ITEM 3. LEGAL PROCEEDINGS.
1. Vastar, as successor in interest to ARCO, is a defendant in a lawsuit that has been restyled Laura Lyon, et al. v. Amoco Production Company, et al., Case No. 93-CV-130, in the District Court for La Plata County (Durango), Colorado, and which was originally filed in May 1993. Vastar is one of seven defendants in this case in which the plaintiffs have alleged widespread methane gas contamination. On June 17, 1994, the trial court granted Vastar's motion to dismiss Vastar from the litigation on the grounds, inter alia, that the court lacked subject-matter jurisdiction over the claims asserted against Vastar. The plaintiffs filed an appeal to the Colorado Court of Appeals and on February 22, 1996, the Court affirmed the trial court's order dismissing the litigation. The plaintiffs applied for a writ of certiorari to the Colorado Supreme Court and on August 28, 1996, the plaintiffs withdrew their application. The Colorado Court of Appeals remanded the case to the trial court for the determination of attorneys' fees and costs due to Vastar and the other defendants from the plaintiffs. The trial court has granted, in part, Vastar's request for attorneys' fees and costs. Vastar also had been named as a defendant in six additional lawsuits brought by individuals in the United States District Court for the District of Colorado. The defendants in all of the above-described lawsuits, including Vastar, have completed final negotiations whereby all of the lawsuits will be dismissed as part of a comprehensive settlement which would involve all federal and state court parties and in which all defendants, including Vastar, would give up their right to attorney fees and costs in return for dismissals with prejudice of all of the cases in all courts. Documents reflecting this complete settlement have been executed by substantially all parties and all of the federal cases have been dismissed with prejudice. The Company expects the remaining Lyon state court case to be similarly dismissed.
2. Vastar and its subsidiaries are involved in a number of other lawsuits, all of which have arisen in the ordinary course of business in operating Vastar's properties or the former ARCO Oil and Gas Company division and Vastar Gas business affairs. Further, pursuant to the Cross-Indemnification Agreement dated as of October 1, 1993, between Vastar and ARCO, Vastar has assumed any and all liabilities incurred before or after the effective date of that certain General Conveyance and Assumption Agreement, dated October 8, 1993, as modified as of December 13, 1993, and December 22, 1993, between Vastar and ARCO that are associated with the ownership or operation of the Subject Properties as defined therein, except for certain scheduled litigation and other liabilities.
The Company does not believe that any ultimate liability resulting from any of the claims and suits described or referred to in paragraphs above will have a material adverse effect on the financial position or results of operation of 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 1997.
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EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is certain information about the executive officers (as such term is defined in Rule 3b-7 promulgated under the Securities Exchange Act of 1934, as amended) of the Company as of March 1, 1998.
NAME, AGE AND PRESENT BUSINESS EXPERIENCE DURING PAST POSITION WITH THE COMPANY FIVE YEARS AND PERIOD SERVED AS OFFICER(A)(B) ------------------------------------------------------------------------- Michael E. Wiley, 47.... Mr. Wiley has been a Director of the Company since Chairman of the Board September 1993 and was elected Chairman of the Board and Director in December 1996. He has been an Executive Vice President of ARCO since March 1997 and a Director of ARCO since June 1997. He was President of the Company from September 1993 to March 1997 and Chief Executive Officer from January 1994 to March 1997. He held the position of Senior Vice President of ARCO from June 1993 to June 1994. He held the position of President of ARCO Oil and Gas Company from June to October 1993. Previously, from 1991 to 1993, he was a Vice President of ARCO and Manager of ARCO Exploration and Production Technology. From 1989 to 1991, he was Vice President of ARCO Oil and Gas Company's Southern District. Mr. Wiley joined ARCO in 1972.
Charles D. Davidson, 48..................... Mr. Davidson was elected President and Chief President, Chief Executive Officer in March 1997 and has been a Executive Officer and Director of the Company since March 1994. From Director September 1993 to March 1997, he served as a Senior Vice President of the Company and from December 1992 to October 1993, he held the position of Senior Vice President of the Eastern District for ARCO Oil and Gas Company. From 1988 to December 1992, he held various positions with ARCO Alaska, Inc. Mr. Davidson joined ARCO in 1972.
Phillip A. Gobe, 45..... Mr. Gobe has been a Senior Vice President of the Senior Vice President Company since May 1997. From March 1995 to May 1997, he served as Vice President, Human Resources of ARCO International Oil and Gas Company. From June 1993 to March 1995, he was the Vice President, Human Resources of ARCO Alaska, Inc. Prior to these assignments, Mr. Gobe served as Operations Manager-- Prudhoe Bay of ARCO from October 1991 to June 1993. Prior to October 1991, Mr. Gobe held various positions of increasing responsibility with ARCO. Mr. Gobe joined ARCO in 1976.
Steven J. Shapiro, 45... Mr. Shapiro has been Senior Vice President and Chief Senior Vice President, Financial Officer of the Company since December 1993 Chief Financial Officer and a Director of the Company since January 1994. He and Director was also Treasurer of the Company from January 1994 until December 1995. He was the President of ARCO Coal Australia Inc. from October 1991 to December 1993. Previously, he held the position of Vice President of Planning of ARCO from 1990 to October 1991. From 1988 to 1990, he was Assistant Treasurer for ARCO serving in both Los Angeles and London. Mr. Shapiro joined ARCO in 1977.
Albert D. Hoppe, 53..... Mr. Hoppe has been Vice President and General Vice President, General Counsel since May 1, 1994 and Secretary of the Counsel and Secretary Company since May 25, 1994. He served as General Attorney for ARCO Coal Company, Denver, Colorado, from June 1992 through April 1994. Previously, from 1976 until 1992, he held various positions in the ARCO legal department in Dallas and Houston, Texas. Prior to joining ARCO in 1976, he was an Assistant United States Attorney in Kansas City, Missouri.
Joseph P. McCoy, 46..... Mr. McCoy has been Vice President and Controller of Vice President and the Company since June 1994 and was designated Controller Principal Accounting Officer, effective July 1, 1994. He held the position of Vice President of Finance, Planning and Control of ARCO Alaska, Inc. from November 1989 to May 1994. Previously, he was Assistant Controller of ARCO from February 1987 to November 1989. From 1984 to 1987, Mr. McCoy served as Controller of ARCO Coal Company and then as Controller of ARCO Transportation Company. Mr. McCoy joined ARCO in 1974.
