ITEM 3. LEGAL PROCEEDINGS
The Company filed suit against Mr. R. E. Steakley in August 1995 to enjoin Mr. Steakley from interfering with the operations of the Company. Mr. Steakley counterclaimed against the Company for surface damages, alleging certain environmental claims. In February 1999, without admitting any liability, the Company and Mr. R. E. Steakley entered into a Settlement and Release Agreement which provided that each of the Company and Mr. Steakley release and discharge the other from all claims and damages which may have occurred through January 31, 1999 and dismiss the pending lawsuits against each other. The Company further agreed to pay Mr. Steakley an amount of $75,000, purchase certain materials from Mr. Steakley at market value which the Company shall use to maintain roads incidental to its operations on the Steakley property and limit the Company's ingress and egress to specified entrances on the Steakley property.
Other than the Bankruptcy Court proceedings, the Company is not a defendant in any additional material pending legal proceedings. 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.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1998.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's Common Stock traded on the Nasdaq National Market since September 1, 1995 under the symbol "NEGX". On November 9, 1998, Nasdaq notified the Company that its common stock would be delisted effective at the close of business that day for failing to meet the net tangible asset test and minimum bid price requirements set forth in NASD Marketplace Rules 4450(a)(3) and 4450(a)(5). Nasdaq also advised the Company that its common stock was immediately eligible for trading on the OTC Bulletin Board through authorized broker-dealers who had been market makers in the Company's stock during the last 30-days. The Company contacted its OTC Market Makers to notify them of Nasdaq's action and to facilitate future trading activity. The Company's common stock currently trades on the OTC Bulletin Board under the symbol "NEGXQ". The following table sets forth for the periods indicated, the high and low closing sales prices for the Company's Common Stock, as reported on Nasdaq and/or the OTC Bulletin Board. The quotations represent prices between dealers in securities and may not include retail mark-up, mark-down, or commission and may not represent actual transactions.
On March 24, 1999, the latest practicable date for providing price information, the last sales price for the Company's Common Stock was $.10.
HOLDERS
As of March 24, 1999, the Company had approximately 4,500 record holders of its shares of Common Stock, including multiple nominee holders for an undetermined number of beneficial owners.
DIVIDENDS ON COMMON STOCK
The Company has not paid cash dividends on its Common Stock and does not expect to declare cash dividends in the foreseeable future. Payment of dividends is prohibited under bankruptcy rules and regulations. Furthermore, any future dividends on the Common Stock will be limited by the terms of the Preferred Stock, which prohibits cash dividends on Common Stock unless all accrued and unpaid dividends on the Preferred Stock have been paid, and the terms of the Company's credit facility with Arnos, Inc., which does not permit dividends on the Common Stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected historical financial and operating data with respect to the Company as of and for each of the five years in the period ended December 31, 1998. The Company acquired significant producing oil and natural gas properties during certain of the periods presented which affects the comparability of the historical financial and operating data for the periods presented. The financial data was derived from the historical financial statements of the Company. This information is not necessarily indicative of the Company's future performance. The financial data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and the related notes thereto of the Company included elsewhere herein.
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(1) Reflects the revenues, results of operations, and production subsequent to the dates of acquisitions of various oil and natural gas properties that affect the comparability of the data presented. The Company acquired a 17% Working Interest in the GAU during 1994. During 1995, the Company acquired interests in producing oil and natural gas properties in the Mustang Island area, the Oak Hill Field, and in Eddy County, New Mexico. In August 1996, the Company completed the Merger with Alexander. See Note 3 of Notes to Consolidated Financial Statements.
(2) The results of operations for the year ended December 31, 1996 include a writedown of oil and natural gas properties of approximately $43.5 million ($28.3 million net of deferred income taxes), in accordance with the full cost method of accounting, which resulted from the Merger. The results of operations for the year ended December 31, 1997, included a writedown of oil and natural gas properties of approximately $46.4 million ($37.5 million, net of deferred income taxes) in accordance with the full cost method of accounting. The results of operations for the year ended December 31, 1998, include a writedown of oil and natural gas properties of approximately $148.4 million in accordance with the full cost method of accounting. See Notes 3 and 12 of Notes to Consolidated Financial Statements.
(3) See the Glossary included elsewhere herein for the definition of EBITDA. EBITDA is not a measure of cash flow as determined by generally accepted accounting principles. The Company has included information concerning EBITDA because EBITDA is a measure used by certain investors in determining the Company's historical ability to service its indebtedness. However, this measure may not be comparable to similarly titled measures of other companies. 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 the Company's operating performance or liquidity.
(4) For the purposes of calculating the ratio of earnings to, or deficiency of earnings over, fixed charges, earnings consist of income before extraordinary items and income taxes plus fixed charges, excluding capitalized interest. Fixed charges consist of interest expense, capitalized interest, the interest component of rent expense, and amortization of debt premium, discount and financing costs. The deficiency of earnings over fixed charges for the years ended December 31, 1994, 1996, 1997 and 1998, were approximately $.05 million, $40.0 million, $44.2 million, and $167.9 million, respectively.
(5) Excludes the full cost ceiling writedowns discussed in Note 2 above.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Company's Financial Statements and "Selected Financial Data" and respective notes thereto, included elsewhere herein. The information below should not be construed to imply that the results discussed herein will necessarily continue into the future or that any conclusion reached herein will necessarily be indicative of actual operating results in the future. Such discussion only represents the best present assessment by management of the Company. Because of the size and scope of the Company's acquisitions during 1996 and the relatively small scale of the Company's operations prior to those acquisitions, the results of operations from 1996 to 1997 are not necessarily comparative.
On December 4, 1998 the Company's 10 3/4% Senior Note bondholders filed an Involuntary Petition for an Order and Relief under Chapter 11 of Title 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, due to non-payment of interest due December 2, 1998, after expiration of a 30-day grace period. On December 23, 1998, the Company filed in the Bankruptcy Court, an Answer to and Motion to Dismiss the pending Involuntary Petition. The Company's Motion affirmed that it (i) was meeting its obligations and generally paying its debts as they became due, unless such debts were the basis of a bona fide dispute and (ii) had arranged with the lender under its credit facility to borrow additional funds sufficient to pay the interest due on the 10 3/4% Senior Notes, conditioned upon the Court's dismissal of the Involuntary Petition. However, on February 8, 1999, the Bankruptcy Court denied the Company's Motion to Dismiss the Involuntary Petition. An Order for Relief was entered by the Bankruptcy Court on February 11, 1999, effective February 8, 1999. The Order for Relief places the Company under the protection of the Court and precludes payment of the interest on the Senior Notes at this time. The Company will act as debtor-in-possession and will continue to operate its business and manage its properties in the ordinary course during its Chapter 11 proceeding. The Company anticipates proposing a Plan of Reorganization within 120 days of February 11, 1999, or at such time as may be extended by the Court. As of December 4, 1998, the Company discontinued the accrual of interest on unsecured liabilities subject to compromise, which primarily relates to the Senior Notes.
OVERVIEW
The Company's current financial condition and 1998 operating results have resulted from the significant decline in oil prices during 1998, coupled with unfavorable revisions in estimates of oil and gas reserves during the year.
The revenues generated by the Company's operations are highly dependent upon the prices of, and demand for, oil and natural gas. The price received by the Company for its oil and natural gas production depends on numerous factors beyond the Company's control, including seasonal price fluctuation, the condition of the U.S. economy, foreign imports, political conditions in other oil and natural gas producing countries, the actions of the Organization of Petroleum Exporting Countries and domestic governmental regulations, legislation and policies. Declines during 1998 in the prices of oil and gas have had a material adverse effect on the carrying value of the Company's oil and gas properties and the Company's revenues, profitability and cash flows.
RESULTS OF OPERATIONS
OVERVIEW OF PRODUCTION, SALES AND UNIT ECONOMICS
The following table sets forth certain information regarding the production volumes, oil and natural gas sales, average sales prices, and unit economics per Mcfe for revenues and costs and expenses related to the Company's oil and natural gas production for the periods indicated.
YEAR ENDED DECEMBER 31, 1998, COMPARED WITH YEAR ENDED DECEMBER 31, 1997
Revenues. Total revenues decreased by $14.0 million (26.7%) to $38.4 million for 1998 from $52.4 million in 1997. The reduction in revenues is primarily due to the decrease in commodity prices from the same period in 1997. Average natural gas prices decreased $.35 per Mcf to $2.02 per Mcf for 1998 from $2.37 for 1997, and average oil prices decreased $6.51 per barrel to $12.66 for 1998 from $19.17 for 1997. The decrease in average prices reduced 1998 revenues by approximately $12.0 million compared to 1997.
Also contributing to the decrease in revenues was the Mmcfe equivalent decrease in production. In 1998, the Company produced 1,238 Mbbls of oil, an increase of 11.5% over 1,110 Mbbls in 1997, and 11,255 Mmcf of natural gas, a decrease of 14.4% over 13,146 Mmcf in the same period of 1997. The increase in oil production is due primarily to the completion of four GAU wells in the first quarter of 1998, the completion of the State Lease #2102 well (in the Greater Bayou Sorrel area) in October of 1998 and the drilling activity on the Company's Anadarko Basin properties. The decline in gas production is primarily due to the flush production in 1997 from the drilling program on the East Texas and Arkoma properties. The Company had limited drilling activity in these areas during 1998.
Also affecting 1998 production was the temporary shut-in of the East Bayou Sorrel field to allow for a pipeline repair, which reduced 1998 production by 291 Mmcfe, the 1997 sale of certain non-strategic properties and natural decline of production not replaced by additional drilling activity. The East Bayou Sorrel field was also shut-in for seven days to allow for the completion of the State Lease #2102 and Hurricane George. The Company expects production to continue to decline unless replaced through drilling, workovers, recompletions and/or acquisitions.
Costs and Expenses. Lease operating expenses increased $1.9 million (28.4%) to $8.6 million for 1998 from $6.7 million for 1997 primarily due to additional wells brought into production during 1998 and 1997. The Company also entered into a saltwater disposal lease and $.4 million was paid for this lease during the fourth Quarter of 1998. The increase in lease operating expenses was in part offset by the 1997 sale of non-strategic properties and the Company's efforts to reduce operating costs. Lease operating expenses per Mcfe
increased to $.46 for 1998 from $.34 for 1997 due to increased costs combined with the Mmcfe equivalent decline in production during the period.
Production taxes decreased $.6 million (19.4%) to $2.5 million for 1998 compared to $3.1 million for 1997. This decrease principally resulted from the decrease in total oil and natural gas revenues discussed above.
Depreciation, depletion and amortization decreased $1.9 million (8.2%) to $21.3 million for 1998 compared to $23.2 million for 1997. This decrease is due to the decrease in the depletion rate per Mcfe from $1.11 in 1997 to $1.06 for 1998. This decrease in the depletion rate was primarily due to the effects on depletion expense of the full cost ceiling writedowns discussed below in 1998.
At March 31, June 30, September 30, and December 31, 1998, the net book value of the Company's oil and natural gas properties exceeded the full cost ceiling, resulting in non-cash writedowns of the oil and natural gas properties totaling $148.4 million for the year. These writedowns resulted primarily from the decline in oil and natural gas prices, costs incurred on unsuccessful exploratory wells drilled during such period and unfavorable revisions to estimates of oil and gas reserves. See Notes 3 and 12 of Notes to Financial Statements.
During 1998, the Company recorded non-recurring charges of approximately $1.9 million for severance and related costs resulting from the restructuring of its executive management team, other personnel changes and costs associated with the Chapter 11 filing.
General and administrative costs increased $1.7 million (38.6%) to $6.1 million compared to $4.4 million for 1997. The increase in general and administrative expenses compared to 1997 was primarily due to increased personnel and office space due to the increase in the scope of the Company's operations. In an effort to reduce general and administrative costs the Company has restructured its executive management team and other personnel. The Company has also renegotiated its office lease and implemented other cost cutting strategies that should help reduce these costs in the future. The Company's capitalized general and administrative expenses totaled $ 1.6 million and $2.0 million for the years ended December 31, 1997 and 1998, respectively. General and administrative costs per Mcfe increased 50.0% to $.33 for 1998 from $.22 for 1997. This increase per Mcfe is attributable to the decrease in production, combined with additional general and administrative costs noted above.
