10-Q/A 1 h93183e10-qa.txt KCS ENERGY, INC. - AMENDMENT TO 09/30/2001 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE ----- SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE ----- SECURITIES EXCHANGE ACT OF 1934 For the transition period from to -------------------- -------------------- Commission file number 1-11698 KCS ENERGY, INC. (Exact name of registrant as specified in its charter) Delaware 22-2889587 -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5555 San Felipe Road, Houston, TX 77056 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (713) 877-8006 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) NOT APPLICABLE -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. (1) X Yes (2) No ------- -------- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock, $0.01 par value: 34,194,171 shares outstanding as of October 31, 2001. This amendment on Form 10-Q/A is being filed to restate KCS Energy, Inc.'s September 30, 2001 unaudited consolidated financial statements related to accounting for the adoption of Statement of Financial Accounting Standard No. 133, Accounting for Derivative Instruments and Hedging Activities. See Note 11 to our unaudited consolidated financial statements for further discussion of the matter. KCS ENERGY, INC. AND SUBSIDIARIES CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS
Three Months Ended Nine Months Ended September 30, September 30, (Amounts in thousands except ---------------------------- ---------------------------- per share data) Unaudited 2001 2000 2001 2000 -------------------------------------------------- ------------ ------------ ------------ ------------ Oil and gas revenue $ 38,747 $ 46,789 $ 143,981 $ 127,272 Other revenue, net 719 193 17,232 1,781 ------------ ------------ ------------ ------------ Total revenue 39,466 46,982 161,213 129,053 ------------ ------------ ------------ ------------ Operating costs and expenses Lease operating expenses 6,806 6,997 23,759 20,597 Production taxes 1,563 1,580 6,629 4,326 General and administrative expenses 2,431 1,939 7,642 5,755 Depreciation, depletion and amortization 15,332 11,664 42,811 36,820 ------------ ------------ ------------ ------------ Total operating costs and expenses 26,132 22,180 80,841 67,498 ------------ ------------ ------------ ------------ Operating income 13,334 24,802 80,372 61,555 ------------ ------------ ------------ ------------ Interest and other income, net 192 85 1,210 437 Interest expense (contractual interest was $9,030 and $27,380 for the three and nine months ended September 30, 2000, respectively) (4,880) (6,698) (17,076) (20,252) ------------ ------------ ------------ ------------ Income before reorganization items and income taxes 8,646 18,189 64,506 41,740 ------------ ------------ ------------ ------------ Reorganization items Write-off of deferred debt issue costs related to senior notes and senior subordinated notes -- -- -- (6,132) Financial restructuring costs (356) (1,642) (3,175) (5,138) Interest income -- 327 227 594 ------------ ------------ ------------ ------------ Total reorganization items (356) (1,315) (2,948) (10,676) ------------ ------------ ------------ ------------ Income before income taxes 8,290 16,874 61,558 31,064 Federal and state income (taxes) benefit 709 -- 7,649 -- ------------ ------------ ------------ ------------ Net income 8,999 16,874 69,207 31,064 Preferred stock dividends (248) -- (741) -- ------------ ------------ ------------ ------------ Income available to common stockholders $ 8,751 $ 16,874 $ 68,466 $ 31,064 ============ ============ ============ ============ Earnings per share of common stock: Basic $ 0.27 $ 0.58 $ 2.23 $ 1.06 Diluted 0.22 0.58 1.81 1.06 ============ ============ ============ ============ Weighted average shares outstanding for computation of earnings per share Basic 32,636 29,266 30,711 29,266 Diluted 40,188 29,326 38,248 29,302 ============ ============ ============ ============
The accompanying notes to condensed consolidated financial statements are an integral part of these statements. 2 KCS ENERGY, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands except per share data) Unaudited September 30, 2001 December 31, 2000 --------------------------------------------------------- ------------------ ----------------- Assets Current assets Cash and cash equivalents $ 25,157 $ 39,994 Trade accounts receivable 23,736 45,954 Other current assets 13,419 5,697 ------------ ------------ Current assets 62,312 91,645 ------------ ------------ Oil and gas properties, full cost method, net 273,210 245,169 Other property, plant and equipment, net 9,674 9,731 ------------ ------------ Property, plant and equipment, net 282,884 254,900 ------------ ------------ Deferred charges and other assets 1,404 790 Deferred taxes 15,320 -- ------------ ------------ $ 361,920 $ 347,335 ============ ============ Liabilities and stockholders' equity Current liabilities Accounts payable $ 22,308 $ 22,974 Accrued interest on public debt 4,122 -- Other accrued liabilities 22,315 19,441 Short-term debt -- 76,705 ------------ ------------ Current liabilities 48,745 119,120 ------------ ------------ Deferred credits and other liabilities Deferred revenue 128,241 -- Other 446 1,359 ------------ ------------ Deferred credits and other liabilities 128,687 1,359 ------------ ------------ Liabilities subject to compromise Senior notes -- 150,000 Senior subordinated notes -- 125,000 Accrued interest on public debt -- 58,198 Pre-petition accounts payable -- 1,978 ------------ ------------ Liabilities subject to compromise -- 335,176 ------------ ------------ Long-term debt Senior notes 79,800 -- Senior subordinated notes 125,000 -- ------------ ------------ Long-term debt 204,800 -- ------------ ------------ Convertible preferred stock 17,876 -- ------------ ------------ Common stockholders' (deficit) equity Common stock, par value $0.01 per share authorized 50,000,000 shares issued 36,277,935 and 31,433,006, respectively 363 314 Additional paid-in capital 157,207 145,098 Retained (deficit) earnings (180,525) (248,991) Accumulated other comprehensive income (10,492) -- Less treasury stock, 2,167,096 shares, at cost (4,741) (4,741) ------------ ------------ Total common stockholders' (deficit) equity (38,188) (108,320) ------------ ------------ $ 361,920 $ 347,335 ============ ============
The accompanying notes to condensed consolidated financial statements are an integral part of these statements. 3 KCS ENERGY, INC. AND SUBSIDIARIES CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