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NAME, AGE AND PRESENT BUSINESS EXPERIENCE DURING PAST POSITION WITH THE COMPANY FIVE YEARS AND PERIOD SERVED AS OFFICER(A)(B) ------------------------- ------------------------------------------
Robert P. Strode, 41..... Mr. Strode was elected Vice President of the Vice President Company in February 1997. He held the position of Managing Director, Exploration of ARCO British Limited from January 1996 to February 1997. From June 1994 to January 1996, he was Vice President, Exploration and Land of ARCO Alaska, Inc. From September 1993 to June 1994, he was North Alaska Exploration Manager of ARCO Alaska, Inc. From 1991 to September 1993, he was Manager, Exploration- Offshore, for ARCO Oil and Gas Company and, from 1986 to 1991, he was District Geophysicist, both onshore and offshore, of ARCO Oil and Gas Company. Mr. Strode joined ARCO in 1979. - ------ (a) Atlantic Richfield Company division names used in the descriptions of business experience of executive officers of the Company are the names which were in effect at the time such officers held such positions. In some instances, these ARCO divisions have been combined or reorganized and, accordingly, activities thereof are presently conducted under different division names.
(b) The By-Laws of the Company provide that each officer shall hold office until the officer's successor is elected or appointed and qualified or until the officer's death, resignation or removal by the Board of Directors.
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PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The principal market in which shares of Vastar common stock, $0.01 par value ("Common Stock"), are traded is the New York Stock Exchange (ticker symbol: VRI). Prices in the foregoing table are from the New York Stock Exchange composite tape.
As of February 27, 1998, the approximate number of holders of record of Common Stock was 102 and the high price per share was $37 7/16 and the low price per share was $37.
The Company has paid regular quarterly cash dividends as follows:
The declaration and payment of dividends are at the discretion of the Board of Directors of the Company and the amount thereof will depend on the Company's results of operations, financial condition, contractual restrictions, cash requirements, future prospects and other factors deemed relevant by the Board of Directors. In addition, the agreement relating to the Company's $1.1 billion bank credit facility (the "Credit Agreement") contains financial and other covenants, including covenants that may, under certain circumstances, have the effect of limiting the Company's ability to pay dividends. The Credit Agreement as amended, has been filed with the Securities and Exchange Commission, which filings have been incorporated by reference as an exhibit to this report on Form 10-K.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The selected financial data set forth below for the Company for the five years ended December 31, 1997, should be read in conjunction with the Consolidated Financial Statements and the Notes included in this Form 10-K.
- ------ (1) Included in 1995 is the receipt of a $21.0 million pre-tax settlement in connection with the termination of a disputed long-term acreage-dedicated gas sales contract. (2) Earnings per share amounts prior to the year ended December 31, 1995, have been omitted because Vastar was a wholly-owned subsidiary of ARCO until June 27, 1994. (3) The ratios of earnings to fixed charges were computed by dividing earnings by fixed charges. For this purpose, earnings include income before income taxes and fixed charges. Fixed charges include interest, amortization of debt expense, and the estimated interest component of rentals. Prior to the inception of the Company on October 1, 1993, the determination of fixed charges is not applicable in that the Company had not incurred any debt. The Company's ratio of earnings to fixed charges for the three months ended December 31, 1993 was 1.2.
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ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following information should be read in connection with the information contained in the Company's Consolidated Financial Statements and the Notes included in this Form 10-K.
GENERAL
Vastar was formed in September 1993 out of the reorganization of ARCO's lower 48 exploration and production operations, when ARCO transferred to Vastar certain producing properties, developed and undeveloped acreage, related liabilities and working capital.
Sales and production volumes and price statistics for the specified periods were as follows:
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The following table sets forth the statements of income for the years ended December 31, 1997, 1996 and 1995. These statements of income are derived from the audited Consolidated Financial Statements included in this Form 10-K.
RESULTS OF OPERATIONS
Impact of the Marketing Alliance
On August 8, 1997, the Company entered into a Formation Agreement (the "Formation Agreement") with Southern Energy, Inc. (formerly known as SEI Holdings, Inc.), a Delaware corporation and a subsidiary of The Southern Company ("SEI"), to combine certain natural gas and power trading and marketing operations of the two companies and create a new energy services company. The new company is named Southern Company Energy Marketing L.P. ("SCEM" or the "Venture"). Through its subsidiaries, Vastar initially holds a 40 percent interest in the Venture, and SEI, through subsidiaries, initially holds a 60 percent interest. SCEM began gas marketing effective September 1, 1997, and power marketing effective January 1, 1998.
Under the terms of the "first closing" of the transaction under the Formation Agreement which occurred effective September 1, 1997, SEI paid $40 million into escrow for Vastar's account and Vastar and SEI contributed certain gas marketing assets to the Venture. The "second closing" was effective January 1, 1998. At the second closing, the $40 million of escrowed funds, along with interest, were released to Vastar, and Vastar contributed additional gas marketing assets and its power marketing operations and SEI contributed its power marketing operations to SCEM. Vastar's gas processing plant assets and related businesses and Vastar's contracts with cogeneration facilities were not contributed to the Venture.
The Company is accounting for its interest in the Venture using the equity method of accounting and therefore the Company's consolidated results after September 1, 1997 will no longer reflect its gas marketing activities in the individual line items of the financial statements. For more details on the transaction see Note 4 of the Notes to Consolidated Financial Statements in this Form 10-K.
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Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Net income for 1997 was $240.5 million, compared to $220.0 million for 1996. The nine percent increase in earnings was primarily the result of higher regional gas prices realized in the San Juan Basin and a decrease in dry hole costs, partially offset by increases in production costs and selling, general and administrative costs.
Natural gas sales decreased by seven percent to $2,331.3 million in 1997 as compared to last year. The lower revenues were the result of marketing sales volumes during the last four months of the year being transacted by SCEM, which is accounted for under the equity method, partially offset by higher regional natural gas prices in the San Juan Basin. Natural gas purchases during 1997 decreased by 12 percent from 1996 to $1,634.4 million primarily as a result of the Venture start-up during the last four months of the year.
