,146 $20,633 $45,407 $49,915 Gas distribution 22,528 24,280 78,552 85,179 Energy services and other 24,509 18,553 43,882 35,536 Eliminations (11,849) (12,222) (28,551) (30,467) ------- ------- -------- -------- $56,334 $51,244 $139,290 $140,163 ======= ======= ======== ======== Operating Income Exploration and production $ 3,065 $ 4,667 $ 9,621 $ 17,102 Gas distribution (708) 229 11,991 12,194 Energy services and other 191 193 859 887 ------- ------- -------- -------- $ 2,548 $ 5,089 $ 22,471 $ 30,183 ======= ======= ======== ========
Exploration and Production Revenues of the exploration and production segment were up slightly for the three month period ended June 30, 1998, and were down 9% for the six month period ended June 30, 1998, both as compared to the same periods in 1997. Operating income of this segment, excluding the write-down, was down $1.6 million for the three months ended June 30, 1998, and was down $7.5 million for the six months ended June 30, 1998, as compared to the same periods in 1997. Gas production for the three months ended June 30, 1998, was 8.0 Bcf, compared to 7.9 Bcf for the same period in 1997. For the six months ended June 30, 1998, gas production was 16.7 Bcf, compared to 16.6 Bcf in 1997. The Company's sales to its utility distribution systems were 6.9 Bcf during the six months ended June 30, 1998, compared to 7.6 Bcf for the same period in 1997. The decline in sales to the utility segment was primarily the result of weather that was 11% warmer than in 1997. Southwestern received an average price of $2.33 per Mcf for its gas production during the three months ended June 30, 1998, up from $2.13 per Mcf for the same - 11 - period in 1997. The Company received an average price of $2.39 per Mcf for its gas production during the six months ended June 30, 1998, down from $2.54 per Mcf for the same period in 1997. Most of the intersegment gas sales to Arkansas Western Gas Company (AWG), the utility subsidiary that operates the Company's northwest Arkansas utility system, are pursuant to a long-term contract entered into in 1978 which was amended and restated in 1994. AWG purchased 4.6 Bcf under this contract at an average price of $3.09 per Mcf in the first six months of 1998, compared to 4.4 Bcf at an average price of $3.32 per Mcf for the same period in 1997. This contract expired July 24, 1998, but is being continued on a month-to-month basis pending resolution of the issues described below. In March, 1997, AWG filed a gas supply plan with the Arkansas Public Service Commission which projects system load growth patterns and long range gas supply needs for the utility's northwest Arkansas system. As part of its long range supply plan, AWG proposed a new intersegment gas supply contract for a similar portion of its system needs at a price competitive with the cost of alternative supplies. After extensive negotiations, the issues surrounding AWG's gas supply plan have not yet been resolved. The Company believes it is likely that these issues will be resolved in a manner that requires that the gas supply now provided under this contract be replaced through a competitive bidding process involving multiple potential suppliers. If this occurs, SEECO's continued sales of these volumes to AWG, and the price of any such sales, will depend on the result of this competitive bidding process. Other sales to AWG are made under long-term contracts with flexible pricing provisions. The Company's oil production was 387 thousand barrels (MBbls) during the six months ended June 30, 1998, down slightly from 398 MBbls for the same period of 1997. Southwestern received an average price of $13.82 per barrel for its oil production during the six months ended June 30, 1998, down from $19.32 per barrel for the same period of 1997. The decrease in average price reflects the general decline in the market price for oil during the first half of 1998. Gas Distribution Operating income of the gas distribution segment decreased $.9 million for the second quarter of 1998 and $.2 million for the first six months of 1998, as compared to the same periods in 1997, due primarily to lower volumes delivered to customers as a result of warmer weather. The utility systems delivered 18.2 Bcf to sales and end-use transportation customers during the six months ended June 30, 1998, down from 18.7 Bcf for the same period in 1997. Operating income for the first six months of 1998 remained relatively flat with 1997 results despite weather that was 10% warmer than normal and 11% warmer than the same period of 1997. Rate increases and tariff changes totaling $3.0 million annually implemented in late 1997 largely offset the effect of warmer weather. The utility also realized 2% growth in the average number of customers. The Company's average rate for its utility sales increased to $5.40 per Mcf during the first six