Other Income and Expenses. The increase of $3.2 million in interest expense to $14.4 million for 1998 from $11.2 million for 1997, was due to the issuance of the Series C Notes in August 1997, and interest on borrowings under the credit facility, partially offset by an increase of $.8 million of interest costs which were capitalized during 1998 related to the Company's unproved oil and natural gas properties. The average balance of debt outstanding during 1998 was $180.6 million as compared to average debt outstanding of $133.4 million for 1997. The weighted average interest rate for 1998 was 9.9% compared to 10.3% for 1997. As of December 4, 1998, the Company discontinued the accrual of interest on unsecured liabilities subject to compromise, which primarily consisted of the Senior Notes, as a result of the Chapter 11 filing. Approximately $1.3 million additional interest expense would have been recognized by the Company if not for the discontinuation of the interest accrual on the Senior Notes.
Net Loss. A net loss of $164.5 million was generated for 1998, compared with net loss of $34.3 million for 1997. The net losses for 1998 and 1997 included writedowns of oil and natural gas properties of $148.4 million and $37.5 million, respectively, net of deferred taxes. Excluding these charges, income decreased $19.3 million in 1998 compared with 1997 due to the decrease in operating income and increased interest expense.
YEAR ENDED DECEMBER 31, 1997, COMPARED WITH YEAR ENDED DECEMBER 31, 1996
Revenues. Total revenues increased by $28.2 million (116.5%) to $52.4 million for 1997 from $24.2 million in 1996. In 1997, the Company produced 1,110 Mbbls of oil, an increase of 112.6% over 522 Mbbls in 1996, and 13,146 Mmcf of natural gas, an increase of 131.4% over 5,681 Mmcf in the same period of 1996. The increase in production primarily from the results of the Drilling Program and the Merger with Alexander completed in August 1996. Also contributing to the increased production is the UMC Acquisition, the CA Acquisition, the Lake Boeuf Acquisition and the Bayou Sorrel Acquisition (collectively, the "1996 Acquisitions") completed during 1996.
Also contributing to the increase in revenues was the increase in average natural gas prices of $.11 per Mcf to $2.37 per Mcf for 1997 from $2.26 for 1996, offset by the decrease in average oil prices of $2.53 per barrel to $19.17 for 1997 from $21.70 for 1996.
Costs and Expenses. Lease operating expenses increased $3.1 million (86.1%) to $6.7 million for 1997 from $3.6 million for 1996 primarily due to the increased production discussed above. Although total lease operating expenses increased, lease operating expenses per Mcfe decreased to $.34 for 1997 from $.41 for 1996.
Production taxes increased $1.8 million (144.2%) to $3.1 million for 1997 compared to $1.3 million for 1996. This increase principally resulted from the increase in total oil and natural gas revenues discussed above and increased production in Louisiana, which has higher production tax rates than Texas, Oklahoma and Arkansas.
Depreciation, depletion and amortization increased $13.3 million (134.3%) to $23.2 million for 1997 compared to $9.9 million for 1996. This increase is due to the increased production. The depletion rate per Mcfe was $1.11 for 1997 compared to $1.10 for 1996. This increase in the depletion rate was primarily due to the acquisition costs incurred in the Merger.
At December 31, 1997, the net book value of the Company's oil and natural gas properties exceeded the full cost ceiling, resulting in a non-cash writedown of the oil and natural gas properties of $46.4 million ($37.5 million net of deferred income taxes). This writedowns resulted primarily from the decline in oil and natural gas prices in the fourth quarter of 1997, combined with the costs incurred on unsuccessful exploratory wells drilled during such period. In August, 1996, as a result of allocating the cost of the Merger with Alexander, under the purchase method of accounting, to the proved oil and natural gas properties acquired in connection with the Merger, the Company recognized a writedown of the oil and natural gas properties, net of related deferred income taxes of $28.3 million. See Notes 3 and 12 of Notes to Financial Statements.
General and administrative costs increased $2.2 million (100.0%) to $4.4 million compared to $2.2 million for 1996, due to the Merger with Alexander, although general and administrative costs per Mcfe decreased 8.3% to $.22 for 1997 from $.24 for 1996. This decrease per Mcfe is attributable to the increase in production discussed above, without a proportionate increase in costs to the Company.
Other Income and Expenses. The increase of $7.1 million in interest expense to $11.2 million for 1997 from $4.1 million for 1996, was due to the issuance of the Notes, partially offset by $2.5 million of interest costs related to the Company's unproved oil and natural gas properties which was capitalized in 1997. The average balance of debt outstanding during 1997 was $133.4 million as compared to average debt outstanding of $41.4 million for 1996. The weighted average interest rate for 1997 was 10.34% compared to 8.64% for 1996.
Net Loss. A net loss of $34.3 million was generated for 1997, compared with net loss of $25.8 million for 1996. The net losses for 1997 and 1996 included writedowns of oil and natural gas properties of $37.5 million and $28.3 million, respectively, net of deferred taxes. Excluding these charges, income increased $.8 million in 1997 compared with 1996 as the increase in 1997 operating income more than offset the increase in interest expense.
LIQUIDITY AND CAPITAL RESOURCES
YEAR ENDED DECEMBER 31, 1998, COMPARED WITH YEAR ENDED DECEMBER 31, 1997
Net cash provided by operating activities was $5.1 million for the year ended December 31, 1998, compared to $22.9 million for the same period in 1997. The decrease in cash flow from operating activities is primarily due to the decrease in income from operations before non-cash charges, resulting from depressed sales prices for oil and gas and reduced production at such prices.
Net cash used by investing activities was $53.3 million for 1998 compared with $75.8 million for 1997. The cash used by investing activities for 1998 included $52.0 million for exploration and development expenditures pursuant to the Company's Drilling Program, including acquisitions of leasehold interests and seismic costs.
Net cash provided by financing activities was $24.8 million for 1998 compared with $64.7 million for the same period in 1997. The net cash provided by financing activities during 1998 consisted primarily of proceeds from the credit facility. In 1997, cash provided by financing activities consisted primarily of proceeds from the issuance of the Series C Notes.
The Company's working capital deficit at December 31, 1998, was $197.8 million compared to a working capital surplus at December 31, 1997 of $8.4 million. The decrease in working capital was due primarily to the classification as a current liability of the $25.0 million due under the Arnos credit facility, the $166.2 million due on the Senior Notes and the accrued interest on the Senior Notes.
YEAR ENDED DECEMBER 31, 1997, COMPARED WITH YEAR ENDED DECEMBER 31, 1996
Net cash provided by operating activities was $22.9 million for the year ended December 31, 1997, compared to $11.8 million for the same period in 1996. The increase in cash flow from operating activities is primarily due to the increase in income from operations before non-cash charges.
Net cash used by investing activities was $75.8 million for 1997 compared with $49.3 million for 1996. The cash used by investing activities for 1997 included $77.9 million for exploration and development expenditures pursuant to the Company's Drilling Program, including acquisitions of leasehold interests and seismic costs. In December 1997, the Company sold its interests in 274 nonstrategic wells for approximately $5.4 million.
Net cash provided by financing activities was $64.7 million for 1997 compared with $45.6 million for the same period in 1996. The net cash provided by financing activities during 1997 consisted primarily of proceeds from the issuance of the Series C Notes. In 1996, cash provided by financing activities consisted primarily of proceeds from the issuance of the Series A Notes and proceeds from the issuance of preferred stock, partially offset by repayments of long-term debt.
The Company's working capital surplus at December 31, 1997, was $8.4 million compared to a working capital deficit at December 31, 1996, of $1.6 million. The increase in working capital was due primarily to the issuance of the Series C Notes, partially offset by the expenditures of cash for oil and gas exploration, acquisition, and development activities.
FUTURE CAPITAL REQUIREMENTS
The Company has made, and will continue to make, ordinary course capital expenditures for the development, and exploitation of oil and natural gas reserves, subject to economic conditions and in accordance with the rulings and procedures set forth by the Court. Due to the Chapter 11 filing and severely depressed oil prices, the Company has suspended its exploratory drilling program. The Company will limit its capital expenditures to ordinary course enhancement of current production through workovers, recompletions, and other production enhancing activities deemed to be economic given current depressed oil and gas prices. Development drilling is anticipated to be limited to (i) ordinary course nonoperated wells in which we have limited working interests and in which the failure to participate may result in drainage, depletion or loss of current reserves and (ii) operated wells deemed to be economical given current oil and gas prices. Large expenditures for developmental drilling may require court approval and none are planned at this time.
The Company has currently budgeted approximately $7.8 million for capital expenditures related to its oil and gas properties in 1999, of which approximately $6.0 million would be for development and exploitation activities, and approximately $1.8 million would be for delay rentals, lease bonuses, geological and geophysical costs. Actual amounts to be expended by the Company for these activities will be dependent upon a number of factors, including Court approval if necessary, oil and natural gas prices, the availability of capital, seismic and contract service costs, availability of drilling rigs and future drilling results. The Company is not contractually committed to expend the budgeted funds.
The Company currently expects that existing cash and cash flows from operations will be sufficient to fund planned capital expenditures for its existing properties through 1999. However, the Company would require additional capital to fund any acquisitions and access to these markets could be limited due to the Chapter 11 proceeding.
Subject to Court approval, the Company may seek additional capital, if required, from traditional reserve base borrowings, equity, and debt offerings or joint ventures to further develop and explore its properties and to acquire additional properties. There is no assurance, even if approved by the Court, that the Company would be able to access additional capital or that, if available, it will be at prices or on terms acceptable to the Company. In addition, the Chapter 11 proceeding and restrictions from the Bankruptcy Court could limit the Company's ability to access additional capital markets.
Should the Company be unable to access the capital markets or should sufficient capital not be available, the development and exploration of the Company's properties could be delayed or reduced and, accordingly, oil and natural gas revenues and operating results may be adversely affected.
10 3/4% SENIOR NOTES DUE 2006
On December 4, 1998 the Company's 10 3/4% Senior Note bondholders filed an Involuntary Petition for an Order for Relief under Chapter 11 of Title 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, due to non-payment of interest due December 2, 1998, after expiration of a 30-day grace period. On December 23, 1998, the Company filed in the Bankruptcy Court, an Answer to and Motion to Dismiss the pending Involuntary Petition. The Company's Motion affirmed that it (i) was meeting its obligations and generally paying its debts as they became due, unless such debts were the basis of a bona fide dispute and (ii) had arranged with the lender under its credit facility to borrow additional funds sufficient to pay the interest due on the 10 3/4% Senior Notes, conditioned upon the Court's dismissal of the Involuntary Petition. However, on February 8, 1999, the Bankruptcy Court denied the Company's Motion to Dismiss the Involuntary Petition. An Order for Relief was entered by the Bankruptcy Court on February 11, 1999. The Order for Relief places the Company under the protection of the Court and precludes payment of the interest on the Senior Notes at this time. The Company shall act as debtor-in-possession and will continue to operate its business and manage its properties in the ordinary course of business during its Chapter 11 proceeding. The Company anticipates proposing a Plan of Reorganization within 120 days of February 11, 1999 or at such time as may be extended by the Court. As of December 4, 1998, the Company discontinued the accrual of interest related to unsecured liabilities subject to compromise, principally the Senior Notes.
Due to the non-payment of interest due December 2, 1998, the Senior Notes were in default at December 31, 1998 and have been classified as a current liability.
In November 1996, the Company issued $100 million aggregate principal amount of unregistered 10 3/4% Series A Notes due 2006. The net proceeds of the Series A Notes of approximately $96.1 million were used to repay approximately $62.0 million of borrowings under the predecessor to the credit facility and to increase the Company's working capital. In 1997, the Series A Notes were exchanged for the registered 10 3/4% Series B Notes due 2006 which are substantially identical to the Series A Notes. Collectively, the Series A Notes and Series B Notes are referred to as the "Series A/B Notes." In August 1997, the Company issued $65.0 million aggregate principal amount of its unregistered 10 3/4% Series C Notes. The net proceeds of the Series C Notes of approximately $64.8 million were used to repay approximately $23.0 million of borrowings under the credit facility, to fund the Drilling Program, and to increase the Company's working capital. In December 1997, the Company exchanged substantially all of the Series A/B Notes and the Series C Notes for registered 10 3/4% Series D Notes due 2006. The Series D Notes are substantially identical to the Series A/B Notes and the Series C Notes. Collectively, the Series A/B Notes, the Series C Notes, and the Series D Notes are referred to as the "Notes." The Notes bear interest at 10 3/4% per annum, payable semi-annually on May 1 and November 1. The Notes mature November 1, 2006, but may be redeemed after November 1, 2001, at the Company's option. The Indentures governing the Notes contain certain covenants, including, but not limited to covenants restricting the ability of the Company and its Restricted Subsidiaries' (as defined), to incur additional indebtedness. See Note 5 of Notes to Consolidated Financial Statements.