Nine Months Ended September 30, ---------------------------- (Dollars in thousands) Unaudited 2001 2000 ---------------------------------------------------- ------------ ------------ Cash flows from operating activities: Net income $ 69,207 $ 31,064 Adjustments to reconcile net income to cash provided by operating activities: Depreciation, depletion and amortization 42,811 36,820 Amortization of deferred revenue (47,152) -- Non-cash losses on derivative instruments 21,857 -- Tax benefit on non-cash losses on derivative instruments (7,649) -- Non-cash gains on derivative instruments (7,694) -- Realized losses on derivative instruments (8,104) -- Other non-cash charges and credits, net 133 1,665 Reorganization items 2,948 10,676 ------------ ------------ 66,357 80,225 Proceeds from Enron Production Payment, net 175,399 -- Realized losses on derivative instruments terminated in connection with Plan of reorganization (27,995) -- Change in trade accounts receivable 22,218 (10,162) Change in accounts payable and accrued liabilities 230 13,137 Change in accrued interest payable (54,076) 12,375 Other, net (4,991) 1,007 ------------ ------------ Net cash provided by operating activities before reorganization items 177,142 96,582 Reorganization items (excluding non-cash write-off of deferred debt issue costs in 2000) (2,948) (4,544) ------------ ------------ Net cash provided by operating activities 174,194 92,038 Cash flows from investing activities: Investment in oil and gas properties, net (69,596) (52,349) Other capital expenditures, net (1,199) (199) ------------ ------------ Net cash used in investing activities (70,795) (52,548) ------------ ------------ Cash flows from financing activities: Repayments of debt (146,905) (22,460) Issuance of convertible preferred stock, net 28,413 -- Deferred financing costs and other 256 (1,325) ------------ ------------ Net cash used in financing activities (118,236) (23,785) ------------ ------------ Net increase (decrease) in cash and cash equivalents (14,837) 15,705 Cash and cash equivalents at beginning of period 39,994 10,584 ------------ ------------ Cash and cash equivalents at end of period $ 25,157 $ 26,289 ============ ============
The accompanying notes to condensed consolidated financial statements are an integral part of these statements. 4 KCS ENERGY, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. The condensed interim financial statements included herein have been prepared by KCS Energy, Inc. (KCS or Company), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and reflect all adjustments which are of a normal recurring nature and which, in the opinion of management, are necessary for a fair statement of the results for interim periods. Certain information and footnote disclosures have been condensed or omitted pursuant to such rules and regulations. Although KCS believes that the disclosures are adequate to make the information presented not misleading, it is suggested that these condensed financial statements be read in conjunction with the financial statements and the notes thereto included in the Company's latest annual report to stockholders. Certain previously reported amounts have been reclassified to conform with current year presentations. 2. Reorganization On January 30, 2001, the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court") confirmed the KCS Energy, Inc. plan of reorganization ("the Plan") under Chapter 11 of Title 11 of the United States Bankruptcy Code after the Company's creditors and stockholders voted to approve the Plan. On February 20, 2001, the Company completed the necessary steps for the Plan to go effective and emerged from bankruptcy having reduced its debt from a peak of $425.0 million in early 1999 to $215.0 million and having cash on hand in excess of $30 million. Under the terms of the Plan the Company: 1) secured a new exit facility in the form of a volumetric production payment ("Enron Production Payment") whereby it sold approximately 43.1 Bcfe (38.3 Bcf of gas and 797,000 barrels of oil) of proved reserves to be delivered in accordance with an agreed schedule over a five year period for net proceeds of approximately $176 million and repaid all amounts outstanding under its existing bank credit facilities, 2) sold $30.0 million of convertible preferred stock, 3) paid to the holders of the Company's 11% Senior Notes, on a pro rata basis, cash equal to the sum of (a) $60.0 million plus the amount of past due accrued and unpaid interest of $15.1 million on $60.0 million of the Senior Notes as of the effective date, compounded semi-annually at 11% per annum and (b) the amount of past due accrued and unpaid interest of $21.5 million on $90.0 million of the Senior Notes as of January 15, 2001, compounded semi-annually at 11% per annum, 4) paid to the holders of the Company's 8 7/8% Senior Subordinated Notes, cash in the amount of past due accrued and unpaid interest of $23.7 million as of January 15, 2001, compounded semi-annually at 8 7/8% per annum, 5) renewed the remaining outstanding $90.0 million principal amount of Senior Notes and $125.0 million principal amount of Senior Subordinated Notes under amended indentures governing the Senior Notes and Senior Subordinated Notes, but without a change in interest rates, and 6) paid pre-petition trade creditors in full. Shareholders retained 100% of their common stock, subject to dilution from conversion of the new convertible preferred stock. The convertible preferred stock offering consisted of 30,000 shares of Series A Convertible Preferred Stock ("Preferred Stock") at a price of $1,000 per share convertible at any time into 10,000,000 shares of KCS Energy, Inc. at a conversion price of $3.00 per share. The Preferred Stock pays a 5% per annum dividend payable quarterly in cash or, during the first two years following issuance, the Company has the option to pay the dividend in shares of KCS common stock. As a result of conversions of the convertible preferred stock, 4.2 million shares of common stock and 0.4 million shares of common stock were issued as of September 30, 2001 and in October 2001, respectively. 3. Deferred Revenue Pursuant to the Enron Production Payment discussed in Note 2, the Company recorded the net proceeds of approximately $176 million as deferred revenue on the balance sheet. Deliveries under the Enron Production Payment are recorded as oil and gas sales revenue with a corresponding reduction of deferred revenue at the effective average discounted price per Mcf of natural gas and per barrel of oil received at closing. For the three months ended September 30, 2001, the Company delivered 4,210 MMcfe and recorded $16.9 million of oil and gas revenue in connection with the Enron Production Payment. Since the inception of the Enron Production Payment in February 2001, the Company delivered 11,752 MMcfe, or 27% of the scheduled deliveries, and recorded $47.2 million of oil and gas revenue. 