months of 1998, up from $5.22 per Mcf for the same period in 1997. The increase was the result of the rate increases discussed above and the effects of weather normalization clauses included in the rate tariffs of Arkansas customers. - 12 - Energy Services Operating income for the energy services segment was $.1 million on revenues of $24.4 million for the second quarter of 1998, compared to $.2 million on revenues of $18.5 million for the same period in 1997. For the six months ended June 30, 1998, operating income for this segment was $.8 million on revenues of $43.7 million, compared to $.9 million on revenues of $35.4 million for the same period in 1997. The Company marketed 21.6 Bcf of gas in the first six months of 1998, compared to 16.4 Bcf for the same period in 1997. The higher margins applicable to the first half of 1997 primarily relate to income realized from the Company's unregulated storage facilities which were utilized to take advantage of the higher gas prices available at that time. A portion of the activity of the energy services segment involves the NOARK Pipeline System (NOARK). The Company's share of NOARK's pre-tax loss included in other income was $.9 million for the second quarter of 1998 and $1.7 million for the first six months of 1998, compared to $.9 million and $2.0 million, respectively, for the same periods in 1997. The improvement in NOARK's pre-tax loss for the first half of 1998 primarily reflects a lower interest rate on NOARK's debt which resulted from a refinancing discussed below in "Changes in Financial Condition". In January, 1998, the Company entered into an agreement with Enogex Inc. (Enogex), a subsidiary of OGE Energy Corp., to expand the NOARK system and provide access to Oklahoma gas supplies through an integration of NOARK with the Ozark Gas Transmission System (Ozark). Ozark is a 437-mile interstate pipeline system which begins in eastern Oklahoma and terminates in eastern Arkansas. On July 1, 1998, the Federal Energy Regulatory Commission (FERC) authorized the operation and integration of the Ozark pipeline and the NOARK pipeline as a single, integrated pipeline. The FERC order also authorized the purchase of Ozark by a subsidiary of Enogex and the construction of integration facilities. Effective August 1, 1998, Enogex acquired Ozark and contributed the pipeline system to the NOARK partnership. Enogex has also acquired the NOARK partnership interests not held by Southwestern. In addition to its purchase of Ozark, Enogex will fund the integration project and an expansion of the combined system. The integrated system will include 749 miles of pipeline and have total throughput capacity of 330 MMcfd. The Company, through its wholly owned subsidiary, Southwestern Energy Pipeline Company, held a 60% general partnership interest in NOARK through July 31, 1998. The Company's ownership interest in NOARK had temporarily increased from 48% in January, 1998 as a result of the Enogex transaction. Enogex will spend approximately $70 million to acquire Ozark and integrate it with NOARK. Upon completion and funding by Enogex of the integration, the Company's interest in the partnership will decrease to 25% and Enogex will own a 75% interest. The parties expect the integrated system to be operational by November 1, 1998. After a start-up period, the Company expects the improved project to eliminate the losses it has been experiencing on its NOARK investment. Operating Costs and Expenses Excluding the impact of the write-down of oil and gas properties, operating costs and expenses increased 17% in the second quarter of 1998 and increased 6% for the first six months of 1998, - 13 - both as compared to the comparable periods in 1997. The increases were primarily caused by increased gas purchases by the energy services segment, increased operating and general expenses and higher depreciation, depletion and amortization expense, offset by lower purchased gas costs of the Company's gas distribution segment. The increase in operating and general expenses was due primarily to increased payroll and benefit costs, and for employee termination benefits and other costs incurred in connection with the closing of the Company's Oklahoma City exploration and production office. The activities of this office were consolidated into the Company's Houston office. The increase in depreciation, depletion and amortization expense was due to an increase in the amortization rate per unit of production in the exploration and production segment. The Company's amortization rate, excluding the impact of the write-down of oil and gas properties, was $1.11 per Mcf equivalent for the first six months of 1998, compared to $1.04 for the same period in 1997. Due to the write-down of its property costs, the Company's amortization rate will drop below these levels. The future amortization rate