-----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, WSUVXlh6+Lz/pEwXRbyN6sEs6o1koRSCFiuk9e9TXvRSoN4HdgVnQkQ8kEHwQtJ7 /dlvR1skEdrXnAsR7JbWpQ== 0000930661-00-000826.txt : 20000331 0000930661-00-000826.hdr.sgml : 20000331 ACCESSION NUMBER: 0000930661-00-000826 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GOTHIC ENERGY CORP CENTRAL INDEX KEY: 0000878482 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 222663839 STATE OF INCORPORATION: OK FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-19753 FILM NUMBER: 587784 BUSINESS ADDRESS: STREET 1: 5727 S LEWIS AVE STE 700 STREET 2: P O BOX 186 CITY: TULSA STATE: OK ZIP: 74105 BUSINESS PHONE: 9187495666 FORMER COMPANY: FORMER CONFORMED NAME: TNC MEDIA INC DATE OF NAME CHANGE: 19930328 10KSB 1 FORM 10-KSB SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-KSB Mark One: [x] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the fiscal year ended December 31, 1999; 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 No. 0-19753 GOTHIC ENERGY CORPORATION - -------------------------------------------------------------------------------- (Name of Small Business Issuer in its Charter) Oklahoma 22-2663839 - -------------------------------------------------------------------------------- (State or Other Jurisdiction of (IRS Employer Incorporation or Organization) Identification No.) 6120 South Yale Avenue - Suite 1200 - Tulsa, Oklahoma 74136 - -------------------------------------------------------------------------------- (Address of Principal Executive Offices) (Zip Code) (918) 749-5666 - -------------------------------------------------------------------------------- (Issuer's Telephone Number, Including Area Code) Securities registered under Section 12(b) of the Exchange Act: Title of Each Class Name of Each Exchange on Which Registered - -------------------------------------------------------------------------------- None - -------------------------------------------------------------------------------- Securities Registered Pursuant to Section 12(g) of the Exchange Act: - -------------------------------------------------------------------------------- Common Stock, par value $.01 per share Redeemable Common Stock Purchase Warrants expiring January 24, 2001 - -------------------------------------------------------------------------------- (Title of Each Class) Check whether the Issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past twelve (12) months (or for such shorter period that the Issuer was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [x] Yes [ ] No Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B in this form, and no disclosure will be contained, to the best of Issuer's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB, or any amendment to this Form 10-KSB. State Issuer's revenues for its most recent fiscal year: $55,624,000 The aggregate market value of the voting stock held by non-affiliates computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of March 1, 2000, was $6,424,166. (Non- affiliates have been determined on the basis of holdings set forth in the information incorporated by reference under Item 11 of this Annual Report on Form 10-KSB.) The number of shares outstanding of each of the Issuer's classes of common equity, as of March 1, 2000, was 18,685,765. DOCUMENTS INCORPORATED BY REFERENCE None TABLE OF CONTENTS ----------------- Page ---- PART I ------ Item 1. Description of Business 3 Item 2. Description of Property 11 Item 3. Legal Proceedings 12 Item 4. Submission of Matters to a Vote of Security Holders 12 PART II ------- Item 5. Market for Common Equity and Related Security Holder Matters 13 Item 6. Management's Discussion and Analysis or Plan of Operation 13 Item 7. Financial Statements 26 Item 8. Changes in and Disagreements on Accounting and Financial Disclosure 26 PART III -------- Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act 27 Item 10. Executive Compensation 29 Item 11. Security Ownership of Certain Beneficial Owners and Management 31 Item 12. Certain Relationships and Related Transactions 33 Glossary 35 PART IV ------- Item 13. Exhibits and Reports on Form 8-K 37 PART I ------ Item 1 - Description of Business: - -------------------------------- General Gothic Energy Corporation is a holding company owning all of the outstanding capital stock of Gothic Production Corporation. As used herein, the term "Gothic Energy" refers to Gothic Energy Corporation (the parent corporation only), "Production Corp." refers to Gothic Production Corporation, and Gothic Energy and Production Corp. are referred to collectively as the "Company". Production Corp., the wholly owned operating subsidiary of Gothic Energy, is an independent energy company primarily engaged in the acquisition, development, exploitation, exploration and production of natural gas and oil. As of December 31, 1999, Production Corp. had proved reserves of 289.2 Bcf of natural gas and 1.9 MMBbls of oil (300.7 Bcfe), with a PV-10 of approximately $213.3 million as estimated by Production Corp's independent petroleum engineers. Production Corp's natural gas and oil reserves and acreage are principally located in the Anadarko, Arkoma and Permian/Delaware basins, which are historically prolific basins with multiple producing horizons and long-lived reserves. These basins generally provide significant development and exploitation potential through low-risk infill drilling and the implementation of new workover, drilling and recompletion technologies. Production Corp. is currently engaged in implementing a comprehensive development and exploitation program designed to increase its natural gas and oil production, earnings, cash flow and net asset value by enhancing proved producing reserves and converting proved undeveloped reserves to proved producing reserves. Production Corp. has identified, as of March 1, 2000, 214 development and exploitation projects within its properties. In July 1997, the Company initiated a comprehensive development program and as of March 1, 2000 had successfully drilled 118 wells, 111 of which have been completed and are producing and, at March 1, 2000, an additional 14 wells were in various stages of completion. Through March 1, 2000, Production Corp. has not engaged in any material exploration activities but intends to devote a limited amount of capital in the future to pursue seismic controlled exploration opportunities. At December 31, 1999, Production Corp. held an interest in approximately 465,000 gross acres (approximately 241,000 net acres) and had an interest in 1,005 gross wells (503 net wells). Production Corp. serves as operator of 578 of the wells in which it has an interest. Operated wells account for approximately 63% of the PV-10 value of Production Corp's proved reserves as of December 31, 1999. Production Corp. had estimated proved reserves of 300.7 Bcfe with a PV-10 of $213.3 million as of December 31, 1999. These reserves, of which 87% were classified as proved developed, had an estimated average reserve life of approximately 10.6 years and 96% were natural gas. For the year ended December 31, 1999, Production Corp. had revenues of $55.6 million, EBITDA of $40.7 million and a net loss of $17.3 million. Business Strategy The Company's objective, through Production Corp., is to increase its reserves, production, earnings, cash flow and net asset value through a growth strategy that includes (i) developing, exploiting and exploring its properties (ii) maintaining a low operating cost structure, and (iii) acquiring strategic natural gas and oil properties in a disciplined manner. . Development, Exploitation and Exploration. Production Corp. seeks to maximize the value of its natural gas and oil properties through development drilling, workovers, recompletions, reductions in operating costs and enhanced operating efficiencies. Production Corp. has, as of March 1, 2000, identified 214 development and exploitation projects within its properties, of which 154 have been assigned proved undeveloped reserves. In 2000, Production Corp., based on currently projected revenues and financing, intends to spend approximately $23.0 million to drill 70 to 80 gross wells, most of which are on proved undeveloped locations. Production Corp. also continually evaluates and pursues exploitation opportunities, including workover and recompletion projects. Production Corp. expects it will spend approximately $2.0 million in 2000 on these projects. Additionally, Production Corp. expects it will spend approximately $3.0 3 million in 2000 on seismic controlled exploration projects. Production Corp. believes geological and geophysical data, including 3D and 2D seismic surveys acquired in the Amoco Acquisition, will enable it to reduce costs and risks associated with drilling activities throughout its Anadarko basin properties. . Maintain Low Cost Operations. Production Corp. is able to control directly operating and drilling costs as the operator of wells comprising approximately 63% of the PV-10 value of proved reserves as of December 31, 1999. In addition, Production Corp. has been able to reduce per unit operating costs by eliminating unnecessary field and corporate overhead costs and by divesting marginal and non-strategic properties with limited development potential. Lease operating expenses, net of production taxes, have decreased 70%, from $0.74 per Mcfe of production in 1997 to $0.22 per Mcfe for the year ended December 31, 1999. Further, general and administrative expenses per Mcfe of production have decreased 40%, from $0.30 per Mcfe to $0.18 per Mcfe over the same period. Production Corp. intends to maintain the reduced operating costs associated with well operations through the use of advanced wireless technology licensed to Production Corp. as part of the Amoco Acquisition. This technology enables Production Corp. to remotely monitor well operations, thereby reducing the need for on-site monitoring personnel. Production Corp. has deployed this technology throughout many of its producing properties in the Anadarko and Arkoma basins. . Strategic Acquisitions. Production Corp. has increased its reserves through acquisitions, having added, since 1994, 424.9 Bcfe through 14 acquisitions at a total acquisition cost of $339.9 million, or an average cost of $0.80 per Mcfe. The properties acquired were producing natural gas and oil properties located primarily in Oklahoma, Texas, New Mexico and Kansas. There were no significant acquisitions in 1999 and none are budgeted for 2000. Production Corp. focuses its acquisition efforts on producing natural gas properties within strategic geographic areas with (i) relatively long-lived natural gas production, (ii) quantifiable development and exploitation potential, (iii) low risk exploration potential, (iv) historically low operating expenses or the potential to reduce operating expenses, (v) close proximity to Production Corp.'s existing production or in areas where Production Corp. has the ability to develop operating economies of scale and (vi) geological, geophysical and other technical and operating characteristics with which management of Production Corp. has expertise. Natural Gas and Oil Reserves The following table sets forth certain information on the total proved natural gas and oil reserves, and the PV-10 of estimated future net revenues of total proved natural gas and oil reserves as of December 31, 1999 for Production Corp. based on the report of Lee Keeling and Associates, Inc. The calculations which Lee Keeling and Associates, Inc. used in preparation of such report were prepared using geological and engineering methods generally accepted by the petroleum industry and in accordance with SEC guidelines.
As of December 31, 1999 ----------------------------------------------------------------------------------- Natural Gas PV-10% Natural Gas Oil Equivalent (in thousands) ------------- ---------------- ------------- ---------------- (MMcf) (MBbls) (Mmcfe) Proved developed reserves 251,631 1,683 261,726 $193,292 Proved undeveloped reserves 37,560 239 38,996 20,040 ------------- ---------------- ------------- ---------------- Total proved reserved 289,191 1,922 300,722 $213,332 ============= ================ ============= ================
Prices used in calculating future net revenue of proved reserves as of December 31, 1999 and related PV-10 were $1.89 per Mcf of natural gas and $24.33 per barrel of oil based on average prices received by Production Corp. during December 1999. Production Corp. has not filed any estimates of proved natural gas and oil reserves with any federal authority or agency other than the Securities and Exchange Commission. 4 Principal Areas of Operations The following table sets forth the principal areas of operation and estimated proved natural gas and oil reserves, PV-10 of the estimated future net revenues and percent of total PV-10 of Production Corp. at December 31, 1999.
Natural % of Oil and Natural Gas Total Field Condensate Gas Equivalent PV-10% PV-10% - --------------------------------- ------------ --------- ------------ -------------- ------------ (MBbls) (MMcf) (MMcfe) (in thousands) Anadarko Basin: Springer Field................... 47 22,818 23,100 $ 15,099 7.1% Northwest Okeene/Cedardale Field. 412 34,368 36,840 27,820 13.0% Cement Field..................... 229 64,466 65,840 40,512 19.0% Mocane Laverne & Hugoton Fields.. 52 10,990 11,302 7,449 3.5% Carter-Knox...................... 8 2,020 2,068 83 - Watonga-Chickasha................ 508 79,598 82,645 63,505 29.8% Arkoma Basin: Arkoma Field..................... - 27,541 27,541 19,701 9.2% Potato Hills..................... - 13,082 13,082 15,388 7.2% Permian/Delaware Basin: Johnson Ranch/Brushy Draw........ 666 10,455 14,451 12,534 5.9% Pecos Slope...................... - 23,853 23,853 8,950 4.2% Hedging Effects................... - - - 2,291 1.1% ----- ------- ------- -------- ----- Totals............................ 1,922 289,191 300,722 $213,332 100.0% ===== ======= ======= ======== =====
Drilling Activity The following table sets forth development drilling results for the years ended December 31, 1997, 1998 and 1999. There were no exploratory wells drilled during those years.
1997 1998 1999 ----------------------- ------------------- --------------------- Gross Net Gross Net Gross Net --------- ------------ --------- -------- ----------- -------- Productive 17.0 9.9 44.0 20.4 41.0 14.5 Drilling and completing --- --- --- --- 15.0 5.6 Non-Productive --- --- 2.0 1.8 5.0 2.9 ---- --- ---- ---- ---- ---- Total 17.0 9.9 46.0 22.2 61.0 23.0 ==== === ==== ==== ==== ====
In the third quarter of 1997, the Company initiated a comprehensive development program and, as of March 1, 2000, had successfully drilled 118 wells, of which 111 have been completed and are producing and, at March 1, 2000, 14 additional wells were at various stages of completion. In 2000, Production Corp., based on currently projected revenues and financing, intends to spend approximately $23.0 million to drill 70 to 80 gross wells, most of which are on proved undeveloped locations. Production Corp. also continually evaluates and pursues exploitation opportunities, including workover and recompletion projects. Production Corp. expects it will spend approximately $2.0 million in 2000 on these projects. Additionally, Production Corp. expects it will spend approximately $3.0 million in 2000 on seismic controlled exploration projects. Production Corp. believes geological and geophysical data, including 3D and 2D seismic surveys acquired in the Amoco Acquisition, will enable it to reduce costs and risks associated with drilling activities throughout its Anadarko basin properties. 5 The final determination with respect to any potential drilling locations and the expected time frame for the drilling of any well will depend on a number of factors, including (i) the results of exploration efforts and the review and analysis of the seismic or other data, (ii) the availability of sufficient capital resources by Production Corp. for drilling prospects, and (iii) economic and industry conditions at the time of drilling, including prevailing and anticipated prices for natural gas and oil and the availability of drilling rigs and crews. There can be no assurance that any wells will, if drilled, encounter reservoirs of commercial quantities of natural gas or oil. Operating Control Over Production Activities Production Corp. operates 578 of the 1,005 wells in which it owns an interest, representing approximately 63% of its PV-10 as of December 31, 1999. The non-operated properties are being operated by unrelated third parties pursuant to operating agreements which are, for the most part, standard to the industry. Decisions about operations regarding non-operated properties may be determined by the outside operator rather than Production Corp. If Production Corp. declines to participate in additional activities proposed by the outside operator, under certain operating agreements, Production Corp. will not receive revenues from, and/or will lose its interest in, the activity in which it declines to participate. Pursuant to the Amoco Acquisition, the Company received a license to use advanced well automation technology developed by Amoco. This technology is a wireless application that allows Production Corp. to remotely monitor production, well pressure and temperature along with other well control factors on a real-time basis. Further, the technology helps to regulate the well's productivity and makes periodic adjustments to allow the well to flow more efficiently. Production Corp. believes that the application of this wireless technology has allowed Production Corp. to employ fewer personnel to monitor well activity and operate wells more economically. This technology is currently being utilized on almost all operated properties in the Anadarko and Arkoma basins as well as on a few significant non-operated properties Production Corp. owns an interest in. Title to Natural Gas and Oil Properties Production Corp. has acquired interests in producing and non-producing acreage in the form of working interests, royalty interests and overriding royalty interests. Substantially all of Production Corp.'s property interests are held pursuant to leases from third parties. The leases grant the lessee the right to explore for and extract natural gas and oil from specified areas. Consideration for a lease usually consists of a lump sum payment (i.e., bonus) and a fixed annual charge (i.e., delay rental) prior to production (unless the lease is paid up) and, once production has been established, a royalty based generally upon the proceeds from the sale of natural gas and oil. Once wells are drilled, a lease generally continues so long as production of natural gas and oil continues. In some cases, leases may be acquired in exchange for a commitment to drill or finance the drilling of a specified number of wells to predetermined depths. Some of Production Corp.'s non-producing acreage is held under leases from mineral owners or a government entity which expire at varying dates. Production Corp. is obligated to pay annual delay rentals to the lessors of certain properties in order to prevent the leases from terminating. Because substantially all of Production Corp's undeveloped acreage is held by production, annual delay rentals are generally nominal. Title to leasehold properties is subject to royalty, overriding royalty, carried, net profits and other similar interests and contractual arrangements customary in the natural gas and oil industry, and to liens incident to operating agreements, liens relating to amounts owed to the operator, liens for current taxes not yet due and other encumbrances. In addition, in certain areas Production Corp's interests in producing properties are subject to certain agreements and other instruments that have not been recorded in real property records. The effect of these unrecorded instruments has been confirmed based upon a review of historical cost and revenue information, including joint interest billings, division orders, check stubs and other production accounting information reflecting such unrecorded interests. Production Corp. believes that such burdens and unrecorded instruments neither materially detract from the value of its interest in the properties, nor materially interfere with the use of such properties in the operation of its business. While updated title opinions may not always be received prior to the acquisition of a producing natural gas and oil property, title opinions on significant producing properties have historically been obtained in connection with pledging Production Corp's producing properties under bank loan agreements. On undeveloped leases, title opinions are usually not obtained until immediately prior to the drilling of a well on a property. Accordingly, 6 Production Corp's proved undeveloped reserves may be the subject of significantly less title investigation. It is contemplated, however, that investigations will be made in accordance with standard practices in the industry before the acquisition of producing properties and before exploratory drilling. Production and Sales Prices Production Corp's production of natural gas and oil is derived solely from within the United States. Production Corp. is not obligated to provide a fixed and determinable quantity of oil and/or natural gas in the future under existing contracts or agreements with customers. However, from time to time, Production Corp. does enter into hedging agreements with respect to its natural gas and oil production. In April 1999, Production Corp. entered into a hedge agreement in the form of a costless collar with respect to the production of 50,000 MMBTU of natural gas per day during the period of May through October 1999. The costless collar placed a floor of $1.80 per MMBTU and a ceiling of $2.26 per MMBTU for the effective price of natural gas received by Production Corp. Additionally, in July 1999 Production Corp. entered into a similar costless collar agreement with respect to the production of 50,000 MMBTU per day during the period of November 1999 through March 2000 which places a floor of $2.30 per MMBTU and a ceiling of $3.03 per MMBTU. In January 2000, Production Corp. entered into a hedge agreement covering 50,000 MMBTU of natural gas per day at a fixed price of $2.435 per MMBTU. This hedge is in effect from April 2000 through October 2000. In February 2000, Production Corp. entered into a hedge agreement covering 20,000 MMBTU of natural gas per day at a fixed price of $2.535 per MMBTU for April 2000 and $2.555 per MMBTU for May 2000. This hedge is in effect for the months of April and May 2000 and the commodity reference price for both contracts is the Panhandle Eastern Pipeline Company, Texas, Oklahoma Mainline Index, ("Panhandle Eastern"). The collars represent approximately 70% of Production Corp's current daily natural gas production. Collar arrangements limit the benefits Production Corp. will realize if actual prices rise above the ceiling price. These arrangements provide for Production Corp. to exchange a floating market price for a fixed range contract price. Payments are made by Production Corp. when the floating price exceeds the fixed range for a contract month and payments are received when the fixed range price exceeds the floating price. The commodity reference price for both contracts is Panhandle Eastern. In August 1999, Production Corp. entered into a hedge agreement covering 10,000 barrels of oil per month at a fixed price of $20.10 per barrel. This hedge is in effect from September 1999 through August 2000. Production Corp. does not refine or process the natural gas and oil it produces, but sells the production to unaffiliated natural gas and oil purchasing companies in the area in which it is produced. Production Corp. sells crude oil on a market price basis and sells natural gas under contracts to both interstate and intrastate natural gas pipeline companies. Marketing of Production Production Corp's production of natural gas and oil is marketed to third parties consistent with industry practices. Typically, oil is sold at the wellhead at field posted prices, and gas is sold under contract at negotiated prices based upon factors normally considered in the industry, such as distance from the well to the pipeline, well pressure, estimated reserves, quality of gas and prevailing supply/demand conditions. Typically, gas production is sold to various pipeline companies. The basic terms of all the contracts are essentially the same in that Production Corp. makes gas production available to the pipeline companies at certain given points of delivery on their pipelines and the pipeline company accepts such gas and delivers it to the end user. The pipeline company then has the obligation to pay Production Corp. a price for the gas which is based on published indices of average pipeline prices or upon a percentage of the pipeline resale value. In January 1998 the Company entered into a ten-year marketing agreement with Continental Natural Gas Company ("Continental"), now CMS Continental Natural Gas, whereby the majority of the natural gas associated 7 with the Amoco Acquisition will be sold to Continental at current market prices adjusted for marketing and transportation fees. The Company's revenues, earnings and cash flows are highly dependent upon current prices for natural gas and oil received by Production Corp. In December 1999, natural gas and oil prices received by Production Corp. for its production were $1.89 per Mcf and $24.33 per Bbl, respectively. In general, prices of natural gas and oil are dependent upon numerous factors beyond the control of Production Corp. including supply and demand, competition, imports and various economic, political, environmental and regulatory developments, and accordingly, future prices of natural gas and oil may be different from prices in effect at December 31, 1999. As of March 1, 2000, the price received by Production Corp. for natural gas had risen to $2.31 per Mcf. In view of the many uncertainties affecting the supply and demand for crude oil, natural gas and refined petroleum products, the Company is unable to accurately predict future natural gas and oil prices and demand or the overall effect they will have on the Company. During the year ended December 31, 1999, Production Corp. sold approximately 56% of its gas production to Continental and 47% of its oil production to Duke Energy, Inc. Competition The natural gas and oil industry is highly competitive in all of its phases. Production Corp. encounters competition from other natural gas and oil companies in all areas of its operations, including the acquisition of producing properties and the marketing of natural gas and oil. Many of these companies possess greater financial and other resources than Production Corp. Competition for acquisition of producing properties is affected by the amount of funds available to Production Corp., information about producing properties available to Production Corp. and any standards established from time to time by Production Corp. for the minimum projected return on investment. Because gathering systems are the only practical method for the intermediate transportation of natural gas, competition is presented by other pipelines and gas gathering systems. Competition may also be presented by alternative fuel sources, including heating oil and other fossil fuels. Because the primary markets for natural gas liquids are refineries, petrochemical plants and fuel distributors, prices are generally set by or in competition with the prices for refined products in the petrochemical, fuel and motor gasoline markets. Regulation The natural gas and oil business is regulated extensively by federal, state and local authorities. Various governmental agencies, both federal and state, have promulgated rules and regulations binding on the natural gas and oil industry and its individual members, some of which carry substantial penalties for the failure to comply. The regulatory burdens on the natural gas and oil industry increase its cost of doing business and, consequently, affect its profitability. Because such laws and regulations are frequently amended or reinterpreted, Production Corp. is unable to predict the future cost of complying with such regulations. Production Corp. believes that it is in material compliance with its regulatory obligations. The States of Oklahoma and Texas and many other states require permits for drilling operations, drilling bonds and reports concerning operations and impose other requirements relating to the exploration and production of natural gas and oil. These states also have statutes or regulations addressing conservation matters, including provisions for the unitization or pooling of natural gas and oil properties, the establishment of maximum rates of production from wells and the regulation of spacing, plugging and abandonment of such wells. Environmental Matters. Production Corp's operations and properties are subject to extensive and changing federal, state and local laws and regulations relating to environmental protection, including the generation, storage, handling, emission, transportation and discharge of materials into the environment, and relating to safety and health. The recent trend in environmental legislation and regulation generally is toward stricter standards, and this trend will likely continue. These laws and regulations may require the acquisition of a permit or other authorization before construction or drilling commences and for certain other activities; limit or prohibit construction, drilling and other activities on certain lands lying within wilderness and other protected areas; and impose substantial liabilities for pollution resulting from Production Corp's operations. The permits required for various areas of Production Corp's operations are subject to revocation, modification and renewal by issuing authorities. Governmental authorities 8 have the power to enforce compliance with their regulations, and violators are subject to fines or injunction, or both. In the opinion of management, Production Corp. is in substantial compliance with current applicable environmental laws and regulations, and Production Corp. has no material commitments for capital expenditures to comply with existing environmental requirements. Nevertheless, changes in existing environmental laws and regulations or in interpretations thereof could have a significant impact on Production Corp., as well as the natural gas and oil industry in general. The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") and comparable state statutes impose strict, joint and several liabilities on owners and operators of sites and on persons who dispose of or arrange for the disposal of "hazardous substances" found at such sites. Although CERCLA currently excludes petroleum from its definition of "hazardous substance," state laws affecting Production Corp.'s operations impose clean-up liability relating to petroleum and petroleum related products. It is not uncommon for the neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. The Resource Conservation and Recovery Act ("RCRA") and comparable state statutes govern the disposal of "solid waste" and "hazardous waste" and authorize imposition of substantial fines and penalties for noncompliance. Although RCRA classifies certain oil field wastes as "non- hazardous," such exploration and production wastes could be reclassified as hazardous wastes, thereby making such wastes subject to more stringent handling and disposal requirements. Federal regulations require certain owners or operators of facilities that store or otherwise handle oil, such as Production Corp., to prepare and implement spill prevention, control countermeasure and response plans relating to the possible discharge of oil into surface waters. The Oil Pollution Act of 1990 contains numerous requirements relating to the prevention of and response to oil spills into waters of the United States. For onshore facilities that may affect waters of the United States, the Environmental Protection Agency ("EPA") requires an operator to demonstrate $10.0 million in financial responsibility, and for offshore facilities the financial responsibility requirement is at least $35.0 million. Regulations are currently being developed under federal and state laws concerning oil pollution prevention and other matters that may impose additional regulatory burdens on Production Corp. In addition, the Clean Water Act and analogous state laws require permits to be obtained to authorize discharge into surface waters or to construct facilities in wetland areas. With respect to certain of its operations, Production Corp. is required to maintain such permits or meet general permit requirements. The EPA recently adopted regulations concerning discharges of storm water runoff. This program requires covered facilities to obtain individual permits, participate in a group or seek coverage under an EPA general permit. Production Corp. believes that it will be able to obtain, or be included under, such permits, where necessary, and to make minor modifications to existing facilities and operations that would not have a material effect on Production Corp. Production Corp. has acquired leasehold interests in numerous properties that for many years have produced natural gas and oil. Although the previous owners of these interests may have used operating and disposal practices that were standard in the industry at the time, hydrocarbons or other wastes may have been disposed of or released on or under the properties. In addition, some of Production Corp's properties are or have been operated by third parties over whom Production Corp. has or had no control. Notwithstanding Production Corp's lack of control over properties operated by others, the failure of the operator to comply with applicable environmental regulations may, in certain circumstances, adversely impact Production Corp. Marketing and Transportation. In the past, the transportation and sale for resale of natural gas in interstate commerce has been regulated pursuant to the Natural Gas Act of 1938, the Natural Gas Policy Act of 1978 (the "NGPA"), and the regulations promulgated thereunder by the Federal Energy Regulatory Commission (the "FERC"). Since 1978, maximum selling prices of certain categories of natural gas sold in the "first sales," whether sold in interstate or intrastate commerce, has been regulated pursuant to the NGPA. The term "first sales" means the first time gas is sold as a severed hydrocarbon after it is produced from the ground. The NGPA established various categories of natural gas and provided for graduated deregulation of price controls of several categories of natural gas. There is currently no price regulation for "first sales" of gas. On July 26, 1989, the Natural Gas Wellhead Decontrol Act was enacted. This act amended the NGPA to remove both price and non-price controls from natural gas sold in "first sales" as of January 1, 1993. Under current market conditions, deregulated gas prices under new contracts tend to be substantially lower than most regulated price ceilings prescribed by the NGPA. The effect of termination of these price controls cannot be determined The FERC regulates interstate natural gas transportation rates and service conditions, which affect the marketing of gas produced by Production Corp., as well as the revenues received by Production Corp. for sales of 9 such production. Since the mid-1980s, FERC has issued a series of orders, culminating in Order Nos. 636, 636-A and 636-B ("Order 636"), that have significantly altered the marketing and transportation of natural gas. Order 636 mandates a fundamental restructuring of interstate pipeline sales and transportation service, including the unbundling by interstate pipelines of the sale, transportation, storage and other components of the city-gate sales services such pipelines previously performed. One of FERC's purposes in issuing the order was to increase competition within all phases of the natural gas industry. Numerous parties have filed petitions for review of Order 636, as well as orders in individual pipeline restructuring proceedings. In July 1996, Order 636 was generally upheld on appeal, and the portions remanded for further action do not appear to materially affect Production Corp. Because Order 636 may be modified as a result of the appeals, it is difficult to predict the ultimate impact of the orders on Production Corp. and its gas marketing efforts. Generally, Order 636 has eliminated or substantially reduced the interstate pipelines' traditional role as wholesalers of natural gas and has substantially increased competition and volatility in natural gas markets. The price Production Corp. receives from the sale of natural gas liquids and oil is affected by the cost of transporting products to markets. Effective January 1, 1995, FERC implemented regulations establishing an indexing system for transportation rates for oil pipelines, which, generally, would index such rates to inflation, subject to certain conditions and limitations. Production Corp. is not able to predict with certainty the effect, if any, of these regulations on its operations. However, the regulations may increase transportation costs or reduce wellhead prices for natural gas liquids and oil. Operational Hazards and Insurance The Company maintains various types of insurance to cover its operations, including $2.0 million of general liability insurance and an additional $5.0 million of excess liability insurance. The Company's insurance does not cover every potential risk associated with the drilling and production of natural gas and oil. Coverage is not obtainable for certain types of environmental hazards. The occurrence of a significant adverse event, the risks of which are not fully covered by the Company's insurance, could have a material adverse effect on the Company's financial condition and results of operations. Moreover, no assurance can be given that the Company will be able to maintain adequate insurance in the future at reasonable rates. Employees As of March 1, 2000 the Company, through Production Corp., had a total of 33 employees consisting of 19 production and land personnel, and 14 financial, accounting and administrative personnel, two of whom are executive officers. Executive Office The Company leases approximately 13,600 square feet of space in Tulsa, Oklahoma for its corporate and administrative offices. The annual rental is approximately $225,000 and the lease expires December 31, 2004. The Company believes this facility is adequate for its present requirements. Incorporation Both Gothic Energy and Production Corp. are Oklahoma corporations. Gothic Energy was originally incorporated on November 19, 1985 under the laws of the State of New Jersey and was reincorporated as a Delaware corporation on June 23, 1994. On December 4, 1996, Gothic Energy was reincorporated as an Oklahoma corporation by merging the Delaware Corporation with and into a wholly owned subsidiary incorporated for that purpose under the laws of the State of Oklahoma. Production Corp. was incorporated on March 26, 1998 and acquired substantially all the assets of Gothic Energy on April 27, 1998. The Company's principal office is at 6120 South Yale Avenue, Suite 1200, Tulsa, Oklahoma 74136, and its telephone number is (918) 749-5666. 10 Item 2 - Description of Property: - -------------------------------- Acreage The following table shows the approximate gross and net acres of leasehold interests of Production Corp. on December 31, 1999.