5 4. Debt Reduction In addition to the debt reduction pursuant to the Plan as outlined in Note 2 above, the Company redeemed an additional $10.2 million of the Senior Notes in March 2001. As of September 30, 2001, the Company's long-term debt consisted of $79.8 million of 11% Senior Notes due January 15, 2003 and $125 million of 8 7/8% Senior Subordinated Notes due January 15, 2006. 5. Accounting and Reporting Requirements During Bankruptcy During 2000 and until the Plan was effective, the Company conducted its business and reported its results of operations and financial position as a debtor-in-possession pursuant to AICPA Statement of Position 90-7 "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7"). In connection therewith, the Company reported all liabilities, which it deemed subject to compromise at amounts reasonably expected to be paid. 6. Derivative Instruments and Other Comprehensive Income Oil and gas prices are historically volatile. The Company manages the risk associated with the price fluctuations affecting it by entering into derivative contracts effectively fixing the price of certain sales volumes for certain time periods. The Company has entered and may continue to enter into derivative contracts to manage this price risk. Effective January 1, 2001, the Company adopted SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133, as amended, establishes accounting and disclosure standards requiring that all derivative instruments be recorded in the balance sheet as an asset or liability, measured at fair value. SFAS No. 133 requires that changes in a derivative instrument's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. At January 1, 2001, the Company's derivative instruments included swaps and collars to manage price risk associated with the production of natural gas. Upon adoption of SFAS No. 133, the Company recorded a liability of $43.8 million representing the fair market value of its derivative instruments at adoption, a related deferred tax asset of $15.3 million and an after-tax cumulative effect of change in accounting principle of $28.5 million to accumulated other comprehensive income. The Company elected not to designate its existing derivative instruments as hedges which, subsequent to adoption of SFAS No. 133, would require that changes in a derivative instrument's fair value be recognized currently in earnings. However, SFAS No. 133 requires the Company's derivative instruments that had been designated as cash flow hedges under accounting principles generally accepted prior to the initial application of SFAS No. 133 continue to be accounted for as cash flow hedges with a transition adjustment reported as a cumulative-effect-type adjustment to accumulated other comprehensive income as mentioned above. In February 2001, the Company terminated certain derivative instruments in connection with its emergence from bankruptcy for a cash payment of $28.0 million, which was offset against the accrued liability recorded in connection with the adoption of SFAS No. 133. During the quarter ended March 31, 2001, as a result of market price decreases, the ultimate cost to settle derivative instruments in place at January 1, 2001 was reduced by $7.7 million. This non-cash gain was recorded in other revenue during the quarter. The actual cost to settle the remaining derivatives was $8.1 million. Under the provisions of SFAS No. 133, if a derivative instrument accounted for as a cash flow hedge is sold, terminated or exercised, the net gain or loss shall remain in accumulated other comprehensive income and be reclassified into earnings in the same period or periods during which the hedged anticipated transaction affects earnings. Accordingly, accumulated other comprehensive income at September 30, 2001 includes $14.2 million (after tax) of the loss realized upon termination of derivative instruments that will be reclassified into earnings over the original term of the derivative instruments, which extended through August 2005. During the nine months ended September 30, 2001, the Company reclassified into earnings as oil and gas revenues $21.9 million related to the expiration of certain instruments and the amortization of the loss realized on natural gas produced during the quarter. The related tax benefit amounted to $7.6 million. At September 30, 2001 the Company had entered into contracts for derivative instruments designated as cash flow hedges covering: 1) 5,035,000 MMBtu with terms extending through October 31, 2002 including 755,000 MMBtu at a price of $4.05 per MMBtu, 2,140,000 MMBtu at a price of $4.02 per MMBtu so long as the NYMEX is above $2.50 (no settlement proceeds if NYMEX is below $2.50), and 2,140,000 MMBtu with floor price of $3.00; and 2) 46,000 barrels of oil with terms extending through December 31, 2001 at a price of $28.15 per barrel. At September 30, 2001 the Company has recorded other current assets of $3.8 million, other non-current assets of $0.4 million and $3.8 million of accumulated other comprehensive income representing the portion of unrealized hedge gains under SFAS No. 133 associated with these derivative instruments. The Company also entered into natural gas call contracts not designated as hedges covering 755,000 MMBtu at $4.05 per MMBtu extending through March 31, 2002. 6 7. New York Stock Exchange Listing In October 1999, the Company reported that it did not meet the current New York Stock Exchange ("NYSE") continued listing standards and has been trading pursuant to an approved business plan to return to compliance within a prescribed time frame. The Company has achieved the continued listing standards and has been informed by the NYSE that it is considered to be in good standing. 8. Supplemental cash flow information The Company considers all highly liquid debt instruments with a maturity of three months or less when purchased to be cash equivalents. Interest payments were $71.4 million and $6.7 million for the nine months ended September 30, 2001 and September 30, 2000, respectively. Interest payments in the current year period were made primarily in connection with the Plan (see Note 2). No income tax payments were made during the nine-month periods ended September 30, 2001 and September 30, 2000. As a result of conversions of the convertible preferred stock, 4.1 million shares of common stock and 0.1 million shares of common stock were issued as of September 30, 2001 and in October 2001, respectively. 9. Earnings Per Share The following is a reconciliation of the numerators and the denominators of the basic and diluted earnings per share computations for income before the cumulative effect of accounting change for the three and nine months ended September 30, 2001:
Three Months Ended Nine Months Ended September 30, 2001 September 30, 2001 ---------------------------------------- ------------------------------------------ Income Shares Per Share Income Shares Per Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount ----------- ------------- --------- ----------- ------------- ----------- Net income $ 8,999 $ 69,207 Less: preferred stock dividends (248) (741) ----------- ------------- --------- ----------- ------------- ----------- Income available to common stockholders 8,751 32,636 $ 0.27 68,466 30,711 $ 2.23 Effect of dilutive securities: Preferred stock conversion 7,351 7,223 Preferred stock dividends 248 71 741 154 Stock options & warrants 130 160 ----------- ------------- --------- ----------- ------------- ----------- Income available to common stockholders assuming dilution $ 8,999 40,188 $ 0.22 $ 69,207 38,248 $ 1.81 =========== ============= ========= =========== ============= ===========
For the three and nine months ended September 30, 2000, basic earnings per share were computed by dividing net income by the average number of common shares outstanding during the period. Diluted earnings per share were computed by dividing net income by the sum of the average number of common shares outstanding plus the average number of common stock equivalents outstanding during the period. The average number of common stock equivalents outstanding for the three and nine months ended September 30, 2000 was 60,000 and 36,000, respectively. 10. Litigation On June 21, 2001, the Texas Supreme Court affirmed the decision of the Fifth Circuit Court of Appeals at Dallas, Texas in favor of the Company in the Jesus Yzaguirre Suit. On July 6, 2001 the royalty owners filed a motion for rehearing and on August 30, 2001 the Texas Supreme Court denied the motion for rehearing. On September 14, 2001, the royalty owners filed a motion to correct opinion and for further rehearing; however, on October 25, 2001, the judgment of the Texas Supreme Court in favor of the Company became final and the litigation was concluded. The background of this litigation 7 is discussed in note 10 of Notes to Consolidated Financial Statements included in the Company's Annual Report to Stockholders on Form 10-K for the year ended December 31, 2000. The Company was a defendant in a lawsuit originally brought by InterCoast Energy Company and MidAmerican Capital Company ("Plaintiffs") against KCS Energy, Inc., KCS Medallion Resources, Inc. and Medallion California Properties Company ("KCS Defendants"), and Kerr-McGee Oil & Gas Onshore LP and Kerr-McGee Corporation ("Kerr-McGee Defendants") in the 234th Judicial District Court of Harris County, Texas under Cause Number 1999-45998. The suit sought a declaratory judgment declaring the rights and obligations of each of the Plaintiffs, the KCS Defendants and the Kerr-McGee Defendants in connection with environmental damages and surface restoration on lands located in Los Angeles County, California which are covered by an Oil & Gas Lease dated June 13, 1935, from Newhall Land and Farming Company, as Lessor, to Barnsdall Oil Company, as Lessee (the "RSF Lease") and by an Oil and Gas Lease dated June 6, 1941, from the Newhall Corporation, as Lessor, to C. G. Willis, as Lessee (the "Ferguson Lease" and together with the RSF Lease, the "Leases"). The Kerr-McGee Defendants, KCS Defendants and Plaintiffs entered into an Agreed Interlocutory Judgment that contains clarification of the language of the 1990 Agreement between predecessors of the KCS Defendants and the Kerr-McGee Defendants (the "1990 Agreement") under which the Leases were transferred from Kerr-McGee's predecessor to predecessors of Medallion California Properties Company ("MCPC"). The Court previously entered the Agreed Interlocutory Judgment, which essentially disposed of interpretation questions concerning the 1990 Agreement. After entry of the Agreed Interlocutory Judgment, the remaining issues in the case concerned the interpretation of the 1996 Stock Purchase Agreement through which certain of the KCS Defendants acquired the stock of MCPC. Specifically, the remaining issues involved the extent to which Plaintiffs are obligated to indemnify the KCS Defendants for environmental investigation costs previously incurred by the KCS Defendants and also for costs of defense and liability to the KCS Defendants, if any, in the California litigation described below. By Compromise and Settlement Agreement dated as of October 19, 2001, the Plaintiffs and KCS Defendants agreed: (i) to settle those issues dealing with the Plaintiffs' obligations to reimburse costs previously incurred in environmental investigation and costs paid before September 30, 2001 in connection with defense of the California case described below; (ii) to provide prospectively for the control of defense and settlement and the sharing of defense costs in the California case described below; and (iii) to defer any disputes concerning the respective liability of Plaintiffs and KCS Defendants for any individual claims until the extent of such individual claim liability, after giving effect to indemnification obligations under the 1990 Agreement, is fully and finally determined. MCPC is a defendant in a lawsuit filed January 30, 2001, by The Newhall Land and Farming Company ("Newhall") against MCPC and Kerr-McGee Corporation and several Kerr-McGee affiliates. The case is currently pending in Los Angeles County Superior Court under Cause Number BC244203. In the suit, Newhall seeks damages and punitive damages for alleged environmental contamination and surface restoration on the lands covered by the RSF Lease and also seeks a declaration that Newhall may terminate the RSF Lease or alternatively, that it may terminate those portions of the RSF Lease on which there is currently default under the Lease. MCPC claims that Newhall is not entitled to lease termination as a remedy and that Kerr-McGee and InterCoast and MidAmerican owe indemnities to MCPC for defense and certain potential liability under Newhall's action, all as more particularly described in the Harris County, Texas litigation described above. Discovery is ongoing, and the lawsuit is set for trial in January 2003. The Company is also a party to various other lawsuits and governmental proceedings, all arising in the ordinary course of business. Although the outcome of all of the above proceedings cannot be predicted with certainty, the Company does not expect such matters to have a