will be impacted by the level of reserve additions and costs added to the full cost pool. Interest expense, net of capitalization, for the six months ended June 30, 1998, was up 6% compared to the same period in 1997, due to slightly higher average borrowings. Interest is capitalized in the exploration and production segment on costs that are unevaluated and excluded from amortization. The Company's capitalized interest for this segment will initially be lower going forward due to the transfer of approximately $27.2 million of previously unevaluated costs to the amortizable full cost pool in the second quarter of 1998. The previously discussed write-down of the Company's oil and gas properties resulted in a deferred tax benefit of $25.9 million. Excluding the impact of this change in deferred, the changes in the provisions for current and deferred income taxes recorded in the three and six month periods ended June 30, 1998, as compared to the same periods in 1997, resulted primarily from the level of taxable income and from the deduction of intangible drilling costs in the year incurred for tax purposes, netted against the turnaround of intangible drilling costs deducted for tax purposes in prior years. Intangible drilling costs are capitalized and amortized over future years for financial reporting purposes under the full cost method of accounting. Year 2000 The year 2000 problem impacts most companies as many informational and operational systems that currently exist will be unable to continue processing in the year 2000 due to the improper recognition of calendar dates. The Company began an initial review in late 1996 of its processing systems and the ability of those systems to process year 2000 data. The primary financial information systems of the Company that are supported by outside vendors are designed to accommodate the century date or are scheduled for an upgrade in 1998 to a year 2000 compliant version at no additional cost to the Company. The Company is currently testing these upgrades and expects these systems to be year 2000 compliant by the end of 1998. Other information systems supported internally by the Company are either scheduled for replacement at which time they will become year 2000 compliant or they will be subject to modification to support year 2000 processing during 1998. The costs associated with the modification of these systems is not expected to have a material impact on the Company's financial condition or its results of operations. - 14 - The Company has also identified internal processes and areas of non-information technology (e.g. equipment with embedded chips) that require modification to process year 2000 data or that require further assessment. The Company is replacing the operating system of its personal computers to the NT version of Windows, which will also result in the replacement of noncompliant personal computers and the related software that is not already year 2000 compliant. This roll-out of NT was a scheduled replacement not directly related to the year 2000 problem. It is expected to be completed by the end of 1998 at an estimated cost of $.6 million. An assessment is underway in other non-information technology areas related to electronic meter reading and field measurement. Currently, replacement of electronic meter reading equipment is estimated to cost approximately $.3 million and is expected to be completed by the end of 1998. The Company has not completed its estimate of the timing and costs related to its field measurement equipment, but it is not expected to have a material impact on the Company's financial condition or its results of operations. The Company is also evaluating the risk of year 2000 noncompliance by third parties through communication with industry partners, suppliers, financial institutions and others. The Company does not have a material relationship with any single third party entity that would cause a significant business interruption as a result of that party's year 2000 noncompliance. However, these third parties have been risk-weighted based upon the historical level of business transacted with the Company. The Company is now beginning the process of contacting parties who have not responded to the Company's request for information or whose responses are inadequate. The parties are being contacted in order of the perceived risk that is posed to the Company by their potential year 2000 noncompliance. The Company is taking the above steps to lessen the risk associated with year 2000 noncompliance by third parties, however, if a substantial number of third parties in the aggregate were not year 2000 compliant in their processing systems, the Company could be adversely impacted by such things as late or incorrect revenue receipts or expense disbursements, communication problems, or scheduling problems related