CREDIT FACILITIES
On August 29, 1996, the Company, NEG-OK and Boomer Marketing, entered into a credit facility with Bank One, as Bank and Administrative Agent, and the Credit Lyonnais New York Branch, as Bank and Syndication Agent
(collectively, the "Banks"). The credit facility consisted of a $100.0 million reducing revolving line of credit, with an initial borrowing base of $60.0 million and a $5.0 million term loan. Interest under the reducing revolving line of credit was payable monthly at the Bank One base rate, as adjusted. The proceeds from the credit facility were used to repay a prior credit facility and the existing indebtedness of NEG-OK, resulting in an extraordinary charge of $292,372 or $.01 per common share in 1996.
In November 1996, the Company repaid the outstanding borrowings under the credit facility with a portion of proceeds from the issuance of $100.0 million principal amount of 10 3/4% Senior Notes due 2006 (the "Series A Notes"). See Note 5.
Also in November 1996, in connection with the issuance of the Series A Notes, the Company revised the credit facility. The credit facility had a borrowing base of $25.0 million. The borrowing base may be redetermined at least semiannually and may require mandated monthly principal reductions from time to time. The principal amount of any borrowings is due at maturity, August 29, 2000 and interest is payable monthly.
The Company granted liens to the Banks on substantially all of the Company's oil and natural gas properties, whether currently owned or hereafter acquired, and a negative pledge on all other oil and natural gas properties. The credit facility requires, among other things, semiannual engineering reports covering oil and natural gas properties, and maintenance of certain financial ratios, including the maintenance of a minimum interest coverage, a current ratio, and a minimum tangible net worth.
The credit facility contains other covenants prohibiting cash dividends, distributions, loans, or advances to third parties, except that cash dividends on preferred stock will be allowed so long as no event of default exists or would exist as a result of the payment thereof. In addition, if the Company is required to purchase or redeem any portion of the Notes, or if any portion of the Notes become due, the borrowing base is subject to reduction.
The Company is required to pay a commitment fee on the unused portion of the borrowing base equal to 1% per annum.
On December 7, 1998, Bank One and Credit Lyonnais gave notice to the Company that all outstanding obligations under the credit facility were accelerated and were immediately due and payable due to certain unspecified Events of Default as defined in the loan agreement.
Effective December 22, 1998, the credit facility and all associated liens were assigned by the Banks to Arnos, Inc., an affiliated subsidiary of the Company's Series D Preferred Stockholder. In a letter dated December 23, 1998, Arnos (1) rescinded the acceleration of the loan, (2) waived all defaults existing at that time and (3) made sufficient borrowings available to pay the interest on the Senior Notes that was due on November 2, 1998 conditioned upon the Bankruptcy Court's dismissal of the Involuntary Petition. To date, no fees or interest have been paid to Arnos. The Company is accruing interest expense at an estimated rate under the Arnos credit facility. The Company had $25,000,000 outstanding under the Arnos credit facility as of December 31, 1998. At December 31, 1998, the Company was in violation of the minimum interest coverage ratio and current ratio covenants under the Arnos credit facility and as a result has classified the borrowings under the credit facility as a current liability.
PREFERRED STOCK
In June 1994, the Company consummated the sale of $5.0 million of the Series B Preferred Stock. Fifty thousand shares of the Series B Preferred Stock were sold by the Company at $100 per share. The Series B Preferred Stock is convertible into shares of the Common Stock at a conversion price of $1.625 per share. In October 1997, 13,813 shares of the Series B Preferred Stock were converted into Common Stock, leaving 38,687 shares of the Series B Preferred Stock outstanding. The board of directors declared dividends on the Series B in December of 1998, which would be made in shares of Series B Preferred Stock. This dividend-in-kind has not been made and is currently in arrears.
In June 1995, the Company consummated the sale of $4.0 million of the Series C Preferred Stock. Forty thousand shares of the Series C Preferred Stock were sold by the Company at $100 per share. The Series C Preferred Stock is
convertible into shares of the Common Stock at a conversion rate of $2.00 per share. The Series B Preferred Stock and Series C Preferred Stock require that dividends be paid on the Series B Preferred Stock and Series C Preferred Stock before any dividends are paid on the Common Stock. In October 1997, 17,000 shares of the Series C Preferred Stock were converted into Common Stock, leaving 23,000 shares of the Series C Preferred Stock outstanding. The board of directors declared dividends on the Series C in December of 1998, which would be made in shares of Series C Preferred Stock. This dividend-in-kind has not been made and is currently in arrears.
In August 1996, the Company completed the sale of 100,000 shares of the Series D Preferred Stock for $10.0 million and 50,000 shares of the Series E Preferred Stock for $5.0 million. The Series D Preferred Stock and Series E Preferred Stock are convertible into shares of the Common Stock at a conversion price of $2.25 per share. As part of such sale, the Company agreed to extend the date at which it may first redeem the Series B Preferred Stock and Series C Preferred Stock from June 14, 1997 to June 14, 1999. In October 1997, 40,500 shares of the Series E Preferred Stock were converted into Common Stock, leaving 9,500 shares of the Series E Preferred Stock outstanding.
See Note 7 of Notes to Consolidated Financial Statements.
FINANCIAL REPORTING IMPACT OF FULL COST METHOD OF ACCOUNTING
The Company follows the full cost method of accounting for oil and natural gas properties. Under such method, the net book value of such properties, less related deferred income taxes, may not exceed a calculated "ceiling." The ceiling is the estimated after-tax future net revenues from proved oil and natural gas properties, discounted at 10% per year. In calculating future net revenues, prices and costs in effect at the time of the calculation are held constant indefinitely, except for changes which are fixed and determinable by existing contracts. The net book value is compared to the ceiling on a quarterly and yearly basis. The excess, if any, of the net book value above the ceiling is required to be written off as a non-cash expense. During 1996, as a result of allocating additional cost, under the purchase method of accounting, to the oil and natural gas properties in connection with the Merger, the Company recognized a non-cash writedown of its oil and natural gas properties of approximately $28.3 million, net of deferred taxes. During the years ended December 31, 1997 and 1998, the net book value of the Company's oil and natural gas properties exceeded the ceiling based on the weighted average prices of crude oil and natural gas received by the Company resulting in non-cash writedowns totaling $37.5 million, net of deferred taxes and $148.4 million, respectively. There can be no assurance that there will not be additional writedowns in future periods under the full cost method of accounting as a result of sustained decreases in oil and natural gas prices or other factors.
RECENT ACCOUNTING PRONOUNCEMENTS
As of January 1, 1998, the Company adopted Financial Accounting Standards Board Statement No. 130, Reporting Comprehensive Income. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Statement 130 establishes rules for the reporting and display of comprehensive income and its components. For 1996, 1997 and 1998, the differences between net earnings and total comprehensive income were not material.
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, which is required to be adopted in years beginning after June 15, 1999. The Company expects to adopt the new Statement effective January 1, 2000. The Statement will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a hedge's change in fair value will be immediately recognized in earnings.
CHANGES IN PRICES AND INFLATION
The prices received by the Company for its oil and natural gas production declined dramatically during 1998. The prices received for crude oil reached their lowest level in 50 years and were the lowest inflation-adjusted oil prices since
the Depression. The Company's revenue and value of its oil and natural gas properties have been and will continue to be adversely affected until such prices recover. Oil and gas prices are subject to seasonal and other fluctuations that are beyond the Company's ability to control or predict.
During 1996, the Company hedged crude oil and natural gas prices through the use of commodity swap agreements in an effort to reduce the effects of the volatility of the price of crude oil and natural gas on the Company's operations. These agreements involved the receipt of fixed-price amounts in exchange for variable payments based on NYMEX prices and specific volumes. In connection with the commodity swap agreements, the Company may also enter into basis swap agreements to reduce the effects of unusual fluctuations between prices actually received at the wellhead and NYMEX prices. Through the use of commodity price and basis swap agreements, the Company can fix the price to be received for specified volumes of production to the commodity swap price less the basis 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 crude oil and natural gas sales. The Company does not hold or issue financial instruments for trading purposes.
While the use of hedging arrangements limits the downside risk of adverse price movements, it may also limit future gains from favorable movements. All hedging has been accomplished pursuant to swap agreements based upon standard forms. The Company addresses market risk by selecting instruments whose value fluctuations correlate strongly with the underlying commodity being hedged. Credit risk related to hedging activities is managed by requiring minimum credit standards for counter parties, periodic settlements, and market to market valuations. The Company has not been required to provide collateral relating to hedging activities. At December 31, 1998, the Company had no hedging or basis swap agreements outstanding. During the years ended December 31, 1996, 1997 and 1998, the Company recognized a net gain of $20,315, $0, and $0 respectively, related to hedging transactions.
At December 31, 1998, the Company had entered into forward sales contracts with two purchasers covering the future production of natural gas. Deliveries under these contracts are priced based on NYMEX prices less a differential whereby the Company may fix the price for deliveries under these contracts at any time three days prior to the close of the then current contract based on the NYMEX prices at that time. The Company pays the cost of transportation of the natural gas to the delivery point specified in the contracts. See Note 9 of Notes to Consolidated Financial Statements.
Although certain of the Company's costs and expenses are affected by the level of inflation, inflation has not had a significant effect on the Company's results of operations during the three years ended December 31, 1998.
YEAR 2000
The year 2000 ("Y2K") problem arises because of computer programs which use two digits rather than four digits to define a year. This may result in miscalculations or complete system failures in processing data with programs using date sensitive information.
The Company currently uses commercially available software for its management information systems, including accounting, engineering, and word processing applications. This software has either already been warranted by the suppliers or publishers to be Y2K compliant or the suppliers and publishers have represented such software will be compliant in upgrades the Company will receive in 1999 at minimal or no cost to the Company.
The Company has reviewed its internal computer systems and expects to be compliant with Y2K by mid-year. The costs of compliance have been minimal and management expects them to remain minimal since its management information systems are warranted to be compliant or are represented to be compliant in upgrades the Company will receive in 1999. Furthermore, the Company replaced its former oil and gas system in 1996 with a Y2K compliant oil and gas package.
Management is in the process of obtaining confirmation from its major suppliers and purchasers that they also are or will be Y2K compliant. The costs of seeking such confirmation are expected to be minimal. Management believes that it will not be practical to independently verify the responses because it does not believe that the Company would be given access to carry out such verification or that the costs of doing so would be affordable. The cost of replacing
non-compliant or non-responsive suppliers and customers will not be possible to determine until the review process has been completed. Any Y2K problems that do occur will likely manifest themselves in reduced production through equipment shut downs or impaired liquidity through inability of customers to take delivery of production or process payments. The Company plans to establish contingency plans by mid-year once its confirmation program is complete and the risks have been more fully quantified.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company from time to time utilizes derivative instruments, principally to hedge natural gas production, whereby gains and losses in the fair value of the derivative instruments are generally offset by price changes in the underlying commodity. Based on this approach, combined with risk assessment procedures and internal controls, management believes that its use of derivative instruments does not expose the Company to material risk, however, the use of derivative instruments for the hedging activities could affect the Company's results of operations in particular quarterly or annual periods. The use of such instruments limits the downside risk of adverse price movements, but it may also limit the Company's ability to benefit from favorable price movements.
At December 31, 1998, the Company had entered into forward sales contracts with two purchasers covering future production of natural gas. Deliveries under these contracts are priced based on NYMEX prices less a differential whereby the Company may fix the price for deliveries under these contracts at any time three days prior to the close of the then current contract based on the NYMEX prices at the time. Deliveries to be made under the forward sales contracts have not been priced as of December 31, 1998.
The Company's exposure to interest rates relates primarily to its borrowings under its credit facility. The Company does not currently use derivatives to manage interest rate risk. Interest is payable on borrowings under the credit facility based on a floating rate. If short-term interest rates average 10% higher in 1999 than they were in 1998, the Company's interest expense would increase by approximately $225,000. This amount was determined by applying the hypothetical interest rate change to the Company's outstanding borrowings under the credit facility at December 31, 1998.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements of the Company required by this Item 8 are included as part of Item 14(a)(1) hereof. These Financial Statements also serve as financial statements required pursuant to Rule 15d-21 and Form 11-K of the Exchange Act for the National Energy Group, Inc. Employee Stock Purchase Plan, as such Plan invests solely in the Company's common stock.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item 10 will be provided in the sections entitled "Proposal 1 - Director Election Proposal", "Management" and "Certain Relationships and Related Transactions" in the Company's definitive proxy statement for its 1999 Annual Meeting of Shareholders (the "Proxy Statement") or in Item 10 of a Form 10-KA, and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 will be provided in the section entitled, "Management" in the Company's Proxy Statement or in Item 11 of a Form 10-KA, and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 will be provided in the section entitled "Security Ownership of Certain Beneficial Owners and Management" in the Company's Proxy Statement or in Item 12 of a Form 10-KA, and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 will be provided in the section entitled "Certain Relationships and Related Transactions" in the Company's Proxy Statement or in Item 13 of a Form 10-KA, and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report.