Average natural gas wellhead prices for 1997 increased $0.22 per Mcf to $2.03 per Mcf as compared to 1996. Although the full year average of Inside FERC Henry Hub (cash) prices (a benchmark used by the Company) decreased slightly, from $2.69 per Mcf in 1996 to $2.62 per Mcf for 1997, Vastar realized a price improvement primarily as the result of higher prices for its San Juan Basin production. Reflected in the Company's natural gas revenues and the average wellhead natural gas price for 1997 and 1996 was the unfavorable impact of $49.0 million and $55.1 million, pre-tax, respectively, related to managing its natural gas price risk associated with its proprietary production.
Natural gas production for 1997 was up slightly from the previous year. Volume increases primarily from exploitation efforts in the San Juan Basin, 1996 redevelopment efforts at High Island 24L and the Mobile 904 start-up offset natural field declines.
Crude oil sales in 1997 were down slightly from 1996 primarily as a result of lower market prices, slightly offset by higher production available for sale.
Crude oil production increased slightly as compared to the previous year. Production increases primarily at Eugene Island 175 and South Pass 60 offset natural field declines.
Net sales for natural gas liquids and other products were down from the previous year. The decrease is a result of a 12 percent decline in average NGL prices, partially offset by a ten percent increase in NGL production available for sale. During the fourth quarter of 1997, NGL production declined primarily as a result of the Company's election to bypass certain processing in favor of selling Btus as natural gas due to the relatively favorable natural gas prices.
Also included in net sales for NGLs and other products is approximately $141.7 million of sales and $142.9 million of purchases and other costs related to power marketing activities during 1997. The power marketing assets were contributed to SCEM effective January 1, 1998.
Operating expenses for 1997 were up 13 percent from last year. The increase is a result of maintenance and workover activities primarily in offshore fields.
Exploration expenses for 1997 were $175.5 million, down from the previous year. Dry hole costs were down $26.1 million when compared to last year, primarily as a result of a higher success rate. Partially offsetting the favorable decrease in dry hole costs was a $13.1 million increase in staff costs due to increased staffing levels necessary to support the Company's expanded exploration program.
Taxes other than income taxes increased $8.8 million during 1997 as compared to 1996. The increase in the Company's average wellhead natural gas prices resulted in higher taxable values on the Company's production.
The income tax benefit of $5.9 million in 1997 was less than the prior year because of higher pre-tax earnings as compared to 1996. The income tax benefit for 1997 and 1996 included the net benefit of $91.7 million and $85.0 million, respectively, of Internal Revenue Code Section 29 tax credits for non- conventional fuels. The increase in tax credits in 1997 was largely the result of increasing San Juan coal seam methane production.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Net income for 1996 of $220.0 million more than doubled when compared to 1995. The earnings increase primarily reflected higher commodity prices and production volumes, partially offset by higher production and exploration costs.
Net sales and other operating revenues increased by $243.1 million to $945.8 million for 1996, primarily as a result of higher prices and sales volumes for natural gas, crude oil and NGLs.
Natural gas sales increased 98 percent to $2,514.5 million during 1996. The higher revenues were a result of higher trading activity levels and an increase in commodity prices. Reflected in natural gas revenues for 1996 was the unfavorable impact of $55.1 million pre-tax or $0.05 per Mcf sold, related to the Company's natural gas price hedging activities.
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Natural gas purchases increased in 1996 to $1,860.5 million, up $1,055.5 million from 1995. This increase was a result of the combined effect of a 56 percent increase in natural gas purchased volumes, which rose to an average of approximately 2.1 Bcfd to support the higher trading activity levels, and a 48 percent increase in the cost of gas purchased, which was driven by higher commodity prices.
Natural gas production for 1996 averaged 872 MMcfd, up eight percent from the previous year. Contributing to the increase were the continuing growth of San Juan Basin production, the January 1996 start-up of the High Island 177 extension discovery and ongoing exploitation successes throughout Vastar's core areas. These improvements more than offset natural field declines during 1996.
Crude oil sales in 1996 were $777.3 million, an increase of 18 percent from the prior year primarily, as a result of higher commodity prices.
Crude oil production was 34.2 MBbld in 1996, an increase of five percent from 1995. The increase reflected higher production primarily from the South Pass 60 and West Delta 106/107 fields, partially offset by natural field declines.
Natural gas liquids and other sales were $90.0 million for 1996, reflecting a 41 percent increase over the prior year. This increase resulted from a combination of higher NGL prices and a 16 percent increase in production volumes. The increase in production volumes, reflected a higher ownership in an onshore gas plant and increased processing volumes.
Other revenues of $20.8 million decreased $16.0 million in 1996 as compared to 1995. The 1996 other revenues were generated primarily from leasing undeveloped mineral fee acreage in East Texas. The 1995 other revenues were generated primarily from the receipt of a $21.0 million payment in settlement upon the termination of a disputed long-term acreage-dedicated gas sales contract.
Exploration expenses were $186.4 million compared to $151.2 million for 1995. The $35.2 million increase was primarily related to higher seismic data purchases and dry hole costs associated with the increased exploration activities in 1996. During 1996, the Company's expenditures for seismic data increased 63 percent to $45.0 million as a result of tripling its onshore seismic database and increasing its offshore seismic database by 70 percent. Of the $45.0 million, 26 percent was attributable to investments required to establish a presence in the deepwater Gulf of Mexico play.
Selling, general and administrative costs increased by $10.8 million to $62.0 million in 1996. This increase was primarily a result of the expansion of Vastar's marketing services.
Taxes other than income taxes increased $8.5 million during 1996 primarily as a result of higher revenues.
Depreciation, depletion and amortization increased in 1996 to $275.9 million compared to $263.3 million in 1995 primarily due to increased production volumes. Included in these costs was a $9.4 million and a $23.1 million non- cash pre-tax charge for 1996 and 1995, respectively, for the impairment of the Company's oil and gas properties and facilities.
The income tax benefit of $7.3 million in 1996 reflected higher pre-tax earnings and higher Section 29 Tax Credits as compared to 1995. The Company recognized $85.0 million and $67.0 million for 1996 and 1995, respectively, of Section 29 Tax Credits for non-conventional fuels. The increase in tax credits in 1996 was largely the result of increasing San Juan coalbed methane production.