Developed Undeveloped Acreage Acreage -------------------- --------------------- Field Gross Net Gross Net - --------------------------------------------------- ------- ------- ------- ------- Anadarko Basin Springer Field................................... 7,200 4,680 150 75 Northwest Okeene/Cedardale Field................. 66,560 51,906 1,920 274 Cement Field..................................... 48,640 29,184 3,385 980 Mocane Laverne & Hugoton Fields.................. 93,518 49,485 420 420 Watonga-Chickasha................................ 135,680 69,196 8,157 4,127 Arkoma Basin Arkoma Field..................................... 74,240 18,560 - - Potato Hills..................................... 5,754 795 6,980 2,523 Permian/Delaware Basin Johnson Ranch/Brushy Draw........................ 160 120 - - Pecos Slope...................................... 12,000 9,000 - - ------- ------- ------ ----- Totals......................................... 443,752 232,926 21,012 8,399 ======= ======= ====== =====
Productive Well Summary The following table sets forth by field the respective interests in productive wells owned by Production Corp. as of December 31,1999.
Gross Net Field Well Count Well Count - ---------------------------------------------------- ------------- -------------- Anadarko Basin: Springer Field................................. 35 14 Northwest Okeene/Cedardale Field............... 189 92 Cement Field................................... 72 18 Mocane Laverne & Hugoton Fields................ 100 56 Watonga-Chickasha.............................. 355 179 Arkoma Basin: Arkoma Field................................... 139 35 Potato Hills................................... 3 1 Permian/Delaware Basin: Johnson Ranch/Brushy Draw...................... 7 3 Pecos Slope.................................... 105 105 ----- --- Totals.......................................... 1,005 503 ===== ===
11 Natural Gas and Oil Production The following table shows the approximate net natural gas and oil production attributable to the Company for the years ended December 31, 1997, 1998 and 1999.
YEAR ENDED DECEMBER 31, 1997 1998 1999 ---------- ---------- ---------- Natural gas (MMcf)............................. 6,583 24,455 25,477 Oil (MBbls).................................... 176 257 158 Natural gas equivalent (MMcfe)................. 7,639 25,997 26,425
Item 3 - Legal Proceedings: - -------------------------- Gothic Energy is a plaintiff in an action instituted on December 22, 1999 in the United States District Court for the Northern District of Oklahoma against Jefferies & Company, Inc. ("Jefferies") seeking actual and punitive damages against Jefferies for intentional interference with contractual relations and business opportunity wherein Gothic Energy claims Jefferies improperly and wrongfully interfered in the closing of the acquisition of the Amoco assets in January 1998. Jefferies has filed a counterclaim against Gothic Energy seeking indemnification under an alleged letter agreement between Gothic Energy and Jefferies for attorney's fees and expenses of litigation, among other things. The litigation is presently in the discovery stage, and management is unable to predict its ultimate outcome. Neither Gothic Energy nor Production Corp. are parties to any other proceedings other than ordinary litigation incidental to their business, the outcome of which management believes will not have a material adverse effect on their financial position or results of operations. Item 4 - Submission of Matters to a Vote of Security Holders: - ------------------------------------------------------------ On October 5, 1999 Gothic Energy held its Annual Meeting of Shareholders to elect three directors of Gothic Energy to hold office until the next Annual Meeting of Shareholders in 2000 and the election and qualification of their successors and to consider and vote on a proposal to approve the adoption of a 1999 Stock Incentive Plan. John Fleming, Brian Bayley and Michael Paulk were elected to serve as directors until the 2000 Annual Meeting of Shareholders and until their successors are elected and qualified. The proposal to approve the adoption of the 1999 Stock Incentive Plan was not passed by the requisite shareholder vote. 12 PART II ------- Item 5 - Market for Common Equity and Related Security Holder Matters: - --------------------------------------------------------------------- Gothic Energy's Common Stock is quoted on the OTC Bulletin Board under the symbol GOTH. The following table sets forth the high and low bid quotations on the OTC Bulletin Board for Gothic Energy's Common Stock by calendar quarter for the period January 1,1996 through March 1, 2000. Bid -------------------------- Calendar Quarter High Low -------------------------------- ----------- ----------- 1998: First Quarter $3.063 $1.813 Second Quarter 2.375 1.188 Third Quarter 1.594 0.563 Fourth Quarter 0.719 0.219 1999: First Quarter 0.719 0.375 Second Quarter 0.813 0.422 Third Quarter 0.531 0.406 Fourth Quarter 0.438 0.156 2000: First Quarter $0.453 $0.141 (through March 1) The foregoing amounts, represent inter-dealer quotations without adjustment for retail markups, markdowns or commissions and do not represent the prices of actual transactions. On March 1, 2000, the closing bid quotations for the Common Stock, as reported on the OTC Bulletin Board, was $0.344. As of March 1, 2000, Gothic Energy had 153 shareholders of record and believes that it has in excess of 500 beneficial holders. Gothic Energy has never paid a cash dividend on its Common Stock and management has no present intention of commencing to pay dividends on its Common Stock. Under the terms of various loan documents, Gothic Energy is prohibited from paying cash dividends on its Common Stock. Item 6 - Management's Discussion and Analysis or Plan of Operation: - ------------------------------------------------------------------ The discussion in this section of this Annual Report is intended to comply with the so called "plain-English" rule adopted by the Commission relating to the language used. A Discussion of Our Results of Operations General As a consequence of our holding company structure, all of our natural gas and oil acquisition, development, exploitation, exploration and production activities are conducted through Production Corp., the wholly-owned operating subsidiary of Gothic Energy. The sole material asset of Gothic Energy, our parent corporation, is the outstanding capital stock of Production Corp. During 1999, our parent corporation incurred $179,000 of general and administrative costs and had approximately $10.0 million of interest expense and related note amortization costs on its outstanding 14-1/8% Senior Secured Discount Notes due 2006. Additionally, Gothic Energy recognized $8.7 -13- million in preferred dividends and amortization of preferred discount on its Series B Convertible Preferred Stock during 1999. The following discussion of our operating results describes the operations of our operating subsidiary, Production Corp., unless we state otherwise. Our results of operations have been significantly affected by the acquisition of producing natural gas and oil properties over the last three years as well as a re-capitalization we completed in April 1998. During 1998, we completed the acquisition of a major amount of natural gas and oil assets from Amoco Corporation for a purchase price of $242.0 million. The Amoco acquisition added approximately 240.0 Bcfe of proved reserves with a PV-10 of approximately $230.1 million to our reserves as of December 31,1997. Our profitability and revenues are dependent, to a significant extent, upon prevailing spot market prices for natural gas and oil. Prices are subject to wide fluctuations in response to changes in supply of and demand for natural gas and oil, market uncertainty and a variety of additional factors that are beyond our control. Such factors include political conditions, weather conditions, government regulations, the price and availability of alternative fuels and overall economic conditions. We incurred a net loss of $129.7 million in 1998, due principally to a decline in natural gas and oil prices during that year. This commodity price decline required that we write down the carrying value of our natural gas and oil properties by $76.0 million. More significantly, the commodity price decline continued to affect our ongoing revenues and cash flows during early 1999, contributing to a net loss of $17.3 million for the year ended December 31, 1999. It is our intention to continue to spend available cash flow (EBITDA less cash interest payable on bank debt and on Senior Secured Notes) on the development of our natural gas and oil properties. With the continued volatility of commodity prices, we will continue to utilize hedging programs. We believe this should help to stabilize cash flow, which is necessary to ensure our ability to generate sufficient reserves to replace current production, but limits the benefit of increases in commodity prices above the hedge price. Should commodity prices fall below current levels, we would be limited in our ability to increase production and maintain cash flow at a level sufficient to meet our ongoing financial covenants under our Credit Facility. Recently, the price of natural gas and oil has increased, but there is no assurance that prices will continue to increase or remain at the current level. Further, the borrowing base amount available under our Credit Facility was redetermined in October 1999 and was reduced from $25.0 million to $20.0 million. On March 27, 2000, the borrowing base amount was further reduced to $15.0 million. There is no assurance that our lender will maintain the available amount at this current level. Gothic Energy is currently engaged in efforts to restructure its balance sheet. It has been engaged in negotiations with both Chesapeake Energy Corporation ("Chesapeake") with respect to Gothic Energy's Senior Redeemable Preferred Stock, Series B ("Preferred Stock") held by Chesapeake and the holders of its 14-1/8% Senior Secured Discount Notes due 2006 (the "Discount Notes") in that regard. The terms of the Preferred Stock held by Chesapeake provide for the payment of dividends at a rate per annum of 12% of the aggregate liquidation preference payable in additional shares of Preferred Stock, provided that after April 1, 2000, at Gothic Energy's option, the dividends payable may be paid in cash. In lieu of cash interest payments, the principal amount of Discount Notes accrete at a rate per annum of 14-1/8% compounded semi-annually to an aggregate principal amount of $104.0 million at May 1, 2002. Thereafter, the Discount Notes accrue interest at the rate of 14-1/8% per annum, payable in cash semi- annually in arrears on May 1 and November 1 of each year. In an effort to eliminate this continuing erosion of the interests of Gothic Energy's common equity by the payment of dividends in kind on the shares of Preferred Stock and enlargement of the outstanding principal of its Discount Note indebtedness, Gothic Energy had, in the latter half of 1999, been seeking to refinance these securities. As a consequence of the reduced levels of market prices for natural gas and oil throughout the latter half of 1998 and into 1999 and the resulting impact on the Company's revenues and financial condition, Gothic Energy was unsuccessful in pursuing its efforts to refinance these securities. On February 29, 2000, Gothic Energy and Production Corp. entered into an agreement with Chesapeake to purchase an option to redeem the 61,007 shares of outstanding Preferred Stock, plus accrued dividends, and 2,439,246 shares of Common Stock held by Chesapeake. The consideration for the purchase of the option is the -14- turn-over to Chesapeake of the operations of certain wells and Production Corp. resigning as operator of those wells and the extension of a right of first refusal under a Participation Agreement with Chesapeake until April 30,2006. A closing under the option and the redemption of the shares will be held upon the fulfillment of various closing conditions including, among others approval by certain lenders of the Company. Gothic Energy is currently in negotiations with the holders of the Discount Notes intended to result in the conversion of that indebtedness into equity securities of Gothic Energy. Inasmuch as those negotiations are ongoing, there can be no assurance as to the success of those efforts or the terms on which the indebtedness of Gothic Energy may be exchanged. It is expected, however, that the exchange of that indebtedness will result in material dilution to the holders of Gothic Energy's Common Stock. Gothic Energy is seeking to enter into agreements with the holders of the Discount Notes to exchange their Discount Notes for shares of Common Stock which agreements are expected to be subject to the fulfillment of various closing conditions. Implementation of the closing by Gothic Energy under the option with Chesapeake and the exchange of the Discount Notes is also expected to be accompanied by efforts to raise additional equity capital through a rights offering or by other means. Gothic Energy is currently engaged in a review of the various means by which the implementation of a restructuring can be accomplished. Gothic Energy is unable to predict the success of these restructuring efforts, the terms on which or means by which its balance sheet may be improved, and the extent of any dilution to be sustained by the holders of its outstanding Common Stock. Natural Gas and Oil Production, Revenue and Price History The table below reflects certain of our summary operating data for the periods presented: 1997 1998 1999 ------- ------- ------- Net Production: Oil (Mbls) 176 257 158 Natural Gas (Mmcf) 6,583 24,455 25,477 Natural Gas Equivalent (Mmcfe) 7,639 25,997 26,425 Oil and Natural Gas Sales: Oil $ 3,551 $ 3,469 $ 2,671 Natural Gas 13,867 47,245 50,296 ------- ------- ------- Total $17,418 $50,714 $52,967 ======= ======= ======= Average Sales Price: Oil (Bbl) $ 20.18 $ 13.50 $ 16.91 Natural gas (Mcf) 2.11 1.93 1.97 Natural gas equivalent (Mcfe) 2.28 1.95 2.00 Expenses ($ per Mcfe): Lease Operating (1) $ 0.74 $ 0.33 $ 0.22 General and Administrative 0.30 0.14 0.18 Depreciation, Depletion and Amortization (2) 0.72 0.91 0.77 - -------------------- (1) These amounts are net of production taxes. (2) These amounts represent depreciation, depletion and amortization of oil and natural gas properties only. A Comparison of Operating Results For The Years Ended December 31, 1999 and December 31, 1998 Our revenues were $55.6 million for the year 1999 as compared to $53.0 million for the year 1998. This represents a 5% increase in total revenue for 1999. Natural gas and oil sales for the year ended 1999 increased $2.3 million to $53.0 million compared to $50.7 million in 1998, or an increase of 5%. Of the 1999 revenues, $2.7 million was from oil sales and $50.3 million was from natural gas sales. In 1998, we had $3.5 million from oil sales and $47.2 million from natural gas sales. The increase in our natural gas and oil sales was primarily the result of higher commodity prices for both natural gas and oil in 1999 compared to 1998. Our oil sales in 1999 were based -15- on the sale of 158,000 barrels at an average price of $16.91 per barrel as compared to 257,000 barrels at an average price of $13.50 per barrel in 1998. Natural gas sales in 1999 were based on the sale of 25.5 Bcf at an average price of $1.97 per mcf compared to 24.5 Bcf at an average price of $1.93 per mcf in 1998. We incurred lease operating expenses during 1999 of $9.6 million compared with lease operating expenses of $12.1 million for 1998. Our lease operating expenses include approximately $3.9 million and $3.5 million in production taxes which we incurred from our share of production in 1999 and 1998, respectively. The decrease in lease operating expenses is primarily due to certain non- recurring costs associated with the Amoco Acquisition transition which were incurred during the first quarter of 1998 and the sale of oil properties in the Johnson Ranch and Brushy Draw areas in early 1999 which had high operating costs. Our lease operating expenses and production taxes as a percentage of natural gas and oil sales decreased to 18% in 1999 as compared to 24% in 1998. Lease operating expenses per Mcfe decreased to $0.22 for 1999 compared to $0.33 in 1998. Both of these decreases we believe are due to our more wide spread use of telemetry and other more efficient means of operating our properties that we acquired as part of our transaction with Amoco in early 1998. Our depreciation, depletion and amortization expense was $21.0 million for 1999 as compared to $24.0 million for 1998. The decrease resulted primarily from the write-down of natural gas and oil properties in the latter half of 1998, which created a smaller depletable base. Our general and administrative costs were $4.7 million for 1999 as compared to $3.8 million for 1998. This increase was primarily the result of personnel we added and other costs we incurred related to the Amoco acquisition and the administrative costs incurred in operating and developing the wells acquired. The costs per Mcfe increased from $0.14 in 1998 to $0.18 in 1999. We also incurred investment banking and related fees in 1999 of $638,000 in connection with our efforts to restructure our balance sheet We account for our oil and gas exploration and development activities using the full cost method of accounting prescribed by the Securities and Exchange Commission ("Commission"). Accordingly, all our productive and non-productive costs incurred in connection with the acquisition, exploration and development of natural gas and oil reserves are capitalized and depleted using the units-of- production method based on proved oil and gas reserves. We capitalize our costs including salaries and related fringe benefits of employees directly engaged in the acquisition, exploration and development of natural gas and oil properties, as well as other directly identifiable general and administrative costs associated with these activities. These costs do not include any costs related to production, general corporate overhead, or similar activities. Our natural gas and oil reserves are estimated annually by independent petroleum engineers. Our calculation of depreciation, depletion and amortization ("DD&A") includes estimated future expenditures that we believe we will incur in developing our proved reserves and the estimated dismantlement and abandonment costs, net of salvage values. In the event the unamortized cost of the natural gas and oil properties we are amortizing exceeds the full cost ceiling as defined by the Commission, we charge the amount of the excess to expense in the period during which the excess occurs. The full cost ceiling is based principally on the estimated future discounted net cash flows from our natural gas and oil properties. Changes in our estimates or declines in prevailing natural gas and oil prices could cause us to reduce in the near term our carrying value of our natural gas and oil properties. A write-down arising out of these conditions is referred to throughout our industry as a full cost ceiling write-down. During the year ended December 31, 1998, we made a $76.0 million pre-tax provision for impairment of our natural gas and oil properties because of the drop in natural gas and oil prices during the last half of 1998. Our full cost ceiling at December 31, 1998 was based on natural gas prices received at the time of $1.81 per Mcf and oil prices received of $10.50 per Bbl. This provision resulted from a full cost ceiling write-down. The write-down is shown in our balance sheet as a reduction of the cost of natural gas and oil properties. We had no full cost ceiling write-down during 1999. We evaluate natural gas and oil reserve acquisition opportunities in light of many factors only a portion of which may be reflected in the amount of proved natural gas and oil reserves that we propose to acquire. In determining the purchase price to be offered, we do not solely rely on proved oil and gas reserves or the value of such reserves determined in accordance with Rule 4-10 of Regulation S-X adopted by the Commission. Factors we consider include the probable reserves of the interests intended to be acquired, anticipated efficiencies and cost reductions that we believe can be made in us operating the producing properties, the additional reserves that we -16- believe can be proven relatively inexpensively based on our knowledge of the area where the interests are located and existing producing properties we own. We may also consider other factors if appropriate. We may conclude that an acquisition is favorable even if there may be a full cost ceiling write-down associated with it based on other factors we believe are important. We do not perform a ceiling test for specific properties acquired because the ceiling test is performed at each quarter and at year end for all of our properties included in our cost center and is based on prices for natural gas and oil as of that date which may be higher or lower than the prices used when evaluating potential acquisitions. We review the transaction in the light of proved and probable reserves, historic and seasonal fluctuations in the prices of natural gas and oil, anticipated future prices for natural gas and oil, the factors described above as well as other factors that may relate to the specific properties under review. Our interest and debt issuance costs were $38.0 million for 1999 as compared to $35.4 million for 1998. This increase was primarily because of higher debt levels associated with our 11 1/8% Senior Secured Notes which were issued in April 1998 by Production Corp., interest on our 14-1/8% Senior Secured Discount Notes which Gothic Energy issued in April 1998, and amortization of the costs incurred to complete the sale of these notes and amendments to our bank credit facility. We incurred interest costs of $26.1 million related to our 11 1/8% Senior Secured Notes, $9.7 million related to our 14 1/8% Senior Secured Discount Notes, $397,000 with our bank, and $1.8 million as amortization of loan costs. We recorded an extraordinary loss on the early extinguishment of debt in the amount of $31.5 million during 1998. The 1998 amount reflects the payment of $20.8 million in consent fees, $6.3 million in the write-off of unamortized discount and debt issuance costs and $4.4 million in unamortized bank loan costs. We obtained consents to the amendment of the terms of our 12 1/4% Senior Notes in early 1998 prior to repaying the notes and also prepaid our bank credit facility in April 1998. Our profitability and revenues are dependent, to a significant extent, upon prevailing spot market prices for natural gas and oil. Natural gas and oil prices and markets have been volatile. Prices are subject to wide fluctuations in response to changes in supply of and demand for natural gas and oil, market uncertainty and a variety of additional factors that are beyond our control. Such factors include political conditions, weather conditions, government regulations, the price and availability of alternative fuels and overall economic conditions. Natural gas prices have fluctuated significantly over the past twelve months. We use the sales method for recording natural gas sales. Our oil and condensate production is sold, title passed, and revenue recognized at or near our wells under short-term purchase contracts at prevailing prices in accordance with arrangements, which are customary in our industry. Our gas sales are recorded as revenues when the gas is metered and title transferred pursuant to the gas sales contracts. During such times as our sales of gas exceed our pro rata ownership in a well, such sales are recorded as revenues unless total sales from the well have exceeded our share of estimated total gas reserves underlying the property at which time the excess is recorded as a gas balancing liability. Such imbalances are incurred from time to time in the ordinary course of our business in the operation of our gas wells as a consequence of operational factors. Certain of such gas balancing liabilities were assumed as part of the acquisition of natural gas and oil properties. At December 31, 1999, we had deferred charges related to gas balancing of $1.5 million and a gas balancing liability of $3.6 million, including $900,000 of deferred credits. The balances that existed at December 31, 1999, except for possible immaterial amounts, were not the result of producing operations we conducted but related to the assets we acquired. It is not our policy to operate wells in such a manner that imbalances are created. We expect that the imbalances that existed at December 31, 1999 will be settled upon abandonment of the wells or will be reflected in the price if the respective well interest is sold prior to then. -17- Matters Relating to Our Liquidity and Capital Resources General Since 1994, our principal sources of cash have been bank borrowings, the sale of equity and debt securities and cash flow from operations. The following reflects our comparative cash flows for the years ended December 31, 1998 and 1999: Year Ended December 31, -------------------------------- 1998 1999 -------- -------- (in thousands) -------------------------------- Net cash provided by operating activities $ 11,567 $13,707 Net cash used in investing activities 191,375 22,241 Net cash provided by financing activities 165,375 8,828 Our net cash provided by operations increased to $13.7 million for 1999 as compared to net cash provided of $11.6 million for 1998. The improved operating cash flows for 1999 relate primarily to the increase in income from operations before non-cash charges, partially offset by increased interest costs and a reduction of other liabilities. We used $22.2 million of net cash in investing activities for 1999 compared to net cash used of $191.4 million in 1998. The 1999 cash used for investing activities includes property development costs of approximately $21.1 million and approximately $3.4 million in cash paid for property and equipment acquisitions. These uses were partially offset by proceeds of $2.2 million received from the sale of substantially all of our Johnson Ranch properties. The 1998 cash used for investing activities includes approximately $218.7 million paid for property acquisitions and $18.4 million for development costs, including the Amoco Acquisition, offset by approximately $44.7 million received from property sales. Our net cash provided by financing activities for 1999 was $8.8 million compared to $165.4 million provided in 1998. The 1999 amount includes net proceeds from our credit facility of $9.0 million, partially offset by the payment of $172,000 in bank and other loan fees. The 1998 amount includes proceeds from long-term debt, related to the Amoco acquisition and the subsequent recapitalization, of $431.3 million and proceeds from the issuance of our Series A and Series B Preferred Stock of $73.5 million, partially offset by the redemption of the Series A Preferred Stock and accrued dividends for $40.8 million, payment of $38.5 million in 12 1/4% Senior Notes consent fees and other bank and offering fees and payments of short and long-term debt of $259.9 million. How We Have Financed Our Activities We have had a series of credit facilities in existence with Bank One, Texas, N.A. commencing in January 1996. Borrowings under these credit facilities were used to finance the payment of all or a substantial portion of the purchase price for the acquisitions of natural gas and oil properties we acquired since early 1996. The proceeds from the sale of equity securities financed substantially all of the balance. At present, the credit facility, with Production Corp. as the borrower and the parent corporation as the guarantor, (the "Credit Facility"), permits borrowings from time to time in the amount of up to $15.0 million. Interest on borrowings is payable monthly at the bank's base rate, as determined from time to time. All outstanding borrowings are due on April 30, 2001, the maturity date, when the Credit Facility ends unless extended or renewed. Borrowings under the Credit Facility are secured by a senior lien on the natural gas and oil assets owned by Gothic Production. As of December 31, 1999, $9.0 million was outstanding under this Credit Facility. At March 27, 2000 $8.5 million was available for borrowing under the Credit Facility. The Credit Facility requires, among other things, semi-annual engineering reports covering oil and natural gas reserves on the basis of which semi-annual and other redeterminations of the borrowing base and monthly commitment reduction are made. The Credit Facility, as amended on May 7, 1999, also includes various affirmative -18- and negative covenants, including, among others, (i) prohibitions against additional indebtedness unless approved by the lenders, subject to certain exceptions, (ii) prohibitions against the creation of liens on the assets of Production Corp., subject to certain exceptions, (iii) prohibitions against cash dividends, (iv) prohibitions against hedging positions unless consented to by Bank One, (v) prohibitions on asset sales, subject to certain exceptions, (vi) restrictions on mergers or consolidations, (vii) a requirement to maintain a ratio of current assets to current liabilities of 1.0 to 1.0, and (viii) a minimum interest coverage ratio of not less than 1.25 to 1.0 for the quarter ended June 30, 1999, 1.50 to 1.0 for the quarter ended September 30, 1999, 1.75 to 1.0 for the quarter ended December 31, 1999 and 2.0 to 1.0 for each remaining quarter starting with the quarter ending March 31, 2000. The Credit Facility includes covenants prohibiting distributions and loans or advances to third parties, subject to certain exceptions. If Production Corp. is required to purchase or redeem any portion of the 11 1/8% Senior Secured Notes, or if any portion of the 11 1/8% Senior Secured Notes become due, the Borrowing Base is subject to reduction. Production Corp. is required to escrow interest payments due on the Senior Secured Notes at such times as its borrowings under the Credit Facility equal or exceed 75% of the Borrowing Base. Events of default include the non-payment of principal, interest or fees, a default under other outstanding indebtedness, a breach of the representations and warranties contained in the loan agreement, material judgements, bankruptcy or insolvency, a default under certain covenants not cured within a grace period, and a change in the management or control of the Company. Our bank credit facility and outstanding notes contain numerous affirmative and negative covenants. We must be in compliance with the Credit Facility in order to borrow funds. In addition, the breach of certain covenants could cause our outstanding indebtedness to the bank to become immediately due and payable. We are also required to be in compliance with the affirmative and negative covenants under our outstanding notes. If we fail to remain in compliance with these covenants under our notes the indebtedness may become immediately due and payable. If either our bank indebtedness or outstanding notes should become immediately due and payable, under the cross-default terms of these debt instruments, the other outstanding indebtedness would become immediately due and payable. This could result in an aggregate of $319.9 million of indebtedness, as of December 31, 1999 being immediately due and payable. Future Capital Requirements and Resources Our capital requirements relate to the acquisition, exploration, enhancement, development and operation of natural gas and oil properties. In general, because our natural gas and oil reserves are depleted by production over time, the success of our business strategy is dependent upon a continuous acquisition, exploitation, enhancement, and development program. In order to achieve profitability and generate cash flow, we are dependent upon acquiring or developing additional natural gas and oil properties or entering into joint natural gas and oil well development arrangements. At year-end, we had $9.0 million outstanding under our credit facility. Under our bank credit facility, we have a current borrowing base of $15.0 million with $8.5 million available for borrowing. The Effect on Us of Changes in Prices and Inflation Our revenues and the value of our natural gas and oil properties are affected by changes in the prevailing prices for natural gas and oil. Natural gas and oil prices are subject to seasonal and other fluctuations that are beyond our control and ability to predict. From time to time, we hedge the natural gas prices we receive through the use of commodity swap agreements in an effort to reduce the effects of the volatility of the price of natural gas and crude oil on our operations. These agreements involve the receipt of fixed-price amounts in exchange for variable payments based on Panhandle Eastern prices and specific volumes. Through the use of commodity price swap agreements, we can fix the price we receive for specified amounts of production to the commodity swap price. The differential to be paid or received, under the swap agreement, is accrued in the month of the related production and recognized as a component of natural gas and crude oil sales. We do not acquire, hold or issue financial instruments for trading purposes. While the use of hedging arrangements limits our downside risk on downward price movements, it may also limit our future gains from upward movements. All hedging is accomplished under agreements based upon industry standard forms. We address market risk by selecting instruments whose value fluctuations correlate -19- strongly with the underlying commodity being hedged. We have not been required to provide collateral relating to our hedging activities. Although certain of our costs and expenses are affected by the level of inflation, inflation has not had a significant effect on our results of operations during 1999. Cautionary Statement for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995 With the exception of historical matters, the matters we have discussed above and elsewhere in this Annual Report are "forward-looking statements" as defined under the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties. The forward-looking statements we discuss in this Annual Report appear in various places including under the headings: (i) "A Discussion of Our Results of Operations - General" as to our ability to borrow under our bank Credit Facility throughout 2000, our ability to obtain waivers from the bank and our ability to successfully negotiate a conversion of our Discount Notes into equity and to otherwise improve the balance sheet of Gothic Energy, (ii) "A comparison of Operating Results For The Year Ended December 31, 1999 and December 31, 1998" relating to our dependence for profits and revenues on prevailing spot market prices for oil and gas, (iii) "Changes in Prices and Inflation" as to the impact of inflation on us, and (iv) "Matters Relating to Our Liquidity and Capital Resources" as to our capital requirements, business strategy, our ability to remain in compliance with the terms of our Credit Facility, our ability to continue as a going concern, ability to attain and maintain profitability and cash flow, our ability to increase our reserves of natural gas and oil through drilling activities, our dependence upon the acquisition of and ability to acquire additional oil and gas properties or entering into joint oil and gas well development arrangements, access to debt and equity capital and availability of joint venture development arrangements, estimates as to our needs for additional capital and the times at which additional capital will be required, expectations as to our sources for this capital and funds, our ability to successfully implement our business strategy, ability to identify and integrate successfully any additional producing oil and gas properties we acquire and whether such properties can be operated profitably, ability to maintain compliance with covenants of our various loan documents and other agreements pursuant to which we have issued securities and obtain waivers when and as required, our ability to borrow funds or maintain levels of borrowing availability under our credit arrangements, statements about Proved Reserves or borrowing availability based on Proved Reserves and future net cash flows and their present value. We want to caution readers that the risk factors described below, as well as those described elsewhere in this Annual Report, or in our other filings with the Commission, in some cases have affected, and in the future could affect, our actual results and could cause our actual consolidated results during 2000 and beyond, to differ materially from those expressed in any forward-looking statements made by or on our behalf. Substantial Indebtedness At December 31, 1999, we had $319.9 million of long-term indebtedness as compared to a negative stockholders' equity of $101.0 million. This level of indebtedness may pose substantial risks to us and the holders of our securities. These risks would include the possibility that we may not generate sufficient cash flow to pay the principal of and interest on our indebtedness and the risk of default thereunder. Our historical earnings were insufficient to cover our fixed charges, including preferred dividends, by $108.9 million and $26.0 million for 1998 and 1999, respectively. If we are unsuccessful in increasing our proved reserves or realizing production from our proved undeveloped reserves, our future net revenue from existing proved reserves may not be sufficient to pay the principal of and interest on our indebtedness in accordance with their terms. Our levels of indebtedness may also adversely affect our ability to incur additional indebtedness and finance our future operations and capital needs, and may limit our ability to pursue other business opportunities. The agreements under which our indebtedness is outstanding contain financial and other restrictive covenants which could limit our operating and financial flexibility and, if violated, would result in an event of default which could preclude our access to credit under our bank credit facility or otherwise have a material adverse effect on us. A default under our bank credit facility or other loan documents could lead to a foreclosure against the assets that collateralize such indebtedness. In addition, the terms of our indebtedness contain provisions whereby a default under one loan agreement may also constitute a default under other indebtedness. If we should default under the terms of one loan agreement such default could also -20- constitute an event of default under other indebtedness which could result in all of such indebtedness becoming immediately due and payable. There are currently no defaults under any of our outstanding indebtedness. Auditors Report; Uncertainty as to Going Concern; Financial Statement Presentation The report of our independent accountants, PricewaterhouseCoopers LLP, dated February 21, 2000, contains an additional paragraph wherein they point out that we have suffered recurring losses from operations and we have a working capital and a net capital deficiency. The report states that these matters raise substantial doubt about our ability to continue as a going concern. Our financial statements have been prepared assuming we will continue as a going concern. Our financial statements do not include any adjustments that would be necessary if we were not to continue as a going concern. Our ability to continue as a going concern makes us substantially dependent on our ability to meet our obligations to pay interest on our outstanding indebtedness. During 2000 management intends to use borrowings under its credit facility to meet a portion of our cash interest payments. If we are unable to remain in compliance with the minimum interest coverage ratio described above under "Substantial Indebtedness" or possibly other covenants in our credit facility, we may be unable to borrow funds under the credit facility. Our inability to borrow funds under our credit facility could cause us to be unable to pay interest on our other outstanding indebtedness. A failure to pay interest on our other outstanding indebtedness would be a default causing all of that indebtedness to be immediately due and payable. Under cross-default provisions under our existing agreements relating to our indebtedness, a default under one loan is likely to result in a default under all our loans. This would make all our indebtedness immediately due and payable. We expect to remain in compliance with our debt covenants or obtain the necessary waivers from the bank throughout 2000 and be able to borrow the necessary funds that may be required to meet our interest payments. Volatility of Natural Gas and Oil Prices; Full Cost Write Down Our revenues, profitability, cash flow, ability to service debt and future growth will be substantially dependent on prevailing prices for natural gas and oil. The amounts of and prices obtainable for our natural gas and oil production will be affected by market factors beyond our control. These include the extent of domestic production, the level of imports of foreign natural gas and oil, the general level of market demand on a regional, national and worldwide basis, domestic and foreign economic conditions that determine levels of industrial production, political events in foreign oil producing regions, and variations in governmental regulations and tax laws or the imposition of new governmental requirements upon the natural gas and oil industry, among other factors. Prices for natural gas and oil are subject to worldwide fluctuation in response to relatively minor changes in supply of and demand for natural gas and oil, market uncertainty and a variety of additional factors that are beyond our control. Any significant decline in natural gas and oil prices would have a material adverse effect on us, including our inability to fund planned operations and capital expenditures, write downs of the carrying value of our natural gas and oil properties, and our inability to meet debt service requirements resulting in defaults under bank loans and other indebtedness. In addition, the marketability of our natural gas and oil production will depend in part upon the availability, proximity and capacity of gathering systems, pipelines and processing facilities. Restrictions Imposed by Lenders The instruments governing our indebtedness impose significant operating and financial restrictions on us. Such restrictions will affect, and in many respects significantly limit or prohibit, among other things, our ability to incur additional indebtedness, pay dividends, repay indebtedness prior to its stated maturity, sell assets or engage in mergers or acquisitions. These restrictions could also limit our ability to affect future financings, make needed capital expenditures, withstand a future downturn in our business or the economy in general, or otherwise conduct necessary corporate activities. Our failure to comply with these restrictions could lead to a default under the terms of such indebtedness. In the event of default, the holders of such indebtedness could elect to declare all of those funds borrowed to be due and payable together with accrued and unpaid interest. In such event, there can be no assurance that we would be able to make such payments or borrow sufficient funds from alternative sources to make any such payment. If our wholly owned operating subsidiary, Production Corp. were unable to repay all amounts declared due and payable under its bank credit facility or its Senior Secured Notes, the lenders could proceed against the collateral granted by Production Corp. to satisfy the indebtedness and other obligations due and payable. If the -21- bank credit facility indebtedness or the Senior Secured Notes of Production Corp. were to be accelerated to become immediately due and payable, there can be no assurance that the assets of Production Corp. would be sufficient to repay in full such indebtedness and our other indebtedness. Even if additional financing could be obtained, there can be no assurance that it would be on terms that are favorable or acceptable to us. In addition, the obligations under the bank credit facility and Production Corp's Senior Secured Notes are secured by substantially all of the assets of Production Corp. The pledge of such collateral to existing lenders could impair our ability to obtain favorable financing from other sources. Ability to Manage Growth Although individual members of our management have significant experience in the natural gas and oil industry, we have been engaged in the natural gas and oil business for approximately five years and have a limited operating history upon which investors may base their evaluation of our performance. As a result of our brief operating history over five years, our operating results from historical periods are not readily comparable and, as a consequence of the Amoco acquisition, are not expected to be indicative of future results. There can be no assurance that we will experience growth in, or maintain our current level of, revenues, natural gas and oil reserves or production. Our natural gas and oil operations to date have focused on the acquisition and development of producing natural gas and oil properties. Our business plan and reserve reports include the drilling of approximately 70 to 80 gross wells during 2000 at an estimated cost of approximately $23.0 million. Any future growth of our natural gas and oil reserves, production and operations may place significant demands on our operational, administrative and financial resources, and the increased scope of operations may present challenges to us due to increased management time and resources required. Our future performance and profitability may depend in part on our ability to successfully integrate the operational, financial and administrative functions of acquired properties into our operations, to hire additional personnel and to implement necessary enhancements to our management systems to respond to changes in our business. There can be no assurance that we will be successful in these efforts. Our inability to integrate acquired properties, to hire additional personnel or to enhance our management systems could have a material adverse effect on our results of operations. Limitation on the Payment of Funds to us by Production Corp. Our cash flow, and consequently the ability of Gothic Energy to pay dividends and to service cash interest payments on its Discount Notes and the repayment of the principal of the Discount Notes is dependent upon the cash flows of Production Corp. and the payment of funds by Production Corp. to Gothic Energy, as its parent corporation, in the form of loans, dividends, or otherwise. The terms of our outstanding indebtedness impose, and agreements entered into in the future may impose, significant restrictions on the payment of dividends and the making of loans by Production Corp. to Gothic Energy. Under the terms of our outstanding indebtedness, subject to certain restrictions, Production Corp. is permitted to pay dividends to us equal to the semi-annual interest payments due on our Discount Notes; provided that upon a notice of default or event of default under the terms of our outstanding indebtedness, Production Corp. will be prohibited from paying such dividends until the date such default or event of default is cured or waived. Accordingly, in such an event, repayment of the Discount Notes may depend upon our ability to effect an offering of capital stock or to refinance the Discount Notes. A default under the Discount Notes or any other outstanding indebtedness would have a material adverse effect on holders of our common stock. Risk of Hedging Activities In an attempt to reduce our sensitivity to energy price volatility, we use swap arrangements that generally result in a fixed price for sales of its natural gas and oil production over periods of up to 12 months. If our reserves are not produced at rates equivalent to the hedged position, we would be required to satisfy our obligations under hedging contracts on potentially unfavorable terms without the ability to hedge that risk through sales of comparable quantities of our own production. Hedging contracts limit the benefits we will realize if actual prices rise above the contract prices. In addition, hedging contracts are subject to the risk that the other party may prove unable or unwilling to perform its obligations under such contracts. Any significant non-performance could have a material adverse financial effect on us. These arrangements provide for us to exchange a floating market price for a fixed contract price. Payments are made by us when the floating price exceeds the fixed price for a contract month and payments are received when the fixed price exceeds the floating price. Settlements on these swaps are based on the -22- difference between the approximate average closing Panhandle Eastern price for a contract month and the fixed contract price for the same month. In April 1999, we entered into a hedge agreement in the form of a costless collar with respect to the production of 50,000 MMBTU of natural gas per day during the period of May through October 1999. The costless collar placed a floor of $1.80 per MMBTU and a ceiling of $2.26 per MMBTU for the effective price we received for natural gas. If the Panhandle Eastern price of natural gas fell below $1.80 per MMBTU during the term of the collar agreement, we were paid the difference by the other party to the agreement on account of gas we sell below $1.80 per MMBTU. If the Panhandle Eastern price of natural gas rose above $2.16 per MMBTU during the term of the collar agreement, we paid the difference to the other party to the agreement on account of gas we sold above $2.26 per MMBTU. Additionally, in July 1999 we entered into a similar costless collar agreement with respect to the production of 50,000 MMBTU per day during the period of November 1999 through March 2000 which places a floor of $2.30 per MMBTU and a ceiling of $3.03 per MMBTU. In January 2000, we entered into a hedge agreement covering 50,000 MMBTU per day at a fixed price of $2.435 per MMBTU. This hedge is in effect from April 2000 through October 2000. In February 2000, we entered into a hedge agreement covering 20,000 MMBTU per day at a fixed price of $2.535 per MMBTU for the month of April 2000 and $2.555 per MMBTU for the month of May 2000. This hedge is in effect for the months of April and May 2000. The commodity reference fixed price for all gas contracts is Panhandle Eastern. These collars represent approximately 70% of our current daily natural gas production. In August 1999, we entered into a hedge agreement covering 10,000 barrels of oil per month at a fixed price of $20.10 per barrel. This hedge is in effect from September 1999 through August 2000. Need to Replace Reserves Our success is substantially dependent on our ability to replace and expand our natural gas and oil reserves through the exploitation and development of our properties and the acquisition of producing properties. These activities involve substantial risk. Without successful acquisition or drilling ventures, we will be unable to replace the reserves being depleted by production, and our assets and revenues, including the reserves, will decline. Our strategy includes increasing our reserve base through continued exploitation of our existing properties, exploration of new and existing properties and acquisitions of producing properties. There can be no assurance that our acquisition and development activities will result in the replacement of, or additions to, our reserves. Similarly, there can be no assurance that we will have sufficient capital to engage in our acquisition or development activities. Successful acquisition of producing properties generally requires accurate assessments of recoverable reserves, future natural gas and oil prices, operating costs, potential environmental and other liabilities and other factors. Such assessments are necessarily inexact, and as estimates their accuracy is inherently uncertain. Acquisition Risks Our growth since we commenced natural gas and oil operations has been largely the result of acquisitions of producing properties. We expect to continue to evaluate and pursue acquisition opportunities available on terms our management considers favorable. The successful acquisition of producing properties requires an assessment of recoverable reserves, future natural gas and oil prices, operating costs, potential environmental and other liabilities and other factors beyond our control. This assessment is necessarily inexact and its accuracy is inherently uncertain. In connection with such an assessment, we perform a review of the subject properties we believe to be generally consistent with industry practices. This review, however, will not reveal all existing or potential problems, nor will it permit a buyer to become sufficiently familiar with the properties to assess fully their deficiencies and capabilities. Inspections may not be performed on every well, and structural and environmental problems are not necessarily observable even when an inspection is undertaken. We generally assume pre-closing liabilities, including environmental liabilities, and generally acquire interests in the properties on an "as is" basis. With respect to our acquisitions to date, we have no material commitments for capital expenditures to comply with existing environmental requirements. There can be no assurance that our acquisitions will be successful. Any unsuccessful acquisition could have a material adverse effect on us. -23- Drilling and Operating Risks The growth of our natural gas and oil reserves is currently substantially dependent on the success of our drilling activities. Drilling activities are subject to many risks, including the risk that no commercially productive reservoirs will be encountered. There can be no assurance that new wells we drill will be productive or that we will recover all or any portion of our investment. Drilling for natural gas and oil may involve unprofitable efforts, not only from dry wells, but from wells that are productive but do not produce sufficient net revenues to return a profit after drilling, operating and other costs. The cost of drilling, completing and operating wells is often uncertain. Our drilling operations may be curtailed, delayed or canceled as a result of numerous factors, many of which are beyond our control. These include economic conditions, mechanical problems, title problems, weather conditions, compliance with governmental requirements and shortages or delays of equipment and services. Our drilling activities may not be successful and, if unsuccessful, such failure may have a material adverse effect on our future results of operations or financial condition. In addition to the substantial risk that wells drilled will not be productive, hazards such as unusual or unexpected geologic formations, pressures, downhole fires, mechanical failures, blowouts, cratering, explosions, uncontrollable flows of natural gas, oil or well fluids, pollution and other physical and environmental risks are inherent in natural gas and oil exploration and production. These hazards could result in substantial losses to us due to injury and loss of life, severe damage to and destruction of property and equipment, pollution and other environmental damage and suspension of operations. As a protection against operating hazards, we maintain insurance coverage against some, but not all, potential losses, as is common in the natural gas and oil industry. We do not fully insure against all risks associated with our business either because such insurance is not available or because the cost thereof is considered prohibitive. The occurrence of an event that is not covered, or not fully covered, by insurance could have a material adverse effect on our financial condition and results of operations. Uncertainty of Estimates of Reserves and Future Net Revenues; Significant Undeveloped Reserves There are numerous uncertainties inherent in estimating quantities of proved reserves, including many factors beyond our control. Information as to our reserves represents estimates based on reports prepared by our independent petroleum engineers, as well as internally generated reports. Petroleum engineering is not an exact science. Information relating to proved natural gas and oil reserves is based upon engineering estimates derived after analysis of information we furnished or the operator of the property furnished. Estimates of economically recoverable natural gas and oil reserves and of future net cash flows necessarily depend upon a number of variable factors and assumptions. These include historical production from the area compared with production from other producing areas, the assumed effects of regulations by governmental agencies and assumptions concerning future natural gas and oil prices, future operating costs, severance and excise taxes, capital expenditures and workover and remedial costs. All of these may in fact vary considerably from actual results. Natural gas and oil prices, which fluctuate over time, may also affect proved reserve estimates. For these reasons, estimates of the economically recoverable quantities of natural gas and oil attributable to any particular group of properties, classifications of such reserves based on risk of recovery and estimates of the future net cash flows expected from the properties which are prepared by different engineers or by the same engineers at different times may vary substantially. Actual production, revenues and expenditures with respect to our reserves will likely vary from estimates, and such variances may be material. Approximately 9% of our estimated PV-10 of proved reserves and 13% of our estimated Bcfe of proved reserves as of December 31, 1999 are classified as undeveloped. Either changes in estimates of proved undeveloped reserves or the inability to fund development could result in substantially reduced reserves. In addition, the timing of receipt of estimated future net revenues from proved undeveloped reserves will be dependent upon the timing and implementation of drilling and development activities estimated by us for purposes of the reserve report. Future Capital Requirements We have made, and will continue to make, substantial capital expenditures for the acquisition, development and production of natural gas and oil reserves, particularly since a portion of our proved reserves consists of proved undeveloped reserves which require significant capital expenditures to develop. We have budgeted capital expenditures of approximately $23.0 million for the year ending December 31, 2000. We are not contractually committed to expend these funds. We currently expect that available cash, cash flows from operations, proceeds -24- from the private or public sale of debt or equity securities, borrowings under the Credit Facility, and sales of certain natural gas and oil properties will be sufficient to fund our debt service requirements and planned capital expenditures for our existing properties through 2000. However, we may need to raise additional capital to fund acquisitions and the development of properties acquired, which capital may not be available to us. Under the terms of our transaction with Chesapeake entered into in April 1998 and as in effect at December 31, 1999, both Chesapeake and we are permitted to designate acreage for development drilling by giving written notice to the other party. In order for us to participate in any drilling proposals submitted by Chesapeake in the acreage which is the subject of our participation agreement, we will need to have available sufficient funds or borrowing availability to participate in the proposed drilling activity. While certain terms of the participation agreement limited the number of wells to be proposed by either party to the amount that would require capital expenditures by either party of $25.0 million in 1999, there is no such limit for 2000 or subsequent years. In the event we should not have funds available at the time, our interest in the well could be forfeited. (See Item 12 - Certain Relationship and Related Transactions, related to subsequent modifications to the Chesapeake agreement.) We may seek additional capital, if required, from traditional reserve base borrowing, equity and debt offerings or joint ventures to further develop and exploit our properties and to acquire additional properties, subject to the limitations contained in the terms of our outstanding indebtedness. Our ability to access additional capital will depend on our continued success in developing our natural gas and oil reserves and the status of the capital markets at the time such capital is required. Accordingly, there can be no assurance that capital will be available to us from any source or that, if available, it will be at prices or on terms acceptable to us. Should we be unable to access the capital markets or should sufficient capital not be available, the development and exploitation of our properties could be delayed or reduced and, accordingly, natural gas and oil revenues and operating results may be adversely affected. Reliance on Key Personnel We are dependent upon the services of our Chief Executive Officer and President, Michael Paulk. The loss of his services could have a material adverse effect on us. We have entered into an employment agreement with Mr. Paulk, with a current expiration date of December 31, 2002. Governmental Regulation Our operations are affected by extensive regulation under various federal, state and local laws and regulations relating to the exploration for and development, production, gathering and marketing of natural gas and oil and the release of materials into the environment. In particular, our natural gas and oil exploration, development and production and our activities in connection with storage and transportation of liquid hydrocarbons are subject to stringent environmental regulation by governmental authorities. Such regulations have increased the costs of planning, designing, drilling, installing, operating and abandoning natural gas and oil wells and other related facilities. Although we believe that our operations are in general compliance with all such laws and regulations, including applicable environmental laws and regulations, risks of substantial costs and liabilities are inherent in natural gas and oil operations. There can be no assurance that significant costs and liabilities will not be incurred in the future. Moreover, it is possible that other developments, such as increasingly strict environmental laws, regulations and enforcement policies thereunder, and claims for damages to property, employees, other persons and the environment resulting from our operations, could result in substantial costs and liabilities in the future. The discharge of natural gas, oil or other pollutants into the air, soil or water may give rise to significant liabilities on our part to the government and third parties. It may require us to incur substantial costs of remediation. Moreover, we have agreed to indemnify sellers of producing properties purchased by us, including Amoco Corporation, among others, against environmental claims associated with such properties. No assurance can be given that existing environmental laws or regulations, as currently interpreted or reinterpreted in the future, or future laws or regulations will not materially adversely affect our results of operations and financial condition or that material indemnity claims will not arise against us with respect to properties we acquired. -25- Competition The natural gas and oil industry is highly competitive. We compete with other companies in acquisitions and the development, production and marketing of natural gas and oil with major oil companies, other independent natural gas and oil concerns, and individual producers and operators. Many of these competitors have substantially greater financial and other resources than we have. Furthermore, the natural gas and oil industry competes with other industries in supplying the energy and fuel needs of industrial, commercial and other consumers. Item 7 - Financial Statements: - ----------------------------- The response to this Item is included in a separate section of this report. See page F-1. Item 8 - Changes in and Disagreements on Accounting and Financial Disclosure: - ---------------------------------------------------------------------------- During the two fiscal years ended December 31, 1999, the Company has not filed any Current Report on Form 8-K reporting any change in accountants in which there was a reported disagreement on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure. -26- PART III -------- Item 9 - Directors, Executive Officers, Promoters and Control Persons; - ---------------------------------------------------------------------- Compliance with Section 16(a) of Exchange Act: - --------------------------------------------- Directors and Executive Officers. The Directors and executive officers of the Company, certain significant employees, their ages and positions with the Company are as follows: Name Age Position With Company ---- --- --------------------- John J. Fleming 60 Chairman of the Board and Director Michael K. Paulk 51 President and Director Steven P. Ensz 48 Vice-President, Finance and Chief Financial Officer Brian E. Bayley 47 Director Bennett G. Shelton 43 Vice-President of Land and Contract Administration Richard O. Mulford 46 Vice-President of Operations Robert G. Snead 61 Exploitation Manager John Coughlon 42 Exploration Manager David Evans 43 Petroleum Engineer R.L. Hilbun 51 Full-Time Consultant, Drilling and Completion Engineer R. Andrew McGuire 33 Controller John J. Fleming: Mr. Fleming was elected a Director of the Company in October 1994. Mr. Fleming is currently President of Bonanza Energy Ltd., engaged in oil and gas exploration and diversified investments. From August 1995 through December 1999, he was Chairman, President and Chief Executive Officer of Profco Resources Ltd., engaged in oil and gas exploration. In December 1998, it merged with GHP Exploration Ltd. to form TransAtlantic Petroleum Corp. Mr. Fleming was Chairman of the Board of American Natural Energy Corporation ("ANEC") from August 1993 to July 1994. He has been involved in the oil and gas industry as president, chairman or chief executive officer of a number of corporations for more than the past fifteen years. Mr. Fleming is also a Director of Imco Recycling Inc., Newfoundland Capital Corporation, CHC Helicopter Corporation, TransAtlantic Petroleum Corp., Poco Petroleum Ltd., Southwestern Gold Corporation and Canabrava Diamond Corporation. Michael K. Paulk: Mr. Paulk was elected President and Director of the Company in October 1994. Mr. Paulk has been engaged in the oil and gas industry for more than fifteen years. He was President of ANEC from its inception in 1985 until his resignation in September 1994 after its acquisition by Alexander Energy Corporation in July 1994. Steven P. Ensz: Mr. Ensz has been Vice-President, Finance and Chief Financial Officer of the Company since March 18, 1998 and is responsible for the financial activities of the Company. From July 1991 to February 1998, he was Vice-President, Finance of Anglo-Suisse, Inc., an oil and natural gas exploration and producing company. From December 1983 to June 1991, he held various positions within the energy industry, including President of Waterford Energy, an independent oil and gas producer. Prior to December 1983, he was a partner with Oak, Simon & Ott, CPAs. He is a certified public accountant. Brian E. Bayley: Mr. Bayley was elected a Director of the Company in February 1996. He has been President of Quest Management Corp., a private management company, since December 1996, and of Quest Ventures Ltd., a private merchant banking company, since December 1996. Prior to April 1997, Mr. Bayley held a variety of positions with Quest Oil & Gas Inc., including Vice President, Corporate Administration from September 1986 to October 1990, President and Chief Executive Officer from October 1990 to October 1996, and Secretary from October 1996 to April 1997. He was a Director from November 1990 to April 1997. Mr. Bayley is a Director of a number of other corporations, none of which are reporting companies under the Securities Exchange Act of 1934, as amended. Bennett G. Shelton: Mr. Shelton was elected Vice President of Land and Contract Administration on December 9, 1998. Prior there, he was employed by the Company as Land Contracts Manager since May 1995. -27- From August 1994 to May 1995, he was a Senior Landman with AEOK and prior thereto he was a Land and Acquisition Manager with ANEC. Prior to April 1991, he was a staff landman with Santa Fe Minerals, Inc. for approximately ten years. Richard O. Mulford: Mr. Mulford was elected Vice President of Operations on December 9, 1998. From April 1995 to November 1998, he was employed as Operations Manager of the Company since April 1995. From April 1985 to April 1995, he was a Production Superintendent with ANEC and has been employed in the oil and natural gas industry since 1978. Robert G. Snead: Mr. Snead, who has served as Exploitation Manager for the Company on a full-time consulting basis since April 1997, was hired as a full- time employee effective September 1, 1997. Between early 1994 and April 1997, he was employed as an independent geologist and from 1985 to 1994 was the Senior Vice-President/ Exploration Manager of LOGO, Inc., an oil and natural gas well operating company. John Coughlon: Mr. Coughlon has been employed by the Company as Exploration Manager since March 1998. Prior thereto, he was, commencing in December 1994, employed by Amoco Production Company, most recently as Senior Staff Geologist. From October 1993 to December 1994 he served as Geological Consultant/Principle of Tower Energy Corporation and prior thereto he was from July 1987 to October 1993 Senior Geologist for Nicor Oil & Gas and from April 1980 to July 1987 he was employed by Mobil Oil Corp. David Evans: Mr. Evans was hired by the Company as a petroleum engineer in November 1997. Prior thereto, he was Production Manager for Petroleum Properties Management Co. from March 1996 to October 1997. From April 1992 to March 1996, he was Engineering Manager for AEOK and from September 1987 to April 1992 he was Vice-President of Exploration and Production for Bradmar Petroleum Corporation. R.L. Hilbun: Mr. Hilbun is a full-time consultant to the Company serving as a drilling and completion engineer. He has served in this capacity since March 1997. Prior thereto, commencing in 1982, he was Vice-President, Operations of PSEC, Inc., a natural gas and oil well operating company. He has been employed in the natural gas and oil industry since 1970. R. Andrew McGuire: Mr. McGuire has been employed by the Company as Controller since November 1994. From February 1991 to October 1994, he was employed as Accounting Manager of ANEC. From May 1988 to February 1991, he was employed by OXY-USA, Inc., a subsidiary of Occidental Petroleum Corp., as an accountant. Mr. McGuire is a certified public accountant. Director and Officer Securities Reports The Federal securities laws require Gothic Energy's Directors and executive officers, and persons who own more than ten percent (10%) of a registered class of Gothic Energy's equity securities to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of any equity securities of Gothic Energy. Copies of such reports are required to be furnished to Gothic Energy. To Gothic Energy's knowledge, based solely on a review of the copies of such reports and other information furnished to Gothic Energy, all persons subject to these reporting requirements filed the required reports on a timely basis with respect to Gothic Energy's year ended December 31, 1999. -28- Item 10 - Executive Compensation: - -------------------------------- The following table sets forth the annual and long-term compensation paid during the Company's three fiscal years ended December 31, 1999 to the Company's chief executive officer and the Company's other most highly compensated executive officers who received compensation exceeding $100,000 and who served in such capacities at December 31, 1999:
SUMMARY COMPENSATION TABLE Annual Compensation - ---------------------------------------------------------------------------------------------------------------------- Compensation -------------------------------------- Other Long-Term Name and Annual Awards/ All Other Principal Position Year Salary Bonus Comp. Option (#) Comp. - ---------------------------------------------------------------------------------------------------------------------- Michael K. Paulk 1999 $189,000 $180,000 -0- 375,000 $179,000(1) 1998 180,000 125,000 -0- 375,000 -0- 1997 150,000 75,000 -0- -0- -0- Steven P. Ensz(2) 1999 157,500 130,000 -0- 375,000 -0- 1998 118,750 100,000 -0- 125,000 -0- Richard O. Mulford 1999 109,000 15,000 -0- 70,000 -0- 1998 72,000 10,000 -0- 50,000 -0- 1997 66,000 5,500 -0- 40,000 -0- Bennett G. Shelton 1999 109,000 15,000 -0- 75,000 -0- 1998 72,000 10,000 -0- 50,000 -0- 1997 66,000 5,500 -0- 40,000 -0-
- -------------------- (1) On September 14, 1999, the Board of Directors of the Company authorized the forgiveness of the repayment of a note owing by Mr. Paulk to the Company. (2) Mr. Ensz was employed by the Company in March 1998. Option Grants in Year Ended December 31, 1999. - ---------------------------------------------- The following table provides information with respect to the above named executive officers regarding options granted to such persons during the Company's year ended December 31, 1999.