material adverse effect, either singly or in the aggregate, on the financial position or results of operations of the Company. It is possible, however, that charges could be required that would be significant to the operating results of a particular period. See Note 10 of Notes to Consolidated Financial Statements included in the Company's Annual Report to Stockholders on Form 10-K for the year ended December 31, 2000. Note 11 - Restatement The Company has been advised by its outside auditors that their earlier advice regarding the Company's treatment of the adoption of Statement of Financial Accounting Standard No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133") was incorrect. Upon adoption of SFAS No. 133 on January 1, 2001, the Company recorded a liability of $43.8 million representing the fair market value of its derivative instruments. All of the Company's derivative instruments that existed at January 1, 2001 were scheduled to expire during the first quarter of 2001 or were terminated in connection with the Company's emergence from Chapter 11 in February 2001. The Company elected not to designate its existing derivatives as hedges and reported the $43.8 million ($28.5 million after-tax) currently through earnings, as a cumulative effect of an accounting change. The outside auditors now believe that the Company's initial adoption of SFAS No. 133 was incorrectly reported through earnings as a traditional cumulative-effect type component of net income at January 1, 2001. Rather, the outside auditors have advised the Company that their current view is that SFAS No. 133 requires the Company's derivative instruments that had been designated as cash flow hedges under accounting principles generally accepted prior to the initial application of SFAS No. 133 continue to be accounted for as cash flow hedges with a transition adjustment reported as a cumulative-effect-type adjustment to accumulated other comprehensive income, a component of stockholders' equity, and not recognized currently through earnings. Under the provisions of SFAS No. 133, if a derivative instrument accounted for as a cash flow hedge is sold, terminated or exercised, the net gain or loss shall remain in accumulated other comprehensive income and be reclassified into earnings in the same period or periods during which the hedged anticipated transaction affects earnings. Accordingly, even though all of the Company's derivatives that existed at January 1, 2001 either expired or were terminated during the first quarter of 2001, accumulated other comprehensive income at September 30, 2001 includes $14.2 million (after tax) of the loss realized upon termination of derivative instruments. This component of accumulated other comprehensive income will be reclassified into earnings over the original term of the derivative instruments, which extended through August 2005. See Note 6. The restatement has no effect on cash flow, total assets, total liabilities and total stockholders' equity (deficit) but does have a non-cash impact on earnings as outlined below:
---------- ------------- --------- Restated As Reported Change ---------- ------------- --------- Condensed Statement of Consolidated Operations for the Three Months Ended September 30, 2001 ----------------------------------------- Oil and gas revenues $ 38,747 $ 40,774 $ (2,027) Net income 8,999 10,317 (1,318) Basic earnings per share of common stock 0.27 0.31 (0.04) Diluted earnings per share of common stock 0.22 0.26 (0.04) Condensed Statement of Consolidated Operations for the Nine Months Ended September 30, 2001 ----------------------------------------- Oil and gas revenues 143,981 165,838 (21,857) Federal and state income tax benefit 7,649 -- 7,649 Cumulative effect of accounting change, net of tax -- (28,451) 28,451 Net income 69,207 54,964 14,243 Basic earnings per share of common stock 2.23 1.77 0.46 Diluted earnings per share of common stock 1.81 1.44 0.37 Condensed Consolidated Balance Sheet at September 30, 2001 ----------------------------------------- Current assets 62,312 62,312 -- Current liabilities 48,745 48,745 -- Retained (deficit) earnings (180,525) (194,768) 14,243 Accumulated other comprehensive income (10,492) 3,751 (14,243) Total common stockholders' (deficit) equity (38,188) (38,188) -- Condensed Statement of Consolidated Cash Flows for the Nine Months Ended September 30, 2001 ----------------------------------------- Net cash provided by operating activities 174,194 174,194 -- Net decrease in cash and cash equivalents (14,837) (14,837) --
8 KCS ENERGY, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General On January 30, 2001, the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court") confirmed the KCS Energy, Inc. Plan of Reorganization ("the Plan") under Chapter 11 of Title 11 of the United States Bankruptcy Code after the Company's creditors and stockholders voted to approve the Plan. On February 20, 2001, the Company completed the necessary steps for the Plan to go effective and emerged from bankruptcy having reduced its debt from a peak of $425.0 million in early 1999 to $215.0 million and having cash on hand in excess of $30 million. See Note 2 to Condensed Consolidated Financial Statements for the key terms of the Plan. Prices for oil and natural gas are subject to wide fluctuations in response to relatively minor changes in the supply of and demand for oil and natural gas, market uncertainty and a variety of other factors that are beyond the Company's control. These factors include political conditions in the Middle East and elsewhere, domestic and foreign supply of oil and natural gas, the level of consumer demand, weather conditions and overall economic conditions. Results of Operations Net income for the three months ended September 30, 2001 was $9.0 million compared to $16.9 million for the same period in 2000. This decrease was attributable to lower natural gas prices, lower production from the Company's volumetric production payment program ("VPP") and higher depletion expense, partially offset by higher working interest production, lower interest expense and lower reorganization expenses. Income before reorganization items and income taxes for the nine months ended September 30, 2001 was $64.5 million compared to $41.7 million for the same period a year ago. This increase was attributable to higher natural gas prices, increased working interest production, higher other revenue and lower interest expense, partially offset by lower production from the VPP program and higher operating expenses. Reorganization items for the nine months ended September 30, 2001 were $2.9 million compared to $10.7 million for the same period last year. Net income for the nine months ended September 30, 2001 was $69.2 million compared to $31.1 million for the same period a year ago. 9