RISK MANAGEMENT AND MARKET-SENSITIVE INSTRUMENTS
From time to time, the Company uses various hedging arrangements, predominantly natural gas and crude oil price swaps, to manage the Company's exposure to price risk from its natural gas and petroleum liquids production. These hedging arrangements have the effect of locking in for specified periods (at predetermined prices or ranges of prices) the prices the Company will receive for the volumes to which the hedge relates. As a result, while these hedging arrangements are structured to reduce the Company's exposure to decreases in price associated with the hedged commodity, they can also limit the benefit the Company might otherwise have received from any price increases associated with the hedged commodity. The Company does not hold or issue financial instruments for trading purposes.
In 1997, Vastar Gas used certain financial instruments, such as natural gas price swaps and futures, to manage its fixed-price purchase and sale commitments, as well as to provide fixed-price physical commitments as a service to its customers and suppliers. Vastar Gas generally balanced its fixed-price physical and financial purchase and sales contracts in terms of contract volumes and timing of delivery obligations in accordance with specific guidelines relative to the amount of these net open positions. In addition, certain internal controls monitored such positions against such guidelines.
SCEM also uses certain financial instruments, such as natural gas and power price swaps and futures, to manage its fixed-price purchase and sale commitments, as well as to provide fixed-price commitments as a service to its customers and suppliers. Although SCEM attempts to balance its fixed-price physical and financial purchase and sales contracts in terms of contract volumes and timing
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of delivery obligations, it is possible that net open positions will exist from time to time. SCEM has established guidelines relative to these net open positions. In addition, SCEM has set up certain internal controls to monitor its positions against these guidelines which are required to be and have been approved by the Company. However, to the extent that SCEM has an open position, SCEM is exposed to risk from fluctuating market prices.
The Company realized approximately $34.7 million and $37.1 million of pre- tax losses in 1997 and 1996, respectively, as a result of all its hedging transactions for natural gas and crude oil.
In 1997 and 1996, the Company hedged 28 percent and 13 percent of its gas production, respectively, and 32 percent and 17 percent of its crude oil production, respectively. The following table summarizes the Company's open positions as of December 31, 1997.
Based on forward price quotes from brokers and NYMEX forward prices as of December 31, 1997, the fair value (deferred pre-tax loss or gain to the Company) for the 1998 hedged transactions in place as of December 31, 1997 would be $7.9 million loss for natural gas and $0.8 million gain for crude oil. The actual gains or losses realized by the Company from such hedges may vary significantly from the foregoing amounts due to the fluctuation of prices in the commodity markets. For example, a hypothetical ten percent increase in the forward price quotes as of December 31, 1997, would increase the unrealized loss by approximately $16.7 million for natural gas and decrease the gain by approximately $0.4 million for crude oil. In order to calculate the hypothetical gain or loss, the relevant parameters of the futures contracts are the type of commodity, the delivery price and the delivery location; due to the short period before expiration, time value of money is ignored in the calculation. This analysis only includes the commodity derivative instruments and not the exposure related to the underlying commodity. Natural gas spot prices fluctuated between $1.78 per Mcf and $4.55 per Mcf (NYMEX Henry Hub) and crude oil prices fluctuated between $17.63 per Bbl and $26.63 per Bbl (NYMEX-WTI-at-Cushing) in 1997.
The Company's commercial paper program is subject to interest rate risk. An abrupt increase in interest rates could increase interest expense. For example, given the Company's debt structure and debt levels at December 31, 1997, a ten percent increase in London Interbank Offered Rate (a benchmark pursuant to which the Company's interest rates may be set) would increase interest expense by $2.2 million. Vastar may periodically elect to enter into interest rate swap agreements with the objective of managing interest rate risk by converting the interest rate on variable rate debt to a fixed rate. Vastar has not entered into nor had any interest rate swaps outstanding at December 31, 1997 and 1996.
LIQUIDITY AND CAPITAL RESOURCES
During 1997, cash flow from operations was $755.2 million, compared to $533.3 million in 1996. The increase was primarily the result of higher gas prices throughout the year, the receipt from ARCO of $59.4 million in connection with the monetization of Internal Revenue Code Section 29 Tax Credits pursuant to a Second Amendment to the Vastar/ARCO Tax Sharing Agreement, and reduced working capital levels from the end of 1996.
Working capital was $(70.6) million at December 31, 1997 and $42.4 million at December 31, 1996. The decrease in working capital was primarily a result of the change in product prices between December 31, 1996 and December 31, 1997.
Net cash used in investing activities was $632.2 million in 1997, a 25 percent increase over 1996, primarily as a result of an increased capital spending program during 1997.
Additions to oil and gas properties and equipment (including dry hole costs) in 1997 totaled $629.5 million. The 1997 capital spending program was principally funded from internally generated funds.
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Capital Spending Summary
Property acquisitions in 1997 included approximately $58.3 million for the purchase of 47 tracts in the March 5, 1997, Outer Continental Shelf ("OCS"), Central Gulf of Mexico Oil and Gas Lease Sale 166 and approximately $22.4 million for the purchase of 31 tracts in the August 27, 1997, OCS, Western Gulf of Mexico Oil and Gas Lease Sale 168.
The Company has announced a 1998 capital spending program of $700 million. Future capital expenditures may be affected by business conditions in the industry, particularly changes in prices of and demand for natural gas, NGLs and crude oil. Changes in tax laws and environmental rules and regulations may also affect future capital expenditures. The Company believes it can essentially fund the 1998 capital spending program from internally-generated cash flows, as well as continue current production rates, at recent market prices. The Company will continue to monitor prices and evaluate its options should prices decline. The Company believes its internally-generated liquidity together with access to external capital resources can provide adequate financial flexibility to take advantage of any potential strategic business opportunities which the Company would consider in 1998. In addition, during the third quarter of 1997 the Company entered into an exploration alliance program that will include the drilling of approximately ten new field wildcat wells and completing various 3-D seismic projects that will continue into 1998.
Cash flow used in financing activities was $134.7 million in 1997, reflecting a $106.3 million pay down of long-term debt (net of new borrowings) and the payment of cash dividends. In 1996, cash flow used in financing activities was $10.0 million reflecting the payment of cash dividends, partially offset by a slight increase in the Company's long-term debt.
In February of 1997, the Company issued $75.0 million of 6.96 percent unsecured Notes, due February 2007 pursuant to its $250 million Medium-Term Note Program. During January 1998, the Company issued $50.0 million of 6.39 percent unsecured notes due January 2008 pursuant to its $250 million Medium- Term Note Program. To date $200 million of notes have been issued under the Medium-Term Note Program. The net proceeds from the February 1997 and January 1998 issuances were used to pay down debt incurred under the Company's Commercial Paper Program and other general obligations of the Company.