1. Financial Statements: See Index to Financial Statements and Financial Statement Schedules on page of this report.
2. Financial Statement Schedules: See Index to Financial Statements and Financial Statement Schedules on page of this report.
3. Exhibits: The following documents are filed as exhibits to this report:
2.1 Agreement and Plan of Merger, dated June 6, 1996, among the Company, NEG-OK, Inc. ("NEG OK"), and Alexander Energy Corporation ("Alexander") (1)
2.2 First Amendment to Agreement and Plan of Merger, dated as of June 20, 1996, among the Company, NEG-OK and Alexander (2)
2.3 Mutual Waiver Agreement dated as of August 29, 1996 by and among the Company, NEG-OK and Alexander (3)
3.1 Certificate of Incorporation of the Company, which includes the Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on November 20, 1990 (4), the Certificate of Elimination of the Redeemable Convertible Preferred Stock, Series A of the Company, filed with the office of the Secretary of State of the State of Delaware on June 2, 1994 (3), the Certificate of Amendment of Certificate of Incorporation of the Company, filed with the office of the Secretary of State of the State of Delaware on August 29, 1996 (3) , the Certificate of Designations of the Company of 10% Cumulative Convertible Preferred Stock, Series B (5), the Certificate of Designations of the Company of 10 1/2% Cumulative Convertible Preferred Stock, Series C (6), the Certificate of Designations of the Company of Convertible Preferred Stock, Series D (3), and the Certificate of Designations of the Company of Convertible Preferred Stock, Series E (3)
3.2 By-laws of the Company (4)
4.1 Certificate of Designations of the Company of 10% Cumulative Convertible Preferred Stock, Series B (5)
4.2 Certificate of Designations of the Company of 10 1/2% Cumulative Convertible Preferred Stock, Series C (6)
4.3 Certificate of Designations of the Company of Convertible Preferred Stock, Series D (3)
4.4 Certificate of Designations of the Company of Convertible Preferred Stock, Series E (3)
4.5 Indenture dated as of November 1, 1996, among the Company, National Energy Group of Oklahoma, Inc. (the "Guarantor"), formerly NEG-OK, and Bank One, Columbus, N.A. (7)
4.6 Indenture dated August 21, 1997, among the Company and Bank One, N.A. (14)
4.7 Instrument of Resignation, Appointment and Acceptance, dated October 23, 1998, between the Company, Bank One, N.A., and Norwest Bank Minnesota, N.A. (19)
10.1 Crude Oil Purchase Contract, dated November 30, 1992, between the Company and Plains Liquids Transport Inc. (8)
10.2 Amendment to Crude Oil Purchase Contract, dated November 17, 1993, between the Company and Plains Liquids Transport, Inc. (5)
10.3 Crude Oil Purchase Contract, dated February 8, 1993, between the Company and Plains Marketing and Transportation Inc. and the predecessor contract, the Crude Oil Purchase Contract, dated November 12, 1991, between Sunnybrook Transmission, Inc. and TriSearch Inc. (8)
10.4 Agreement for Purchase and Sale (Mustang Island) dated April 20, 1995, between the Company and Sierra Mineral Development, L.C. (6)
10.5 Agreement for Purchase and Sale (Oak Hill) dated April 12, 1995, between the Company and Sierra 1994 I Limited Partnership (6)
10.6 Stock Purchase Agreement, dated as of June 14, 1995, among the Company, Arbco Associates L.P., Offense Group Associates L.P., Kayne, Anderson Nontraditional Investments L.P., and Opportunity Associates L.P. (6)
10.7 High River Limited Partnership Warrant to purchase 700,000 Shares of Common Stock, dated August 29, 1996 (3)
10.8 Form of Series E Investors' Warrants to purchase an aggregate 350,000 Shares of Common Stock, dated August 29, 1996 (3)
10.9 Gascon Partners Warrant to Purchase 300,000 shares of the Company's Common Stock (13)
10.10 Prudential Securities Incorporated Warrant to Purchase 100,000 Shares of the Company's Common Stock (3)
10.11 Gaines Berland, Inc. Warrant to Purchase 300,000 Shares of the Company's Common Stock dated August 29, 1996 (3)
10.12 Gaines Berland, Inc. Warrant to Purchase 700,000 Shares of the Company's Common Stock dated August 29, 1996 (3) 10.13 Executive Employment Agreement, dated January 1, 1996, between the Company and Miles D. Bender (9)
10.13 Executive Employment Agreement, dated January 1, 1996, between the Company and Miles D. Bender (9)
10.14 Separation Agreement, dated November 24, 1998, between the Company and Miles D. Bender (19)
10.15 Executive Employment Agreement, dated January 1, 1996, between the Company and Melissa Rutledge (9)
10.16 Separation Agreement between the Company and Robert A. Imel dated October 31, 1997 (15)
10.17 Separation Agreement, dated May 18, 1998, between the Company and William T. Jones (17)
10.18 Executive Employment Agreement, dated June 6, 1996, between the Company and Jim L. David (1)
10.19 Executive Employment Agreement dated March 20, 1997, between the Company and Philip D. Devlin (10)
10.20 Separation Agreement, dated May 19, 1998, between the Company and Gene W. Anderson (19)
10.21 Executive Employment Agreement dated August 25, 1997, between the Company and C. Dewayne Cravens (19)
10.22 Separation Agreement, dated May 18, 1998, between the Company and C. Dewayne Cravens (19)
10.23 Executive Employment Agreement, dated January 29, 1998, between the Company and Fred R. Miller (15)
10.24 Executive Employment Agreement, dated March 5, 1998, between the Company and Chuck Elsey (16)
10.25 Termination Notice and Agreement, dated October 28, 1998, between the Company and Chuck Elsey(19)
10.26 Executive Employment Agreement, dated April 13, 1998, between the Company and Kent Lueders(16)
10.27 Executive Employment Agreement, dated June 1, 1998, between the Company and Leslie Wylie(17)
10.28 National Energy Group, Inc. 1996 Incentive Compensation Plan (11)
10.29 National Energy Group, Inc. Employee Stock Purchase Plan(12)
10.30 National Energy Group, Inc. Employee Severance Policy(19)
10.31 Agreement dated January 1, 1996 between the Company and Sandefer Oil & Gas, Inc.(1)
10.32 Consulting Agreement dated January 1, 1996 between Sandefer Oil & Gas, Inc. and Potosky Oil & Gas, Inc. and Atocha Exploration, Inc.(1)
10.33 Memorandum of Amendment dated March 27, 1997 amending (i) Agreement dated January 1, 1996 between the Company and Sandefer Oil & Gas, Inc. and (ii) Consulting Agreement dated January 1, 1996 between Sandefer Oil & Gas, Inc. and Potosky Oil & Gas, Inc. and Atocha Exploration, Inc.(15)
10.34 First Amendment dated April 15, 1997 to (i) Agreement dated January 1, 1996 between the Company and Sandefer Oil & Gas, Inc. and (ii) Consulting Agreement dated January 1, 1996 between Sandefer Oil & Gas, Inc. and Potosky Oil & Gas, Inc. and Atocha Exploration, Inc.(15)
10.35 Restated Loan Agreement dated August 29, 1996 among Bank One and Credit Lyonnais New York Branch ("Credit Lyonnais") and the Company, NEG-OK and Boomer Marketing Corporation ("Boomer")(3)
10.36 $50,000,000 Revolving Note dated August 29, 1996 payable to Bank One(3)
10.37 $50,000,000 Revolving Note dated August 29, 1996 payable to Credit Lyonnais(3)
10.38 Assignment of $50,000,000 Revolving Note to Arnos Corp. from BankOne, Texas, N.A.(19)
10.39 Assignment of $50,000,000 Revolving Note to Arnos Corp. from Credit Lyonnais New York Branch(19)
10.40 Unlimited Guaranty of NEG-OK dated August 29, 1996 for the benefit of Bank One(3)
10.41 Unlimited Guaranty of NEG-OK, dated August 29, 1996 for the benefit of Credit Lyonnais(3)
10.42 Unlimited Guaranty of Boomer dated August 29, 1996 for the benefit of Bank One(3)
10.43 Unlimited Guaranty of Boomer dated August 29, 1996 for the benefit of Credit Lyonnais(3)
10.44 First Amendment to Restated Loan Agreement dated October 31, 1996 among Bank One and Credit Lyonnais and the Company, Guarantor and Boomer(9)
10.45 Second Amendment to Restated Loan Agreement dated October 31, 1996, among Bank One and Credit Lyonnais and the Company, Guarantor and Boomer(10)
10.46 Third Amendment to Restated Loan Agreement dated October 31, 1996, among Bank One and Credit Lyonnais and the Company, Guarantor and Boomer(10)
10.47 Fourth Amendment to Restated Loan Agreement dated October 31, 1996, among Bank One and Credit Lyonnais and the Company, Guarantor and Boomer(5)
10.48 Multi-State Assignment Agreement dated December 22, 1998 between BankOne, Texas, NA, Credit Lyonnais New York Branch and Arnos, Corp.(19)
10.49 Multi-State Assignment Agreement, LaFourche Parish, Louisiana, dated December 22, 1998, between BankOne, Texas, NA, Credit Lyonnais New York Branch and Arnos Corp.(19)
10.50 Multi-State Assignment Agreement, Iberville Parish, Louisiana, dated December 22, 1998, between BankOne, Texas, NA, Credit Lyonnais New York Branch and Arnos Corp.(19)
10.51 Oklahoma Assignment Agreement, dated December 22, 1998, between BankOne, Texas, NA, Credit Lyonnais New York Branch and Arnos, Corp.(19)
10.52 Arnos Corporation Letter dated December 23, 1998(19)
12.1 Computation of Ratio of Earnings to Fixed Charges(19)
23.1 Consent of Ernst & Young LLP, Independent Auditors(19)
24.1 Power of Attorney (included in signature pages to this Form 10-K)(19)
27.1 Financial Data Schedule(19)
99.1 Order of Bankruptcy Court Granting Relief on Involuntary Petition(18)
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(1) Incorporated by reference to the Company's Registration Statement on Form S-4 (No. 333-9045), dated July 29, 1996.
(2) Incorporated by reference to Amendment No. 1 to the Company's Registration Statement on Form S-4 (No. 333-9045), dated August 7, 1996.
(3) Incorporated by reference to the Company's Current Report on Form 8-K, dated August 29, 1996.
(4) Incorporated by reference to the Company's Registration Statement on Form S-4 (No. 33-38331), dated April 23, 1991.
(5) Incorporated by reference to the Company's Current Report on Form 8-K, dated June 17, 1994.
(6) Incorporated by reference to the Company's Current Report on Form 8-K, dated July 17, 1995.
(7) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996.
(8) Incorporated by reference to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1992.
(9) Incorporated by reference to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1995.
(10) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997.
(11) Incorporated by reference to the Company's Schedule 14A filed April 25, 1997.
(12) Incorporated by reference to the Company's Form S-8 filed December 23, 1997.
(13) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997.
(14) Incorporated by reference to the Company's Form S-4 (No. 333-38075), filed October 16, 1997.
(15) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1997.
(16) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998.
(17) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.
(18) Incorporated by reference to the Company's Current Report on Form 8-K, dated February 8, 1999.
(19) Filed herewith.
(b) The Company filed a report on Form 8-K, dated February 8, 1999, reporting the entry of an Order for Relief Under Chapter 11 of the Bankruptcy Code by the United States Bankruptcy Court for the Northern District of Texas, Dallas Division. Under the Order, the Court assumed jurisdiction and supervision of the Company and its assets and business.
GLOSSARY
Wherever used herein, the following terms shall have the meaning specified.
Bbl -- One stock tank barrel, or 42 U.S. 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 the 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. The hydrocarbons are classified as proved but non-producing reserves.
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 an oil and natural gas reservoir to the depth of 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 (including interest income and excluding discontinued operations, extraordinary items, charges resulting from changes in accounting and significant nonrecurring revenues and expenses) before interest expense, income taxes, depletion, depreciation and amortization, and the provision for impairment of oil and natural gas properties. EBITDA is not a measure of cash flow as determined by generally accepted accounting principles. EBITDA information has been included in this document 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.
Mbbl -- One thousand Bbl.
Mcf -- One thousand cubic feet.
Mcfe -- One thousand cubic feet of Natural Gas Equivalent.
Mmcf -- One million cubic feet.
Mmcfe -- One million cubic feet of Natural Gas Equivalent.