% of Total Options/ Market Number of Securities SARs Granted to Exercise or Price on Name Underlying SARs/ Employees in Base Price Expiration Date of Options Granted (#) Fiscal Year ($/Share) Date Grant - -------------------------------------------------------------------------------------------------------------------------- Michael K. Paulk 250,000(1) 19% $0.53 02/03/2004 $0.53 125,000(2) 10% 0.15 12/31/2004 0.15 Steven P. Ensz 250,000(1) 19% 0.53 02/03/2004 0.53 125,000(2) 10% 0.15 12/31/2004 0.15 Richard O. Mulford 70,000(3) 5% 0.40 07/22/2004 0.40 Bennett G. Shelton 75,000(3) 6% 0.40 07/22/2004 0.40
- -------------------- (1) Of which, options to purchase 125,000 shares become exercisable on February 3, 2000 and options to purchase the remaining 125,000 shares become exercisable on February 3, 2001, provided, however, such options become immediately fully exercisable in the event of a "change of control," as defined, of the Company. (2) Of which, options to purchase 62,500 shares become exercisable on December 31, 2000 and options to purchase the remaining 62,500 shares become exercisable on December 31, 2001, provided, however, such -29- options become immediately fully exercisable in the event of a "change of control," as defined, of the Company. (3) Of which, options to purchase 35,000 shares and 37,500 shares, respectively, become exercisable on July 22, 2000 and options to purchase the remaining 35,000 shares and 37,500 shares, respectively, become exercisable on July 22, 2001, provided, however, such options become immediately fully exercisable in the event of a "change of control," as defined, of the Company. Stock Option Holdings at December 31, 1999. - ------------------------------------------ The following table provides information with respect to the above named executive officers regarding Company options held at the end of the Company's year ended December 31, 1999 (such officers did not exercise any options during the most recent fiscal year).
Value of Unexercised Number of Unexercised Options In-the-Money Options at December 31,1999 at December 31, 1999 (1) Name Exercisable Unexercisable Exercisable Unexercisable - ---------------------------------------------------------------------------------------------------------------- Michael K. Paulk 312,500 562,500 -0- -0- Steven P. Ensz 62,500 437,500 -0- -0- Richard O. Mulford 105,000 95,000 -0- -0- Bennett G. Shelton 100,000 100,000 -0- -0-
- -------------------- (1) Based on the closing sales price on December 31,1999 of $0.15. Employment Agreements The Company has entered into an employment agreement with Michael Paulk effective January 1, 1999 pursuant to which he is employed as the President of the Company. Mr. Paulk currently receives a base salary of $225,000 per year. In addition, he is to receive a cash bonus as may be determined by the Company's Board of Directors. Mr. Paulk is also entitled to participate in such incentive compensation and benefit programs as the Company makes available. The term of Mr. Paulk's agreement is for a period of three years and at the end of the first year and at the end of each succeeding year the agreement is automatically extended for one year such that at the end of each year there will automatically be three years remaining on the term of the agreement. Mr. Paulk can terminate the agreement at the end of the initial term and any succeeding term on not less than six months notice. In the event the employment agreement is terminated by the Company (other than for cause, as defined), Mr. Paulk is entitled to receive a payment representing all salary due under the remaining full term of his agreement and the Company is obligated to continue his medical insurance and other benefits provided under the agreement in effect for a period of one year after such termination. In the event of a change in control, as defined, of the Company, Mr. Paulk has the right to terminate his employment agreement with the Company within sixty days thereafter, whereupon the Company would be obligated to pay to him a sum equal to three years his base salary under the agreement plus a lump sum payment of $250,000. The Company has also entered into an employment agreement with Steven P. Ensz effective January 1, 1999 pursuant to which he is employed as the Vice President and Chief Financial Officer of the Company. Mr. Ensz currently receives a base salary of $187,500 per year. In addition, he is to receive a cash bonus as may be determined by the Company's Board of Directors. Mr. Ensz is also entitled to participate in such incentive compensation and benefit programs as the Company makes available. The term of Mr. Ensz' agreement is for a period of three years and at the end of the first year and at the end of each succeeding year the agreement is automatically extended for one year such that at the end of each year there will automatically be three years remaining on the term of the agreement. Mr. Ensz can terminate the agreement at the end of the initial term and any succeeding term on not less than six months notice. In the event the employment agreement is terminated by the Company (other than for cause, as defined), Mr. Ensz is entitled to receive a payment representing all salary due under the remaining full term of his agreement and the Company is obligated to continue his medical insurance and other benefits provided under the agreement in effect for a period of one year after such termination. In the event of a change in control, as defined, of the Company, Mr. Ensz has the right to terminate his employment agreement with -30- the Company within sixty days thereafter, whereupon the Company would be obligated to pay to him a sum equal to three years his base salary under the agreement plus a lump sum payment of $200,000. Directors Compensation Each outside Director of Gothic Energy received a fee of $15,000 for serving in that capacity during 1999 and each Director is reimbursed for his out-of-pocket expenses in attending meetings. Item 11 - Security Ownership of Certain Beneficial Owners and Management: - ------------------------------------------------------------------------ Set forth below is information concerning the Common Stock ownership of all persons known by Gothic Energy to own beneficially 5% or more of Gothic Energy's Common Stock, and the Common Stock ownership of each Director of Gothic Energy and all Directors and officers of Gothic Energy as a group, as of March 1, 2000. As of March 1, 2000, Gothic Energy had 18,685,765 shares of Common Stock outstanding. Name and Address of Beneficial Holder, Identity of Group (1)(2) Amount (3) Percent of Class ---------------------------------- -------------- ---------------- Michael Paulk 1,049,891(4) 5.4% John Fleming 712,500(5) 3.7% Brian E. Bayley 712,500(6) 3.7% Stratum Group, L.L.C. (7) 1,000,000(8) 5.1% 650 Fifth Avenue New York, New York 10019 Carl C. Icahn (7) 1,600,000 8.6% High River Limited Partnership (7) Riverdale LLC (7) Little Meadow Corp. (7) 100 South Bedford Road Mount Kisco, New York 10549 Amoco Corporation (7) 1,500,000(9) 7.4% 200 East Randolph Drive Chicago, Illinois 60601 Chesapeake Energy Corporation(10) 2,394,125 12.8% 6100 North Western Avenue Oklahoma City, Oklahoma 73118 OppenheimerFunds, Inc. (11) 1,265,913 6.3% Two World Trade Center, 34th Floor New York, New York 10048 All Officers and Directors as a 3,374,891 15.4% Group (6 persons) - -------------------- (1) This tabular information is intended to conform with Rule 13d-3 promulgated under the Securities Exchange Act of 1934 relating to the determination of beneficial ownership of securities. The tabular information gives effect to the exercise of warrants or options exercisable within 60 days of the date of this table owned in each case by the person or group whose percentage ownership is set forth opposite the respective percentage and is based on the assumption that no other person or group exercise their option. (2) The address of Mr. Paulk is c/o the Company, 6120 South Yale Avenue, Suite 1200, Tulsa, Oklahoma 74136. The address of Mr. Fleming is 1500, 340 12th Avenue SW, Calgary, Alberta T2R 1L5. The address of Mr. Bayley is c/o Quest Management Corp., 1095 West Pender Street-Suite 850, Vancouver, British Columbia, Canada V6E 2M6. -31- (3) Except as otherwise noted, shares beneficially owned by each person as of March 1, 2000 were owned of record and each person had sole voting and investment power with respect to all shares beneficially held by such person. (4) Includes (i) 312,500 shares issuable upon exercise of options at an exercise price of $0.40 per share and (ii) 187,500 shares issuable upon exercise of options at an exercise price of $0.40 per share, which become exercisable on April 28, 2000. Also includes 250,000 shares issuable on exercise of options at an exercise price of $0.53 per share, of which options to purchase 125,000 shares become exercisable on February 4, 2000 and options to purchase the remaining 125,000 shares become exercisable on February 4, 2001. Also includes 125,000 shares issuable on exercise of options at an exercise price of $0.15 per share, of which options to 62,500 shares become exercisable on December 31, 2000 and options to purchase the remaining 62,500 shares become exercisable on December 31, 2001. In the event of a "change of control" of Gothic Energy, as defined in the option agreements, such remaining options become immediately exercisable. (5) Includes 100,000 shares issuable on exercise of options at an exercise price of $0.40 per share which are exercisable during the five-year period beginning July 11, 1995, 50,000 shares issuable on exercise of options at an exercise price of $0.40 per share which are exercisable during the five- year period beginning July 16, 1996, 150,000 shares issuable on exercise of options at an exercise price of $0.40 per share which are exercisable during the five year period beginning April 28, 1998, and 250,000 shares issuable on exercise of options at an exercise price of $0.53 per share which are exercisable during the five-year period beginning February 4, 1999. Also includes 162,500 shares issuable on exercise of options at an exercise price of $0.15 per share, of which 81,250 shares become exercisable on December 31, 2000 and options to purchase the remaining 81,250 shares become exercisable on December 31, 2001. (6) Includes 150,000 shares issuable on exercise of options at an exercise price of $0.40 per share which are exercisable during the five-year period beginning July 16, 1996, 150,000 shares issuable on exercise of options at an exercise price of $0.40 per share which are exercisable during the five- year period beginning April 28, 1998, and 250,000 shares issuable on exercise of options at an exercise price of $0.53 per share which are exercisable during the five-year period beginning February 4, 1999. Also includes 162,500 shares issuable on exercise of options at an exercise price of $0.15 per share, of which 81,250 shares become exercisable on December 31, 2000 and options to purchase the remaining 81,250 shares become exercisable on December 31, 2001. (7) Based on information contained in Schedule 13D provided by such person. (8) Issuable on exercise of common stock purchase warrants at $2.67 per share, as adjusted. The general partner of Stratum Group, L.P. is Stratum Finance, L.L.C. and the members of Stratum Finance, L.L.C. are Energy Investment Partners, a New York general partnership, Joseph M. Rinaldi, Michael W. Walker, Richard E. Bani, John C. Alvardo, Curt S. Taylor, and Betsy D. Cotton. Stratum Finance, L.L.C. is managed by Energy Investment Partners, which has four votes, Joseph M. Rinaldi, who has one vote, and Michael W. Walker, appointed by the natural person members of Stratum Finance, L.L.C., who has one vote. Energy Investment Partners has three general partners, SGLLC Partners, L.P. ("SGLLC"), SGLLC Partners Offshore, L.P. ("Offshore") and The Beacon Group Energy Investment Fund, L.P. ("Fund"). The sole general partner of each of SGLLC and Offshore is SG-GP, L.P. whose sole general partner is Energy Fund GPI, Inc. ("GPI"). The sole general partner of Fund is Beacon Energy Investors, L.P. ("Investors"). The sole general partner of Investors is BEIGP, Inc. ("BEIGP"). The names of the officers and Directors of both GPI and BEIGP are Geoffrey Boisi, John McWilliams, Preston Miller, Harold Pote, Faith Rosenfeld, Robert Semmens, David Remmington, Thomas Mendell and Frank Murray. (9) Issuable on exercise of common stock purchase warrants at $2.59 per share, as adjusted. (10) In addition, as of March 1, 2000, Chesapeake holds 61,007 shares of Senior Redeemable Preferred Stock Series B with a liquidation value of $1,000 per share. Commencing April 30, 2000, such shares are convertible into a number of shares of Gothic Energy Common Stock determined by dividing the liquidation value by the conversion price currently of $2.04167 per share. The Company entered into an option agreement on February 28,2000 to redeem the shares of Common Stock and Preferred Stock held by Chesapeake, the consummation of which is subject to the fulfillment of certain conditions. (11) Based on information contained in Schedule 13G/A provided by such person. -32- Item 12 - Certain Relationships and Related Transactions: - -------------------------------------------------------- At December 31, 1999, Mr. Paulk was indebted to the Company in the amount of $179,000 under an interest bearing promissory note dated September 1, 1997 due, as extended, on January 31, 2000. On September 14, 1999, the Board of Directors of the Company authorized the forgiveness of the repayment of this note. On January 23, 1998, the Company completed the Amoco Acquisition pursuant to which, among other things, the Company issued to Amoco a five-year common stock purchase warrant to purchase 1.5 million shares of Common Stock exercisable at $3.00 per share. On April 27, 1998, Production Corp. completed a transaction, entered into on March 31, 1998, with Chesapeake Energy Corporation ("Chesapeake") pursuant to which it (i) executed a participation agreement granting to Chesapeake a 50% interest in substantially all of Production Corp's undeveloped acreage, (ii) sold for $20.0 million a 50% interest in Production Corp's natural gas and oil properties in the Arkoma basin, and (iii) sold 50,000 shares of Gothic Energy's Series B Preferred Stock and a common stock purchase warrant. The Series B Preferred Stock had a liquidation preference of $50.0 million and a dividend rate per annum equal to 12 1/2% of the aggregate liquidation preference payable in additional shares of Series B Preferred Stock, provided that, after April 1, 2000, at Gothic Energy's option, dividends may be paid in cash. On June 30, 2008, the Series B Preferred Stock is mandatorily redeemable in shares of Common Stock valued at the fair market value on the date of redemption. Gothic Energy has the option at any time prior to April 30, 2000 to redeem the Series B Preferred Stock, in whole or in part, at 105% of the liquidation preference payable in cash out of the net proceeds of a public or private offering of any equity security. After April 30, 2000, the Series B Preferred Stock can be redeemed, in whole or in part, at a redemption price equal to the liquidation preference. After April 20, 2000, the Series B Preferred Stock is convertible into a number of shares of Common Stock determined by dividing the liquidation preference by the higher of $2.04167 or the fair market value on the date the Series B Preferred Stock is converted. Notwithstanding the foregoing, no holder or group can convert the Series B Preferred Stock to the extent that the conversion of such shares would cause such holder or group to own more than 19.9% of Gothic Energy's outstanding Common Stock. The shares of Series B Preferred Stock have no voting rights except as required by Oklahoma law. At December 31, 1999, reflecting dividends paid, Chesapeake held 59,216 shares of Series B Preferred Stock. The Series B Preferred Stock ranks senior to all classes of Common Stock and other series and classes of preferred stock with respect to dividend rights and rights on liquidation, winding up and dissolution. On August 17, 1999, Chesapeake fully exercised the common stock purchase warrant issued in April 1998 and purchased 2,394,125 shares of Gothic Energy's common stock. The shares were issued pursuant to the cashless exercise provisions of the warrant that permitted Chesapeake to surrender the right to exercise the warrant for a number of shares of Gothic Energy's common stock have a market value equivalent to the total exercise price. The total exercise price was $23,941.25 or $0.01 per share. An aggregate of 45,121 warrants were surrendered in payment of the total exercise price. Pursuant to the Participation Agreement between Production Corp. and Chesapeake, Production Corp. sold Chesapeake the right through April 30, 2003 to participate in up to 50% of Production Corp's interest in the development of any of Production Corp's non-producing leasehold interests (other than the Arkoma basin and certain New Mexico properties). Chesapeake also was sold the right to participate in up to 50% of Production Corp's interest in any subsequently acquired properties. During the year ended December 31, 1999, Chesapeake elected to participate to the extent of 50% of Production Corp's interest in the development of 29 non-producing properties and no acquired properties. On February 29, 2000, the Company and Chesapeake entered into agreements which will substantially revise the Production Corp./Chesapeake Joint Venture ("JV") Development Agreement originally entered into on March 31, 1998, and will provide for Gothic Energy to redeem, without any additional consideration, its Series B Preferred Stock and Common Stock held by Chesapeake (the "Securities") as part of a plan of restructuring. The redemption of the Securities and various revisions to the JV are subject to material conditions including approval by certain lenders of the Company. -33- The revised agreement and Securities redemption include the following significant terms: . Extension of the JV for three years with an immediate exclusion of the state of Texas south of latitude 34o North from the provisions of the JV. . Granting a right of first refusal to Chesapeake on any property dispositions made by Production Corp. . Segregation of first development rights, with Production Corp. having the first right to future drilling, completion and operating activities in its core operating area in the Watonga-Chickasha Trend and also to its undeveloped acreage in Potato Hills, Carter Knox, Cottonwood Creek, Oklahoma and Pecos Slope, New Mexico. Chesapeake will have first right in all other areas containing JV acreage. Additionally, Chesapeake will assume operations of 28 wells which were drilled in the JV by Chesapeake but had been operated since first production by Production Corp. . A permanent assignment to Chesapeake of the undeveloped leasehold interest originally assigned to Chesapeake on March 31, 1998 that was subject to reassignment to the Company by Chesapeake in 2003. . A permanent assignment to Chesapeake of Production Corp's remaining JV undeveloped leasehold in 16 counties located in the Anadarko and Arkoma basins in Oklahoma and Kansas. The acreage in this assignment excludes 15 proved undeveloped locations retained by Production Corp. Production Corp's remaining 50% interest in undeveloped acreage outside the 16 county areas will not be conveyed to Chesapeake, and specifically, undeveloped acreage in Watonga-Chickasha Trend and the Cement Field is not being conveyed. . Chesapeake will have the right to acquire all of Production Corp's participation in wells in the 16 county area (excluding the participation in the 15 proved undeveloped locations retained by Production Corp.) that are drilled between February 1, 2000 and the closing of this transaction. Chesapeake's cost to acquire these wells will be the reimbursement of Production Corp's unrecovered cost of drilling, completing and operating the wells. . Redemption by Gothic Energy of its entire issue of Series B Preferred Stock having a liquidation preference of approximately $61 million, at February 29, 2000, and of 2.4 million shares of Gothic Energy's common stock. -34- . GLOSSARY Wherever used herein, the following terms shall have the meanings specified. Bbl--One stock tank barrel, or 42 US gallons liquid volume, used herein in reference to crude oil or other liquid hydrocarbons. Bcf--One billion cubic feet. Bcfe--One billion cubic feet of natural gas equivalent. Behind Pipe--Hydrocarbons in a potentially producing horizon penetrated by a well bore the production of which has been postponed pending the production of hydrocarbons from another formation penetrated by the well bore. These hydrocarbons are classified as proved but non-producing reserves. Boe--Barrels of oil equivalent (converting six Mcf of natural gas to one Bbl of oil). Developed Acreage--Acres which are allocated or assignable to producing wells or wells capable of production. Development Well--A well drilled within the proved area of a natural gas and oil reservoir to the depth of a stratigraphic horizon known to be productive. Dry Well--A well found to be incapable of producing either oil or natural gas in sufficient quantities to justify completion as an oil or natural gas well. EBITDA--Earnings (excluding discontinued operations, extraordinary items, charges resulting from changes in accounting and significant non-recurring revenues and expenses) before interest expense, provision for (or benefit for) income taxes, depletion, depreciation and amortization expenses, and the provision for impairment of natural gas and oil properties. EBITDA is not a measure of cash flow as determined by generally accepted accounting principles. EBITDA information has been included in this Prospectus because EBITDA is a measure used by certain investors in determining historical ability to service indebtedness. EBITDA should not be considered as an alternative to, or more meaningful than, net income or cash flows as determined in accordance with generally accepted accounting principles as an indicator of operating performance or liquidity. Exploratory Well--A well drilled to find and produce oil or natural gas in an unproved area, to find a new reservoir in a field previously found to be productive of oil or natural gas in another reservoir, or to extend a known reservoir. Gross Acres or Gross Wells--The total acres or wells, as the case may be, in which a working interest is owned. Infill Well--A well drilled between known producing wells to better exploit the reservoir Mbbl--One thousand Bbl. Mmbbl--One million Bbl. Mboe--One thousand barrels of oil equivalent. Mcf--One thousand cubic feet. Mcfe--One thousand cubic feet of natural gas equivalent, using the ratio of one Bbl of crude oil to six Mcf of natural gas. Mmcf--One million cubic feet. -35- Mmcfe--One million cubic feet of natural gas equivalent. Natural Gas and Oil Lease--An instrument by which a mineral fee owner grants to a lessee the right for a specific period of time to explore for natural gas and oil underlying the lands covered by the lease and the right to produce any natural gas and oil so discovered generally for so long as there is production in economic quantities from such lands. Net Acres or Net Wells--The sum of the fractional working interests owned in gross acres or gross wells. NYMEX--New York Mercantile Exchange. Overriding Royalty Interest--A fractional undivided interest in a natural gas and oil property entitling the owner to a share of natural gas and oil production, in addition to the usual royalty paid to the owner, free of costs of production. PDNP--Proved developed, non-producing or behind the pipe reserves. Productive Well--A well that is producing oil or natural gas or that is capable of production. Proved Developed Reserves--Reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. Proved Reserves--The estimated quantities of crude oil, natural gas and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Proved Undeveloped Reserves or PUD--Reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for completion. PV-10--The discounted future net cash flows for proved natural gas and oil reserves computed on the same basis as the Standardized Measure, but without deducting income taxes, which is not in accordance with generally accepted accounting principles. PV-10 is an important financial measure for evaluating the relative significance of natural gas and oil properties and acquisitions, but should not be construed as an alternative to the SEC PV-10 (as determined in accordance with generally accepted accounting principles). Reserve Life--The estimated productive life of a proved reservoir based upon the economic limit of such reservoir producing hydrocarbons in paying quantities assuming certain price and cost parameters. For purposes of this Report, reserve life is calculated by dividing the Proved Reserves (on an Mcfe basis), as of December 31, 1999 by projected production volumes for the 12 months ending December 31, 2000. Royalty Interest--An interest in a natural gas and oil property entitling the owner to a share of natural gas and oil production free of costs of production. Secondary Recovery--A method of natural gas and oil extraction in which energy sources extrinsic to the reservoir are utilized. Standardized Measure--The estimated future net cash flows from proved natural gas and oil reserves computed using prices and costs at the dates indicated, after income taxes and discounted at 10%. Undeveloped Acreage--Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of natural gas and oil regardless of whether such acreage contains proved reserves. Working Interest--The operating interest which gives the owner the right to drill, produce and conduct operating activities on the property and a share of production, subject to all royalties, overriding royalties and other burdens and to all costs of exploration, development and operations and all risks in connection therewith. -36- PART IV ------- Item 13 - Exhibits and Reports on Form 8-K: - ------------------------------------------
Exhibit Description - ------------------------- -------------------------------------------------------------------------------- 3.1 Certificate of Incorporation of the Company filed October 11,1996 (1) 3.2 Certificate of Ownership and Merger of the Company filed October 22, 1996 (1) 3.4 By-Laws of the Company (1) 4.1 Specimen Stock Certificate 4.2 Warrant Agreement between Company and American Stock Transfer & Trust Company, as Warrant Agent, including form of Redeemable Warrant (2) 10.1 1989 Incentive Stock Option and Non-Statutory Plan, as amended (1) 10.2 1996 Omnibus Incentive Plan (1) 10.3 1996 Non-Employee Stock Option Plan (1) 10.2.1 Employment Agreement dated as of January 1, 1999 between the Company and Michael Paulk 10.2.2 Employment Agreement dated as of January 1, 1999 between the Company and Steven P. Ensz 10.3 Warrant Certificate to purchase 1,000,000 Shares of Company's Common Stock at $3.25 per share issued to Stratum (3) 10.4 Registration Rights Agreement dated as of September 9, 1997 among the Company, Gothic Energy of Texas, Inc., Gothic Gas Corporation, Oppenheimer & Co., Inc, Banc One Capital Corporation and Paribas Corporation. (4) 10.5 Warrant Agreement between the Company and American Stock Transfer & Trust Company, as Warrant Agent, dated as of September 9, 1997(4) 10.6 Common Stock Purchase Warrant issued to Norse Exploration, Inc., and Norse Pipeline, Inc. (5) 10.7 Purchase and Sale Agreement dated November 25, 1997 between Amoco Production Company, as Seller, and Gothic Energy Corporation, as Buyer (6) 10.8 Securities Purchase Agreement dated as of January 23, 1998(7) 10.9 Warrant Agreement between the Company and American Stock Transfer & Trust Company, dated as of January 23, 1998(7) 10.10 Registration Rights Agreement dated as of January 23, 1998(7) 10.11 Common Stock Registration Rights Agreement dated as of January 23, 1998(7)
-37- 10.12 Warrant to Purchase Common Stock of the Company expiring November 24, 2002(7) 10.13 Securities Purchase Agreement dated as of March 31, 1998 by and among Gothic Energy Corporation, Chesapeake Gothic Corp. and Chesapeake Acquisition Corporation (filed as Exhibit 10.2 to Current Report on Form 8-K dated March 31, 1998)(8) 10.14 Sale and Participation Agreement dated March 31, 1998 between Chesapeake Gothic Corporation, Gothic Energy of Texas, Inc. and Gothic Production Corporation (filed as Exhibit 10.3 to Current Report on Form 8-K dated March 31, 1998)(8) 10.15 Oil and Gas Asset Purchase Agreement dated March 31, 1998 among Chesapeake Gothic Corp., Chesapeake Acquisition Corporation and Gothic Energy Corporation (filed as Exhibit 10.4 to Current Report on Form 8-K dated March 31, 1998)(8) 10.16 Indenture dated as of April 21, 1998 between GPC and The Bank of New York, as Trustee, with respect to the 11-1/8% Senior Secured Notes due 2005(8) 10.17 Registration Rights Agreement dated as of April 21, 1998 by and among GPC, Gothic, Donaldson, Lufkin & Jenrette Securities Corporation and CIBC Oppenheimer Corp. (8) 10.18 Securities Purchase Agreement dated as of April 21, 1997 among Gothic and the Purchasers named therein with respect to 104,000 Units of Securities of Gothic (8) 10.19 Indenture dated as of April 21, 1998 between Gothic and The Bank of New York, as Trustee, with respect to the 14-1/8% Senior Secured Discount Notes due 2006(8) 10.20 Warrant Agreement dated as of April 21, 1998 between Gothic and American Stock Transfer & Trust Company, as Warrant Agent (8) 10.21 Notes Registration Rights Agreement dated as of April 21, 1998 among Gothic and the Purchasers named therein (8) 10.22 Warrant Registration Rights Agreement dated as of April 21, 1998 among Gothic and the Purchasers named therein (8) 10.23 Certificate of Designation for the Senior Redeemable Preferred Stock, Series B (8) 10.24 Warrant to Purchase Common Stock dated April 27, 1998 issued to Chesapeake Gothic Corp.(8) 10.25 Securities Purchase Agreement dated as of March 31, 1998 by and among Gothic Energy Corporation, Chesapeake Gothic Corp. and Chesapeake Acquisition Corporation (9)
-38- 10.26 Sale and Participation Agreement dated March 31, 1998 between Chesapeake Gothic Corporation, Gothic Energy of Texas, Inc. and Gothic Production Corporation (9) 10.27 Oil and Gas Asset Purchase Agreement dated March 31, 1998 among Chesapeake Gothic Corp., Chesapeake Acquisition Corporation and Gothic Energy Corporation (9) 10.28 Option Purchase Agreement dated February 28, 2000 between Gothic Energy Corporation, Gothic Production Corporation and Chesapeake Exploration Limited Partnership. 21.0 Subsidiaries of the registrant: Name State or Jurisdiction of Incorporation - ------------------------- ------------------------------------------------------------------------------------ Gothic Production Oklahoma Corporation 23.0 Consent of PricewaterhouseCoopers LLP 27.0 Financial Data Schedule.