In the first quarter of 1997, the Company entered into an amended and restated revolving credit agreement dated as of March 31, 1997, relating to its $1.1 billion bank line of credit (the "Bank Credit Facility") which extended the term of the Bank Credit Facility until March 31, 2002. As of December 31, 1997, the Company had no debt outstanding under this facility.
In the fourth quarter of 1996, the Company established a $1.1 Billion Commercial Paper Program for the private placement to accredited investors of up to $1.1 billion (outstanding at any one time) of unsecured notes with maturities of up to 270 days from date of issue (the "CP Notes"). In the Commercial Paper Placement Agency Agreements relating to the program, the Company has agreed to maintain credit lines sufficient to support payment of the CP Notes. At December 31, 1997, the Company had $372.7 million of CP Notes outstanding under the program. The effective rate of commercial paper borrowing during 1997 averaged 5.7 percent (6.2 percent at December 31, 1997).
In September 1996, the Company entered into a contract with Diamond Offshore Drilling for the major upgrade and operation of a semisubmersible drilling rig, Ocean Victory, for a three-year deepwater drilling program in the Gulf of Mexico. In November 1997, the Company commenced its Gulf of Mexico deepwater drilling program using the Ocean Victory, with the spudding of the King Prospect (Mississippi Canyon 764). The contract for the Ocean Victory along with other contracts for support equipment are anticipated to cost approximately $160 million over the term of the contract. During 1997 the Company incurred approximately $10 million under the terms of these contracts. See Note 19 of the Notes to the Consolidated Financial Statements in this Form 10-K for a discussion of subsequent events relating to the status of the Ocean Victory.
The Company's ratios of earnings to fixed charges for the year ended December 31, 1997, 1996 and 1995 was 5.9, 5.1 and 2.0, respectively. For this purpose, earnings include income before income taxes and fixed charges. Fixed charges include interest, amortization of debt expenses and the estimated interest component of rental expense.
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ENVIRONMENTAL MATTERS
At December 31, 1997, $139.6 million had been accrued for the total estimated cost, net of salvage value, of plugging and abandoning wells, dismantling platforms and facilities as required by contract, regulation or law, and the estimated costs of restoration and reclamation of land associated with such facilities. This accrual for dismantlement and restoration costs includes a component for compliance with new environmental laws and regulations. These environmental related costs include the removal of contaminants and the restoration of the site. See Note 9 of the Notes to Consolidated Financial Statements in this Form 10-K.
During 1997, 1996 and 1995, the Company did not incur any significant charges to income for environmental remediation costs and made no related payments. At December 31, 1997, the Company did not have a separate environmental remediation reserve for Superfund or similar clean-up sites. See Notes 2 and 9 of the Notes to Consolidated Financial Statements in this Form 10-K regarding Dismantlement, Restoration and Reclamation Costs.
On the basis of management's best assessment of the ultimate amount and timing of the contingencies associated with environmental matters, any expenses or judgments related to such matters are not expected to have a material adverse effect on the Company's financial condition, results of operations or cash flows.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 issue is the result of computer programs written and computer chips programmed using two digits rather than four to define the applicable year. Any of the Company's computer programs that have date-sensitive software as well as anything with a computer chip may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities.
Based on a recent assessment, the Company determined that it must modify or replace portions of its software so that its computer systems can properly utilize dates beyond December 31, 1999. The Company presently believes that with modifications to existing software and conversions to new software, the Year 2000 issue will be adequately addressed. However, if such modifications and conversions are not made, or are not completed timely, the Year 2000 issue could have an impact on the operations of the Company and such impact could be material.
The Company will utilize both internal and external resources to reprogram, or replace, and test the software for Year 2000 modifications. The Company plans to complete the Year 2000 project for critical systems no later than December 31, 1998. The total remaining cost of the Year 2000 project (i) is estimated at $2 million, (ii) is being funded through operating cash flows and (iii) will be expensed as incurred over the next two years. To date, the Company has incurred and expensed approximately $0.5 million related to the assessment of its Year 2000 project and the development and implementation of its remediation plan.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See (i) Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Management and Market-Sensitive Instruments and (ii) Note 17 of the Notes to the Consolidated Financial Statements in this Form 10-K. For a description of accounting policies, see Note 2 of the Notes to the Consolidated Financial Statements in this Form 10-K.
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ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors of Vastar Resources, Inc.:
We have audited the accompanying consolidated balance sheet of Vastar Resources, Inc. as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 1997. 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 Vastar Resources, Inc. as of December 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.
As discussed in Note 6 to the consolidated financial statements, the Company changed its method of accounting for the impairment of long-lived assets in 1995.
/s/ COOPERS & LYBRAND L.L.P.
COOPERS & LYBRAND L.L.P. Houston, Texas February 12, 1998
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VASTAR RESOURCES, INC.
CONSOLIDATED STATEMENT OF INCOME
The accompanying notes are an integral part of the consolidated financial statements.
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VASTAR RESOURCES, INC.
CONSOLIDATED BALANCE SHEET
The accompanying notes are an integral part of the consolidated financial statements.
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VASTAR RESOURCES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
The accompanying notes are an integral part of the consolidated financial statements.
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VASTAR RESOURCES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
The accompanying notes are an integral part of the consolidated financial statements.
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. FORMATION OF THE COMPANY AND BASIS OF PRESENTATION
Vastar Resources, Inc. ("Vastar" or the "Company") is one of the largest independent (non-integrated) oil and gas companies in the United States. The Company is engaged in the exploration, development, production and marketing of natural gas, crude oil and natural gas liquids. The Company's four principal producing areas are offshore in the Gulf of Mexico, the Gulf Coast region (south Texas, southeast Texas and south Louisiana), the San Juan/Rockies region (northwest New Mexico, southwest Colorado and Wyoming) and the Mid-Continent region (northeast Texas, Oklahoma, northern Louisiana, Arkansas and Kansas). Effective September 1, 1997, Vastar began marketing its natural gas through Southern Company Energy Marketing L.P. ("SCEM"), a limited partnership owned by subsidiaries of Vastar and The Southern Company, in which Vastar currently owns a 40 percent interest. Prior to that time, substantially all the Company's natural gas production was sold to and marketed by its wholly-owned subsidiary, Vastar Gas Marketing, Inc. Vastar directly markets its crude oil and natural gas liquids nationwide.