Natural Gas Equivalent -- The ratio of one Bbl of crude oil to six Mcf of natural gas.
Net Acres or Net Wells -- The sum of the fractional Working Interests owned in Gross Acres or Gross Wells.
NYMEX -- New York Mercantile Exchange.
Oil and Natural Gas Lease -- An instrument by which a mineral fee owner grants to a lessee the right for a specific period of time to explore for oil and natural gas underlying the lands covered by the lease and the right to produce any oil and natural gas so discovered generally for so long as there is production in economic quantities from such lands.
OPEC -- Organization of Petroleum Exporting Countries.
Overriding Royalty Interest -- A fractional undivided interest in an oil and natural gas property entitling the owner of a share of oil and natural gas production, in addition to the usual royalty paid to the owner, free of costs of production.
PDNP -- Proved developed, nonproducing, or Behind the Pipe reserves.
Productive Well -- A well that is producing oil or natural gas or that is capable of production.
Proved Developed Producing Reserves -- Proved reserves that can be expected to be recovered from currently producing zones under the continuation of present operating methods.
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 -- 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.
PUD -- See Proved Undeveloped Reserves.
PV 10% -- The discounted future net cash flows for Proved Reserves of oil and natural gas 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 oil and natural gas properties and acquisitions, but should not be construed as an alternative to the Standardized Measure (as determined in accordance with generally accepted accounting principles).
Revenue Interest -- The interest in a lease or well that receives a proportionate share of all revenues from that lease or well as identified in the division order.
Royalty Interest -- An interest in an oil and natural gas property entitling the owner to a share of oil and natural gas production free of costs of production.
Secondary Recovery -- A method of oil and natural gas extraction in which energy sources extrinsic to the reservoir are utilized.
Standardized Measure -- The estimated future net cash flows from Proved Reserves of oil and natural gas computed using prices and costs, at the date 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 oil and natural gas regardless of whether such acreage contains Proved Reserves.
Working Interest -- The operating interest which gives the owner the right to participate in the drilling, producing, and conducting operating activities on the property and a share of all costs of exploration, development, and operations and all risks in connection therewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
POWER OF ATTORNEY AND SIGNATURES
The undersigned directors and officers of National Energy Group, Inc. hereby constitute and appoint Bob G. Alexander with full power to act and with full power of substitution and resubstitution, our true and lawful attorney-in-fact with full power to execute in our name and on our behalf in the capacities indicated below any and all amendments to this Form 10-K and to file the same, with all exhibits thereto and other documents in connection therewith with the Commission, and hereby ratify and confirm all that such attorney-in-fact, which he or his substitute shall lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities on March 31, 1999.
/s/ Bob G. Alexander President, Chief Executive - ------------------------------------------------ Officer and Director Bob G. Alexander
/s/ Jim L. David Assistant to President - ------------------------------------------------ and Director Jim L. David
/s/ Russell D. Glass Director - ------------------------------------------------ Russell D. Glass
/s/ Martin Hirsch Director - ------------------------------------------------ Martin Hirsch
/s/ Robert H. Kite Director - ------------------------------------------------ Robert H. Kite
/s/ Robert J. Mitchell Director - ------------------------------------------------ Robert J. Mitchell
/s/ Jack G. Wasserman Director - ------------------------------------------------ Jack G. Wasserman
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
FINANCIAL STATEMENT SCHEDULES
All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders National Energy Group, Inc.
We have audited the accompanying consolidated balance sheets of National Energy Group, Inc., as of December 31, 1997 and 1998, and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of National Energy Group, Inc., at December 31, 1997 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company has suffered recurring losses from operations. Additionally, as discussed in Note 1 of the Notes to the Consolidated Financial Statements, on February 11, 1999, the United States Bankruptcy Court granted an Involuntary Petition for an Order for Relief under Chapter 11 of Title 11 of the United States Bankruptcy Code. These matters raise substantial doubt about the ability of the Company to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
ERNST & YOUNG LLP
Dallas, Texas March 24, 1999
NATIONAL ENERGY GROUP, INC. CONSOLIDATED BALANCE SHEETS (NOTE 1)
ASSETS
See accompanying notes.
NATIONAL ENERGY GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (NOTE 1)
See accompanying notes.
NATIONAL ENERGY GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (NOTE 1)
See accompanying notes.
NATIONAL ENERGY GROUP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (NOTE 1)
See accompanying notes.
NATIONAL ENERGY GROUP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED) (NOTE 1)
See accompanying notes.
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
1. SUBSEQUENT EVENT - BANKRUPTCY ORDER
On December 4, 1998 the Company's 10 3/4% Senior Note bondholders filed an Involuntary Petition for an Order for Relief under Chapter 11 of Title 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, due to non-payment of interest due December 2, 1998, after expiration of a 30-day grace period. On December 23, 1998, the Company filed in the Bankruptcy Court, an Answer to and Motion to Dismiss the pending Involuntary Petition. The Company's Motion affirmed that it (i) was meeting its obligations and generally paying its debts as they become due, unless such debts were the basis of a bona fide dispute and (ii) had arranged with the lender under its credit facility to borrow additional funds sufficient to pay the interest due on the 10 3/4% Senior Notes, conditioned upon the Court's dismissal of the Involuntary Petition. However, on February 8, 1999, the Bankruptcy Court denied the Company's Motion to Dismiss the Involuntary Petition. An Order for Relief was entered by the Bankruptcy Court on February 11, 1999. The Order for Relief places the Company under the protection of the Court and precludes payment of the interest on the Senior Notes at this time. Additionally, payment of liabilities existing as of February 11, 1999 to certain unsecured creditors and dividends in arrears to holders of the Company's Preferred Stock and any pending litigation are stayed during the Bankruptcy proceeding. The Company shall act as debtor-in-possession and will continue to operate its business and manage its properties in the ordinary course of business during its Chapter 11 proceeding. The Company anticipates proposing a Plan of Reorganization within 120 days of February 11, 1999 or at such time as may be extended by the Court. As of December 4, 1998, the Company discontinued the accrual of interest related to unsecured liabilities subject to compromise, principally the Senior Notes, as a result of the Chapter 11 filing. Approximately $1.3 million additional interest expense would have been recognized by the Company if not for the discontinuation of the interest accrual on the Senior Notes.
The accompanying consolidated financial statements have been prepared on a going concern basis of accounting and do not reflect any adjustments that might result should the Company be unable to continue as a going concern. The Company's recent losses from operations and the related Chapter 11 proceeding raise concern about its ability to continue as a going concern. The appropriateness of using the going concern basis is dependent upon, among other things (i) confirmation of a plan of reorganization under the Bankruptcy Code, (ii) the ability to achieve profitable operations after such confirmation and (iii) the ability to generate sufficient cash from operations to meet its obligations.
The Company anticipates proposing a Plan of Reorganization in accordance with the federal bankruptcy laws as administered by the Bankruptcy Court. Confirmation of a Plan of Reorganization could materially change the amounts currently recorded in the financial statements. The financial statements do not give effect to any adjustment to the carrying value of assets, or amounts and classifications of liabilities that might be necessary as a consequence of this matter.
Through December 31, 1998, the Company has incurred expenses of approximately $.3 million relating to the bankruptcy proceedings. At December 31, 1998, substantially all of the Company's unsecured liabilities are subject to compromise under the terms of the bankruptcy proceeding.
2. SIGNIFICANT ACCOUNTING POLICIES
Organization and Business
National Energy Group, Inc. was incorporated under the laws of the State of Delaware on November 20, 1990. The Company has historically engaged in the exploration, acquisition, exploitation, development, and operation of crude oil and natural gas properties in major producing basins onshore in Texas, Louisiana, Oklahoma, Arkansas, and Mississippi and offshore in the Gulf of Mexico.
Consolidation
The consolidated financial statements include the accounts of National Energy Group, Inc., and its subsidiaries. All significant intercompany transactions and balances have been eliminated.
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Accounting 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 these estimates.
Cash and Cash Equivalents
Cash and cash equivalents may include demand deposits, short-term commercial paper, and/or money-market investments with maturities of three months or less when purchased. At December 31, 1997, all cash and cash equivalents were invested with Bank One, Texas, N.A. At December 31, 1998, all cash and cash equivalents were invested with either Bank One or Chase Bank of Texas.
Oil and Natural Gas Properties
The Company utilizes the full cost method of accounting for its crude oil and natural gas properties. Under the full cost method, all productive and nonproductive costs incurred in connection with the acquisition, exploration, and development of crude oil and natural gas reserves are capitalized and amortized on the units-of-production method based upon total proved reserves. The costs of unproven properties are excluded from the amortization calculation until the individual properties are evaluated and a determination is made as to whether reserves exist. Conveyances of properties, including gains or losses on abandonments of properties, are treated as adjustments to the cost of crude oil and natural gas properties, with no gain or loss recognized.
Under the full cost method, the net book value of oil and natural gas properties, less related deferred income taxes, may not exceed the estimated after-tax future net revenues from proved oil and natural gas properties, discounted at 10% per year (the ceiling limitation). In arriving at estimated future net revenues, estimated lease operating expenses, development costs, abandonment costs, and certain production related and ad-valorem taxes are deducted. In calculating future net revenues, prices and costs in effect at the time of the calculation are held constant indefinitely, except for changes which are fixed and determinable by existing contracts. The net book value is compared to the ceiling limitation on a quarterly and yearly basis. The excess, if any, of the net book value above the ceiling limitation is required to be written off as a non-cash expense. During 1996, as a result of allocating additional cost, under the purchase method of accounting, to the oil and natural gas properties in connection with the Alexander Energy acquisition, the Company recognized a non-cash writedown of its oil and natural gas properties of approximately $43.5 million. During the years ended December 31, 1997 and 1998, the net book value of the Company's oil and natural gas properties exceeded the ceiling limitation resulting in non-cash writedowns totaling $46.4 and $148.4 million, respectively. There can be no assurance that there will not be additional writedowns in future periods under the full cost method of accounting as a result of sustained decreases in oil and natural gas prices or other factors.
Oil and natural gas properties excluded from the ceiling limitation consist primarily of unevaluated acreage, acquisition costs, and related seismic and other geological and geophysical costs (unproven properties). During 1998, unproven properties with a carrying value of approximately $32.0 million were transferred to proved properties, largely as a result of drilling activities and became subject to the full cost ceiling. At December 31, 1998, due to uncertainty relating to the Company's ability to obtain Court approval for exploration of its remaining portfolio of unproven properties and due to low oil prices which make the projects uneconomical, the remaining carrying value of the unproven properties, approximately $9.1 million, was transferred to proved properties and became subject to the ceiling limitation.
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company has capitalized internal costs of $487,835, $1,582,021 and $1,950,914 for the years ended December 31, 1996, 1997, and 1998, respectively. Such capitalized costs include salaries and related benefits of individuals directly involved in the Company's acquisition, exploration, and development activities based on the percentage of their time devoted to such activities. During the years ended December 31, 1997 and 1998, the Company capitalized interest costs of $2,545,617 and $3,371,279 related to its unproved oil and gas properties.
Other Property and Equipment
Other property and equipment includes furniture, fixtures, and other equipment. Such assets are recorded at cost and are depreciated over their estimated useful lives using the straight-line method.
Maintenance and repairs are charged against income when incurred; renewals and betterments, which extend the useful lives of property and equipment, are capitalized.
Income Taxes
Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in the period that includes the enactment date. The measurement of deferred tax assets is adjusted by a valuation allowance, if necessary, to recognize the extent to which, based on available evidence, the future tax benefits more likely than not will be realized.
Financial Instruments
The Company does not hold or issue financial instruments for trading purposes.
See Notes 4 and 5 for disclosure of the fair value of borrowings under the Company's credit facility and the 10 3/4% Senior Notes, respectively.
The Company from time to time utilizes certain derivative financial instruments to hedge future oil and gas prices. (Note 9). Gains and losses arising from the use of these instruments are deferred until realized and are reported as oil and natural gas sales.
The Company's marketable securities are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of stockholders' equity. Realized gains and losses and declines in value judged to be other-than-temporary are included in interest income. The cost of securities sold is based on the specific identification method.
The following is a summary of available-for-sale securities at December 31, 1997 and 1998:
The Company had no sales of marketable securities in 1998.
The Company's investment in marketable securities is comprised of securities of another independent oil and gas company.
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company sells crude oil and natural gas to various customers. In addition, the Company participates with other parties in the operation of crude oil and natural gas wells. Substantially all of the Company's accounts receivable are due from either purchasers of crude oil and natural gas or participants in crude oil and natural gas wells for which the Company serves as the operator. Generally, operators of crude oil and natural gas properties have the right to offset future revenues against unpaid charges related to operated wells. Crude oil and natural gas sales are generally unsecured.