Three Months Ended Nine Months Ended September 30, September 30, --------------------------- --------------------------- 2001 2000 2001 2000 ------------ ------------ ------------ ------------ Production: Gas (MMcf) 8,956 9,164 28,292 30,233 Oil (Mbbl) 288 324 934 997 Liquids (Mbbl) 98 107 275 189 Summary (MMcfe): Working interest 10,167 9,524 32,008 28,541 VPP 1,105 2,237 3,538 8,815 ------------ ------------ ------------ ------------ Total 11,272 11,761 35,546 37,356 Average Price: Gas (per Mcf) $ 3.49 $ 3.94 $ 4.21 $ 3.24 Oil (per bbl) 21.77 29.27 22.20 26.94 Liquids (per bbl) 12.46 11.13 14.76 12.58 Total (per Mcfe) 3.44 3.98 4.05 3.41 Revenue: Gas $ 31,256 $ 36,063 $ 119,189 $ 98,004 Oil 6,270 9,532 20,733 26,891 Liquids 1,221 1,194 4,059 2,377 ------------ ------------ ------------ ------------ Total $ 38,747 $ 46,789 $ 143,981 $ 127,272 ============ ============ ============ ============
Note: Production includes 4,210 MMcfe and 11,752 MMcfe for the three and nine months ended September 30, 2001, respectively, dedicated to the Enron Production Payment. See Notes 2 and 3 to Condensed Consolidated Financial Statements. Gas revenue For the three months ended September 30, 2001, gas revenue decreased 13% to $31.3 million primarily due to an 11% decrease in average realized natural gas prices. Working interest production increased 7%, partially offset by a 51% decrease in scheduled production from the VPP program. The decrease in VPP production in 2001 was primarily attributable to the expiration of certain VPPs and limited investment in this program since 1999. For the nine months ended September 30, 2001, gas revenue increased $21.2 million to $119.2 million due to a 30% increase in average realized natural gas prices and a 12% increase in working interest production, partially offset by a 60% decrease in scheduled production from the VPP program. Oil and liquids revenue For the three months ended September 30, 2001, oil and liquids revenue decreased 30% to $7.5 million compared to the same period in 2000 primarily as a result of a 26% decrease in average realized oil prices. For the nine months ended September 30, 2001, oil and liquids revenue decreased 15% to $24.8 million due to an 18% decrease in average realized oil prices. Other revenue, net For the nine months ended September 30, 2001, other revenue was $17.2 million. Of this, $8.2 million was from the sale of emission reduction credits, $7.7 million was from non-cash gains on 10 derivative instruments that were not designated as oil and gas hedges when the Company adopted SFAS No. 133 (see Note 6 to Condensed Consolidated Financial Statements), and the remainder was primarily attributable to marketing and transportation revenue. Lease operating expenses For the nine months ended September 30, 2001, lease operating expenses were $23.8 million compared to $20.6 million for the same period a year ago. The increased costs in the 2001 nine-month period reflect start-up costs associated with the Hartland gas processing plant in Michigan, higher ad valorem taxes, higher working interest production, and an increased level of workovers of oil and gas wells in order to maximize production during the first half of 2001 when natural gas prices were high. Production taxes Production taxes, which are generally based on a percentage of revenue (excluding VPP revenue) increased $2.3 million to $6.6 million for the nine months ended September 30, 2001, compared to the same periods in 2000, due to higher oil and gas revenue associated with the increase in working interest production and higher average realized prices. General and administrative expenses General and administrative expenses ("G&A") were $2.4 million for the three months ended September 30, 2001 compared to $1.9 million for the same period in 2000. For the nine months ended September 30, 2001 G&A were $7.6 million compared to $5.8 million for the same period in 2000. The increase in G&A during the 2001 three and nine month periods is largely due to the cost of the employee retention bonus program that was put in place in October 2000 in order for the Company to retain its employees during the reorganization process and restricted stock grants to employees. Depreciation, depletion and amortization The Company provides for depletion on its oil and gas properties using the future gross revenue method based on recoverable reserves valued at current prices. For the three months ended September 30, 2001, depreciation, depletion and amortization ("DD&A") increased $3.7 million to $15.3 million due to a higher DD&A rate. The DD&A rate increased to 36% of oil and gas revenue for the three months ended September 30, 2001 compared to 25% for the same period a year ago due largely to lower natural gas and oil prices and a higher depletable base. For the nine months ended September 30, 2001, DD&A increased $6.0 million to $42.8 million compared to the same period a year ago due to higher oil and gas revenue during the first half of 2001 partially offset by a lower DD&A rate. Interest and other income Interest and other income increased $0.8 million to $1.2 million for the nine months ended September 30, 2001, compared to the same period in 2000 due to higher interest income associated with accumulated cash and cash equivalents. Interest expense Interest expense for the three months ended September 30, 2001 was $4.9 million compared to reported interest expense of $6.7 million for the same period a year ago. For the nine months ended September 30, 2001, interest expense was $17.1 million compared to reported interest expense of $20.3 million for the same period in 2000. In accordance with SOP 90-7, the 2000 three and nine-month periods excluded $2.8 million and $8.3 million, respectively, of interest expense associated with the Company's senior subordinated notes. See Note 5 to Condensed Consolidated Financial Statements. The lower interest expense in 2001 reflects significantly lower outstanding debt. 11 Reorganization items For the nine months ended September 30, 2001, the Company recorded $2.9 million of reorganization items, primarily for legal and financial advisory services in connection with the completed Chapter 11 proceedings. For the same period in 2000, the Company recorded $10.7 million of reorganization items, $6.1 million of which was a non-cash write-off of deferred debt issuance costs associated with the Company's Senior Notes and Senior Subordinated Notes in accordance with SOP 90-7 and the remainder was primarily for legal and