Effective October 1, 1993, Atlantic Richfield Company ("ARCO") conveyed beneficial title to certain producing properties located in the Gulf of Mexico, Texas, Louisiana, Oklahoma, Kansas, New Mexico, Colorado and Arkansas, together with certain developed and undeveloped acreage (collectively, the "Properties") to Vastar, ARCO'S wholly-owned subsidiary, at the time of the conveyance. ARCO also conveyed to the Company all of the outstanding stock of each of the following subsidiaries of ARCO: Vastar Gas Marketing, Inc. (formerly ARCO Natural Gas Marketing, Inc.), F&H Pipeline Company, Grant Gathering Company and Wilburton Hub, Inc. For financial reporting purposes, the Properties and the capital stock of the subsidiaries were recorded at ARCO's historical cost. On December 7, 1993, Vastar borrowed $1.25 billion from a group of banks and paid a special dividend to ARCO in the same amount. In the second quarter of 1994, the Company paid $125 million in additional special cash dividends to ARCO.
ARCO owns 80,000,001 shares (82.2 percent) of the outstanding common stock, par value $0.01 per share ("Common Stock") of the Company, and as of May 19, 1994, the Company and ARCO entered into an agreement granting ARCO certain rights as a stockholder of the Company. In order to allow ARCO to continue to include the Company as part of its "affiliated group" for federal income tax purposes, ARCO has been granted, pursuant to such agreement, the cumulative, continuing right to purchase from the Company at the then-current market price, such number of shares of Common Stock or preferred stock, or both, as may be necessary to preserve that status. For additional information relating to the relationships between the Company and ARCO, see Note 5 to the Notes to Consolidated Financial Statements in this Form 10-K.
On July 5, 1994, the Company completed an initial public offering of 17,250,000 shares of its common stock. The Company received proceeds of approximately $453 million for such shares, net of the underwriting discount of approximately $26 million and expenses of $4 million.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of all subsidiaries and ventures in which an interest is held. All material intercompany balances and transactions are eliminated. Investments in affiliates over which the Company can exercise influence and generally owns between 20 percent and 50 percent are accounted for using the equity method.
Cash Equivalents
Cash equivalents consist of highly liquid investments, such as time deposits, certificates of deposit and marketable securities other than equity securities with original maturities of three months or less. Cash equivalents are stated at cost, which approximates market value.
Oil and Gas Properties
Oil and gas properties are accounted for using the successful efforts method. Under this method, all development costs and acquisition costs of proved properties are capitalized and amortized on a units-of-production basis over the remaining life of proved developed reserves and proved reserves, respectively. Costs of drilling exploratory wells are initially capitalized, but charged to expense if and when a well is determined to be unsuccessful. Oil and gas unproved property costs are capitalized and amortized on a composite basis, considering past success experience and average property life.
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Costs of retired, sold or abandoned properties that constitute a part of an amortization base are charged or credited, net of proceeds, to the accumulated depreciation, depletion and amortization reserve. Gains or losses from the disposal of other properties are recognized currently. Expenditures for maintenance, repairs and minor renewals necessary to maintain properties in operating condition are expensed as incurred. Major replacements and renewals are capitalized. All properties are stated at the lower of cost or cost less any impairment recognition.
Inventories
Inventories are comprised principally of materials and supplies, and are stated at the lower of cost (determined on an average basis) or market. Product inventories are stated at the lower of current market value or cost and represent approximately 15 percent of total year-end inventory. Cost is determined under the last-in, first-out (LIFO) method.
Dismantlement, Restoration and Reclamation Costs
The estimated costs, net of salvage value, of dismantling facilities or projects with limited lives or facilities that are required to be dismantled by contract, regulation or law, and the estimated costs of restoration and reclamation of land associated with such projects, are accrued on a unit-of- production basis during operations and classified as a deferred liability. Such costs are included in depreciation, depletion and amortization charges in the current period.
Income Taxes
The Company and its subsidiaries join with ARCO and ARCO's domestic subsidiaries in filing a consolidated federal income tax return. The Company and ARCO are parties to a tax sharing agreement, effective October 1, 1993, and amended on June 1, 1995, relating to these taxes (the "Tax Sharing Agreement"). During the first quarter of 1997, ARCO and the Company agreed to a second amendment to the Tax Sharing Agreement, effective January 1, 1997 (the "Second Amendment"). The Second Amendment removes certain limitations under the prior agreement and generally allows the Company to receive payment from ARCO for all Section 29 Tax Credits in the year generated. In return, the Company agreed to a 3.25 percent reduction in the value of the Section 29 Tax Credits generated from properties acquired by the Company before June 1, 1995. ARCO and Vastar also agreed to apply the same 3.25 percent reduction to the $61.4 million of Section 29 Tax Credits carried forward as of December 31, 1996, in exchange for a payment upon execution of the Second Amendment. Accordingly, Vastar received $59.4 million from ARCO on March 20, 1997. Under the Tax Sharing Agreement, as amended by the Second Amendment, the Company is able to use its Section 29 Tax Credits to reduce its federal income tax payments to ARCO by the greater of (i) the amount of such credits which could be used by the Company if its tax liability was calculated on a stand-alone tax basis and (ii) the amount of such credits used by the ARCO Tax Group (as defined in the Tax Sharing Agreement), in each case, less the 3.25 percent discount on certain credits. Tax credits that are not used by Vastar in the current year pursuant to the Tax Sharing Agreement, as amended by the Second Amendment, will generally be carried forward and used in subsequent tax years. See Note 10 of the Notes to Consolidated Financial Statements in this Form 10- K for further information.
State tax expense is computed using the applicable average tax rates for both unitary and nonunitary state filings. State franchise taxes are also calculated on a stand-alone basis.
Revenue Recognition
Revenue is normally recognized from jointly-owned properties as oil and gas is produced and sold for Vastar's account. An overlift (i.e., when Vastar sells gas in excess of its entitlement) is recorded as a liability if it is significant in quantity and the remaining underground reserves are not sufficient to satisfy the deficiency. Underlifts (i.e., when Vastar sells less gas than its entitlement) are recorded only when contracts specify that lifting imbalances be settled in cash. Overlifts and underlifts to be settled in cash are recorded as adjustments to revenue. The recorded lifting imbalances at December 31, 1997 and 1996, were insignificant.