__________________________ * Filed herewith. (1) Filed as an exhibit to Annual Report on Form 10-KSB for the year ended December 31, 1997 (2) Filed as an exhibit to Registration Statement on Form SB-2 (File No. 33- 99190) (3) Filed as an exhibit to Current Report on Form 8-K for May 31, 1995 (4) Filed as an exhibit to Current Report on Form 8-K for September 9, 1997 (5) Filed as an exhibit to Current Report on Form 8-K for February 18,1997 (6) Filed as an exhibit to Current Report on Form 8-K/A for November 25, 1997 (7) Filed as an exhibit to Current Report on Form 8-K/A for January 23, 1998 (8) Filed as an exhibit to Current Report on Form 8-K for April 27,1998. (9) Filed as an exhibit to Current Report on Form 8-K for March 31, 1998. -39- SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. Gothic Energy Corporation By: /s/ Michael K. Paulk ----------------------------- Michael K. Paulk, President 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 Company and in the capacities and on the dates indicated. Signature Title Date - --------- ----- ---- /s/ Michael K. Paulk President (Principal March 27, 2000 - ------------------------- Executive Officer and Director) Michael K. Paulk /s/ Steven P. Ensz Vice-President, Finance and Chief March 27,2000 - ------------------------- Financial Officer (Principal Steven P. Ensz Financial and Accounting Officer) /s/ John J. Fleming Director March 27, 2000 - ------------------------- John J. Fleming /s/ Brian E. Bayley Director March 27, 2000 - ------------------------- Brian E. Bayley -40- INDEX TO FINANCIAL STATEMENTS
Report of Independent Accountants......................................................................... F-2 Consolidated Balance Sheet, December 31, 1999............................................................. F-3 Consolidated Statement of Operations, Years ended December 31, 1998 and 1999.............................. F-4 Consolidated Statement of Stockholders' Equity (Deficit), Years ended December 31, 1998 and 1999.......... F-5 Consolidated Statement of Cash Flows, Years ended December 31, 1998 and 1999.............................. F-6 Notes to Consolidated Financial Statements................................................................ F-7
F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Gothic Energy Corporation In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows present fairly, in all material respects, the financial position of Gothic Energy Corporation and Subsidiary at December 31, 1999, and the results of their operations and their cash flows for the years ended December 31, 1998 and 1999, in conformity with accounting principles generally accepted in the United States. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States which require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring losses from operations and has a working capital and a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. PricewaterhouseCoopers LLP Tulsa, Oklahoma February 21, 2000 F-2 GOTHIC ENERGY CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEET December 31, 1999 (dollars in thousands, except par value)
ASSETS ------ 1999 --------- CURRENT ASSETS: Cash and cash equivalents........................................................... $ 2,583 Natural gas and oil receivables..................................................... 8,163 Receivable from officers and employees.............................................. 77 Other............................................................................... 624 --------- TOTAL CURRENT ASSETS.............................................................. 11,447 PROPERTY AND EQUIPMENT: Natural gas and oil properties on full cost method: Properties being amortized........................................................ 258,818 Unproved properties not subject to amortization................................... 5,473 Equipment, furniture and fixtures................................................... 6,123 Accumulated depreciation, depletion and amortization................................ (54,170) --------- PROPERTY AND EQUIPMENT, NET......................................................... 216,244 OTHER ASSETS, NET.................................................................... 10,706 --------- TOTAL ASSETS...................................................................... $ 238,397 ========= LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT) ---------------------------------------------- CURRENT LIABILITIES: Accounts payable trade.............................................................. $ 4,630 Revenues payable.................................................................... 6,047 Accrued interest.................................................................... 4,357 Other accrued liabilities........................................................... 893 --------- TOTAL CURRENT LIABILITIES......................................................... 15,927 LONG-TERM DEBT, NET.................................................................. 319,857 GAS IMBALANCE LIABILITY.............................................................. 3,648 COMMITMENTS AND CONTINGENCIES (NOTES 1, 2 AND 8) STOCKHOLDERS' EQUITY (DEFICIT): Series B Preferred stock, par value $.05, authorized 165,000 shares; 59,216 shares issued and outstanding............................................................ 45,612 Common stock, par value $.01, authorized 100,000,000 shares; issued and outstanding 18,685,765 shares...................................................... 187 Additional paid in capital.......................................................... 42,987 Accumulated deficit................................................................. (189,821) --------- TOTAL STOCKHOLDERS' EQUITY (DEFICIT).............................................. (101,035) --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT).............................. $ 238,397 =========
See accompanying notes to consolidated financial statements F-3 GOTHIC ENERGY CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENT OF OPERATIONS For The Years Ended December 31, 1998 and 1999 (in thousands, except per share amounts)
1998 1999 --------- -------- REVENUES: Natural gas and oil sales...................................................... $ 50,714 $ 52,967 Well operations................................................................ 2,319 2,657 --------- -------- Total revenues................................................................. 53,033 55,624 COSTS AND EXPENSES: Lease operating expense........................................................ 12,129 9,605 Depletion, depreciation and amortization....................................... 24,001 20,969 General and administrative expense............................................. 3,823 4,675 Investment banking and related fees............................................ - 638 Provision for impairment of natural gas and oil properties..................... 76,000 - --------- -------- Operating income (loss).......................................................... (62,920) 19,737 Interest expense and amortization of debt issuance costs......................... (35,438) (37,988) Interest and other income........................................................ 433 942 Loss on sale of investments...................................................... (305) - --------- -------- LOSS BEFORE EXTRAORDINARY ITEM................................................... (98,230) (17,309) LOSS ON EARLY EXTINGUISHMENT OF DEBT............................................. 31,459 - --------- -------- NET LOSS......................................................................... (129,689) (17,309) PREFERRED DIVIDEND ($125.76 and $120.32 PER PREFERRED SHARE)..................... 5,599 6,820 PREFERRED DIVIDEND--AMORTIZATION OF PREFERRED DISCOUNT........................... 5,095 1,847 --------- -------- NET LOSS AVAILABLE FOR COMMON SHARES............................................. $(140,383) $(25,976) ========= ======== LOSS PER COMMON SHARE BEFORE EXTRAORDINARY ITEM, BASIC AND DILUTED.................................................................... $ (6.70) $ (1.51) ========= ======== NET LOSS PER COMMON SHARE, BASIC AND DILUTED..................................... $ (8.63) $ (1.51) ========= ======== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING....................................... 16,262 17,219 ========= ========
See accompanying notes to consolidated financial statements F-4 GOTHIC ENERGY CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) For the Years Ended December 31, 1998 and 1999 (in thousands, except per share data)
Common Preferred Additional Shares Shares Common Preferred Paid-In Accumulated Outstanding Outstanding Stock Stock Capital Deficit ----------- ----------- ------ --------- ---------- ----------- BALANCE, AT DECEMBER 31, 1997................ 16,262 -- $162 $ -- $36,043 $ (23,462) Issuance of Series A Preferred stock......... -- 37 -- 33,909 (20) -- Warrants issued in connection with Series A Preferred.......................... -- -- -- -- 941 -- Warrants issued in connection with Amoco acquisition...................... -- -- -- -- 1,153 -- Redemption of Series A Preferred............. -- (37) -- (33,909) -- -- Issuance of Series B Preferred stock......... -- 50 -- 31,527 -- -- Warrants issued in connection with Series B Preferred..................... -- -- -- -- 4,879 -- Preferred Stock dividend - Series A.......... -- -- -- -- -- (1,412) Preferred dividend - amortization of discount - Series A...................... -- -- -- -- -- (3,864) Preferred Stock dividend - Series B.......... -- 4 -- 4,187 -- (4,187) Preferred dividend - amortization of discount - Series B...................... -- -- -- 1,231 -- (1,231) Net loss..................................... -- -- -- -- -- (129,689) Realized loss on available for sale investments................................. -- -- -- -- -- -- Advance to officer........................... -- -- -- -- -- -- ----------- ----------- ------ --------- ---------- ----------- BALANCE, AT DECEMBER 31, 1998................ 16,262 54 162 36,945 42,996 (163,845) Preferred Stock dividend - Series B.......... -- 6 -- 6,820 -- (6,820) Preferred dividend - amortization of discount - Series B....................... -- -- -- 1,847 -- (1,847) Issuance of common stock as employee severance................................... 30 -- -- -- 16 -- Issuance of common stock on warrant conversion........................... 2,394 -- 25 -- (25) -- Forgiveness of officer note receivable....... -- -- -- -- -- -- Net loss..................................... -- -- -- -- -- (17,309) ----------- ----------- ------ --------- ---------- ----------- BALANCE, AT DECEMBER 31, 1999................ 18,686 60 $ 187 $ 45,612 $ 42,987 $ (189,821) =========== =========== ====== ========= ========== =========== Accumulated Other Total Comprehensive Note Stockholders' Income Receivable Equity ------------- ---------- ------------- BALANCE, AT DECEMBER 31, 1997................ $ (121) $ (169) $ 12,453 Issuance of Series A Preferred stock......... -- -- 33,889 Warrants issued in connection with Series A Preferred.......................... -- -- 941 Warrants issued in connection with Amoco acquisition...................... -- -- 1,153 Redemption of Series A Preferred............. -- -- (33,909) Issuance of Series B Preferred stock......... -- -- 31,527 Warrants issued in connection with Series B Preferred..................... -- -- 4,879 Preferred Stock dividend - Series A.......... -- -- (1,412) Preferred dividend - amortization of discount - Series A...................... -- -- (3,864) Preferred Stock dividend - Series B.......... -- -- -- Preferred dividend - amortization of discount - Series B...................... -- -- -- Net loss..................................... -- -- (129,689) Realized loss on available for sale investments................................. 121 -- 121 Advance to officer........................... -- (10) (10) ------------- ---------- ------------- BALANCE, AT DECEMBER 31, 1998................ -- (179) (83,921) Preferred Stock dividend - Series B.......... -- -- -- Preferred dividend - amortization of discount - Series B....................... -- -- -- Issuance of common stock as employee severance................................... -- -- 16 Issuance of common stock on warrant conversion........................... -- -- -- Forgiveness of officer note receivable....... -- 179 179 Net loss..................................... -- -- (17,309) ------------- ---------- ------------- BALANCE, AT DECEMBER 31, 1999................ $ -- $ -- $ (101,035) ============= ========== =============
See accompanying notes to consolidated financial statements F-5 GOTHIC ENERGY CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENT OF CASH FLOWS For The Years Ended December 31, 1998 and 1999 (in thousands)
1998 1999 --------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss...................................................................... $(129,689) $(17,309) ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Depreciation, depletion and amortization...................................... 24,001 20,969 Amortization of discount and loan costs....................................... 1,994 1,769 Provision for impairment of natural gas and oil properties.................... 76,000 - Accretion of interest on discount notes....................................... 6,023 9,678 Loss on early extinguishment of debt.......................................... 31,459 - Other......................................................................... - 179 CHANGES IN ASSETS AND LIABILITIES: Increase in accounts receivable............................................... (4,009) (949) Increase in other current assets.............................................. (143) (403) Increase in accounts and revenues payable..................................... 5,605 1,438 Increase (decrease) in gas imbalance and other liabilities.................... 65 (2,532) Increase in accrued liabilities............................................... 411 639 Decrease (increase) in other assets........................................... (150) 228 --------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES....................................... 11,567 13,707 NET CASH USED BY INVESTING ACTIVITIES: Collection of note receivable from officer and director....................... 167 - Purchase of available-for-sale investments.................................... (462) - Proceeds from sale of investments............................................. 1,359 - Proceeds from sale of property and equipment.................................. 44,678 2,228 Purchase of property and equipment............................................ (218,738) (3,413) Property development costs.................................................... (18,379) (21,056) --------- -------- NET CASH USED BY INVESTING ACTIVITIES........................................... (191,375) (22,241) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from short-term borrowings........................................... 60,000 - Payments of short-term borrowings............................................. (60,000) - Proceeds from long-term borrowings............................................ 431,290 31,000 Payments of long-term borrowings.............................................. (259,884) (22,000) Redemption of preferred stock, net............................................ (40,809) - Proceeds from sale of preferred stock, net.................................... 73,475 - Payment of loan and offering fees............................................. (38,535) (172) Other......................................................................... (162) - --------- -------- NET CASH PROVIDED BY FINANCING ACTIVITIES....................................... 165,375 8,828 NET CHANGE IN CASH AND CASH EQUIVALENTS......................................... (14,433) 294 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.................................. 16,722 2,289 --------- -------- CASH AND CASH EQUIVALENTS, END OF PERIOD........................................ $ 2,289 $ 2,583 ========= ======== SUPPLEMENTAL DISCLOSURE OF INTEREST PAID........................................ $ 23,063 $ 26,541 ========= ========
See accompanying notes to consolidated financial statements F-6 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. GENERAL AND ACCOUNTING POLICIES Organization and Nature of Operations--The consolidated financial statements include the accounts of Gothic Energy Corporation, ("Gothic Energy"), a "holding company", and its subsidiary, Gothic Production Corporation ("Production Corp.") since its formation in April of 1998, (collectively referred to as the "Company"). All significant intercompany balances and transactions have been eliminated. Production Corp., the wholly owned subsidiary of Gothic Energy, is an independent energy company primarily engaged in the business of acquiring, developing and exploiting natural gas and oil reserves in Oklahoma, Texas, New Mexico and Kansas. Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In addition, accrued and deferred lease operating expenses, gas imbalance liabilities, natural gas and oil reserves (see Note 13) and the tax valuation allowance (see Note 7) also include significant estimates which, in the near term, could materially differ from the amounts ultimately realized or incurred. Cash Equivalents--Cash equivalents include cash on hand, amounts held in banks, money market funds and other highly liquid investments with a maturity of three months or less at date of purchase. Concentration of Credit Risk--Financial instruments which potentially subject Production Corp. to concentrations of credit risk consist principally of derivative contracts (see "Hedging Activities" below), cash, cash equivalents and trade receivables. Production Corp.'s accounts receivable are primarily from the purchasers (See Note 10--Major Customers) of natural gas and oil products and exploration and production companies which own interests in properties operated by Production Corp. The industry concentration has the potential to impact Production Corp's overall exposure to credit risk, either positively or negatively, in that the customers may be similarly affected by changes in economic, industry or other conditions. Production Corp. generally does not require collateral from customers and Production Corp. had an account receivable from one customer of approximately $2,300,000 at December 31, 1999. The cash and cash equivalents are with major banks or institutions with high credit ratings. At December 31, 1999, Production Corp. had a concentration of cash of $5,758,000 with one bank, which was in excess of federally insured limits. Fair Value of Financial Instruments--The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments". The estimated fair value amounts have been determined by the Company using available market information. Considerable judgment is required in interpreting market data to develop the estimates of fair value. The use of different market assumptions or valuation methodologies may have a material effect on the estimated fair value amounts. The carrying values of items comprising current assets and current liabilities approximate fair values due to the short-term maturities of these instruments. The Company estimates the fair value of Production Corp's 11 1/8% Senior Secured Notes and Gothic Energy's 14 1/8% Senior Secured Discount Notes using estimated market prices. The Company's carrying amount for such debt at December 31, 1999, was $235,000,000 and $75,857,000, respectively, compared to an approximate fair value of $197,400,000 and $35,880,000, respectively. The carrying value of other long-term debt approximates its fair value as interest rates are primarily variable, based on prevailing market rates. Hedging Activities - Production Corp. has involvement with derivative financial instruments, as defined in Statement of Financial Accounting Standards No. 119 "Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments", and does not use them for trading purposes. Production Corp's objective is to hedge F-7 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) a portion of its exposure to price volatility from producing natural gas. These arrangements may expose Production Corp. to credit risk from its counterparty. In April 1999, Production Corp. entered into a hedge agreement in the form of a costless collar with respect to the production of 50,000 MMBTU of natural gas per day during the period of May through October 1999. The costless collar placed a floor of $1.80 per MMBTU and a ceiling of $2.26 per MMBTU for the effective price of natural gas received by Production Corp. Additionally, in July 1999 Production Corp. entered into a similar costless collar agreement with respect to the production of 50,000 MMBTU per day during the period of November 1999 through March 2000 which places a floor of $2.30 per MMBTU and a ceiling of $3.03 per MMBTU. The collars represent approximately 70% of Production Corp's current daily natural gas production. Collar arrangements limit the benefits Production Corp. will realize if actual prices rise above the ceiling price. These arrangements provide for Production Corp. to exchange a floating market price for a fixed range contract price. Payments are made by Production Corp. when the floating price exceeds the fixed range for a contract month and payments are received when the fixed range price exceeds the floating price. The commodity reference price for both contracts is the Panhandle Eastern Pipeline Company, Texas, Oklahoma Mainline Index. In August 1999, Production Corp. entered into a hedge agreement covering 10,000 barrels of oil per month at a fixed price of $20.10 per barrel. This hedge is in effect from September 1999 through August 2000. Gains and losses on such natural gas and oil contracts are reflected in revenues when the natural gas or crude oil is sold. If the open gas collar noted above had been settled on December 31, 1999, Production Corp. would have recognized a gain of $769,000. If the open crude oil hedge noted above had been settled on December 31, 1999, Production Corp. would have recognized a loss of $282,000. Additionally, in January 2000, Production Corp. entered into a hedge agreement covering 50,000 MMBTU per day at a fixed price of $2.435 per MMBTU. This hedge is in effect from April 2000 through October 2000. In February 2000, Production Corp. entered into a hedge agreement covering 20,000 MMBTU per day at a fixed price of $2.535 per MMBTU for April 2000 and $2.555 per MMBTU for May 2000. This hedge is in effect for the months of April and May 2000. The commodity reference price for both contracts is the Panhandle Eastern Pipeline Company, Texas, Oklahoma Mainline Index. Natural Gas and Oil Properties--Production Corp. accounts for its natural gas and oil exploration and development activities using the full cost method of accounting prescribed by the Securities and Exchange Commission (''SEC''). Accordingly, all productive and non-productive costs incurred in connection with the acquisition, exploration and development of natural gas and oil reserves are capitalized and depleted using the units-of-production method based on proved natural gas and oil reserves. Production Corp. capitalizes costs including salaries and related fringe benefits of employees and/or consultants directly engaged in the acquisition, exploration and development of natural gas and oil properties, as well as other directly identifiable general and administrative costs associated with such activities. Such costs do not include any costs related to production, general corporate overhead, or similar activities. Production Corp.'s natural gas and oil reserves are estimated annually by independent petroleum engineers. Production Corp's calculation of depreciation, depletion and amortization ("DD&A") includes estimated future expenditures to be incurred in developing proved reserves and estimated dismantlement and abandonment costs, net of salvage values. The average composite rate used for DD&A of natural gas and oil properties was $0.91 and $0.77 per Mcfe in 1998 and 1999, respectively. DD&A of natural gas and oil properties amounted to $23,600,000 and $20,444,000 in 1998 and 1999, respectively. In the event the unamortized cost of natural gas and oil properties being amortized exceeds the full cost ceiling as defined by the SEC, the excess is charged to expense in the period during which such excess occurs. The full cost ceiling is based principally on the estimated future discounted net cash flows from Production Corp's natural gas and oil properties. Production Corp. recorded a $76,000,000 provision for impairment of natural gas and oil properties during the year ended December 31, 1998. No such provision was recorded in 1999. As discussed in Note 13, estimates of natural gas and oil reserves are imprecise. Changes in the estimates or declines in natural gas and oil prices could cause Production Corp. in the near-term to reduce the carrying value of its natural gas and oil properties. F-8 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Sales and abandonments of properties are accounted for as adjustments of capitalized costs with no gain or loss recognized unless a significant amount of reserves is involved. Since all of Production Corp's natural gas and oil properties are located in the United States, a single cost center is used. Equipment, Furniture and Fixtures--Equipment, furniture and fixtures are stated at cost and are depreciated on the straight-line method over their estimated useful lives which range from three to seven years. Debt Issuance Costs--Debt issuance costs, including the original issue discount, associated with Production Corp's 11 1/8% Senior Secured Notes Due 2005 and Gothic Energy's 14 1/8% Senior Secured Discount Notes Due 2006, are amortized and included in interest expense using the effective interest method over the term of the notes. The unamortized portion of debt issuance costs associated with Production Corp's Credit Facility is included in other assets and amortized and included in interest expense using the straight-line method over the term of the Facility. Amortization of debt issuance costs for the years ended December 31, 1998 and 1999 amounted to $1,994,000 and $1,769,000, respectively. Natural Gas and Oil Sales and Natural Gas Balancing--Production Corp. uses the sales method for recording natural gas sales. Production Corp's oil and condensate production is sold, title passed, and revenue recognized at or near its wells under short-term purchase contracts at prevailing prices in accordance with arrangements which are customary in the oil industry. Sales of gas applicable to Production Corp's interest in producing natural gas and oil leases are recorded as revenues when the gas is metered and title transferred pursuant to the gas sales contracts covering its interest in gas reserves. During such times as Production Corp's sales of gas exceed its pro rata ownership in a well, such sales are recorded as revenues unless total sales from the well have exceeded Production Corp's share of estimated total gas reserves underlying the property at which time such excess is recorded as a gas imbalance liability. At December 31, 1999, total sales exceeded Production Corp's share of estimated total gas reserves on 32 wells by $2,752,000 (1,449,000 Mcf), based on the year- end "spot market" price of natural gas. The gas imbalance liability has been classified in the balance sheet as non-current, as Production Corp. does not expect to settle the liability during the next twelve months. Production Corp. has recorded deferred charges for estimated lease operating expenses incurred in connection with its underproduced gas imbalance position. At December 31, 1999, cumulative total gas sales volumes for underproduced wells were less than Production Corp's pro-rata share of total gas production from these wells by 4,435,000 Mcf, resulting in prepaid lease operating expenses of $1,464,000, which are included in other assets in the accompanying balance sheet. The rate used to calculate the deferred charge is the average annual production costs per Mcf. Production Corp. has recorded accrued charges for estimated lease operating expenses incurred in connection with its overproduced gas imbalance position. At December 31, 1999, cumulative total gas sales volumes for overproduced wells exceeded Production Corp's pro-rata share of total gas production from these wells by 2,717,000 Mcf, resulting in accrued lease operating expenses of $897,000, which are included in the gas imbalance liability in the accompanying balance sheet. The rate used to calculate the accrued liability is the average annual production costs per Mcf. Income Taxes--The Company applies the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). Under SFAS No. 109, deferred tax liabilities or assets arise from the temporary differences between the tax basis of assets and liabilities, and their basis for financial reporting, and are subject to tests of realizability in the case of deferred tax assets. A valuation allowance is provided for deferred tax assets to the extent realization is not judged to be more likely than not. Loss per Common Share - Loss per common share before extraordinary item and net loss per common share are computed in accordance with Statement of Financial Accounting Standards No. 128 ("FAS 128"). Presented on the Consolidated Statement of Operations is a reconciliation of loss available to common shareholders. There is no difference between actual weighted average shares outstanding, which are used in computing basic loss per share and diluted weighted average shares, which are used in computing diluted loss per share because the effect of outstanding options and warrants would be antidilutive. Warrants and options to purchase approximately F-9 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 20,775,000 and 19,940,000 shares were outstanding as of December 31, 1998 and 1999 and were excluded from the computation of diluted loss per share due to their anti-dilutive impact. Stock Based Compensation--The Company applies Accounting Principles Board Opinion No. 25 in accounting for its stock option plans. Under this standard, no compensation expense is recognized for grants of options which include an exercise price equal to or greater than the market price of the stock on the date of grant. Accordingly, based on the Company's grants in 1998 and 1999, no compensation expense has been recognized. Recently issued Financial Accounting Pronouncements - In June 1998, the FASB issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities". FAS 133, as amended, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000 (January 1, 2001 for the Company). FAS 133 standardizes the accounting for derivative instruments by requiring that all derivatives be recognized as assets and liabilities and measured at fair value. Upon the Statement's initial application, all derivatives are required to be recognized in the statement of financial position as either assets or liabilities and measured at fair value. In addition, all existing hedging relationships must be designated, reassessed, documented and the accounting conformed to the provisions of FAS 133. Production Corp. is evaluating the impact on its financial position and results of operations of adopting FAS 133. NOTE 2. GOING CONCERN The Company incurred a net loss of $129,689,000 in 1998, due principally to a decline in commodity prices during that year. This commodity price decline required Production Corp. to write down the carrying value of its natural gas and oil properties by $76,000,000. More significantly, the commodity price decline continued to affect the ongoing revenues and cash flows of Production Corp. during early 1999, resulting in a net loss of $17,309,000 for the year ended December 31, 1999. It is the intention of Production Corp. to continue to spend available cash flow (EBITDA less cash interest payable on Senior Secured Notes) on the development of natural gas and oil properties. With the continued volatility of commodity prices, hedging programs will continue to be utilized by Production Corp. This should help to stabilize cash flow, which is necessary to ensure Production Corp's ability to generate sufficient reserves to replace current production, but limits the benefit of increases in commodity prices above the hedge price. Should commodity prices fall below current levels, Production Corp. would be limited in its ability to increase production and related cash flow to a level sufficient to meet its ongoing financial covenants under its Credit Facility. The price of natural gas and oil has recently been increasing, but there is no assurance that it will continue to increase or remain at the current level. Further, the borrowing base amount available under Production Corp's Credit Facility was redetermined in October 1999 and was reduced to $20,000,000. The next scheduled redetermination date is April 1, 2000 and there is no assurance that Production Corp's lender will maintain the available amount at this current level. NOTE 3. SUBSEQUENT EVENTS On February 29, 2000, the Company and Chesapeake Energy Corporation ("Chesapeake") entered into agreements which will substantially revise the Production Corp./Chesapeake Joint Venture ("JV") Development Agreement originally entered into on March 31, 1998, and will provide for Gothic Energy to redeem, without any additional consideration, its Series B Preferred Stock and Common Stock held by Chesapeake, (the "Securities"), as part of a plan of restructuring. The redemption of the Securities and various revisions to the JV are subject to material conditions including approval by certain lenders of the Company. The revised agreement and Securities redemption include the following significant terms: . Extension of the JV for three years with an immediate exclusion of the state of Texas south of latitude 34o North from the provisions of the JV. . Granting a right of first refusal to Chesapeake on any property dispositions made by Production Corp. F-10 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) . Segregation of first development rights, with Production Corp. having the first right to future drilling, completion and operating activities in its core operating area in the Watonga-Chickasha Trend and also to its undeveloped acreage in Potato Hills, Carter Knox, Cottonwood Creek, Oklahoma and Pecos Slope, New Mexico. Chesapeake will have first right in all other areas containing JV acreage. Additionally, Chesapeake will assume operations of 28 wells which were drilled in the JV by Chesapeake but had been operated since first production by Production Corp. . A permanent assignment to Chesapeake of the undeveloped leasehold interest originally assigned to Chesapeake on March 31, 1998 that was subject to reassignment to Production Corp. by Chesapeake in 2003. . A permanent assignment to Chesapeake of Production Corp's remaining JV undeveloped leasehold in 16 counties located in the Anadarko and Arkoma basins in Oklahoma and Kansas. The acreage in this assignment excludes 15 proved undeveloped locations retained by Production Corp. Production Corp's remaining 50% interest in undeveloped acreage outside the 16 county areas will not be conveyed to Chesapeake, and specifically, undeveloped acreage in Watonga-Chickasha Trend and the Cement Field is not being conveyed. . Chesapeake will have the right to acquire all of Production Corp's participation in wells in the 16 county area (excluding the participation in the 15 proved undeveloped locations retained by Production Corp.) that are drilled between February 1, 2000 and the closing of this transaction. Chesapeake's cost to acquire these wells will be the reimbursement of Production Corp's unrecovered cost of drilling, completing and operating the wells. . Redemption by Gothic Energy of its entire issue of Series B Preferred Stock having a liquidation preference of approximately $61,000,000 and of 2,394,125 shares of Gothic Energy's common stock. NOTE 4. FINANCING ACTIVITIES Credit Facility On April 27, 1998, Production Corp., with Gothic Energy as guarantor, entered into a credit facility, with Bank One (the "Credit Facility"). The Credit Facility consists of a revolving line of credit, with an initial Borrowing Base of $25,000,000. Borrowings are limited to being available for the acquisition and development of natural gas and oil properties, letters of credit and general corporate purposes. The Borrowing Base will be redetermined at least semi-annually. Upon completion of the October 1, 1999 redetermination, the borrowing base was reduced to $20,000,000. The principal is due at maturity, April 30, 2001. Interest is payable monthly calculated at the Bank One Base Rate, as determined from time to time by Bank One. Production Corp. may elect to calculate interest under a London Interbank Offered Rate ("LIBOR") plus 1.5% (or up to 2.0% in the event the loan balance is greater than 75% of the Borrowing Base). Production Corp. is required to pay a commitment fee on the unused portion of the Borrowing Base equal to 1/2 of 1% per annum. Under the Credit Facility, Bank One holds first priority liens on substantially all of the natural gas and oil properties of Production Corp., whether currently owned or hereafter acquired. As of December 31, 1999, Production Corp. had $9,000,000 outstanding under the Credit Facility. The Credit Facility requires, among other things, semi-annual engineering reports covering oil and natural gas reserves on the basis of which semi-annual and other redeterminations of the borrowing base and monthly commitment reduction are made. The Credit Facility, as amended on May 7, 1999, also includes various affirmative and negative covenants, including, among others, (i) prohibitions against additional indebtedness unless approved by the lenders, subject to certain exceptions, (ii) prohibitions against the creation of liens on the assets of Production Corp., subject to certain exceptions, (iii) prohibitions against cash dividends, (iv) prohibitions against hedging positions unless consented to by Bank One, (v) prohibitions on asset sales, subject to certain exceptions, (vi) restrictions on mergers or consolidations, (vii) a requirement to maintain a ratio of current assets to current liabilities of 1.0 to 1.0, and (viii) a minimum interest coverage ratio of not less than 1.25 to 1.0 for the quarter ended June 30, 1999, 1.5 to 1.0 for the quarter ended September 30, 1999, 1.75 to 1.0 for the quarter ended December 31, 1999 and F-11 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 2.0 to 1.0 for each remaining quarter starting with the quarter ending March 31, 2000. The Credit Facility includes covenants prohibiting distributions, loans or advances to third parties, subject to certain exceptions. If Production Corp. is required to purchase or redeem any portion of the 11 1/8% Senior Secured Notes, or if any portion of the 11 1/8% Senior Secured Notes become due, the Borrowing Base is subject to reduction. Production Corp. is required to escrow interest payments due on the Senior Secured Notes at such times as its borrowings under the Credit Facility equal or exceed 75% of the Borrowing Base. Events of default include the non-payment of principal, interest or fees, a default under other outstanding indebtedness, a breach of the representations and warranties contained in the loan agreement, material judgements, bankruptcy or insolvency, a default under certain covenants not cured within a grace period, and a change in the management or control of the Company. 