Allowances for bad debt totaled approximately $120,000 and $150,000 at December 31, 1997 and 1998, respectively. At December 31, 1997 and 1998, the carrying value of the Company's accounts receivable approximates fair value.
Natural Gas Production Imbalances
The Company accounts for natural gas production imbalances using the sales method, whereby the Company recognizes revenue on all natural gas sold to its customers notwithstanding the fact that its ownership may be less than 100% of the natural gas sold.
Stock Options
The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for its employee stock options. Under APB 25, if the exercise price of an employee's stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized.
Earnings (Loss) Per Share
Earnings (loss) per share is computed in accordance with Financial Accounting Standards Board Statement No. 128, Earnings per Share. Basic earnings per share data is computed by dividing net income (loss) applicable to common shareholders by the weighted average number of common shares outstanding and excludes any dilutive effects of options, warrants, and convertible securities. Shares issuable upon exercise of options and warrants are included in the computation of diluted earnings per common and common equivalent share to the extent that they are dilutive. Diluted earnings per share computations also assume the conversion of the Company's preferred stock (Note 7) if such conversion has a dilutive effect. For the years ended December 31, 1996, 1997, and 1998, neither the common equivalent shares nor the assumed conversion of the preferred stock had a dilutive effect on the loss per share calculations. Accordingly, both basic and diluted loss per share calculations for such periods are based on the weighted average number of common shares outstanding during each year.
Recent Accounting Pronouncements
As of January 1, 1998, the Company adopted Financial Accounting Standards Board Statement No. 130, Reporting Comprehensive Income. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Statement 130 establishes rules for the reporting and display of comprehensive income and its components. For 1996, 1997 and 1998, the differences between net earnings and total comprehensive income were not material.
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, which is required to be adopted in years beginning after June 15, 1999. The Company expects to adopt the new Statement effective January 1, 2000. The Statement will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a hedge's change in fair value will be immediately recognized in earnings.
Reclassifications
Certain previously reported amounts have been reclassified to conform with the current presentation.
3. ACQUISITIONS
In January 1996, the Company completed the acquisition of oil and natural gas properties in offshore Nueces County, Texas, adjacent to the Company's Mustang Island property, from C/A Limited, Chartex Petroleum Company, and Petrotex Engineering Company. The acquisition includes interests in five wells, a pipeline and separation facility related to Mustang Island. The consideration for this acquisition consisted of 140,857 shares of the Company's Common Stock and $675,000 in cash.
In February 1996, the Company completed the acquisition of two oil and gas wells on one offshore block, interests in five other offshore blocks, and a related production platform and equipment in offshore Nueces County, Texas, adjacent to the Company's Mustang Island property, from UMC Petroleum Corporation (the "UMC Acquisition"). The consideration for this acquisition consisted of $1.5 million in cash, which was funded primarily from borrowings under a credit agreement with Bank One.
In April 1996, the Company won exploration rights on 16 offshore tracts (covering 7,765 acres) in the Mustang Island area in offshore Nueces County, Texas, through successful bids with the State of Texas ("Offshore Lease Acquisition"). The Company paid $1.4 million in cash for these rights, and the purchase was funded by borrowings under a credit facility with Bank One and available cash.
On August 29, 1996, the Company completed the acquisition of Alexander Energy Corporation. The transaction consisted of a merger of Alexander with and into National Energy Group of Oklahoma, Inc., formerly known as NEG-OK, Inc., a wholly-owned subsidiary of the Company ("NEG-OK"). Pursuant to the Merger, (a) the separate corporate existence of Alexander terminated, (b) each share of Alexander common stock, par value $.03 per share ("Alexander Common Stock"), together with certain rights associated with the Alexander Common Stock outstanding immediately before the Merger, were converted into 1.7 shares of the Company's Common Stock, and (c) all outstanding options and warrants to purchase Alexander Common Stock were assumed by the Company and converted into options and warrants to purchase Common Stock. In lieu of fractional shares, Alexander shareholders otherwise entitled to receive fractional shares of Common Stock were paid in cash an amount equal to $4.375 multiplied by the fraction of a share of Common Stock to be received. On December 31, 1996, NEG-OK was merged into and with the Company and its separate corporate existence ceased to exist.
In connection with the Merger, on August 29, 1996, the Company, NEG-OK, and Boomer Marketing Corporation, a wholly-owned subsidiary of NEG-OK, entered into a new credit facility. See Note 4. On August 29, 1996, the Company also closed the sale of 100,000 shares of its Convertible Preferred Stock, Series D, $1.00 par value per share, the sale of 50,000 shares of its Convertible Preferred Stock, Series E, $1.00 par value per share, and warrants to purchase 1,050,000 shares of Common Stock. See Note 7.
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
3. ACQUISITIONS (CONTINUED)
The cost of acquiring Alexander was approximately $69.4 million, consisting of the following (in thousands):
The fair value of the securities issued in connection with the Merger was calculated using the price of the Company's Common Stock at the time the Merger was announced to the public of $3.00 per share.
The Company's purchase price was allocated to the consolidated assets and liabilities of NEG-OK based on preliminary estimates of fair values with the remaining purchase price allocated to proved oil and gas properties. No goodwill was recorded in this transaction.
The allocation of the purchase price is summarized as follows (in thousands):
Under the full cost method of accounting, the carrying value of oil and gas properties (net of related deferred taxes) is generally not permitted to exceed the sum of the present value (10% discount rate) of estimated future net cash flows, after tax, from proved reserves, based on current prices and costs, plus the lower of cost or estimated fair value of unproved properties (the "full cost ceiling"). Based upon the combined full cost ceiling at August 29, 1996, and the preliminary allocation of the Company's purchase price, the purchase price allocated to oil and gas properties was in excess of the full cost ceiling using oil and natural gas prices being received by the Company and NEG-OK in August 1996 of $20.75 per Bbl and $2.21 per Mcf. Such excess was written off at the date of acquisition, resulting in a charge to the Company's results of operations of $28.3 million as follows (in thousands):
In September 1996, the Company acquired an approximate 87.5% working interest in two wells and certain proved undeveloped reserves in the South Lake Boeuf Field, La Fourche Parish, Louisiana (the "Lake Boeuf Acquisition") for approximately $7.2 million, consisting of $1.5 million in cash and 1,758,460 shares of Common Stock.
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
3. ACQUISITIONS (CONTINUED)
The following pro forma data presents the results of the Company for the year ended December 31, 1996, as if the acquisitions of Mustang Island, Oak Hill, the Enron Properties, NEG-OK, and the Lake Boeuf Acquisition had occurred on January 1, 1996. The pro forma results of operations are presented for comparative purposes only and are not necessarily indicative of the results which would have been obtained had the acquisitions been consummated as presented. The following data reflect pro forma adjustments for oil and gas revenues, production costs, depreciation, and depletion related to the properties and businesses acquired, interest on borrowed funds, additional preferred stock dividend requirements, and the related income tax effects, but excluding the effect of the full cost ceiling writedown recorded in 1996 (in thousands, except per share amounts).
In October 1996, the Company acquired certain leasehold interests located in the East Bayou Sorrel Field, Iberville Parish, Louisiana from W&T Offshore, Inc. The consideration paid by the Company consisted of $3,300,000 in cash. In November 1996, the Company completed the acquisition of oil and natural gas properties and related facilities located in the Bayou Sorrel Field, Iberville Parish, Louisiana. The consideration paid by the Company consisted of $9.0 million cash, 477,612 shares of the Company's Common Stock and conveyance of 3% overriding royalty interest in the property acquired, limited to production below 11,000 feet. In December 1996, the Company acquired certain oil and natural gas properties located in the East Bayou Sorrel Field, Iberville Parish, Louisiana. The consideration paid by the Company consisted of $7.0 million in cash. The Company funded the cash portion of these acquisitions from available cash. These acquisitions consisted principally of proved developed nonproducing and unproved properties and, accordingly, did not have a significant impact on the Company's results of operations for 1996.
In December 1996, the Company acquired, for $4.2 million in cash, John Hancock Mutual Life Insurance Company's limited partnership interests in certain limited partnerships in which the Company was the general partner. The limited partnerships owned working interests in the Anadarko and Arkoma Basin areas of Oklahoma and the Giddings area of Texas.
In March 1998, the Company acquired Fortune Natural Resources Corporation's interests in the East Bayou Sorrel field for approximately $4.5 million in cash. In June 1998, the Company acquired Germany Oil Company's interest in six state leases and one producing well in the Mustang Island area for $.4 million in cash. These acquisitions did not have a significant impact on the Company's results of operations for 1998.
4. CREDIT FACILITIES
On August 29, 1996, the Company, NEG-OK and Boomer Marketing, entered into a credit facility with Bank One, as Bank and Administrative Agent, and the Credit Lyonnais New York Branch, as Bank and Syndication Agent (collectively, the "Banks"). The credit facility consisted of a $100.0 million reducing revolving line of credit, with an initial borrowing base of $60.0 million and a $5.0 million term loan. Interest under the reducing revolving line of credit was payable monthly at the Bank One base rate, as adjusted. The proceeds from the credit facility were used to repay a prior credit facility and the existing indebtedness of NEG-OK, resulting in an extraordinary charge of $292,372 or $.01 per common share in 1996.
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
4. CREDIT FACILITIES (CONTINUED)
In November 1996, the Company repaid the outstanding borrowings under the credit facility with a portion of proceeds from the issuance of $100.0 million principal amount of 10 3/4% Senior Notes due 2006 (the "Series A Notes"). See Note 5.
Also in November 1996, in connection with the issuance of the Series A Notes, the Company revised the credit facility. The credit facility had a borrowing base of $25.0 million. The borrowing base may be redetermined at least semiannually and may require mandated monthly principal reductions from time to time. The principal amount of any borrowings is due at maturity, August 29, 2000 and interest is payable monthly.
The Company granted liens to the Banks on substantially all of the Company's oil and natural gas properties, whether currently owned or hereafter acquired, and a negative pledge on all other oil and natural gas properties. The credit facility requires, among other things, semiannual engineering reports covering oil and natural gas properties, and maintenance of certain financial ratios, including the maintenance of a minimum interest coverage, a current ratio, and a minimum tangible net worth.
The credit facility contains other covenants prohibiting cash dividends, distributions, loans, or advances to third parties, except that cash dividends on preferred stock will be allowed so long as no event of default exists or would exist as a result of the payment thereof. In addition, if the Company is required to purchase or redeem any portion of the Notes, or if any portion of the Notes become due, the borrowing base is subject to reduction.
The Company is required to pay a commitment fee on the unused portion of the borrowing base equal to 1% per annum.
On December 7, 1998, Bank One and Credit Lyonnais gave notice to the Company that all outstanding obligations under the credit facility were accelerated and were immediately due and payable due to certain unspecified Events of Default as defined in the loan agreement.
Effective December 22, 1998, the credit facility and all associated liens were assigned by the Banks to Arnos, Inc., an affiliated subsidiary of the Company's Series D Preferred Stockholder. In a letter dated December 23, 1998, Arnos (1) rescinded the acceleration of the loan, (2) waived all defaults existing at that time and (3) made sufficient borrowings available to pay the interest on the Senior Notes that was due on November 2, 1998, conditioned upon the Bankruptcy Court's dismissal of the Involuntary Petition. To date, no fees or interest have been paid to Arnos. The Company is currently accruing interest expense at an estimated rate under the Arnos credit facility. The Company had $25,000,000 outstanding under the Arnos credit facility as of December 31, 1998. At December 31, 1998, the Company was in violation of the minimum interest coverage ratio and current ratio covenants under the Arnos credit facility and has classified borrowings under the facility as current liabilities.
At December 31, 1998, the fair value of borrowings under the Arnos credit facility approximates the carrying value of the liability.
5. 10 3/4 SENIOR NOTES DUE 2006
On December 4, 1998 the Company's 10 3/4% Senior Note bondholders filed an Involuntary Petition for an Order for Relief under Chapter 11 of Title 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division due to non-payment of interest due December 2, 1998, after expiration of 30 day grace period. On December 23, 1998, the Company filed in the Bankruptcy Court, an Answer to and Motion to Dismiss the pending Involuntary Petition. The Company's Motion affirmed that it (i) was meeting its obligations and generally paying its debts as they become due, unless such debts were the basis of a bona fide dispute and (ii) had arranged with the lender under its credit facility to borrow additional funds sufficient to pay the interest due on the 10 3/4% Senior Notes, conditioned upon the Court's dismissal of the Involuntary Petition. However, on February 8, 1999, the Bankruptcy Court denied the Company's Motion to Dismiss the Involuntary Petition. An Order for Relief was entered by the Bankruptcy Court on February 11, 1999. The Order for Relief places the Company under the protection of the Court and precludes payment of the interest on the Senior Notes at this time. The Company shall act as debtor-in-possession and will continue to operate its business and manage its properties in the ordinary course of business during its Chapter 11 proceeding. The Company anticipates proposing a Plan of Reorganization within 120 days of February 11, 1999 as such time may be extended by the Court. As a result of the Chapter 11 proceeding, the Company discontinued accruing interest on the Notes as of December 4, 1998, principally the Senior Notes, as a result of the Chapter 11 filing. Approximately $1.3 million additional interest expense would have been recognized by the Company if not for the discontinuation of the interest accrual on the Senior Notes.