to the transportation of natural gas. Based upon its assessment to date of third party assurances, the Company does not anticipate any material disruptions in its business activities as a result of third party noncompliance, although it cannot be certain that such disruptions will not occur. CHANGES IN FINANCIAL CONDITION Changes in the Company's financial condition at June 30, 1998, as compared to December 31, 1997, primarily reflect the seasonal nature of the gas distribution segment of the Company's business. Routine capital expenditures, cash dividends and scheduled debt retirements are predominately funded through cash provided by operations. For the first six months of 1998 and 1997, net cash provided by operating activities was $70.4 million and $64.2 million, respectively, and exceeded the total of these routine requirements. The increase in net cash provided by operating activities during the first six months of 1998 was largely due to the utility segment's collection of $9.6 million of gas costs incurred during the past year, but deferred for collection until 1998 pursuant to the utility's purchased gas adjustment clauses in its filed rate tariffs. The Company had net over-recovered purchased gas costs of $.1 million at June 30, 1998, that were classified - 15 - as a current liability. At December 31, 1997, the Company had net under- recovered purchased gas costs of $9.4 million. This amount was classified as a current asset. Financing Requirements The Company has access to $80.0 million of medium to long-term capital at current market lending rates through two floating rate credit facilities. Of this amount, $9.0 million was outstanding at June 30, 1998, all of which was classified as long-term debt. During the first six months of 1998, the Company's revolving long-term debt decreased by $37.4 million primarily due to cash flow generated by seasonally high utility revenues and the collection of deferred gas costs discussed above. Due primarily to the second quarter write-down of the Company's oil and gas properties, shareholders' equity decreased by $35.6 million, as compared to December 31, 1997. As a result, long-term debt at June 30, 1998, accounted for 58.2% of the Company's capitalization, up slightly from 57.2% at December 31, 1997. The Company expects its outstanding borrowings to increase during the upcoming months of 1998 as cash generated from operations will be less than the requirements for routine capital expenditures and cash dividends due to lower levels of heating-generated revenues and seasonally higher capital expenditures resulting from favorable drilling and construction weather. The Company's capital expenditures for the first six months of 1998 were $26.4 million, compared to $41.5 million for the same period in 1997. Planned capital spending during 1998 is expected to be at least $15.0 million, lower than actual 1997 spending. The Company is currently reviewing the timing and level of its capital expenditures for the remainder of 1998 and may further reduce its planned capital spending. In connection with the Enogex transaction discussed above, the Company and a previous general partner converted certain of their loans to the NOARK partnership, plus accrued interest, into equity, and contributed approximately $10.7 million to the partnership to fund costs incurred in connection with the prepayment of NOARK's 9.74% Senior Secured Notes. The Company's share of the contribution was $6.5 million and is the primary reason for the increase in investments during the first half of 1998. The notes were temporarily refinanced with Senior Secured Notes payable to the other current general partner of NOARK. In June, 1998, the NOARK partnership issued $80.0 million of 7.15% Notes due 2018. Proceeds from the issue of the notes were used to repay the Senior Secured Notes and amounts borrowed under the partnership's bank revolving line of credit. The notes require semi-annual principal payments of $1.0 million beginning in December, 1998. The Company and the other general partner of NOARK have severally guaranteed the principal and interest payments on the NOARK debt. The Company's share of the several guarantee is 60%. Working Capital Accounts receivable has declined since December 31, 1997, due primarily to seasonally lower deliveries of the gas distribution segment. The decrease in income taxes receivable resulted from the receipt of federal income tax refunds and an increase in taxes payable resulted from taxable income generated in the first half of 1998. Accounts payable has decreased since December 31, 1997 due to the seasonally lower gas purchases for the gas distribution segment and due to the timing of expenditures. Other changes in current assets and current liabilities between periods resulted primarily from the timing of expenditures and receipts. - 16 - FORWARD-LOOKING