11-1/8% Senior Secured Notes Due 2005 The 11-1/8% Senior Secured Notes Due 2005 ("Senior Secured Notes") issued by Production Corp. are fully and unconditionally guaranteed by Gothic Energy. The aggregate principal amount of Senior Secured Notes outstanding is $235,000,000 issued under an indenture dated April 21, 1998 (the "Senior Note Indenture"). The Senior Secured Notes bear interest at 11-1/8% per annum payable semi-annually in cash in arrears on May 1 and November 1 of each year commencing November 1, 1998. The Senior Secured Notes mature on May 1, 2005. All of the obligations of Production Corp. under the Senior Secured Notes are collateralized by a second priority lien on substantially all of Production Corp's natural gas and oil properties, subject to certain permitted liens. Production Corp. may, at its option, at any time on or after May 1, 2002, redeem all or any portion of the Senior Secured Notes at redemption prices decreasing from 105.563%, if redeemed in the 12-month period beginning May 1, 2002, to 100.00% if redeemed in the 12-month period beginning May 1, 2004 and thereafter plus, in each case, accrued and unpaid interest thereon. Notwithstanding the foregoing, at any time prior to May 1, 2002, Production Corp. may, at its option, redeem all or any portion of the Senior Secured Notes at the Make-Whole Price (as defined in the Senior Note Indenture) plus accrued or unpaid interest to the date of redemption. In addition, in the event Production Corp. consummates one or more Equity Offerings (as defined in the Senior Note Indenture) on or prior to May 1, 2001, Production Corp., at its option, may redeem up to 33-1/3% of the aggregate principal amount of the Senior Secured Notes with all or a portion of the aggregate net proceeds received by Production Corp. from such Equity Offering or Equity Offerings at a redemption price of 111.125% of the aggregate principal amount of the Senior Secured Notes so redeemed, plus accrued and unpaid interest thereon to the redemption date; provided, however, that following such redemption, at least 66-2/3% of the original aggregate principal amount of the Senior Secured Notes remains outstanding. Following the occurrence of any Change of Control (as defined in the Senior Note Indenture), Production Corp. will offer to repurchase all outstanding Senior Secured Notes at a purchase price equal to 101% of the aggregate principal amount of the Senior Secured Notes, plus accrued and unpaid interest to the date of repurchase. The Senior Note Indenture under which the Senior Secured Notes were issued contains certain covenants limiting Production Corp. with respect to or imposing restrictions on the incurrence of additional indebtedness, the payment of dividends, distributions and other restricted payments, the sale of assets, creating, assuming or permitting to exist any liens (with certain exceptions) on its assets, mergers and consolidations (subject to meeting certain conditions), sale leaseback transactions, and transactions with affiliates, among other covenants. Events of default under the Senior Note Indenture include the failure to pay any payment of principal or premium when due, failure to pay for 30 days any payment of interest when due, failure to make any optional redemption payment when due, failure to perform any covenants relating to mergers or consolidations, failure to perform any other covenant or agreement not remedied within 30 days of notice from the Trustee under the Senior Note Indenture or the holders of 25% in principal amount of the Senior Secured Notes then outstanding, defaults under other indebtedness of Production Corp. or Gothic Energy causing the acceleration of the due date of such indebtedness having an outstanding principal amount of $10,000,000 or more, the failure of Production Company to be a wholly owned subsidiary of Gothic Energy, and certain other bankruptcy and other court proceedings, among other matters. F-12 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 14 1/8% Senior Secured Discount Notes Due 2006 The 14 1/8% Senior Secured Discount Notes Due 2006 (the "Discount Notes") were issued by Gothic Energy under an indenture (the "Discount Note Indenture") dated April 21, 1998 in such aggregate principal amount and at such rate of interest as generated gross proceeds of $60,155,000. Gothic Energy also issued seven-year warrants to purchase, at an exercise price of $2.40 per share, 825,000 shares of Gothic Energy's Common Stock with the Discount Notes. The estimated fair value of such warrants was approximately $554,000 on the date of issuance. The Discount Notes were issued at a substantial discount from their principal amount and accrete at a rate per annum of 14 1/8%, compounded semi- annually, to an aggregate principal amount of $104,000,000 at May 1, 2002. Thereafter, the Discount Notes accrue interest at the rate of 14 1/8% per annum, payable in cash semi-annually in arrears on May 1 and November 1 of each year, commencing November 1, 2002. The Discount Notes mature on May 1, 2006 and are collateralized by a first priority lien against the outstanding shares of capital stock of Production Corp. The carrying amount of the Discount Notes as of December 31, 1999 was $75,857,000. Gothic Energy may, at its option, at any time on or after May 1, 2003, redeem all or any portion of the Discount Notes at redemption prices decreasing from 107.063% if redeemed in the 12-month period beginning May 1, 2003 to 100.00% if redeemed in the 12-month period beginning May 1, 2005 and thereafter plus, in each case, accrued and unpaid interest thereon. Notwithstanding the foregoing, at any time prior to May 1, 2003, Gothic Energy may, at its option, redeem all or any portion of the Discount Notes at the Make-Whole Price (as defined in the Discount Note Indenture) plus accrued or unpaid interest to the date of redemption. In addition, in the event Gothic Energy consummates one or more Equity Offerings (as defined in the Discount Note Indenture) on or prior to May 1, 2001, Gothic Energy, at its option, may redeem up to 33-1/3% of the Accreted Value (as defined in the Discount Note Indenture) of the Discount Notes with all or a portion of the aggregate net proceeds received by Gothic Energy from such Equity Offering or Equity Offerings at a redemption price of 114.125% of the Accreted Value of the Discount Notes so redeemed, plus accrued and unpaid interest thereon to the redemption date; provided, however, that following such redemption, at least 66-2/3% of the Accreted Value of the Discount Notes remains outstanding. Following the occurrence of any Change of Control (as defined in the Discount Note Indenture), Gothic Energy will offer to repurchase all outstanding Discount Notes at a purchase price equal to, prior to May 1, 2002, 101% of the Accreted Value of the Discount Notes on the date of repurchase, plus accrued and unpaid interest to the date of repurchase and thereafter, 101% of the aggregate principal amount of the Discount Notes plus accrued and unpaid interest and Liquidated Damages, if any, to the date of repurchase. The Discount Note Indenture under which the Discount Notes were issued contains certain covenants limiting Gothic Energy with respect to or imposing restrictions on the incurrence of additional indebtedness, the payment of dividends, distributions and other restricted payments, the sale of assets, creating, assuming or permitting to exist any liens (with certain exceptions) on its assets, mergers and consolidations (subject to meeting certain conditions), sale leaseback transactions, and transactions with affiliates, among other covenants. Events of default under the Discount Note Indenture include the failure to pay any payment of principal or premium when due, failure to pay for 30 days any payment of interest when due, failure to make any optional redemption payment when due, failure to perform any covenants relating to mergers or consolidations, failure to perform any other covenant or agreement not remedied within 30 days of notice from the Trustee under the Discount Note Indenture or the holders of 25% in principal amount of the Discount Notes then outstanding, defaults under other indebtedness of Gothic Energy causing the acceleration of the due date of indebtedness having an outstanding principal amount of $10,000,000 or more, the failure of Production Corp. to be a wholly owned subsidiary of Gothic Energy, and certain other bankruptcy and other court proceedings, among other matters. NOTE 5. STOCKHOLDERS' EQUITY In January 1999, Gothic Energy issued 30,000 shares of its common stock as part of a severance package to a former employee. On August 17, 1999, Chesapeake Energy Corporation fully exercised the common stock purchase warrant issued to it in April 1998 and purchased 2,394,125 shares of Gothic Energy's common stock. The warrant had been issued to Chesapeake as part of the transaction involving the sale to Chesapeake of shares of F-13 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Gothic Energy's Series B Senior Redeemable Preferred Stock, a 50% interest in Production Corp's Arkoma basin natural gas and oil properties and a 50% interest in substantially all of Production Corp's undeveloped acreage. The shares were issued pursuant to the cashless exercise provisions of the warrant that permitted Chesapeake to surrender the right to exercise the warrant for a number of shares of Gothic Energy's common stock having a market value equivalent to the total exercise price. The total exercise price was $23,941.25 or $0.01 per share. An aggregate of 45,121 warrants were surrendered in payment of the total exercise price. The shares of common stock were issued pursuant to the exemption from the registration requirements of the Securities Act of 1933, as amended, afforded by section 4 (2) thereof. Preferred Stock Offering Series B Preferred Stock and Warrant. On April 27, 1998, as part of the Recapitalization, Gothic Energy issued 50,000 shares of Series B Preferred Stock with an aggregate liquidation preference of $50,000,000 and the warrant to purchase 2,439,246 shares of Gothic Energy's Common Stock, discussed above. The estimated fair value of such warrant was $4,879,000 on the date of issuance. The Series B Preferred Stock, with respect to dividend rights and rights on liquidation, winding-up and dissolution, ranks senior to all classes of Common Stock of Gothic Energy and senior to all other classes or series of any class of preferred stock. Holders of the Series B Preferred Stock are entitled to receive dividends payable at a rate per annum of 12% of the aggregate Liquidation Preference of the Series B Preferred Stock payable in additional shares of Series B Preferred Stock; provided that after April 1, 2000, at Gothic Energy's option, it may pay the dividends in cash. Dividends are cumulative and will accrue from the date of issuance and are payable quarterly in arrears. At any time prior to April 30, 2000, the Series B Preferred Stock may be redeemed at the option of Gothic Energy in whole or in part, at 105% of the Liquidation Preference payable in cash out of the net proceeds from a public or private offering of any equity security, plus accrued and unpaid dividends (whether or not declared), which shall also be paid in cash. At any time on or after April 30, 2000, the Series B Preferred Stock may be redeemed at the option of Gothic Energy in whole or in part, in cash at a redemption price equal to the Liquidation Preference. Gothic Energy is required to redeem the Series B Preferred Stock on June 30, 2008 at a redemption price equal to the Liquidation Preference payable in cash or, at the option of Gothic Energy, in shares of Common Stock valued at the fair market value at the date of such redemption. Except as required by Oklahoma law, the holders of Series B Preferred Stock are not entitled to vote on any matters submitted to a vote of the stockholders of Gothic Energy. The Series B Preferred Stock is convertible at the option of the holders on or after April 30, 2000 into the number of fully paid and non-assessable shares of Common Stock determined by dividing the Liquidation Preference by the higher of (i) $2.04167 or (ii) the fair market value on the date the Series B Preferred Stock is converted. Notwithstanding the foregoing, no holder or group shall be able to convert any shares of Series B Preferred Stock to the extent that the conversion of such shares would cause such holder or group to own more than 19.9% of the outstanding Common Stock of Gothic Energy. (See Note 3) Other Warrants In connection with past financing arrangements and as compensation for consulting and professional services, Gothic Energy has issued other warrants to purchase its common stock. F-14 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) A summary of the status of Gothic Energy's warrants as of December 31, 1997, 1998 and 1999, and changes during the years ended December 31, 1998 and 1999 is presented below:
Warrants Outstanding Warrants Exercisable ---------------------------- ------------------------- Weighted Weighted Average Number Average Number Exercise Outstanding Price Exercisable Price ----------- --------- ----------- ---------- Balance at December 31, 1997 11,404,531 $2.54 11,404,531 $2.54 Warrants granted 5,940,024 1.06 ---------- Balance at December 31, 1998 17,344,555 $2.00 17,344,555 $2.00 Warrants exercised/expired (2,639,246) (.20) ---------- Balance at December 31, 1999 14,705,309 $2.33 14,705,309 $2.33 ==========
The following table summarizes information about Gothic Energy's warrants, which were outstanding, and those which were exercisable, as of December 31, 1999:
Warrants Outstanding Warrants Exercisable -------------------- ----------------------- Weighted Weighted Weighted Price Number Average Average Number Average Range Outstanding Life Price Exercisable Price ------------ ----------- --------- -------- ----------- ---------- $.34 - $3.00 14,705,309 2.0 years $2.33 14,705,309 $ 2.33
NOTE 6. STOCK OPTIONS Incentive Stock Option Plan--Gothic Energy has an incentive stock option and non-statutory option plan (the ''Plan''), which provides for the issuance of options to purchase up to 2,500,000 shares of Common Stock to key employees and Directors. The incentive stock options granted under the Plan are generally exercisable for a period of ten years from the date of the grant, except that the term of an incentive stock option granted under the Plan to a stockholder owning more than 10% of the outstanding common stock must not exceed five years and the exercise price of an incentive stock option granted to such a stockholder must not be less than 110% of the fair market value of the common stock on the date of grant. The exercise price of a non-qualified option granted under the Plan may not be less than 40% of the fair market value of the common stock at the time the option is granted. As of December 31, 1998 and 1999, options to purchase 2,095,000 and 2,500,000 shares of common stock, respectively, had been issued under the Plan. Half of the options are exercisable after the completion of one year of future service as an employee or director with the remaining options being exercisable upon completion of the second year of future service. No non-qualified options have been issued under the Plan. Omnibus Incentive Plan--On August 13, 1996 at the Annual Shareholders' Meeting, the shareholders approved the 1996 Omnibus Incentive Plan and the 1996 Non-Employees Stock Option Plan. The 1996 Omnibus Incentive Plan provides for compensatory awards of up to an aggregate of 1,000,000 shares of Common Stock of Gothic Energy to officers, directors and certain other key employees. Awards may be granted for no consideration and consist of stock options, stock awards, stock appreciation rights, dividend equivalents, other stock-based awards (such as phantom stock) and performance awards consisting of any combination of the foregoing. Generally, options will be granted at an exercise price equal to the lower of (i) 100% of the fair market value of the shares of Common Stock on the date of grant or (ii) 85% of the fair market value of the shares of Common Stock on the date of exercise. Each option will be exercisable for the period or periods specified in the option agreement, which will generally not exceed 10 years from the date of grant. As of December 31, 1999, options to purchase 1,000,000 shares of common stock had been issued under the Omnibus Incentive Plan. Non-Employee Stock Option Plan--The 1996 Non-Employee Stock Option Plan provides a means by which non-employee Directors of the Company and consultants to the Company can be given an opportunity to purchase stock in Gothic Energy. The Plan provides that a total of 1,000,000 shares of Gothic Energy's Common F-15 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Stock may be issued pursuant to options granted under the Non-Employee Plan, subject to certain adjustments. The exercise price for each option granted under the Non-Employee Plan will not be less than the fair market value of the Common Stock on the date of grant. Each option will be exercisable for the period or periods specified in the option agreement, which can not exceed 10 years from the date of grant. Options granted to Directors will terminate thirty (30) days after the date the Director is no longer a Director of Gothic Energy. As of December 31, 1998 and 1999, options to purchase 600,000 and 1,000,000 shares of common stock, respectively, had been issued under the Non-Employee Plan. A summary of the status of Gothic Energy's stock options as of December 31, 1997, 1998 and 1999, and changes during December 31, 1998 and 1999, is presented below:
Options Outstanding Options Exercisable ----------------------------------- ----------------------------- Weighted Weighted Average Number Average Number Exercise Outstanding Price Exercisable Price ---------------- ----------------- -------------- ------------- Balance at December 31, 1997 2,690,000 $1.17 1,850,000 $1.52 Options granted 1,285,000 .40 Options forfeited (545,000) .40 --------- Balance at December 31, 1998 3,430,000 $1.00 1,927,500 $1.47 Options granted 2,185,000 .39 Options forfeited (380,000) .40 --------- Balance at December 31, 1999 5,235,000 $0.79 2,807,500 $1.13 =========
The following table summarizes information about Gothic Energy's stock options which were outstanding, and those which were exercisable, as of December 31, 1999:
Options Outstanding Options Exercisable ------------------------------------------- ----------------------------- Weighted Weighted Weighted Price Number Average Average Number Average Range Outstanding Life Price Exercisable Price ------------ --------------- ------------ ------------ -------------- ------------- $1.50 -$3.30 735,000 1.2 years $3.21 735,000 $3.21 $0.15 -$0.53 4,500,000 3.5 years $0.40 2,072,500 $0.40 --------- --------- 5,235,000 2,807,500 ========= =========
Gothic Energy applies Accounting Principles Board Opinion No. 25 in accounting for stock options granted to employees, including directors, and Statement of Financial Accounting Standards No. 123 (''SFAS No. 123'') for stock options and warrants granted to non-employees. No compensation cost has been recognized in 1998 or 1999. Had compensation been determined on the basis of fair value pursuant to SFAS No. 123, net loss and loss per share would have been increased as follows:
1998 1999 ----------- ---------- (in thousands) Net loss available for common shares: As reported............................................................. $(140,383) $(25,976) ========= ======== Pro Forma............................................................... $(141,232) $(26,439) ========= ======== Basic and diluted loss per share: As reported............................................................. $ (8.63) $ (1.51) ========= ======== Pro Forma............................................................... $ (8.68) $ (1.54) ========= ========
The fair value of each option granted is estimated using the Black Scholes model. Gothic Energy's stock volatility was 0.81 and 0.95 in 1998 and 1999, respectively, based on previous stock performance. Dividend yield was estimated to remain at zero with an average risk free interest rate of 4.81 percent and 5.59 percent in 1998 F-16 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) and 1999, respectively. Expected life was three years for options issued in both 1998 and 1999 based on the vesting periods involved and the make up of participating employees within each grant. Fair value of options granted during 1998 and 1999 under the Stock Option Plan were $643,000 and $646,000, respectively. NOTE 7. INCOME TAXES Deferred tax assets and liabilities are comprised of the following at December 31, 1999 (in thousands): Deferred tax assets: Gas balancing liability........................................................ $ 1,386 Net operating loss carryforwards............................................... 42,371 Depletion carryforwards........................................................ 257 Tax over book basis of natural gas and oil properties.......................... 14,423 Accrued wages.................................................................. 119 ------- Gross deferred tax assets...................................................... 58,556 Deferred tax liabilities: Deferred lease operating expenses.............................................. (556) ------- Gross deferred tax liabilities................................................. (556) Net deferred tax assets........................................................... 58,000 Valuation allowance............................................................ 58,000 ------- $ - =======
Net operating losses of approximately $104,679,000 are available for future use against taxable income. These net operating loss carryforwards (''NOL'') expire in the years 2010 through 2019. In addition, an acquisition in January, 1996 made available approximately $6,147,000 of net operating loss carryforwards and $675,000 of depletion carryforwards generated prior to the acquisition. However, the loss carryforwards and depletion carryforwards are limited annually under Internal Revenue Code Section 382 due to a change in ownership. The net operating loss carryforwards expire in the years 2000 through 2010 and the depletion carryforwards can be carried forward indefinitely. Pursuant to Section 382 of the Internal Revenue Code of 1986, as amended, in the event that a substantial change in the ownership of the Company were to occur in the future (whether through the sale of stock by a significant shareholder or shareholders, new issuances of stock by the Company, conversions, a redemption, recapitalization, reorganization, any combination of the foregoing or any other method) so that ownership of more than 50% of the value of the Company's capital stock changed during any three-year period, the Company's ability to utilize its NOL's could be substantially limited. Realization of the net deferred tax asset is dependent on generating sufficient taxable income in future periods. The Company has recorded a 100% valuation allowance, as it is more likely than not that realization will not occur in the future. NOTE 8. COMMITMENTS AND CONTINGENCIES The Company has entered into an employment agreement with its President effective January 1, 1999. The President currently receives a base salary of $225,000 per year. In addition, he is to receive a cash bonus as may be determined by the Company's Board of Directors. The President is also entitled to participate in such incentive compensation and benefit programs as the Company makes available. The term of the agreement is for a period of three years and at the end of the first year and at the end of each succeeding year the agreement is automatically extended for one year such that at the end of each year there will automatically be three years remaining on the term of the agreement. The President can terminate the agreement at the end of the initial term and any succeeding term on not less than six months notice. In the event the employment agreement is terminated by the Company (other than for cause, as defined), the President is entitled to receive a payment representing all salary due under the remaining full term of his agreement and the Company is obligated to continue his medical insurance and other benefits provided under the agreement in effect for a period of one year after such termination. In the event of a change in F-17 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) control, as defined, of the Company, the President has the right to terminate his employment agreement with the Company within sixty days thereafter, whereupon the Company would be obligated to pay to him a sum equal to three years of his base salary under the agreement, plus a lump sum payment of $250,000. The Company has also entered into an employment agreement with its Chief Financial Officer effective January 1, 1999. The Chief Financial Officer currently receives a base salary of $187,500 per year. In addition, he is to receive a cash bonus as may be determined by the Company's Board of Directors. The CFO is also entitled to participate in such incentive compensation and benefit programs as the Company makes available. The term of the agreement is for a period of three years and at the end of the first year and at the end of each succeeding year the agreement is automatically extended for one year such that at the end of each year there will automatically be three years remaining on the term of the agreement. The CFO can terminate the agreement at the end of the initial term and any succeeding term on not less than six months notice. In the event the employment agreement is terminated by the Company (other than for cause, as defined), the CFO is entitled to receive a payment representing all salary due under the remaining full term of his agreement, and the Company is obligated to continue his medical insurance and other benefits provided under the agreement in effect for a period of one year after such termination. In the event of a change in control, as defined, of the Company, the CFO has the right to terminate his employment with the Company within sixty days thereafter, whereupon the Company would be obligated to pay to him a sum equal to three years base salary, plus a lump sum payment of $200,000. The Company leases its corporate offices and certain office equipment and automobiles under non-cancelable operating leases. Rental expense under non- cancelable operating leases was $190,000 and $240,000 for the years ended December 31, 1998 and 1999, respectively. Remaining minimum annual rentals under non-cancelable lease agreements subsequent to December 31, 1999 are as follows: 2000........................................ 327,000 2001........................................ 295,000 2002........................................ 282,000 2003........................................ 267,000 2004........................................ 247,000 The Company is not a defendant in any pending legal proceedings other than routine litigation incidental to its business. While the ultimate results of these proceedings cannot be predicted with certainty, the Company does not believe that the outcome of these matters will have a material adverse effect on the Company's financial position or results of operations. NOTE 9. BENEFIT PLAN Production Corp. maintains a 401(k) Plan for the benefit of its employees. The Plan was implemented in October 1997. The Plan permits employees to make contributions on a pre-tax salary reduction basis. Production Corp. makes limited matching contributions to the Plan, and may also make other discretionary contributions. Production Corp's contributions for 1998 and 1999 were $62,000 and $85,000, respectively. NOTE 10. MAJOR CUSTOMERS During the year ended December 31, 1999, the Company was a party to contracts whereby it sold 56% of its natural gas production to CMS Continental Natural Gas Corporation ("Continental"), and 47% of its oil production to Duke Energy, Inc. The Company has a ten-year marketing agreement, whereby the majority of the natural gas associated with the Amoco Acquisition will be sold to Continental, at market prices, under this agreement. NOTE 11. RELATED PARTY TRANSACTIONS During 1997, Gothic Energy made advances totaling $336,000 to two officers and directors of Gothic Energy. In February 1998, $168,000 was received in connection with a severance agreement. The balance outstanding on the remaining advance was $179,000 as of December 31, 1998 and this amount was forgiven by Gothic Energy during 1999. F-18 NOTE 12. SUMMARIZED FINANCIAL INFORMATION Production Corp. was organized in March 1998 as a wholly owned subsidiary of Gothic Energy. On April 27, 1998, Gothic Energy transferred to Production Corp. its ownership of all its natural gas and oil properties. Following is the summarized financial information related to the Company as of December 31, 1999 and for the years ended December 31, 1998 and 1999. (in thousands):
As of December 31, 1999 ------------------------------------------------------------ Gothic Energy Gothic Energy Gothic Production Corporation Corporation Corporation Consolidated ------------- ----------------- ------------- Current assets $ - $ 11,447 $ 11,447 Non-current assets 1,772(2) 225,178 226,950 Current liabilities - 15,927 15,927 Non-current liabilities 75,857(3) 247,648 323,505
For the year ended December 31, 1999 ------------------------------------------------------------ Gothic Energy Gothic Energy Gothic Production Corporation Corporation Corporation Consolidated ------------- ----------------- ------------- Total revenues $ - $ 55,624 $ 55,624 Operating costs and expenses 179(4) 35,708 35,887 Interest expense and amortization of debt issuance cost 9,958 28,030 37,988 Net loss (10,137) (7,172) (17,309)
For the year ended December 31, 1998 ------------------------------------------------------------ Gothic Energy Gothic Energy Gothic Production Corporation Corporation Corporation(1) Consolidated ------------- ----------------- ------------- Total revenues $ 21,033 $ 32,000 $ 53,033 Operating costs and expenses 16,172 23,781 39,953 Provision for impairment of natural gas and oil properties - 76,000 76,000 Interest expense and amortization of debt issuance cost 16,821 18,617 35,438 Loss before extraordinary item (12,408) (85,822) (98,230) Net loss (43,842) (85,847) (129,689)
(1) Since the Recapitalization on April 27, 1998 (2) Includes unamortized debt issuance costs (3) Includes 14 1/8% Senior Secured Discount Notes (4) Officer compensation F-19 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) NOTE 13. SUPPLEMENTARY NATURAL GAS AND OIL INFORMATION Financial Data The following supplemental historical and reserve information is presented in accordance with Financial Accounting Standards Board Statement No. 69, "Disclosures About Oil and Gas Producing Activities". Capitalized Costs--The aggregate amounts of capitalized costs relating to natural gas and oil producing activities, net of valuation allowances, and the aggregate amounts of the related accumulated depreciation, depletion, and amortization at December 31, 1999 were as follows:
1999 -------------- (in thousands) Proved properties...................................................... $258,818 Unproved properties, not subject to depreciation, depletion and amortization (1)..................................................... 5,473 Less: Accumulated depreciation, depletion, and amortization............ (53,137) -------- Net natural gas and oil properties.................................. $211,154 ========
(1) Production Corp. expects to evaluate the unproved properties during the next two years. Costs Incurred--Costs incurred in natural gas and oil property acquisition, exploration and development activities for the years ended December 31, 1998 and 1999 were as follows:
1998 1999 ------------ ------------ (in thousands) Proved property acquisition........................................... $225,103 $ 1,499 Unproved property acquisition......................................... 2,109 2,611 Development costs..................................................... 16,270 18,445 -------- ------- Total costs incurred............................................... $243,482 $22,555 ======== =======
NATURAL GAS AND OIL RESERVES DATA (UNAUDITED) Estimated Quantities--Natural gas and oil reserves cannot be measured exactly. Estimates of natural gas and oil reserves require extensive judgments of reservoir engineering data and are generally less precise than other estimates made in connection with financial disclosures. Proved reserves are those quantities which, upon analysis of geological and engineering data, appear with reasonable certainty to be recoverable in the future from known natural gas and oil reservoirs under existing economic and operating conditions. Proved developed reserves are those reserves which can be expected to be recovered through existing wells with existing equipment and operating methods. Proved undeveloped reserves are those reserves which are expected to be recovered from new wells on undrilled acreage or from existing wells where a relatively major expenditure is required. Estimates of natural gas and oil reserves require extensive judgments of reservoir engineering data as explained above. Assigning monetary values to such estimates does not reduce the subjectivity and changing nature of such reserve estimates. Indeed, the uncertainties inherent in the disclosure are compounded by applying additional estimates of the rates and timing of production and the costs that will be incurred in developing and producing the reserves. The information set forth herein is therefore subjective and, since judgments are involved, may not be comparable to estimates submitted by other natural gas and oil producers. In addition, since prices and costs do not remain static and no price or cost escalations or de-escalations have been considered, the results are not necessarily indicative of the estimated fair market value of estimated proved reserves nor of estimated future cash flows and significant revisions could occur in the near term. Accordingly, these estimates are expected to change as future information becomes available. All of Production Corp's reserves are located onshore in the states of Oklahoma, Texas, New Mexico, Arkansas and Kansas. F-20 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following unaudited table, which is based on reports of Lee Keeling and Associates, Inc., sets forth proved natural gas and oil reserves:
1998 1999 ----------------------- --------------------- Bbls Mcf Bbls Mcf --------- ---------- --------- ---------- (in thousands) (in thousands) Proved Reserves: Beginning of year..................................................... 3,585 127,460 1,761 306,668 Revisions of previous estimates....................................... (872) 39,577 319 6,598 Purchases of reserves in place........................................ 1,362 233,007 - 1,402 Production............................................................ (257) (24,455) (158) (25,477) Sales of reserves in place............................................ (2,057) (68,921) - - ------ ------- ----- ------- End of year 1,761 306,668 1,922 289,191 ====== ======= ===== ======= Proved Developed: Beginning of year..................................................... 2,503 91,690 1,523 254,762 End of year........................................................... 1,523 254,762 1,683 251,631
Standardized Measure of Discounted Future Net Cash Flows--Future net cash inflows are based on the future production of proved reserves of natural gas and crude oil as estimated by Lee Keeling and Associates, Inc., independent petroleum engineers, by applying current prices of natural gas and oil to estimated future production of proved reserves. The average prices used in determining future cash inflows for natural gas and oil as of December 31, 1999, were $1.89 per mcf, and $24.33 per barrel, respectively. Future net cash flows are then calculated by reducing such estimated cash inflows by the estimated future expenditures (based on current costs) to be incurred in developing and producing the proved reserves and by the estimated future income taxes. Estimated future income taxes are computed by applying the appropriate year-end statutory tax rate to the future pretax net cash flows relating to Production Corp's estimated proved natural gas and oil reserves. The estimated future income taxes give effect to permanent differences and tax credits and allowances. Included in the estimated standardized measure of future cash flows are certain capital projects (future development costs). Production Corp. estimates the capital required to develop its undeveloped natural gas and oil reserves during 2000 to be approximately $23,000,000. Production Corp's planned financial arrangements are discussed in Notes 2 and 4. If such capital is not employed, the estimated future cash flows will be negatively impacted. The following table sets forth Production Corp's unaudited estimated standardized measure of discounted future net cash flows.