In November 1996, the Company issued $100 million aggregate principal amount of unregistered 10 3/4% Senior Notes due 2006 (the "Series A Notes"). The net proceeds of the Series A Notes of approximately $96.1 million were used to repay approximately $62.0 million of borrowings under a prior facility and to increase the Company's working capital. In 1997, the Series A Notes were exchanged for registered 10 3/4% Senior Notes due 2006 (the "Series B Notes") which were substantially identical to the Series A Notes. Collectively, the Series A Notes and Series B Notes are referred to as the Series A/B Notes." In August 1997, the Company issued $65.0 million aggregate principal amount of its unregistered 10 3/4% Senior Notes (the "Series C Notes"). The net proceeds of the Series C Notes of approximately $64.8 million were used to repay approximately $23.0 million of borrowings under the credit facility and to increase the Company's working capital. In December 1997, the Company exchanged substantially all of the Series A/B Notes and all of the Series C Notes for registered 10 3/4% Senior Notes due 2006 (the "Series D Notes"). The Series D Notes are substantially identical to the Series A/B Notes and the Series C Notes. Collectively, the Series A/B Notes, the Series C Notes and the Series D Notes are referred to as the "Notes." The Notes bear interest at an annual rate of 10 3/4%, payable semiannually in arrears on May 1 and November 1 of each year. The Notes are senior, unsecured obligations of the Company, ranking pari passu with all existing and future senior indebtedness of the Company, and senior in right of payment to all future subordinated indebtedness of the Company. Subject to certain limitations set forth in the indenture covering the Notes (the "Indenture"), the Company and its subsidiaries may incur additional senior indebtedness and other indebtedness.
At December 31, 1997 and 1998, unamortized issuance premiums associated with the Notes totaled $1,396,622 and $1,238,513, respectively.
The Indenture provides that the Notes will be unconditionally guaranteed (the "Guarantee") by any subsidiary designated by the Company as a Restricted Subsidiary (a "Guarantor"). As a result of the merger of NEG-OK into the Company on December 31, 1996, the Company has no Restricted Subsidiaries.
The Indenture contains certain covenants limiting the Company and any Restricted Subsidiaries, with respect to the following: (i) assets sales; (ii) restricted payments; (iii) the incurrence of additional indebtedness and the issuance of certain redeemable preferred stock; (iv) liens; (v) sale and leaseback transactions; (vi) lines of business; (vii) dividend and other payment restrictions affecting subsidiaries; (viii) mergers and consolidations; and (ix) transactions with affiliates.
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
The Notes mature on November 1, 2006. At any time on or after November 1, 2001, the Company may, at its option, redeem all or any portion of the Notes at the redemption prices expressed as percentages of the principal amount of the Notes set forth below, plus, in each case, accrued and unpaid interest thereon to the applicable redemption date, if redeemed during the 12-month period beginning November 1 of the years indicated below:
Notwithstanding the foregoing, at any time prior to November 1, 2001, the Company may, at its option, redeem all or any portion of the Notes at the Make-Whole Price, as defined, plus accrued and unpaid interest to the date of redemption. In addition, in the event the Company consummates one or more Equity Offerings, as defined, on or prior to November 1, 1999, the Company, at its option, may redeem up to $35.0 million of the aggregate principal amount of the Notes with all or a portion of the aggregate net proceeds received by the Company from such Equity Offering or Equity Offerings at a redemption price of 110.75% of the aggregate principal amount of the Notes so redeemed, plus accrued and unpaid interest thereon to the redemption date; provided, however, that following such redemption, at least $65.0 million of the aggregate principal amount of the Notes remains outstanding.
Upon a Change of Control, as defined, the Company will be required, subject to certain conditions, to offer to repurchase all Notes at 101% of the principal amount thereof, plus accrued and unpaid interest to the date of purchase.
Due to the non-payment of interest due December 2, 1998, the Notes were in default at December 31, 1998, and have been classified as a current liability.
At December 31, 1998, the fair value of the Notes, as determined by quoted market prices, was approximately $62.7 million.
6. COMMITMENTS AND CONTINGENCIES
The Company leases office space under an operating lease. Rental expense charged to operations was approximately $117,000, $275,000, and $364,000 during the years ended December 31, 1996, 1997 and 1998, respectively. Minimum lease payments under future operating lease commitments at December 31, 1998, are as follows:
The Company filed suit against Mr. R. E. Steakley in August 1995 to enjoin Mr. Steakley from interfering with the operations of the Company. Mr. Steakley counterclaimed against the Company for surface damages, alleging certain environmental claims. In February 1999, without admitting any liability, the Company and Mr. R. E. Steakley entered into a Settlement and Release Agreement which provided that each of the Company and Mr. Steakley release and discharge the other from all claims and damages which may have occurred through January 31, 1999 and dismiss the pending litigation against each other. The Company further agreed to pay Mr. Steakley an amount of $75,000, purchase certain materials from Mr. Steakley at market value which the Company shall use to maintain roads incidental to its operations on the Steakley property and limit the Company's ingress and egress to specified entrances on the Steakley property.
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Other than the Bankruptcy Court proceeding, the Company is not a defendant in any additional material pending legal proceedings. 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.
7. STOCKHOLDERS' EQUITY
Preferred Stock
At December 31, 1998, the Company has authorized 330,000 shares of $1.00 par value convertible preferred stock designated in four series B through E:
On June 3, 1994, the Company consummated the sale of $5,000,000 of the Company's 10% Cumulative Convertible Preferred Stock, Series B. Fifty thousand shares of Series B were sold by the Company at $100.00 per share. The Series B is convertible into shares of Common Stock at a conversion price of $1.625 per share. The Series B has a liquidation and dividend preference over the Common Stock. The Series B has a 10% dividend, payable semi-annually. The Company has the option to make six dividend payments in shares of Series B; after the sixth such payment, the holders of Series B have the option to receive additional dividends in shares of Series B or to accrue such dividends in cash. If the Company makes four dividend payments in shares of Series B, the holders of Series B have the right to appoint one-third of the members of the Company's Board of Directors. In December 1998, the Board of Directors declared a dividend on Series B to be made in shares of Series B. To date, the dividends have not been paid and therefore there are $193,435 dividends in arrears at December 31, 1998. The Series B is redeemable by the Company beginning June 14, 1999, at $100.00 per share, plus accrued and unpaid dividends; provided, however, that the Company cannot redeem any shares of Series B unless and until all outstanding shares of the Series C have been redeemed by the Company. The holders of Series B currently have the right to appoint one member to the Company's Board of Directors. The Series B requires that dividends be paid on the Series B before any dividends are paid on Common Stock.
The holders of Series B are entitled to one vote for each share as to matters upon which by law they are entitled to vote as a class. The approval of a majority of the Series B, voting separately as a class, is required to (i) make changes to the Company's Certificate of Incorporation or By-Laws which adversely affect the Series B, (ii) authorize or issue additional shares of Series B, (iii) issue preferred stock equal to or senior to the Series B as to dividends or liquidation, or (iv) subject to certain exceptions, to effect an extraordinary transaction that requires a vote of the Company's stockholders. As a result, a class vote of the holders of Series B would be required for the Company to merge or be acquired and may therefore delay, deter, or prevent a change in control of the Company.
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
7. STOCKHOLDERS' EQUITY (CONTINUED)
In June 1995, the Company consummated the sale of $4.0 million of the Company's 10 1/2% Cumulative Convertible Preferred Stock, Series C. Forty thousand shares of Series C were sold by the Company at $100.00 per share. The Series C is convertible into shares of Common Stock at a conversion price of $2.00 per share.
The Series C has a liquidation and dividend preference over the Common Stock and is parity stock to the previously issued Series B. The Series C has a 10 1/2% dividend, payable semi-annually. The Company has the option to make six dividend payments in shares of Series C; after the sixth such payment, the holders of Series C have the option to receive additional dividends in shares of Series C or to accrue such dividends in cash.
If the Company makes four dividend payments in shares of Series C, the holders of Series C (voting as a class with other affected series of preferred stock with similar voting rights) have the right to appoint one-third of the members of the Company's Board of Directors; provided, however, that if the holders of Series B are presently entitled to a similar right, then the holders of Series C shall have no such right until the right of the holders of Series B terminates. In December 1998, the Board of Directors declared a dividend on Series C to be made in shares of Series C. To date, the dividend is unpaid and therefore there are $120,750 dividends in arrears at December 31, 1998. The Series C is redeemable by the Company beginning June 14, 1999, at $100.00 per share, plus accrued and unpaid dividends. The holders of the Series C currently have the right to appoint one member to the Company's Board of Directors. The holders of Series C are entitled to one vote for each share as to matters upon which by law they are entitled to vote as a class. The approval of a majority of the Series C, voting separately as a class, is required to (i) make changes to the Company's Certificate of Incorporation or By-Laws which adversely affect the Series C, (ii) authorize or issue additional shares of Series C, (iii) issue preferred stock equal to or senior to the Series C as to dividends or liquidation, (iv) subject to certain exceptions, to effect an extraordinary transaction that requires a vote of the Company stockholders. As a result, a class vote of the holders of Series C, as well as the Series B, would be required for the Company to merge or be acquired and may therefore delay, deter, or prevent a change in control of the Company.
On August 29, 1996, the Company closed the sale for $10.0 million to High River Limited Partnership of 100,000 shares of its Convertible Preferred Stock, Series D, $1.00 par value per share and warrants to purchase 700,000 shares of Common Stock exercisable immediately at $2.50 per share, which warrants expire five years from their date of issuance. The rights and preferences of the Series D are described in the Certificate of Designations of the Series D and include the immediate right to convert all the shares of the Series D into 4,444,444 shares of Common Stock, based upon the initial conversion price of $2.25 per share.
The holder of the Series D is entitled to one vote for each share when entitled to vote as described below and as to matters upon which by law it is entitled to vote as a class. The holder of Series D has the right to appoint one member to the Board of Directors. The Company may not, without the consent of the director appointed by the holder of Series D, voluntarily file for protection under federal or other bankruptcy laws. In addition, the holder of Series D currently has the right to choose to appoint one-half of the members of the Board of Directors plus one member (including the member appointed by the Series D) if it elects to exercise such right. Currently, the holder of the Series D has appointed a total of three directors to the Board.
On August 29, 1996, simultaneously with the closing of the sale for $10.0 million of the Series D to High River, the Company also closed the sale for $5.0 million to two insurance companies and four affiliates of Kayne, Anderson Investment Management, Inc., a registered investment adviser, of 50,000 shares of Convertible Preferred Stock, Series E, $1.00 par value per share and warrants to purchase 350,000 shares of the Common Stock exercisable immediately at $2.50 per share, which warrants expire five years from their date of issuance. The Series E has the rights and preferences described in the Certificate of Designations of the Series E which include the immediate right to convert all of the shares of the Series E into 2,222,222 shares of the Common Stock, based upon the initial conversion price of $2.25 per share. The Series E will vote together with the Common Stock on all matters submitted to the holders of Common Stock and shall have that number of votes per share equal to the number of shares of Common Stock into which such share is convertible as of the record date for the vote.
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
7. STOCKHOLDERS' EQUITY (CONTINUED)
In October 1997, 13,813 shares of Series B Preferred Stock, 17,000 shares of Series C Preferred Stock and 40,500 shares of Series E Preferred Stock were converted into approximately 3.5 million shares of Common Stock.
Common Stock
Holders of Common Stock are entitled to one vote for each share held of record on all matters voted on by stockholders. The shares of the Common Stock do not have cumulative voting rights, which means that the holders of more than 50% of the shares of the Common Stock voting for the election of the directors can elect all of the directors to be elected by holders of the Common Stock, in which event the holders of the remaining shares of Common Stock will not be able to elect any director. Upon any liquidation, dissolution, or winding-up of the affairs of the Company, holders of the Common Stock would be entitled to receive, pro rata, all of the assets of the Company available for distribution to stockholders, after payment of any liquidation preference of any Preferred Stock that may be issued and outstanding at the time. Holders of the Common Stock have no subscription, redemption, sinking fund, or preemptive rights.