Hedging and Related Activities
The Company utilizes derivative instruments in the form of natural gas and crude oil price swap and price collar agreements in order to manage price risk associated with future crude oil and natural gas production and fixed-price crude oil and natural gas purchase and sale commitments. Such agreements are accounted for as hedges using the deferral method of accounting. Gains and losses resulting from these transactions are deferred and included in other assets or accrued liabilities, as appropriate, until recognized as operating income in the Company's Consolidated Statement of Income as the physical production required by the contracts is delivered.
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The cash flows related to any recognized gains or losses associated with these hedges are reported as cash flows from operations. If the hedge is terminated prior to expected maturity, gains or losses are deferred and included in income in the same period as the physical production required by the contracts is delivered.
The Company also uses derivative instruments in the form of interest rate swaps primarily as a hedge against interest exposure on variable rate debt and such agreements are accounted for as hedges using the accrual method of accounting. The differences to be paid or received on swaps designated as hedges are included in interest expense during the period to which the payment or receipt relates. The related amounts payable to, or receivable from, the counterparties are included in other assets or accrued liabilities. The cash flows related to any recognized gains or losses associated with these hedges are reported as cash flows from operations. The Company is currently not a party to any interest rate swaps.
The conditions to be met for a derivative instrument to qualify as a hedge are the following: (i) the item to be hedged exposes the Company to price or interest rate risk; (ii) the derivative reduces the risk exposure and is designated as a hedge at the time the derivative contract is entered into; and (iii) at the inception of the hedge and throughout the hedge period there is a high correlation of changes in the market value of the derivative instrument and the fair value of the underlying item being hedged.
When the designated item associated with a derivative instrument matures, is sold, extinguished or terminated, derivative gains or losses are recognized as part of the gain or loss on sale or settlement of the underlying item. When a derivative instrument is associated with an anticipated transaction that is no longer expected to occur or if correlation no longer exists, the gain or loss on the derivative is recognized in income to the extent the future results have not been offset by the effects of price or interest rate changes on the hedged item since the inception of the hedge.
Stock-based Compensation
Employee stock options are accounted for under the intrinsic-value-based method prescribed by Accounting Principles Board Opinion No. 25.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Reclassifications
Certain previously reported amounts have been restated to conform to classifications adopted in 1997.
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. NET SALES AND OTHER OPERATING REVENUES
Net sales and other operating revenues were as follows for the years ended December 31:
- ------ (1) The weighted average lifting and purchase cost per Mcfe associated with proprietary production and third party purchased volumes multiplied by the related party sales volumes results in average costs of $409.0 million, $186.1 million and $233.1 million for 1997, 1996 and 1995 respectively. The increase in related party sales is the result of the transfer of Vastar's gas marketing activities to SCEM in September 1997. (2) Includes purchases from related parties at a cost of $196.7 million, $23.8 million and $46.4 million for 1997, 1996 and 1995, respectively.
4. SOUTHERN COMPANY ENERGY MARKETING L.P. ("SCEM")
On August 8, 1997, the Company entered into a Formation Agreement (the "Formation Agreement") with Southern Energy, Inc. (formerly known as SEI Holdings, Inc.), a Delaware corporation ("SEI") and a subsidiary of The Southern Company, to combine certain natural gas and power trading and marketing operations of the two companies and create a new energy services company. The new company is named Southern Company Energy Marketing L.P. ("SCEM" or the "Venture"). SCEM is managed, through subsidiaries, by SEI and Vastar and began gas marketing, effective September 1, 1997, and power marketing, effective January 1, 1998. Through its subsidiaries, Vastar currently holds a 40 percent interest in the Venture, and SEI, through subsidiaries, currently holds a 60 percent interest. SCEM is engaged in the business of trading and marketing natural gas, electricity and other energy- related commodities. SCEM provides energy and energy-related commodities, products and services to wholesale and retail customers in North America.(a)
Under the terms of the "first closing" of the transaction under the Formation Agreement which occurred effective September 1, 1997, SEI paid $40 million into escrow for Vastar's account and Vastar and SEI contributed certain gas marketing assets to the Venture. The "second closing" was effective January 1, 1998. At the second closing, the $40 million of escrowed funds, along with interest, were released to Vastar, and Vastar contributed additional gas marketing assets and its power marketing operations and SEI contributed its power marketing operations to SCEM. Vastar's gas processing plant assets and related businesses and Vastar's contracts with cogeneration facilities were not contributed to the Venture. The Company expects to record an after tax gain of approximately $10 to $12 million in the first quarter of 1998 related to this transaction.
For the first five years of operation, Vastar is to receive, subject to certain exceptions, minimum cash distributions from the Venture of $20 million for the year 1998, $20 million for the year 1999, $25 million for the year 2000, $30 million for the year 2001 and $30 million for the year 2002.
On July 1, 2001, the interests of SEI and Vastar will shift to 75 percent and 25 percent, respectively. No additional consideration will be received by Vastar in connection with this ownership change. During the year 2002, SEI has an option to purchase an additional five percent interest in the Venture from Vastar for $80 million (the "SEI Call Option") and on January 1, 2003, Vastar has an option to sell to certain subsidiaries of SEI its remaining interest for $210 million (or $130 million if the SEI Call Option has been exercised). Under limited conditions, SEI has an additional option to purchase Vastar's entire interest in the Venture commencing on September 1, 1997 and expiring on December 31, 2007, for $580 million (or $500 million if the SEI Call Option has been exercised) or a certain multiple of earnings, whichever is higher.
- ------ (a) See Items 1. and 2. Business Properties--Marketing in this Form 10-K for a detailed description of the ownership of SCEM.
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In connection with the Formation Agreement, Vastar entered into a Gas Purchase and Sale Agreement with SCEM for a primary term expiring on December 31, 2007, pursuant to which Vastar committed to sell, and SCEM committed to purchase (subject to certain partial releases or early termination), substantially all of the gas produced and owned or controlled by Vastar within the lower 48 states of the United States, Canada and Mexico, at market-based prices. The Gas Purchase and Sale Agreement excludes certain natural gas from the commitment and also reserves to Vastar certain rights, including gas processing rights. The agreement requires that Vastar make available to SCEM a minimum monthly quantity of natural gas which can be purchased by Vastar on the open market to supply to SCEM, if necessary. Gas sales under this contract began September 1, 1997.