December 31, December 31, 1998 1999 ---------------- ---------------- (in thousands) Cash Flows Relating to Proved Reserves: Future cash inflows.............................................................. $ 573,604 $ 596,216 Future production costs.......................................................... (141,253) (139,458) Future development costs......................................................... (37,028) (26,969) Future income tax expense........................................................ (47,264) (30,113) --------- --------- 348,059 399,676 Ten percent annual discount factor............................................... (169,297) (201,291) --------- --------- Standardized Measure of Discounted Future Net Cash Flows......................... $ 178,762 $ 198,385 ========= =========
F-21 GOTHIC ENERGY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following table sets forth changes in the standardized measure of discounted future net cash flows:
December 31, December 31, 1998 1999 ------------ ------------ (in thousands) Standardized measure of discounted future cash flows-beginning of period............ $ 94,102 $178,762 Sales of natural gas and oil produced, net of Operating expenses.................... (38,585) (43,362) Purchases of reserves-in-place...................................................... 231,184 1,000 Sales of reserves-in-place.......................................................... (62,933) - Revisions of previous quantity estimates and Changes in sales prices and production costs................................................................. (54,416) 44,109 Accretion of discount............................................................... 9,410 17,876 -------- -------- Standardized measure of discounted future Cash flows-end of period.................. $178,762 $198,385 ======== ========
F-22 EX-10.28 2 OPTION PURCHASE AGREEMENT 2/2/00 EXHIBIT 10.28 ------------- OPTION PURCHASE AGREEMENT ------------------------- THIS AGREEMENT is made this 28th day of February, 2000, between GOTHIC ENERGY CORPORATION, an Oklahoma corporation ("GEC"), GOTHIC PRODUCTION COMPANY, an Oklahoma corporation ("GPC" and, jointly and severally with GEC, the "Buyer"), and CHESAPEAKE EXPLORATION LIMITED PARTNERSHIP, an Oklahoma limited partnership, successor in interest by merger to Chesapeake Gothic Corp. (the "Seller"). R E C I T A L S : WHEREAS, the Seller owns (a) 61,007.474 shares of GEC's Senior Redeemable Preferred Stock, Series B, $0.05 par value per share, (b) the right to receive accrued and unpaid dividends on such Preferred Stock payable in kind, and (c) 2,394,125 shares of GEC's Common Stock, $0.01 par value per share (collectively, the "GEC Securities"); WHEREAS, the Seller and one or more of the wholly owned subsidiaries of Chesapeake Energy Corporation (collectively, the "CEC Parties"), and the Buyer and the Buyer's affiliated entities (collectively, the "Gothic Parties") are parties to that certain Sale and Participation Agreement dated as of March 31, 1998, as amended (the "Participation Agreement") pursuant to which: (a) the Seller acquired an undivided fifty percent (50%) interest in certain oil, gas and related assets from the Gothic Parties, (b) the CEC Parties and the Gothic Parties provided for the maintenance, joint development and operation of the Existing Acreage, the Related Interests and the Acquisition Acreage (as those terms are defined in the Participation Agreement), and (c) an area of mutual interest was created among the CEC Parties and the Gothic Parties covering lands located in the States of Arkansas, Kansas, New Mexico (excluding the Pecos Slope Acreage), Oklahoma and Texas; WHEREAS, the Buyer desires to purchase an option to acquire all of the Seller's GEC Securities (the "Option") pursuant to the Option Agreement in the form at Schedule "A" attached as a part hereof (the "Option Agreement") which the Seller is willing to sell to the Buyer in exchange for certain modifications to the Participation Agreement and the performance of certain other agreements and documents set forth herein, all subject to the terms and conditions set forth in this Agreement; WHEREAS, one or more of the Discount Noteholders (as hereinafter defined) have made the execution and delivery of this Agreement and the Option a condition precedent to the Discount Noteholders entering into agreements to convert the debt held by such parties to equity of the Buyer. NOW, THEREFORE, in consideration of the mutual covenants herein contained and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. Purchase and Sale. Subject to the terms and conditions set forth in this ----------------- Agreement, the Seller hereby agrees to sell the Option and the Buyer hereby agrees to purchase the Option and perform the Purchase Consideration. 2. Purchase Consideration. Upon satisfaction or waiver of the conditions ---------------------- precedent set forth in paragraph 3 hereof in accordance with the terms thereof, and in consideration for the sale of the Option to the Buyer and as a condition precedent to the effectiveness of such grant, the Buyer will cause the Gothic Parties to take the following actions (the"Purchase Consideration") on the Closing Date (as hereinafter defined): 2.1 Operations. The Gothic Parties will take all actions necessary to ---------- turn over to the CEC Parties operations on: (a) the wells identified at Schedule "2.1" attached as a part hereof; and (b) all wells which have been or are currently being developed under the Participation Agreement and all other wells now or hereafter proposed which are located in: (i) Meade and Clark Counties, Kansas, and (ii) Texas, Beaver, Harper, Ellis, Woods, Woodward, Dewey, Major, Blaine (Township 19N only), Custer, Grady, Pittsburg, Haskell, Latimer (except for Sections 19-36 of Township 3N Range 20E) and LeFlore Counties, Oklahoma, by permanently resigning as operator and waiving any rights under the Participation Agreement to become operator of such wells in the future. On the Closing Date the Gothic Parties will execute and deliver resignation of operator letters in form and substance satisfactory to the Seller and will vote all of the Gothic Parties' interests in such properties for the Chesapeake Parties as successor operator (the "Operator Documents"). 2.2 Extensions and Right of First Refusal. The Gothic Parties take all ------------------------------------- actions necessary to: (a) extend the term of the reassignment obligation under paragraph 1.3 of the Participation Agreement until April 30, 2006; (b) extend the Termination Date (as defined in paragraph 14 of the Participation Agreement) until April 30, 2006, for the portion of the Participation Area included in the States of Arkansas, Kansas and Oklahoma and the portion of the State of Texas located north of latitude 34 degrees N; (c) amend the default and remedies provisions under paragraph 13 of the Participation Agreement; and (d) grant the CEC Parties preferential purchase and related rights with respect to sales of assets covered by the Participation Agreement. In order to evidence such extension, the parties will execute and deliver the Amendment Documents (as defined below) simultaneously with the execution of this Agreement. 3. Conditions Precedent to Option Grant. Unless waived in writing by the ------------------------------------ Buyer and the Seller, the sale of the Option pursuant to this Agreement is subject to the satisfaction of all of the following conditions precedent on or before March 14, 2000 (the "Condition Satisfaction Period"), unless extended in writing by the Seller: 3.1 Authorization. The terms of this Agreement and the Option will have ------------- been duly authorized by the respective Boards of Directors of the Buyer and the Seller. 3.2 Consents. The Buyer and the Seller will have received required -------- written consents to the terms and conditions of this Agreement from the holders of the Buyer's 14 1/8% Senior Secured Discount Notes (the "Discount Noteholders"), Bank One, Texas, N.A., and any other necessary parties. 3.3 No Actions. No actions will have been taken or threatened to prevent ---------- any party from entering into of this Agreement, performing this Agreement or seeking other relief as a result of this Agreement. 3.4 Discount Noteholders. The Discount Noteholders and the Gothic Parties -------------------- will have executed and delivered the instruments necessary to evidence the agreement of the Discount Noteholders to convert all of the notes held by the Discount Noteholders into equity of the Buyer. 3.5 Additional Documents. The Gothic Parties and the CEC Parties will -------------------- have each executed and delivered to the other parties such additional documents and instruments as might be reasonably requested by the Buyer or the Seller to consummate this Agreement. 3.6 JIB Payments. The Gothic Parties and the CEC Parties will have each ------------ paid current all joint interest billings owing to the parties as required by the Joint Operating Agreements attached to the Participation Agreement. 4. Closing. Unless extended in writing by the Seller, the transactions ------- contemplated by this Agreement will be consummated on the date (the "Closing Date") which is two (2) business days after the date all of the conditions under paragraph 3 of this Agreement have been satisfied in full or waived in writing by the Buyer and the Seller. 4.1 Seller's Deliveries. Subject to the terms and conditions of this ------------------- Agreement and the performance of the Buyer's obligations under paragraph 4.2 of this Agreement, on the Closing Date the Seller will deliver or cause to be delivered to the Buyer the following items (all documents will be duly executed and acknowledged where required): 4.1.1 Option. The Option and the Amendment Documents (as hereinafter ------ defined); -2- 4.1.2 Evidence of Authority. Such resolutions, certificates of good --------------------- standing, incumbency certificates and other evidence of authority with respect to the Seller as might be reasonably requested by the Buyer; 4.1.3 Additional Documents. Such additional documents as might be -------------------- reasonably requested by Gothic to consummate this Agreement. 4.2 Buyer's Deliveries. On the Closing Date, the Buyer will deliver or ------------------ cause to be delivered to the Seller the following items (all documents will be duly executed and acknowledged where required): 4.2.1 Purchase Consideration. The Gothic Parties will have each ---------------------- executed and delivered to the Seller the Second Amendment to Participation Agreement in the form of Schedule "4.2.1" attached hereto as a part hereof and the other documents contemplated thereby (the "Amendment Documents"), the Operator Documents and any other documents required to evidence the Purchase Consideration; 4.2.2 Evidence of Authority. Such corporate resolutions, --------------------- certificates of good standing, incumbency certificates and other evidence of authority with respect to each of the Gothic Parties as might be reasonably requested by the Seller; 4.2.3 Additional Documents. Such additional documents as might be -------------------- reasonably requested by the Seller to consummate this Agreement. 5. Seller Representations and Warranties. The Seller hereby represents and ------------------------------------- warrants to the Buyer that: 5.1 Title. The Seller has good and valid title to the GEC Securities, ----- free and clear of all liens, claims and encumbrances. 5.2 Authority and Reliance. The Seller has taken all necessary action to ---------------------- authorize the execution, delivery and performance of this Agreement, the Amendment Documents, the Operator Documents and the Option Agreement and has adequate power, authority and legal right to enter into, execute, deliver and perform this Agreement and to issue the Option as contemplated hereby. 5.3 Consents. No consent, approval, license, qualification or formal -------- exemption from, nor any filing, declaration or registration with, any court, governmental agency or regulatory authority or any securities exchange is required in connection with the execution, delivery or performance by the Seller of this Agreement. 5.4 Litigation. There is no action, suit, investigation or proceeding, ---------- governmental or otherwise, pending or, to the best knowledge of the Seller, threatened to which any of the CEC Parties is or would be a party which seeks to restrain, enjoin, prevent the consummation of or otherwise challenge this Agreement or the Seller's granting of the Option or questions the legality or validity of any such transactions or seeks to recover damages or obtain other relief in connection with any such transactions. 6. Buyer Representations and Warranties. The Buyer hereby represents and ------------------------------------ warrants to the Seller that: 6.1 Authority and Reliance. The Buyer has taken all necessary action to ---------------------- authorize the execution, delivery and performance of this Agreement, the Amendment Documents, the Operator Documents and the Option Agreement and has all requisite corporate power, authority and legal right to enter into, execute, deliver and perform this Agreement, the Amendment Documents, the Operator Documents and the Option Agreement. The Buyer further represents and warrants that, -3- in purchasing the Option, the Buyer has relied upon independent investigations made by the Buyer or the Buyer's representatives, that the Buyer has had sufficient opportunities to make inquiries of the Seller and that the Buyer and such representatives have been given the opportunity to examine all documents concerning the terms and conditions of the Option. The Buyer represents and warrants that the Buyer is experienced in the oil and gas business, has knowledge and experience in business and financial matters and is competent to evaluate the value of the Option and the benefits and risks relating to the purchase of the Option and the Buyer has determined that the consideration being given by the Buyer is the fair value equivalent of the consideration being received by the Buyer for the granting of the Option. 6.2 Consents. The Buyer has obtained and provided to the Seller all -------- consents, approvals or waivers necessary or appropriate for the Buyer to enter into this Agreement and to consummate the transactions contemplated hereby. No other authorization, consent, approval, license, qualification or formal exemption from, nor any filing, declaration or registration with, any court, governmental agency or regulatory authority or any securities exchange is required in connection with the execution, delivery or performance by the Gothic Parties of this Agreement. 6.3 Litigation. There is no action, suit, investigation or proceeding, ---------- governmental or otherwise, pending or, to the best knowledge of the Buyer, threatened to which any of the Gothic Parties is or would be a party which seeks to restrain, enjoin, prevent the consummation of or otherwise challenge this Agreement or the Buyer's purchase of the Option or questions the legality or validity of any such transactions or seeks to recover damages or obtain other relief in connection with any such transactions. 7. Default; Failure of Conditions. In the event either party fails to perform ------------------------------ such party's obligations hereunder (except as excused by another party's default) (the "Defaulting Party") such failure will constitute an event of default under this Agreement and the other party (the "Other Party") will have the right to exercise any and all remedies available at law or in equity unless such default is waived by the Other Party or cured by the Defaulting Party within five (5) business days after receipt of notice of such default. The remedies provided by this Agreement are cumulative and will not exclude any other remedy to which the Other Party might be entitled under this Agreement or applicable law. In the event the Other Party elects to selectively and successfully enforce the Other Party's rights under this Agreement, such action will not be deemed a waiver or discharge of any other remedy. During the pendency of any default or disputes, this Agreement will be deemed to be in full force. Notwithstanding anything herein to the contrary, on the occurrence of a default or other breach of this Agreement by the Buyer, the Seller may terminate the Option and the Option Agreement in the sole and absolute discretion of the Seller. 8. Standstill. Each of the parties irrevocably agree that the negotiation, ---------- preparation, execution and delivery of this Agreement and any preliminary discussions with any person regarding this Agreement, the Option or any similar transaction will not and did not violate any standstill, nonsolicitation or similar agreement including, without implied limitation, paragraph 5.4 of the Securities Purchase Agreement among the Buyer, Chesapeake Acquisition Corporation and Chesapeake Gothic Corp. dated March 31, 1998 (the "Securities Purchase Agreement"), and relating to the purchase of the GEC Securities by affiliates of the Seller. The Buyer hereby releases, acquits and forever discharges the CEC Parties and the CEC Parties' directors, officers, shareholders, partners, members, employees, agents, attorneys, parent corporations, subsidiary corporations, affiliates and such parties' respective successors and assigns from any and all claims, whether asserted or assertable, known or unknown, and all actions, debts, suits, causes of action, both at law and in equity, demands, defenses, offsets, liabilities, losses, obligations or damages directly or indirectly related to any violation or alleged violation of the Securities Purchase Agreement arising out of any action, inaction, contact, discussions or matter prior to the date of this Agreement including, without implied limitation, any violation or alleged violation of any standstill or confidentiality agreement set forth in the Securities Purchase Agreement or otherwise. 9. Deferral of Operations Turnovers. Notwithstanding anything to the -------------------------------- contrary in this Agreement or in the Participation Agreement, during the Condition Satisfaction Period, the Seller will not be required to turnover -4- operations on any wells located in the areas described in paragraph 2.1 of this Agreement including, without limitation, the Della 1-9 well. 10. Miscellaneous. It is further agreed as follows: ------------- 10.1 Time. Time is of the essence of this Agreement. ---- 10.2 Notices. Any notice, demand or communication required or permitted ------- to be given by any provision of this Agreement will be in writing and will be deemed to have been given and received when delivered personally or by telefacsimile to the party designated to receive such notice, or on the date following the day sent by overnight courier, or on the third (3rd) business day after the same is sent by certified mail, postage and charges prepaid, directed to the following addresses or to such other or additional addresses as any party might designate by written notice to the other parties: To the Buyer: Gothic Energy Corporation 6120 South Yale Avenue, Suite 1200 Tulsa, Oklahoma 74136 Attn: Michael K. Paulk Telephone (918) 749-5666 Fax No. (918) 749-5882 With a copy to: Pray, Walker, Jackman, Williamson & Marlar 900 OneOk Plaza 100 West 5th Street Tulsa, Oklahoma 74103-4218 Attn: Ira L. Edwards, Jr. Telephone (918) 581-5500 Fax No. (918) 581-5599 To the Seller: Chesapeake Energy Corporation 6100 North Western Avenue Oklahoma City, Oklahoma 73118 Attn: Aubrey K. McClendon Telephone (405) 879-9226 Fax No. (405) 848-8588 With a copy to: Self, Giddens & Lees, Inc. 2725 Oklahoma Tower 210 Park Avenue Oklahoma City, Oklahoma 73102 Attn: Ray Lees Telephone (405) 232-3001 Fax: (405) 232-5553 10.3 Press Release. Except to the extent required by applicable ------------- disclosure requirements, all press releases relating to this Agreement and the transactions contemplated by this Agreement will be approved by the Buyer and the Seller prior to dissemination. 10.4 Choice of Law. This Agreement will be interpreted, construed and ------------- enforced in accordance with the laws of the State of Oklahoma and will be deemed for such purposes to have been made, executed and performed in Oklahoma County, Oklahoma. All claims, disputes and other matters -5- in question arising out of or relating to this Agreement will be decided by proceedings instituted and litigated in the District Court of Oklahoma County, Oklahoma, or the United States District Court for the Western District of Oklahoma. 10.5 Headings. The paragraph headings contained in this Agreement are for -------- reference purposes only and are not intended to affect in any way the meaning or interpretation of this Agreement. 10.6 No Oral Agreements. There are no unwritten oral agreements, ------------------ understandings, warranties or representations with respect to the subject matter of this Agreement. 10.7 Assignment. It is agreed that neither party may assign such party's ---------- rights nor delegate such party's duties under this Agreement without the express written consent of the other party to this Agreement. 10.8 Amendment. Neither this Agreement, nor any of the provisions hereof --------- can be changed, waived, discharged or terminated, except by an instrument in writing signed by the party against whom enforcement of the change, waiver, discharge or termination is sought. 10.9 Severability. If any clause or provision of this Agreement is ------------ illegal, invalid or unenforceable under any present or future law, the remainder of this Agreement will not be affected thereby. It is the intention of the parties that if any such provision is held to be illegal, invalid or unenforceable, there will be added in lieu thereof a provision as similar in terms to such provisions as is possible to cause such provision to be legal, valid and enforceable. 10.10 Attorney Fees. If any party institutes an action or proceeding ------------- against any other party relating to the provisions of this Agreement, the party to such action or proceeding which does not prevail will reimburse the prevailing party therein for the reasonable expenses of attorneys' fees and disbursements incurred by the prevailing party. 10.11 Waiver. Waiver of performance of any obligation or term contained ------ in this Agreement by any party, or waiver by one party of the other's default hereunder must be in writing and will not operate as a waiver of performance of any other obligation or term of this Agreement or constitute a future waiver of the same obligation or a waiver of any future default. IN WITNESS WHEREOF, the Seller and the Buyer have executed this Agreement as of the date first above written. GOTHIC ENERGY CORPORATION, an Oklahoma corporation By ----------------------------------- Michael K. Paulk, President GOTHIC PRODUCTION COMPANY, an Oklahoma corporation By ----------------------------------- Michael K. Paulk, President (jointly and severally referred to herein as the "Buyer") -6- CHESAPEAKE EXPLORATION LIMITED PARTNERSHIP, an Oklahoma limited partnership By: Chesapeake Operating, Inc., General Partner By ------------------------------ Aubrey K. McClendon, Chief Executive Officer (the "Seller") -7- OPTION AGREEMENT ---------------- THIS AGREEMENT is made this ____ day of __________, 2000, between GOTHIC ENERGY CORPORATION, an Oklahoma corporation ("GEC"), GOTHIC PRODUCTION COMPANY, an Oklahoma corporation ("GPC"and, jointly and severally with GEC, "Gothic"), and CHESAPEAKE EXPLORATION LIMITED PARTNERSHIP, an Oklahoma limited partnership, successor in interest by merger to Chesapeake Gothic Corp. ("Chesapeake"). R E C I T A L S : WHEREAS, Chesapeake owns (a) __________________ shares of GEC's Senior Redeemable Preferred Stock, Series B, $0.05 par value per share, (b) the right to receive accrued and unpaid dividends on such Preferred Stock payable in kind, and (c) 2,394,125 shares of GEC's Common Stock, $0.01 par value per share (collectively, the "GEC Securities"); WHEREAS, Chesapeake or one or more of the wholly owned subsidiaries of Chesapeake Energy Corporation (collectively, the "CEC Parties"), and Gothic and its affiliated entities (collectively, the "Gothic Parties") are parties to that certain Sale and Participation Agreement dated as of March 31, 1998, as amended (the "Participation Agreement") pursuant to which: (a) Chesapeake acquired an undivided fifty percent (50%) interest in certain oil, gas and related assets from the Gothic Parties, (b) the CEC Parties and the Gothic Parties provided for the maintenance, joint development and operation of the Existing Acreage, the Related Interests and the Acquisition Acreage (as those terms are defined in the Participation Agreement), and (c) an area of mutual interest was created among the CEC Parties and the Gothic Parties covering lands located in whole or in part in the States of Arkansas, Kansas, New Mexico (excluding the Pecos Slope Acreage), Oklahoma and Texas; and WHEREAS, Gothic has purchased an option to acquire all of Chesapeake's GEC Securities which Chesapeake has granted, such option to be evidenced by and subject to the terms and conditions set forth in this Agreement. NOW, THEREFORE, in consideration of receipt of the consideration set forth in that certain Option Purchase Agreement of even date herewith, the mutual covenants herein contained and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. Option Agreement. Chesapeake hereby grants to Gothic the right and option to purchase all of the GEC Securities owned by Chesapeake (the "Option") in strict accordance with the terms and conditions of this Agreement. 2. Term. Unless Fully Exercised in strict accordance with all of the terms and conditions set forth in this Agreement, unless extended in writing by Chesapeake, the Option will expire on the Final Schedule Schedule "A" - -------------- Page 1 of 17 Pages earlier of: (i) __________, 2000, at 5:00 p.m. Oklahoma City, Oklahoma time; or (ii) thirty (30) days after the confirmation order of the plan of bankruptcy for Gothic (the "Option Period"), and all rights and obligations of Chesapeake and the Gothic Parties under this Agreement will expire and terminate without any further notice or action. The Option will be deemed "Fully Exercised" if, and only if, each of the following actions is completed before the expiration of the Option Period: (a) receipt by Chesapeake of the exercise notice under paragraph of this Agreement; (b) satisfaction in full by the Gothic Parties of all conditions precedent set forth in this Agreement; and (c) full and complete performance by the Gothic Parties of the Exercise Consideration (as defined below) including, without implied limitation, the execution, delivery and recordation (where appropriate) of the Conveyance Documents and the Restated Participation Agreement (as those terms are defined below). 3. Exercise. Gothic may exercise the Option at any time prior to the expiration of the Option Period by delivery to Chesapeake of a written notice advising Chesapeake of Gothic's intent to exercise the Option. On receipt of such notice of intent to exercise: (a) this Agreement will be deemed a legally binding agreement by Gothic to purchase the GEC Securities from Chesapeake prior to the expiration of the Option Period on the terms and conditions stated in this Agreement; and (b) this Agreement will be deemed to be a legally binding agreement by Chesapeake to sell the GEC Securities to Gothic prior to the expiration of the Option Period under the terms and conditions stated in this Agreement. Notwithstanding the foregoing, Chesapeake will have no obligation to assign or deliver any interest in the GEC Securities to Gothic until the Option is Fully Exercised. 4. Exercise Consideration. The payment of the "Exercise Consideration" means the performance by Gothic of all of the following agreements in accordance herewith: 4.1 Sale and Conveyance. As a portion of the Exercise Consideration the Gothic Parties will convey and assign to the CEC Parties all of the Gothic Parties' right, title and interest in and to the Properties (as defined below) free and clear of any and all liens, claims and encumbrances. The Properties assigned to the CEC Parties will be assigned pursuant to the form of assignment at Schedule "(a)" attached as a part hereof with appropriate schedules attached to describe the Properties as set forth in Schedule "4.1(b)" attached hereto as a part hereof (the "Property Schedules") and the Properties located within the CHK Area (as hereinafter defined) will be released from the terms of the Participation Agreement in all respects. 4.2 Participation Agreement. The Gothic Parties and the CEC Parties will enter into the Amended and Restated Participation Agreement in the form of Schedule "" attached as a part hereof (the "Restated Participation Agreement") which will amend and replace the Participation Agreement to the extent set forth in the Restated Participation Agreement. 4.3 Definitions. For purposes of this Agreement the term "Properties" means the following: (a) any right to any reconveyance in favor of the Gothic Parties under Final Schedule Schedule "A" - -------------- Page 2 of 17 Pages paragraph 1.3 of the Participation Agreement, any reversion or any other interest owned by the Gothic Parties under the Participation Agreement in the fifty percent (50%) interest in the Existing Acreage, the Related Interests and the Acquisition Acreage (as those terms are defined in the Participation Agreement) previously conveyed to the CEC Parties together with any related interests or property rights acquired by the CEC Parties so that the CEC Parties own such interest in any and all acreage, interests and property rights acquired in connection with the Participation Agreement free and clear of all re- assignment obligations, reversionary interests or any other terms or obligations under the Participation Agreement; (b) except for the Gothic Wellbore Interests (as defined below) but specifically including any other wells participated in by the Gothic Parties pursuant to paragraph 5.8 of this Agreement, all of the Gothic Parties' right, title and interest in all oil, gas and mineral interests of every kind and character within the CHK Area (as defined below) together with any related interests and property rights including, without limitation, any interest in farmout agreements, contribution agreements, exploration agreements, access agreements, the Existing Acreage, the Related Interests, the Acquisition Acreage and other agreements to acquire such interests which are owned by the Gothic Parties in the CHK Area; and (c) the right to operations of all wells in the CHK Area including, without limitation, any well containing the Gothic Wellbore Interests. For purposes of this Agreement: (y) the term "CHK Area" means: (i) Meade and Clark Counties, Kansas, and (ii) Texas, Beaver, Harper, Ellis, Woods, Woodward, Dewey, Major, Blaine (Townships in 19N only), Custer, Grady (Townships in 7N, 8N and 9N only), Pittsburg, Haskell, Latimer (excluding Sections 25, 34, 35 and 36 in Township 3 North, Range 19 East, Sections19, 22, 23, 24, 26, 27, 28, 29, 30, 31, 32, 33, 34, 35 and 36 in Township 3 North, Range 20 East and Sections 19, 20, 27, 28, 31, 32, 33, and 34 in Township 3 North, Range 21 East) and LeFlore Counties, Oklahoma; and (z) the term "Gothic Wellbore Interests" means the Gothic Parties' interests in the following wellbores (but excluding any interest in any acreage within the applicable governmental production unit): (i) any wellbores in the CHK Area which were producing in paying quantities as of February 1, 2000, and (ii) the next wellbores to be drilled in the designated quarter section of the governmental spacing units as described in Schedule "4.3" attached hereto as a part hereof which includes four (4) locations in Custer County, Oklahoma, six (6) locations in Pittsburg County, Oklahoma, four (4) locations in Latimer County, Oklahoma and one (1) location in Major County, Oklahoma. 5. Conditions Precedent to Exercise. Unless waived in writing by Chesapeake in Chesapeake's sole discretion, the right of Gothic to exercise the Option is subject to the satisfaction of all of the following conditions precedent: 5.1 Plan of Reorganization. A plan of reorganization for Gothic will have been confirmed under the United States Bankruptcy Code, as amended, on terms and conditions which approve, without modification, this Agreement, the Restated Participation Agreement and all of the other instruments, agreements, Final Schedule Schedule "A" - -------------- Page 3 of 17 Pages conveyances, certificates, memoranda and other documents to be entered into upon the exercise of the Option and the consummation of the provisions of this Agreement (the "Conveyance Documents"). 5.2 Approvals. Chesapeake and Gothic will have received written consents and approvals to the terms and conditions of this Agreement and the Conveyance Documents in form and substance satisfactory to Chesapeake from the holders of the Gothic's 14 1/8% Senior Secured Discount Notes, the holders of the Gothic's Senior Notes, Bank One, Texas, N.A., and any other necessary parties deemed necessary or prudent by Chesapeake. 5.3 Lien Releases. Chesapeake will have received lien releases and other documents required to assure Chesapeake that the Properties and the other interests to be acquired by the CEC Parties under the Conveyance Documents will be free and clear of all liens, claims and encumbrances. 5.4 Conveyance Documents. The Conveyance Documents will have been duly executed, acknowledged (where appropriate) and delivered by the Gothic Parties and the CEC Parties, the Conveyance Documents will include a certificate making and reaffirming each of the representations, warranties, covenants and agreements set forth in this Agreement, and the covenants and conditions precedent set forth therein will have been satisfied. 5.5 Litigation. No actions, suits or litigation will have been threatened or filed seeking to prevent the consummation of the transactions contemplated by the Conveyance Documents or seeking damages or other relief as a result of the Conveyance Documents or the consummation of the transactions contemplated thereby and: (a) no preliminary or permanent injunction or other order will have been issued by any court of competent jurisdiction or any regulatory body preventing consummation of the transactions contemplated by this Agreement or the Conveyance Documents; (b) no action will have been commenced or threatened against Chesapeake, Gothic or any of their respective affiliates, associates, officers or directors seeking damages arising from, to prevent or challenge the transactions contemplated by this Agreement and the Conveyance Documents; (c) all representations and warranties of Gothic contained herein will be true and correct in all material respects on and as of the date of the exercise of the Option; and (d) the Gothic Parties will have performed or satisfied on and as of the date of the exercise of the Option, all obligations, covenants, agreements and conditions contained in this Agreement and the Conveyance Documents to be performed or complied with by the Gothic Parties. 