Warrants
In June 1994, in connection with the sale of the Series B Preferred Stock, the Company issued warrants to purchase 307,692 shares of Common Stock at a price of $1.625 per share. During 1995, 255,492 of these warrants were exercised and the remainder was exercised in 1996. In 1995, the Company granted warrants to purchase 300,000 shares of Common Stock at a price of $1.625 per share, pursuant to a consulting agreement. The estimated fair value of the warrants was determined at the date of grant and charged to general and administrative expenses over the vesting period. During 1997, 300,000 of these warrants were exercised. In June 1995, in connection with the acquisition of Oak Hill (Note 3), the Company issued warrants to purchase 200,000 shares of Common Stock at a price of $2.00 per share. During 1996, 100,000 of these warrants were exercised. During 1998, the remaining warrants expired.
During 1996, the Company issued warrants to purchase 1,050,000 shares of Common Stock with exercise prices of $2.50 per share to the purchasers of the Series D and Series E and issued warrants to purchase 300,000 shares of Common Stock with exercise prices of $2.875 per share to financial advisors in connection with this transaction. In connection with the Merger, the Company issued warrants to purchase 800,000 shares of Common Stock to two financial advisors. Warrants to purchase 700,000 shares have an exercise price of $2.875 per share while warrants to purchase 100,000 shares have an exercise price of $4.09 per share. The Company also assumed 396,015 warrants to purchase Common Stock at prices ranging from $2.07 to $3.00 in the Merger. During 1997, 353,515 of these warrants were exercised and the remainder expired during 1998. During 1997, the Company issued warrants to purchase 300,000 shares of common stock with exercise prices of $3.00 per share in connection with the formation of a drilling joint venture.
The following table summarizes warrants outstanding at December 31, 1998:
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
7. STOCKHOLDERS' EQUITY (CONTINUED)
Stock Options
A summary of the Company's stock option activity, and related information for the years ended December 31, 1996, 1997, and 1998, follows:
Information related to options outstanding and exercisable at December 31, 1998, is summarized below:
Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation, requires the disclosure of pro forma net income and earnings per share information computed as if the Company had accounted for its employee stock options granted subsequent to December 31, 1994, under the fair value method set forth in SFAS 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1996, 1997 and 1998, respectively: a risk-free interest rates of 6%, 5.5% and 5.5%, a dividend yield of 0%, and volatility factors of .54, .53 and .53. In addition, the fair value of these options was estimated based on an expected life of three to five years for options granted by the Company and one year for options assumed in the merger with Alexander.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. In addition, because SFAS 123 is applicable only to options granted subsequent to December 31, 1994, the pro forma information does not reflect the pro forma effect of all
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
7. STOCKHOLDERS' EQUITY (CONTINUED)
previous stock option grants of the Company, and thus the pro forma information is not necessarily indicative of future amounts until SFAS 123 is applied to all outstanding stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows (in thousands except for earnings per share information):
Stock Purchase Plan
During 1998, the Company's shareholders approved the Company's Employee Stock Purchase Plan ("ESPP"). Pursuant to the ESPP, employees can purchase the common stock of the Company at a specified price through payroll deductions during an offering period, currently established on a semi-annual basis. In June 1998, approximately 46,000 shares were issued to employees under the ESPP.
8. INCOME TAXES
The reconciliation of income taxes computed at the U.S. federal statutory tax rates to the benefit for income taxes on the income (loss) before extraordinary item is as follows:
The computation of the net deferred tax asset (liability) follows:
At December 31, 1998, the Company had net operating loss carryforwards available for federal income tax purposes of approximately $85.0 million which expire beginning in 1999. Utilization of approximately $32.0 million of the net operating loss carryforwards is subject to various limitations because of previous changes in control of ownership (as defined in the Internal Revenue Code) of the Company and Alexander. Additional net operating loss limitations may be imposed as a result of subsequent changes in stock ownership of the Company. Bankruptcy proceedings may eliminate all or a portion of the Company's net operating loss carryforwards. For federal income tax purposes, the Company also has statutory depletion carryforwards of $3.8 million, which do not expire.
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
9. NATURAL GAS HEDGING ACTIVITIES AND FORWARD SALES CONTRACTS
While the use of financial hedging arrangements limits the downside risk of adverse price movements, it may also limit future gains from favorable movements. All financial hedging is accomplished pursuant to swap agreements based upon standard forms. The Company addresses market risk by selecting instruments whose value fluctuations correlate strongly with the underlying commodity being hedged. Credit risk related to hedging activities is managed by requiring minimum credit standards for counterparties, periodic settlements, and mark to market valuations. The Company has not been required to provide collateral relating to its hedging activities.
During the year ended December 31, 1996, the Company recognized a net gain of $20,315 related to hedging transactions. At December 31, 1997 and 1998, the Company had no financial hedging agreements outstanding.
At December 31, 1998, the Company had entered into forward sales contracts with two purchasers covering future production of natural gas as follows:
Deliveries under these contracts are priced based on NYMEX prices less a differential whereby the Company may fix the price for deliveries under these contracts at any time three days prior to the close of the then current contract based on the NYMEX prices at the time. Deliveries to be made under the forward sales contracts have not been priced as of December 31, 1998. The Company pays the cost of transportation of the natural gas to the delivery point specified in the contracts.
10. RESTRUCTURING CHARGES
During 1998, the Company recorded non-recurring restructuring charges of $1,869,169. These charges related primarily to severance and related costs resulting from restructuring of the Company's executive management team, and other personnel changes and costs associated with the Chapter 11 filing. The components of the restructuring charges are as follows:
Substantially all of the restructuring charges required cash outlays which have been made as of December 31, 1998.
11. CRUDE OIL AND NATURAL GAS PRODUCING ACTIVITIES
Costs incurred in connection with the exploration acquisition, development, and exploitation of the Company's crude oil and natural gas properties for the years ended December 31, 1996, 1997, and 1998, are as follows:
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
The acquisitions of properties in 1996 include $132.8 million of proved properties and $6.3 million of unproved properties acquired in the Merger. See Note 3.
During 1996, as a result of allocating additional cost under the purchase method of accounting, to the oil and natural gas properties in connection with the Merger, the Company recognized a non-cash writedown of its oil and natural gas properties of approximately $43.5 million. During 1997 and 1998, the net book value of the Company's oil and natural gas properties exceeded the full cost ceiling resulting in writedowns of the oil and natural gas properties of $46.4 million and $148.4 million, respectively. There can be no assurance that there will not be additional writedowns in future periods under the full cost method of accounting as a result of sustained decreases in oil and natural gas prices or other factors.
Revenues from individual purchasers that exceed 10% of total crude oil and natural gas sales are as follows:
The Company believes that the loss of these purchasers would not have a significant impact on the Company's results of operations or financial condition.
12. SUPPLEMENTARY CRUDE OIL AND NATURAL GAS RESERVE INFORMATION (UNAUDITED)
The revenues generated by the Company's operations are highly dependent upon the prices of, and demand for, oil and natural gas. The price received by the Company for its oil and natural gas production depends on numerous factors beyond the Company's control, including seasonality, the condition of the U.S. economy, foreign imports, political conditions in other oil and natural gas producing countries, the actions of the Organization of Petroleum Exporting Countries and domestic governmental regulations, legislation and policies. Declines during 1998 in the prices of oil and gas have had an adverse effect on the carrying value of the Company's oil and gas properties and the Company's revenues, profitability and cash flows.
The Company has made, and will continue to make, ordinary course capital expenditures for the development, and exploitation of oil and natural gas reserves, subject to economic conditions and in accordance with the rulings and procedures set forth by the Court. Due to the Chapter 11 filing and severely depressed oil prices, the Company has suspended its exploratory drilling program. The Company will limit its capital expenditures to ordinary course enhancement of current production through workovers, recompletions, and other production enhancing activities deemed to be economic given current depressed oil and gas prices. Development drilling is anticipated to be limited to (i) ordinary course nonoperated wells in which the Company has limited working interests and in which the failure to participate may result in drainage, depletion or loss of current reserves and (ii) operated wells deemed to be economical given current oil and gas prices. Large expenditures for developmental drilling may require Court approval and none are planned at this time.
The Company has interests in crude oil and natural gas properties that are principally located onshore in Texas, Louisiana, Oklahoma, Arkansas, and offshore in the Gulf of Mexico. The Company does not own or lease any crude oil and natural gas properties outside the United States.
In 1995 and 1996, the Company retained independent petroleum engineering firms to provide year-end estimates of the Company's future net recoverable crude oil, natural gas, and natural gas liquids reserves. In 1997 and 1998, such estimates were prepared by the Company's in-house reserve engineers. Estimated proved net recoverable reserves as shown below include only those quantities that can be expected to be commercially
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
12. SUPPLEMENTARY CRUDE OIL AND NATURAL GAS RESERVE INFORMATION (UNAUDITED) (CONTINUED)
recoverable at prices and costs in effect at the balance sheet dates under existing regulatory practices and with conventional equipment and operating methods.
Proved developed reserves represent only those reserves expected to be recovered through existing wells. Proved undeveloped reserves include those reserves expected to be recovered from new wells on undrilled acreage or from existing wells on which a relatively major expenditure is required for recompletion.
Net quantities of proved developed and undeveloped reserves of natural gas and crude oil, including condensate and natural gas liquids, are summarized as follows:
The following is a summary of a standardized measure of discounted net cash flows related to the Company's proved crude oil and natural gas reserves. For these calculations, estimated future cash flows from estimated future production of proved reserves were computed using crude oil and natural gas prices as of the end of each period presented. Future development, production and abandonment costs attributable to the proved reserves were estimated assuming that existing conditions would continue over the economic lives of the individual leases and costs were not escalated for the future. Estimated future income tax expenses were calculated by applying future statutory tax rates (based on the current tax law adjusted for permanent differences and tax credits) to the estimated future pretax net cash flows related to proved crude oil and natural gas reserves, less the tax basis of the properties involved.
The Company cautions against using this data to determine the fair value of its crude oil and natural gas properties. To obtain the best estimate of fair value of the crude oil and natural gas properties, forecasts of future economic conditions, varying discount rates, and consideration of other than proved reserves would have to be incorporated into the calculation. In addition, there are significant uncertainties inherent in estimating quantities of proved reserves and in projecting rates of production that impair the usefulness of the data.
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
12. SUPPLEMENTARY CRUDE OIL AND NATURAL GAS RESERVE INFORMATION (UNAUDITED) (CONTINUED)
The standardized measure of discounted future net cash flows relating to proved crude oil and natural gas reserves are summarized as follows:
The following are the principal sources of change in the standardized measure of discounted future net cash flows:
During recent years, there have been significant fluctuations in the prices paid for crude oil in the world markets. This situation has had a destabilizing effect on crude oil posted prices in the United States, including the posted prices paid by purchasers of the Company's crude oil. The net weighted average prices of crude oil and natural gas at December 31, 1996, 1997, and 1998, used in the above table were $25.36, $17.03 and $10.46 per barrel of crude oil, respectively, and $3.72, $2.38 and $2.06 per thousand cubic feet of natural gas, respectively.
NATIONAL ENERGY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
13. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
The Company's operating results for each quarter of 1997 and 1998 are summarized as follows (in thousands, except per share data):
EXHIBIT INDEX
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(1) Incorporated by reference to the Company's Registration Statement on Form S-4 (No. 333-9045), dated July 29, 1996.
(2) Incorporated by reference to Amendment No. 1 to the Company's Registration Statement on Form S-4 (No. 333-9045), dated August 7, 1996.
(3) Incorporated by reference to the Company's Current Report on Form 8-K, dated August 29, 1996.
(4) Incorporated by reference to the Company's Registration Statement on Form S-4 (No. 33-38331), dated April 23, 1991.
(5) Incorporated by reference to the Company's Current Report on Form 8-K, dated June 17, 1994.
(6) Incorporated by reference to the Company's Current Report on Form 8-K, dated July 17, 1995.
(7) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996.
(8) Incorporated by reference to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1992.
(9) Incorporated by reference to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1995.
(10) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997.
(11) Incorporated by reference to the Company's Schedule 14A filed April 25, 1997.
(12) Incorporated by reference to the Company's Form S-8 filed December 23, 1997.
(13) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997.
(14) Incorporated by reference to the Company's Form S-4 (No. 333-38075), filed October 16, 1997.
(15) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1997.
(16) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998.
(17) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.
(18) Incorporated by reference to the Company's Current Report on Form 8-K, dated February 8, 1999.
(19) Filed herewith.