financial advisory services. Income tax benefit In connection with the adoption of SFAS No. 133, the Company recorded a liability of $43.8 million representing the fair market value of its derivative instruments upon adoption and an after-tax loss from the cumulative effect of a change in accounting principle to other comprehensive income of $28.5 million. For the three months ended September 30, 2001, the Company reclassified $2.0 million of the liability as a non-cash reduction to oil and gas revenues and recorded a related tax benefit of $0.7 million. For the nine months ended September 30, 2001, the Company reclassified $21.9 million of the liability and recorded a related tax benefit of $7.6 million. Liquidity and Capital Resources The Company's liquidity and financial condition have improved significantly during the last two years. Year 2000 earnings were a record $41.5 million and cash flow from operating activities (before reorganization items) was $137.3 million. In addition, the Company funded a $69.1 million capital investment program while significantly reducing debt and increasing cash balances. Following confirmation of the Company's Plan of reorganization on January 30, 2001, KCS emerged from Chapter 11 on February 20, 2001 having reduced its outstanding debt balances from a peak of $425 million in early 1999 to $215 million and reduced it further to $204.8 million. Cash flow from operating activities Net income adjusted for non-cash charges and reorganization items for the nine months ended September 30, 2001 decreased $13.9 million to $66.4 million as higher realized natural gas prices and net income were partially offset by amortization of deferred revenue associated with the Enron Production Payment. Net cash provided by operating activities before reorganization items for the first nine months of 2001 was $177.1 million compared to $96.6 million for the same period a year ago. In addition to the items noted above, the current year nine-month period also reflects the net proceeds of $175.4 million from the Enron Production Payment, the payment of $71.4 million of interest and the $28 million cost of terminating certain derivative instruments in connection with the emergence from Chapter 11. The decrease in trade accounts receivable is mainly due to lower oil and gas prices. The Company believes that its cash flow from operations should be sufficient to meet its short-term operating requirements and that it has sufficient resources available to support its business and long-term growth strategies. Investing activities Capital expenditures for the nine months ended September 30, 2001 were $72.9 million of which $26.1 million was for the acquisition of proved reserves, $34.3 million was for development activities, $11.4 million was for lease acquisitions, seismic surveys and exploratory drilling, and $1.1 million was for other assets. During this period, the Company sold certain oil and gas properties for net proceeds of $2.1 million. New Accounting Standards In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 requires entities to record the fair value of a liability for legal obligations associated with the retirement obligations of tangible long-lived assets in the periods in which it is incurred. When the liability is initially recorded, the entity increases the carrying amount of the related long-lived asset. The liability is accreted to the fair value at the time of settlement over the useful life of the asset, and the capitalized cost is depreciated over the useful life of the related asset. The standard is effective for fiscal years beginning after June 15, 2002, with earlier application encouraged. The Company is currently evaluating the effect of adopting Statement No. 143 on its financial statements and has not yet determined the timing of adoption. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144 addresses the financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 supersedes SFAS No. 121 but retains its fundamental provisions for the (a) recognition/measurement of impairment of long- 12 lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. SFAS No. 144 also supersedes the accounting/reporting provisions of APB Opinion No. 30 for segments of a business to be disposed of but retains the requirement to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of or is classified as held for sale. SFAS No. 144 is effective for the Company beginning in 2002. The Company is currently evaluating the impact of this new standard. Forward-looking Statements The information disclosed in this Form 10-Q includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements, other than statements of historical facts, included herein regarding planned capital expenditures, increases in oil and gas production, the number of anticipated wells to be drilled after the date hereof, the Company's financial position, business strategy and other plans and objectives for future operations, are forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, they do involve certain assumptions, risks and uncertainties, and the Company can give no assurance that such expectations will prove to be correct. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the timing and success of the Company's drilling activities, the volatility of prices and supply and demand for oil and gas, the numerous uncertainties inherent in estimating quantities of oil and gas reserves and actual future production rates and associated costs, the usual hazards associated with the oil and gas industry (including blowouts, cratering, pipe failure, spills, explosions and other unforeseen hazards), and changes in regulatory requirements. All forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by such factors. 13 MARKET RISK DISCLOSURE The Company has entered and may continue to enter into swaps, futures contracts and options to manage the price risk associated with the production of natural gas and oil. These derivatives have the effect of fixing for specified periods the prices the Company will receive for the volumes to which the derivative relates. As a result, while these derivatives are structured to reduce the Company's exposure to decreases in the price associated with the underlying commodity, they also limit the benefit the Company might otherwise have received from any price increases associated with the commodity. In accordance with Item 305 of Regulation S-K, the Company has elected the tabular method to disclose market-risk related to derivative financial instruments as well as other financial instruments. The following table sets forth the Company's natural gas hedged position at September 30, 2001.