INFORMATION All statements, other than historical financial information, included in this discussion and analysis of financial condition and results of operations may be deemed to be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements reflect the Company's current views with respect to future events and performance. The Company believes that its expectations are based on reasonable assumptions. No assurances, however can be given that its goals will be achieved. Important factors that could cause actual results to differ materially from those in the forward-looking statements herein include (1) the timing and extent of changes in commodity prices for gas and oil and interest rates, (2) the timing and extent of the Company's success in discovering, developing, producing, and estimating reserves, (3) the effects of weather and regulation on the Company's gas distribution segment, and (4) conditions in capital markets, availability of oil field services, drilling rigs, and other equipment, as well as other competitive factors during the periods covered by the forward-looking statements. - 17 - PART II OTHER INFORMATION Item 1 - Legal Proceedings In 1997, the Company's subsidiary, Southwestern Energy Production Company (SEPCO), filed suit against several parties, including an outside consultant previously employed by SEPCO, alleging breach of contract, fraud, and other causes of action in connection with services performed on SEPCO's south Louisiana exploration projects. On June 23, 1998, the outside consultant filed a counterclaim against SEPCO. The consultant's primary cause of action relates to a claim that he is contractually entitled to a 25% interest in the Boure' project, one of SEPCO's south Louisiana exploration projects. The counterclaim alleges seven different claims for relief, including breach of contract, fraud, and defamation and requests damages in excess of $10,000,000 for each claim plus punitive damages in excess of $10,000,000. The Company feels these claims are without merit and intends to vigorously contest them. Although the total amount of these claims is significant in the aggregate, management believes, based on its investigation, that the Company's ultimate liability, if any, will not be material to its consolidated financial position or results of operation. Items 2 - 3 No developments required to be reported under Items 2 - 3 occurred during the quarter ended June 30, 1998. Item 4 - Submission of Matters to a Vote of Security Holders The Company held its Annual Meeting of Shareholders on May 21, 1998, for the purpose of electing Directors of the Company for the ensuing year and to vote on a proposal to amend and restate the Southwestern Energy Company 1993 Stock Incentive Plan. Holders of 21,090,696 shares voted in total. Holders of 20,911,401 shares voted for the election of directors and 179,195 shares voted as withheld. Shares voted regarding the proposal to amend the Southwestern Energy Company 1993 Stock Incentive Plan were 15,811,187 for the amendment, 5,050,064 against, and 229,345 voted as abstentions. The Directors were elected with the number of shares voted as follows: Voted For Withheld --------- -------- Lewis E. Epley, Jr. 20,877,946 212,750 John Paul Hammerschmidt 20,858,779 231,917 Robert L. Howard 20,901,327 189,369 Kenneth R. Mourton 20,895,472 195,224 Charles E. Scharlau 20,877,528 213,168 - 18 - Items 5 - 6(a) No developments required to be reported under Items 5 - 6(a) occurred during the quarter ended June 30, 1998. Item 6(b) On May 27, 1998, the Company filed a current report on Form 8-K dated May 22, 1998, announcing the appointment of Harold M. Korell as President and Chief Operating Officer of Southwestern Energy Company and its subsidiaries. On June 2, 1998, the Company filed a current report on Form 8-K dated May 27, 1998, regarding a decision issued by the Arkansas Court of Appeals remanding an order of the Arkansas Public Service Commission (APSC) because the order did not contain adequate findings of fact for the court to conduct a meaningful review of the APSC's decision. The APSC's order was issued in November, 1996 in connection with a rate case filed by the Company's utility subsidiary. Signatures ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SOUTHWESTERN ENERGY COMPANY --------------------------- Registrant DATE: August 14, 1998 /s/ GREGORY D. KERLEY --------------------- -------------------------------- Gregory D. Kerley Senior Vice President - Finance and Chief Financial Officer - 19 - EX-27 2 FINANCIAL DATA SCHEDULE FOR 2ND QTR - 1998
5 1,000 6-MOS DEC-31-1998 JUN-30-1998 1,976 0 24,187 0 19,358 49,562 995,055 (458,395) 611,683 47,951 259,071 0 0 2,774 183,185 611,683 135,343 139,290 0 183,202 0 0 8,188 (54,076) (21,090) (32,986) 0 0 0 (32,986) (1.33) 0
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