5.6 Lease Maintenance. The Gothic Parties will have maintained in full force and effect all of the oil, gas and mineral leases, farmout agreements, joint development agreements, joint operating agreements and other oil and gas related Final Schedule Schedule "A" - -------------- Page 4 of 17 Pages interests covered by the Participation Agreement in full force and effect and will not have rejected or terminated any of such interests or breached any of the terms or conditions applicable thereto. 5.7 No Default. The Gothic Parties will have not defaulted under this Agreement, the Participation Agreement or the Option Purchase Agreement, each of the Gothic Parties' representations and warranties will be true and correct in all material respects and there will not have occurred any event that would constitute an event of default with the passage of time. 5.8 Participation. The Gothic Parties will not have proposed any wells to be drilled in or on any governmental production unit (as defined in the Participation Agreement) containing any of the Properties in the CHK Area as to which drilling operations had not commenced prior to February 1, 2000 and, with respect to any wells (other than the Gothic Wellbore Interests) proposed by the Chesapeake Parties or third parties spudded after February 1, 2000 ("Interim Wells"), in the event the Gothic Parties elect to participate therein, all of the interests of the Gothic Parties in such Interim Wells and the governmental spacing units with respect thereto will, at Chesapeake's election, be included in the Properties to be conveyed to Chesapeake pursuant to paragraph 10.2.1 of this Agreement. In the event the Gothic Parties elect not to participate in any such Interim Wells, the Gothic Parties will have farmed out, assigned or otherwise conveyed to the Chesapeake Parties, the Gothic Parties' interests in any such Interim Wells and the governmental spacing units pursuant to the Participation Agreement. 5.9 JIB Payments. The Gothic Parties will have paid current all joint interest billings owing to the CEC Parties as required by the Joint Operating Agreements attached to the Participation Agreement. 5.10 Motion to Affirm. Within forty-five (45) days after the filing of the petition in bankruptcy for one or more of the Gothic Parties, the Gothic Parties will have filed a motion and will thereafter diligently pursue entry of an order in such bankruptcy proceeding to irrevocably affirm this Agreement, the Option, the Conveyance Documents, the Participation Agreement and the Restated Participation Agreement in all respects. 6. Chesapeake Representations and Warranties. Chesapeake hereby represents and warrants to Gothic that as of the date of this Agreement and until the Option is exercised in accordance with the terms and conditions of this Agreement or the Option Period has expired without the Option being exercised: 6.1 Ownership. Chesapeake has and will have good and valid title to the GEC Securities, free and clear of all liens, claims and encumbrances. No person or entity other than the CEC Parties has or will have any interest in the GEC Final Schedule Schedule "A" - -------------- Page 5 of 17 Pages Securities either of record or beneficially. 6.2 Authority. Chesapeake has taken all necessary action to authorize the execution, delivery and performance of this Agreement and has adequate corporate power, authority and legal right to enter into, execute, deliver and perform this Agreement and to consummate the transactions contemplated hereby. 6.3 Absence of Liabilities. Except as approved by Gothic in writing prior to the Closing Date: (a) Chesapeake has no debt, liability, obligation or commitment, absolute or contingent, known or unknown, relating to or connected with the GEC Securities; (b) the GEC Securities will not be subject to or liable for any claim, debt, liability, lien, encumbrance, obligation, guaranty or commitment of Chesapeake on the Closing Date; and (c) any such claims, debts, liabilities, obligations or commitments will be the sole responsibility of Chesapeake and Chesapeake hereby agrees to indemnify and hold harmless Gothic from all such matters. 6.4 Consents and Approvals. No notice to, filing with, or authorization, consent or approval of any governmental entity, person or other entity is necessary for the consummation of the transactions contemplated by this Agreement. The execution, delivery, performance and consummation of this Agreement does not and will not: (a) violate, conflict with or constitute a default or an event that, with notice or lapse of time or both, would be a default, breach or violation under any term or provision of any instrument, agreement, contract, commitment, license, promissory note, conditional sales contract, indenture, mortgage, deed of trust, lease or other agreement, instrument or arrangement to which Chesapeake is a party or by which Chesapeake or, to the best of Chesapeake's knowledge, the GEC Securities are bound; (b) violate, conflict or constitute a breach of any statute, regulation or judicial or administrative order, award, judgment or decree to which Chesapeake is a party or to which Chesapeake or, to the best of Chesapeake's knowledge the GEC Securities are bound; or (c) result in the creation or imposition of any adverse claim or interest, lien, encumbrance, charge, equity or restriction of any nature whatever, upon or affecting Chesapeake, or to the best of Chesapeake's knowledge, the GEC Securities or Gothic. 7 Gothic Representations and Warranties. Gothic hereby represents and warrants to Chesapeake that as of the date of this Agreement and as of the Closing Date: 7.1 Authority and Reliance. Gothic has taken all necessary action to authorize the execution, delivery and performance of this Agreement and has all requisite corporate power, authority and legal right to enter into, execute, deliver and perform this Agreement and to consummate the transactions contemplated hereby and to own, lease, and operate its properties and to conduct its business as now being conducted. Gothic represents and warrants that Gothic is experienced in the Final Schedule Schedule "A" - -------------- Page 6 of 17 Pages oil and gas business and has knowledge and experience in business and financial matters and, with respect to investments generally and, in particular, investments generally comparable to the Option and the GEC Securities, Gothic is competent to evaluate the value of each of the GEC Securities and the Exercise Price and the benefits and risks relating to this Agreement and Gothic has determined that the consideration being given by Gothic is the fair value equivalent of the consideration being received by Gothic for the purchase and exercise of the Option. If Gothic exercises the Option, Gothic's representations and warranties hereunder will extend fully to the exercise of the Option as if made on the date the Option is exercised. 7.2 Consents. Gothic has obtained and provided to Chesapeake all consents, approvals or waivers necessary or appropriate for Gothic to enter into this Agreement and to consummate the transactions contemplated hereby. No other authorization, consent, approval, license, qualification or formal exemption from, nor any filing, declaration or registration with, any court, governmental agency or regulatory authority or any securities exchange is required in connection with the execution, delivery or performance by the Gothic Parties of this Agreement. 7.3 Litigation. There is no action, suit, investigation or proceeding, governmental or otherwise, pending or, to the best of Gothic's knowledge, threatened to which any of the Gothic Parties is or would be a party or of which the Properties, the Properties or other assets of the Gothic Parties is or would be subject. 7.4 Properties. All of the oil, gas and related interests of every kind and character owned by the Gothic Parties or any of the Gothic Parties' direct or indirect subsidiaries which are located in the CHK Area are described in Schedule "7.4" attached as a part hereof. 8. Covenants. Unless waived in writing, the parties agree to the following during the Option Period: 8.1 Conduct of Businesses. Prior to the exercise of the Option or expiration of the Option Period, the Gothic Parties will operate in a businesslike manner in accordance with prior practices and will maintain and preserve all of the assets and businesses of the Gothic Parties including the Properties. 8.2 Properties. The Gothic Parties have not and will not: (a) transfer, sell, mortgage, pledge, encumber or dispose of any assets covered by this Agreement or the Restated Participation Agreement, except for the existing mortgages which have been subordinated to the interests of Chesapeake pursuant to the Participation Agreement; or (b) except in the ordinary course of business consistent with past business practices, make or permit any amendment or termination of any material contract, agreement or commitment affecting the assets covered by this Final Schedule Schedule "A" - -------------- Page 7 of 17 Pages Agreement or the Restated Participation Agreement. 8.3 Consents. The parties will use their best efforts to obtain, all licenses, permits, consents, approvals, authorizations, qualifications and orders of governmental authorities and parties to contracts with the Gothic Parties as are necessary for the consummation of the transactions contemplated by this Agreement or are reasonably requested by Chesapeake. 8.4 Litigation. Promptly on learning thereof, each party to this Agreement will notify the other party of any litigation, suit or administrative proceeding that could reasonably be expected to have a material adverse affect on the ability of the parties to consummate the transactions contemplated by this Agreement or the Conveyance Documents, or otherwise adversely affect any of the businesses, affairs, assets, prospects, operations or conditions, financial or otherwise, of the parties, whether or not the claim is considered to be covered by insurance. Gothic and Chesapeake each agree to not to agree to or join in the pursuit of any injunctive relief prohibiting the transactions contemplated by this Agreement. 8.5 Plan of Reorganization. Gothic will not propose or consent to any plan of reorganization which materially conflicts with any of the terms and conditions of this Agreement, the Conveyance Documents or the Restated Participation Agreement and will not dispute or seek to modify or rescind this Agreement in any bankruptcy proceeding or other action affecting Gothic. The Gothic Parties will simultaneously provide to Chesapeake copies of all notices, filings and other documents relating to the Gothic Parties bankruptcy, reorganization or any proposed plan of reorganization including, without limitation, all communications to, from or among any of the Gothic Parties, any formal or informal committees of creditors or security holders or any creditors of the Gothic Parties, whether before or after the filing of bankruptcy. 8.6 GEC Securities. Chesapeake will not transfer, sell, pledge, encumber or dispose of any of the GEC Securities. 9. Representations and Warranties for the Properties. As an inducement to Chesapeake to enter into this Agreement and accept the assignment of the interests in the Properties, Gothic represents and warrants to Chesapeake that as of the date of this Agreement and the Closing Date: 9.1 No Assumption of Obligations. Except as approved by Chesapeake in writing prior to the Closing Date, the execution and consummation of this Agreement will not obligate Chesapeake with respect to (or result in the assumption by Chesapeake of) any obligation of Gothic arising prior to the Closing Date under or with respect to, any liability, agreement or commitment relating to the Properties including, without implied limitation, to pay to or share with any third Final Schedule Schedule "A" - -------------- Page 8 of 17 Pages party any portion of the Hydrocarbons attributable to the Properties. The term "Hydrocarbons" means and includes oil, gas, casinghead gas, condensate, natural gas liquids and all components of the foregoing. 9.2 Absence of Liabilities. Except as approved by Chesapeake in writing prior to the Closing Date: (a) Gothic has no debt, liability, obligation or commitment, absolute or contingent, known or unknown, relating to or connected with the Properties; (b) neither Chesapeake nor the Properties will be subject to or liable for any claim, debt, liability, lien, encumbrance, obligation, guaranty or commitment on the Closing Date; and (c) any such claims, debts, liabilities, obligations or commitments will be the sole responsibility of Gothic and Gothic hereby agrees to indemnify and hold harmless Chesapeake from all such matters. Gothic has complied and will continue to comply with all applicable federal, state or local statutes, laws and regulations. 9.3 Contracts. Gothic has delivered to Chesapeake true copies (or descriptions, in the case of oral agreements) of all of the contracts and agreements relating to the Properties including, without limitation, all marketing and production sales contracts. Except as approved by Chesapeake in writing prior to the Closing Date, no such marketing or production sales contracts will in any way prevent or hinder Chesapeake in taking in kind Chesapeake's share of production from the Properties. There are no other material contracts, commitments or agreements in effect related to the Properties that have not been disclosed to Chesapeake in writing. To the best of Gothic's knowledge: (a) such contracts and agreements are in full force and effect; (b) no event of default or event which would become an event of default with the giving of notice or passage of time has occurred; and (c) no condition presently exists which would give any party to any such contract the right to terminate such contract. There are no other material contracts, commitments or agreements in effect related to the Properties. 9.4 Consents and Approvals. No notice to, filing with, or authorization, consent or approval of any governmental entity, person or other entity is necessary for the consummation of the transactions contemplated by this Agreement. The execution, delivery, performance and consummation of this Agreement does not and will not: violate, conflict with or constitute a default or an event that, with notice or lapse of time or both, would be a default, breach or violation under any term or provision of any instrument, agreement, contract, commitment, license, promissory note, conditional sales contract, indenture, mortgage, deed of trust, lease or other agreement, instrument or arrangement to which Gothic is a party or by which Gothic or, to the best of Gothic's knowledge, the Properties are bound; violate, conflict or constitute a breach of any statute, regulation or judicial or administrative order, award, judgment or decree to which Gothic is a party or to which Gothic or, to the best of Gothic's knowledge the Properties are bound; or result in the creation or imposition of any adverse claim or interest, lien, Final Schedule Schedule "A" - -------------- Page 9 of 17 Pages encumbrance, charge, equity or restriction of any nature whatever, upon or affecting Gothic, or to the best of Gothic's knowledge, the Properties or Chesapeake. 9.5 Litigation. To the best of Gothic's knowledge there is: (a) no action, suit or proceeding pending, threatened or contemplated against Gothic or the Properties; and (b) no proceeding, investigation, charge, audit or inquiry threatened or pending before or by any federal, state, municipal or other governmental court, department, commission, board, bureau, agency or instrumentality which might result in an adverse effect on Gothic or the Properties. Gothic hereby agrees to indemnify and hold harmless Chesapeake with respect to any and all litigation and proceedings. 9.6 Title. Gothic owns, possesses and holds good and defensible title beneficially and of record in and to the respective Properties free and clear of all claims, liens, encumbrances, conditions, restrictions, calls on production, obligations to pay to or share with third parties any revenue or other matter adversely affecting the value or ownership of the Properties. All of the oil, gas and related interests of every kind and character owned by Gothic or any of Gothic's affiliates which are located in the CHK Area are described in the Conveyance Documents. Gothic is entitled to receive not less than the "Net Revenue Interest" set forth in the Conveyance Documents of all Hydrocarbons produced, saved and marketed from the Properties without reduction, suspension or termination of such interest throughout the duration of the productive life of such Properties and is in no event obligated to bear any of the costs and expenses related to the maintenance, development or operation (including, without limitation, the costs and expenses of plugging and abandoning any wells and removal and salvage of any equipment and facilities) of the Properties throughout the productive life of the Properties in excess of the "Working Interest" set forth in Conveyance Documents. To the best of Gothic's knowledge, there are no suspended revenues or any basis to suspend revenues from the Properties. To the best of Gothic's knowledge, there does not exist any lien, claim, encumbrance, restriction or other matter which might cause Chesapeake to not receive for its own account free and clear of all liens, claims and encumbrances the percentage of the fair market value of all Hydrocarbons produced, saved or used from each of the Properties after the Closing Date equal to the Net Revenue Interest designated in the Conveyance Documents. 9.7 Foreign Person. Gothic is not a "foreign person" as that term is defined under the Internal Revenue Code of 1986. 9.8 Oil and Gas Leases in Good Standing. Except as approved by Chesapeake in writing prior to the Closing Date, to the best of Gothic's knowledge all oil and gas leases which are material singly or in the aggregate are in full force and effect, and Gothic is not in default thereunder. Final Schedule Schedule "A" - -------------- Page 10 of 17 Pages 9.9 Taxes. All ad valorem, property, production, severance and similar taxes and assessments based on or measured by the ownership of property comprising the Properties or the production or removal of hydrocarbons or the receipt of proceeds therefrom have been timely paid when due and are not in arrears. 9.10 Contracts, Consents and Preferential Rights. Gothic has disclosed to Chesapeake in writing after the date hereof by reference to this paragraph: (a) all partnership, joint venture, farmin/farmout, dry hole, bottom hole, acreage contribution, area of mutual interest, purchase and/or acquisition agreements of which any terms remain executory which materially affect the Properties; (b) all other executory contracts to which Gothic is a party which materially affect any item of the Properties; (c) all governmental or court approvals and third party contractual consents required in order to consummate the transactions contemplated by this Agreement; (d) all agreements pursuant to which third parties have preferential rights or similar rights to acquire any portion of the Properties upon the sale contemplated by this Agreement; and (e) all other contracts and agreements which are in any single case of material importance to the Properties. 9.11 Tax Partnerships. None of the Properties is treated for income tax purposes as being owned by a partnership. 9.12 Environmental Conditions. Gothic is not aware, and has not received notice from any person, entity or governmental body, agency or commission, of any release, disposal, event, condition, circumstance, activity, practice or incident concerning any land, facility, asset or property that: (a) interferes with or prevents compliance or continued compliance by Gothic (or by Chesapeake after the Closing Date) with any federal, state or local law, regulation, code or ordinance or the terms of any license or permit issued pursuant thereto; or (b) gives rise to or results in any common law or other liability of Gothic to any person, entity or governmental body, agency or commission for damage or injury to natural resources, wildlife, human health or the environment which would have a material adverse effect on Gothic in each case. Gothic is not aware of any civil, criminal or administrative action, lawsuit, demand, litigation, claim, hearing, notice of violation, investigation or proceeding, pending or threatened, against Gothic or operator of any of the lands, facilities, assets and properties owned or formerly owned, operated, leased or used by Gothic as a result of the violation or breach of any federal, state, or local law, regulation, code or ordinance or any duty arising at common law to any person, entity or governmental body, singly or in the aggregate, which if determined adversely would have a material adverse effect on Gothic. 9.13 Plugging Status. To the best of Gothic's knowledge, all wells on the Properties that have been permanently plugged and abandoned have been so plugged and Final Schedule Schedule "A" - -------------- Page 11 of 17 Pages abandoned in accordance in all material respects with all applicable requirements of each governmental authority having jurisdiction over Gothic and the Properties. 9.14 Affiliate Transactions. There are no transactions affecting any of the Properties between Gothic and any of Gothic's affiliates. As used in this Agreement, "affiliate" means, with respect to any person or entity, each other person or entity directly or indirectly controlling controlled by or under common control with such person. 9.15 Full Disclosure. This Agreement, any schedule referenced in or attached to this Agreement, any document furnished to Chesapeake under this Agreement and any certification furnished to Chesapeake under this Agreement does not contain any untrue statement of a material fact and does not omit to state a material fact necessary to make the statements made, in the circumstances under which they were made, not misleading. All of the representations, warranties and covenants in this Agreement: (a) are true and correct as of the date made; (b) will be true and correct as of the Closing Date; and (c) will survive and not be waived, discharged, released, modified, terminated or affected by any due diligence by Chesapeake. 10. Closing. Unless the Option Period has expired or the closing is extended in writing by Gothic and Chesapeake, the transactions contemplated by this Agreement will be consummated on the date (the "Closing Date") which is five (5) business days after the later of: (a) the notice of intent to exercise under paragraph of this Agreement; or (b) the date all of the conditions under this Agreement have been satisfied in full. 10.1 Chesapeake's Deliveries. Subject to the terms and conditions of this Agreement, on the Closing Date Chesapeake will deliver or cause to be delivered to Gothic the following items (all documents will be duly executed and acknowledged where required): 10.1.1 GEC Securities. Conditioned on the Option being Fully Exercised, the GEC Securities due under paragraph of this Agreement together with stock powers with all signatures guaranteed in the form attached hereto as Schedule "10.1.1"; 10.1.2 Evidence of Authority. Such resolutions, certificates of good standing, incumbency certificates and other evidence of authority with respect to Chesapeake as might be reasonably requested by Gothic; 10.1.3 JIB Payments. Current payment of all joint interest billings owing to the Gothic Parties as required by the Joint Operating Agreements attached to the Participation Agreement; Final Schedule Schedule "A" - -------------- Page 12 of 17 Pages 10.1.4 Closing Memorandum. A memorandum setting forth the items delivered and accounting for the payments made on the Closing Date; 10.1.5 Additional Documents. Such additional documents as might be reasonably requested by Gothic to consummate this Agreement; and 10.1.6 Interim Wells. In the event Chesapeake elects to include the Gothic Parties' interests in the Interim Wells in the Properties pursuant to paragraph 5.8 hereof, Chesapeake will pay to the Gothic Parties an amount equal to the Gothic Parties' unrecovered drilling costs for such Interim Wells. 10.2 Gothic's Deliveries. On the Closing Date, Gothic will deliver or cause to be delivered to Chesapeake the following items (all documents will be duly executed and acknowledged where required): 10.2.1 Assignments. The Conveyance Documents in substantially the form and substance satisfactory to Chesapeake conveying to Chesapeake all of Gothic Parties' right, title and interest in and to the Properties including, without limitation, all of the right, title and interest in and to the Interim Wells in the event Chesapeake elects to include the Interim Wells in the Properties pursuant to paragraph 5.8 hereof; 10.2.2 Releases. Releases and termination statements with respect to any and all liens, claims, security interests and other encumbrances covering any of the Properties including a release of any reconveyance rights in favor of the Gothic Parties under the Participation Agreement; 10.2.3 Evidence of Authority. Such corporate resolutions, certificates of good standing, incumbency certificates and other evidence of authority with respect to each of the Gothic Parties as might be reasonably requested by Chesapeake; 10.2.4 Closing Memorandum. A memorandum setting forth the items delivered and accounting for the payments made on the Closing Date; 10.2.5 Additional Documents. Such additional documents as might be reasonably requested by Chesapeake to consummate this Agreement. 10.3 Costs. Gothic will pay the following closing costs: (a) Gothic's attorneys' fees, investment banker's fees and bank fees; (b) the cost of recording all mortgage or other lien releases and the cost of documentary stamps to be affixed to any deeds conveying title to the Properties to Chesapeake; and (c) any other charge imposed by any governmental authority for the transfer of any item comprising the Final Schedule Schedule "A" - -------------- Page 13 of 17 Pages Properties. Chesapeake will pay only Chesapeake's attorneys' fees and the cost of recording the Conveyance Documents. Chesapeake and the Gothic Parties each agree to use their respective best efforts to take any and all reasonable action to minimize the recording costs and other charges associated with the consummation of the transactions contemplated by this Agreement. 10.4 Files and Data. As of the Closing Date and at all times thereafter during the term of the Restated Participation Agreement, Gothic will make available to Chesapeake for copying, at Chesapeake's expense, all files, records, reports and other data relating to the Properties. 11. Default. In the event either party fails to perform such party's obligations hereunder (except as excused by another party's default) (the "Defaulting Party") such failure will constitute an event of default under this Agreement and the other party (the "Other Party") will have the right to exercise any and all remedies available at law or in equity including, without limitation, specific performance of this Agreement or any one or more of the provisions herein contained, unless such default is waived by the Other Party or cured by the Defaulting Party within five (5) business days after receipt of notice of such default. The remedies provided by this Agreement are cumulative and will not exclude any other remedy to which the Other Party might be entitled under this Agreement or applicable law. In the event the Other Party elects to selectively and successfully enforce the Other Party's rights under this Agreement, such action will not be deemed a waiver or discharge of any other remedy. During the pendency of any default or disputes, this Agreement will be deemed to be in full force and effect. Notwithstanding anything herein to the contrary, on the occurrence of a default or other breach of this Agreement by Gothic, Chesapeake may terminate the Option in the sole and absolute discretion of Chesapeake. 12. Miscellaneous. It is further agreed as follows: 12.1 Time. Time is of the essence of this Agreement. 12.2 Notices. Any notice, demand or communication required or permitted to be given by any provision of this Agreement will be in writing and will be deemed to have been given and received when delivered personally or by telefacsimile to the party designated to receive such notice, or on the date following the day sent by overnight courier, or on the third (3rd) business day after the same is sent by certified mail, postage and charges prepaid, directed to the following addresses or to such other or additional addresses as any party might designate by written notice to the other parties: Final Schedule Schedule "A" - -------------- Page 14 of 17 Pages To Gothic: Gothic Energy Corporation 6120 South Yale Avenue, Suite 1200 Tulsa, Oklahoma 74136 Attn: Michael K. Paulk Telephone (918) 749-5666 Fax No. (918) 749-5882 With a copy to: Pray, Walker, Jackman, Williamson & Marlar 900 OneOk Plaza 100 West 5th Street Tulsa, Oklahoma 74103-4218 Attn: Ira L. Edwards, Jr. Telephone (918) 581-5500 Fax No. (918) 581-5599 To Chesapeake: Chesapeake Energy Corporation 6100 North Western Avenue Oklahoma City, Oklahoma 73118 Attn: Aubrey K. McClendon Telephone (405) 879-9226 Fax No. (405) 848-8588 With a copy to: Self, Giddens & Lees, Inc. 2725 Oklahoma Tower 210 Park Avenue Oklahoma City, Oklahoma 73102 Attn: Ray Lees Telephone (405) 232-3001 Fax: (405) 232-5553 12.3 Cooperation. At all times during the Option Period the parties agree to execute and deliver, or cause to be executed and delivered, such documents and do, or cause to be done, such other acts and things as might reasonably be requested by the other party to this Agreement to assure that the benefits of this Agreement are realized by the parties. 12.4 Press Release. Except to the extent required by applicable disclosure requirements, all press releases relating to this Agreement and the transactions contemplated by this Agreement and the Conveyance Documents will be approved by Gothic and Chesapeake prior to dissemination. 12.5 Choice of Law. This Agreement will be interpreted, construed and enforced in accordance with the laws of the State of Oklahoma and will be deemed for such Final Schedule Schedule "A" - -------------- Page 15 of 17 Pages purposes to have been made, executed and performed in Oklahoma County, Oklahoma. All claims, disputes and other matters in question arising out of or relating to this Agreement will be decided by proceedings instituted and litigated in the District Court of Oklahoma County, Oklahoma or the United States District Court for the Western District of Oklahoma. 12.6 Headings. The paragraph headings contained in this Agreement are for reference purposes only and are not intended to affect in any way the meaning or interpretation of this Agreement. 12.7 Entire Agreement. This Agreement and any document executed in connection herewith on or after the date of this Agreement constitute the entire agreement between the parties with respect to the subject matter hereof and there are no agreements, understandings, warranties or representations except as set forth herein. 12.8 Assignment. It is agreed that the parties may not assign such party's rights nor delegate such party's duties under this Agreement without the express written consent of the other parties to this Agreement. 12.9 Amendment. Neither this Agreement, nor any of the provisions hereof can be changed, waived, discharged or terminated, except by an instrument in writing signed by the party against whom enforcement of the change, waiver, discharge or termination is sought. 12.10 Severability. If any clause or provision of this Agreement is illegal, invalid or unenforceable under any present or future law, the remainder of this Agreement will not be affected thereby. It is the intention of the parties that if any such provision is held to be illegal, invalid or unenforceable, there will be added in lieu thereof a provision as similar in terms to such provisions as is possible to cause such provision to be legal, valid and enforceable. 12.11 Attorney Fees. If any party institutes an action or proceeding against any other party relating to the provisions of this Agreement, the party to such action or proceeding which does not prevail will reimburse the prevailing party therein for the reasonable expenses of attorneys' fees and disbursements incurred by the prevailing party. 12.12 Waiver. Waiver of performance of any obligation or term contained in this Agreement by any party, or waiver by one party of the other's default hereunder will not operate as a waiver of performance of any other obligation or term of this Agreement or a future waiver of the same obligation or a waiver of any future default. Final Schedule Schedule "A" - -------------- Page 16 of 17 Pages IN WITNESS WHEREOF, Chesapeake and Gothic have executed this Agreement as of the date first above written. GOTHIC ENERGY CORPORATION, an Oklahoma corporation By ------------------------------------ Michael K. Paulk, President GOTHIC PRODUCTION COMPANY, an Oklahoma corporation By ------------------------------------ Michael K. Paulk, President (jointly and severally referred to herein as "Gothic") CHESAPEAKE EXPLORATION LIMITED PARTNERSHIP, an Oklahoma limited partnership By: Chesapeake Operating, Inc., General Partner By ------------------------------------ Aubrey K. McClendon, Chief Executive Officer ("Chesapeake") Final Schedule Schedule "A" - -------------- Page 17 of 17 Pages EX-23 3 CONSENT OF PRICEWATERHOUSECOOPERS LLP EXHIBIT 23.0 Consent of PricewaterhouseCoopers LLP CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (File No. 333-23239, No. 333-38679 and No. 333-68085) and on Form S-8 (File No. 333- ______, No. 333-______, and No. 333-______) of Gothic Energy Corporation of our report dated February 21, 2000, relating to the financial statements, which appears in the Annual Report to Shareholders on Form 10-KSB. PricewaterhouseCoopers LLP Tulsa, Oklahoma March 28, 2000 EX-27.0 4 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 2,583 0 8,240 0 0 11,447 270,414 (54,170) 238,397 15,927 319,857 0 45,612 187 (146,834) 238,397 52,967 55,624 35,887 35,887 0 0 37,988 (17,309) 0 (17,309) 0 0 0 (17,309) (1.51) (1.51)
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