NYMEX NATURAL GAS --------------------------------------------------------------------------------------- NYMEX Crude Oil --------------------------- Swaps Puts Written Calls Swaps --------------------------- --------------------------- --------------------------- --------------------------- @ $4.03 per MMBtu @ $3.00 per MMBtu @ $4.05 per MMBtu $28.15 Per BBl --------------------------- --------------------------- --------------------------- --------------------------- Unrealized Unrealized Unrealized Unrealized Volume Gain(Loss) Volume Gain(Loss) Volume Gain(Loss) Volume Gain(Loss) MMBtu ($000's) MMBtu ($000's) MMBtu ($000's) Bbls ($000's) ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ 2001 4th Qtr. 305,000 403 -- -- 305,000 -- 46,000 206 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Total 305,000 403 -- -- 305,000 -- 46,000 206 2002(*) 2,590,000 3,057 2,140,000 321 450,000 -- -- -- 2003 -- -- -- -- -- -- -- -- 2004 -- -- -- -- -- -- -- -- 2005 -- -- -- -- -- -- -- --
* Includes 2,140,000 MMBtu at a price of $4.02 per MMBtu so long as the monthly NYMEX settlement is above $2.50 for the period Aril - October (No settlement proceeds in NYMEX is below $2.50) The Company accounts for oil and natural gas futures contracts and commodity price swaps in accordance with SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities". Prior to the implementation of the Plan on February 20, 2001, the Company used fixed and variable rate long-term debt to finance the Company's capital spending program. See Note 2 to Condensed Consolidated Financial Statements. These debt arrangements exposed the Company to market risk related to changes in interest rates. During the first quarter of 2001, the Company's weighted average contractual interest rate on its weighted average variable rate debt of $42.1 million was 9.3%. The Company's variable rate debt was repaid in full on February 20, 2001. During the nine months ended September 30, 2001, the Company's weighted average contractual interest rate on its fixed rate debt of $218.5 million was 9.8%. 14 KCS ENERGY, INC. - FORM 10-Q PART II - OTHER INFORMATION Item 1. Legal Proceedings. Reference is made to Item 3, Legal Proceedings, in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. On June 21, 2001, the Texas Supreme Court affirmed the decision of the Fifth Circuit Court of Appeals at Dallas, Texas in favor of the Company in the Jesus Yzaguirre Suit. On July 6, 2001 the royalty owners filed a motion for rehearing and on August 30, 2001 the Texas Supreme Court denied the motion for further rehearing. On September 14, 2001, the royalty owners filed a motion to correct opinion and for further rehearing; however, on October 25, 2001, the judgment of the Texas Supreme Court in favor of the Company became final and the litigation was concluded. The background of this litigation is discussed in note 10 of Notes to Consolidated Financial Statements included in the Company's Annual Report to stockholders on Form 10-K for the year ending December 31, 2000. The Company was a defendant in a lawsuit originally brought by InterCoast Energy Company and MidAmerican Capital Company ("Plaintiffs") against KCS Energy, Inc., KCS Medallion Resources, Inc. and Medallion California Properties Company ("KCS Defendants"), and Kerr-McGee Oil & Gas Onshore LP and Kerr-McGee Corporation ("Kerr-McGee Defendants") in the 234th Judicial District Court of Harris County, Texas under Cause Number 1999-45998. The suit sought a declaratory judgment declaring the rights and obligations of each of the Plaintiffs, the KCS Defendants and the Kerr-McGee Defendants in connection with environmental damages and surface restoration on lands located in Los Angeles County, California which are covered by an Oil & Gas Lease dated June 13, 1935, from Newhall Land and Farming Company, as Lessor, to Barnsdall Oil Company, as Lessee (the "RSF Lease") and by an Oil and Gas Lease dated June 6, 1941, from the Newhall Corporation, as Lessor, to C. G. Willis, as Lessee (the "Ferguson Lease" and together with the RSF Lease, the "Leases"). The Kerr-McGee Defendants, KCS Defendants and Plaintiffs entered into an Agreed Interlocutory Judgment that contains clarification of the language of the 1990 Agreement between predecessors of the KCS Defendants and the Kerr-McGee Defendants (the "1990 Agreement") under which the Leases were transferred from Kerr-McGee's predecessor to predecessors of Medallion California Properties Company ("MCPC"). The Court previously entered the Agreed Interlocutory Judgment, which essentially disposed of interpretation questions concerning the 1990 Agreement. After entry of the Agreed Interlocutory Judgment, the remaining issues in the case concerned the interpretation of the 1996 Stock Purchase Agreement through which certain of the KCS Defendants acquired the stock of MCPC. Specifically, the remaining issues involved the extent to which Plaintiffs are obligated to indemnify the KCS Defendants for environmental investigation costs previously incurred by the KCS Defendants and also for costs of defense and liability to the KCS Defendants, if any, in the California litigation described below. By Compromise and Settlement Agreement dated as of October 19, 2001, the Plaintiffs and KCS Defendants agreed: (i) to settle those issues dealing with the Plaintiffs' obligations to reimburse costs previously incurred in environmental investigation and costs paid before September 30, 2001 in connection with defense of the California case described below; (ii) to provide prospectively for the control of defense and settlement and the sharing of defense costs in the California case described below; and (iii) to defer any disputes concerning the respective liability of Plaintiffs and KCS Defendants for any individual claims until the extent of such individual claim liability, after giving effect to indemnification obligations under the 1990 Agreement, is fully and finally determined. MCPC is a defendant in a lawsuit filed January 30, 2001, by The Newhall Land and Farming Company ("Newhall") against MCPC and Kerr-McGee Corporation and several Kerr-McGee affiliates. The case is currently pending in Los Angeles County Superior Court under Cause Number BC244203. In the suit, Newhall seeks damages and punitive damages for alleged environmental contamination and surface restoration on the lands covered by the RSF Lease and also seeks a declaration that Newhall may terminate the RSF Lease or alternatively, that it may terminate those 15 portions of the RSF Lease on which there is currently default under the Lease. MCPC claims that Newhall is not entitled to lease termination as a remedy and that Kerr-McGee and InterCoast and MidAmerican owe indemnities to MCPC for defense and certain potential liability under Newhall's action, all as more particularly described in the Harris County, Texas litigation described above. Discovery is ongoing, and the lawsuit is set for trial in January 2003. The Company is also a party to various other lawsuits and governmental proceedings. See Note 10 of Notes to Consolidated Financial Statements included in the Company's Annual Report to stockholders on Form 10-K for the year ended December 31, 2000. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits: None. (b) Reports on Form 8-K. There were no reports on Form 8-K filed during the three months ended September 30, 2001. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. KCS ENERGY, INC. December 28, 2001 /S/ FREDERICK DWYER ------------------------------- Frederick Dwyer Vice President, Controller and Secretary 16