The Company is accounting for its interest in the Venture using the equity method of accounting and therefore the Company's consolidated results after September 1, 1997, will no longer reflect its gas marketing activities in the individual line items of the financial statements.
5. RELATED PARTY TRANSACTIONS AND COST ALLOCATIONS
Effective October 1, 1993, the Company and ARCO (including ARCO subsidiaries) entered into a series of agreements which, among other things, included natural gas and crude oil purchase and sale agreements, an accounting and land administration services agreement, a technical services agreement and a corporate services agreement. These agreements were developed in connection with the establishment of the Company by ARCO, and, therefore, were not the result of arm's-length negotiations between independent parties.
The purchase and sale agreements include the sales of substantially all of ARCO's lower 48 proprietary natural gas production from its ARCO Permian Unit to the Company and the sales of substantially all of Vastar's proprietary crude oil and NGLs to ARCO at agreed-upon prices approximating current market values. The contract relating to natural gas terminated as of April 1, 1995. The contract relating to crude oil terminated as of January 1, 1995, when the Company began to directly market its crude oil. However, Vastar has continued to market crude oil to ARCO on a month-to-month basis at market-based prices. The contract relating to NGLs terminated as of March 31, 1996, when the Company began to directly market its NGLs. However, Vastar has continued to market NGLs to ARCO on a month-to-month basis at market-based prices. The accounting and land administration services agreement included accounting, internal control, royalty administration, land administration and the computer services associated with these activities. This agreement terminated as of January 1, 1995. The technical services agreement includes a variety of oil and gas technical services and information technology services. The provisions for information technology under this agreement terminated on October 31, 1995, while the remaining portion of the agreement is for an indefinite term. Under the corporate services agreement, ARCO provides the Company various financial, legal, insurance, internal audit and other administrative services and the Company provides ARCO with certain financial and other services as agreed. This agreement provides for an indefinite term. Charges under each of these service agreements are determined based on usage or other methods that management believes to be reasonable.
Vastar has entered into a Gas Purchase and Sale Agreement with SCEM pursuant to which Vastar committed to sell, and SCEM committed to purchase, substantially all of the gas produced and owned or controlled by Vastar within the lower 48 states of the United States, Canada and Mexico, at market-based prices. Natural gas sales under this contract began September 1, 1997. Vastar also purchases natural gas from SCEM pursuant to an agreement effective September 1, 1997. See Note 4 of the Notes to Consolidated Financial Statements in this form 10-K for further information.
Pursuant to a working capital loan arrangement, Vastar and SEI have agreed to loan SCEM up to $50 million. Vastar's commitment to make working capital loans is limited to $20 million which corresponds to Vastar's 40 percent interest in SCEM. Vastar and SEI are parties to an Intercreditor Agreement pursuant to which either party may make advances to SCEM and seek a corresponding reimbursement of the other party's pro rata share of the advance. At December 31, 1997, $9.6 million, plus accrued interest, was owed by SCEM to Vastar for working capital advances made to SCEM pursuant to this arrangement.
An analysis of net settlements for the years ended December 31, 1997, 1996 and 1995 were as follows:
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. OIL AND GAS PROPERTIES AND EQUIPMENT
Oil and gas properties and equipment, at cost, and related accumulated depreciation, depletion and amortization were as follows at December 31:
In December 1993, Vastar borrowed $1.25 billion under an unsecured, revolving credit agreement. The facility was amended in the second quarter of 1995, in the first quarter of 1996 and again in the first quarter of 1997. As of December 31, 1997, commitments under this facility, as amended to date, totaled $1.1 billion and the commitment expires March 31, 2002. The effective rate of this borrowing during 1996 averaged 5.8 percent. During 1997 there was no debt outstanding under this facility. The agreement contains certain covenants, the most restrictive of which (i) require Vastar to maintain minimum levels of tangible stockholders' equity and maintain certain financial ratios, (ii) restrict the Company's ability to encumber its assets and (iii) may restrict, under certain circumstances, the Company's ability to pay dividends.
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
On November 14, 1994, the Company filed a registration statement with the Securities and Exchange Commission covering the issuance of up to $500 million of debt securities. These securities may be offered from time to time on terms to be determined at the time of the sale. As of December 31, 1995, $150 million of 8.75 percent unsecured notes, due in 2005, had been issued pursuant to this registration statement. In the second quarter of 1995, the Company established a $250 Million Medium-Term Note Program pursuant to this registration statement. The following table summarizes issuances pursuant to the Medium-Term Note Program as of January 31, 1998.
The net proceeds of the above issuances were primarily used to pay down debt incurred under the Company's Commercial Paper Program and other general obligations of the Company.
In October 1996, the Company established a $1.1 Billion Commercial Paper Program for the private placement to accredited investors of up to $1.1 billion (outstanding at any one time) of unsecured notes with maturities of up to 270 days from the date of issue (the "CP Notes"). In the Commercial Paper Placement Agency Agreements relating to the program, the Company has agreed to maintain credit lines sufficient to support payment of the CP Notes. The proceeds from the Commercial Paper Program were used to pay down the debt incurred under the Revolving Credit Facility. At December 31, 1997, the Company had $372.7 million of CP Notes outstanding under the program. The effective rate of commercial paper borrowing during 1997 and 1996 averaged 5.7 percent and 5.6 percent, respectively (6.2 percent at December 31, 1997).
The estimated fair value of total long-term debt at December 31, 1997 and 1996 was $696.9 million and $792.9 million, respectively. The fair value of Vastar's long-term debt was based on quoted market prices.
Vastar periodically enters into interest rate swap agreements with the objective of managing interest rate risk by converting the interest rate on variable rate debt to a fixed rate. As of December 31, 1997, Vastar had no outstanding interest rate swaps. No interest rate swaps were settled in 1997 and the financial impact of the swaps settled in 1996 was immaterial.
9. DEFERRED LIABILITIES AND CREDITS
Deferred liabilities and credits were as follows at December 31:
The Company accrues amounts for the dismantling of facilities and plugging and abandonment of wells on a unit-of-production basis. The Company accrued expenses of approximately $7.1 million, $2.0 million and $8.7 million and paid approximately $17.1 million, $10.1 million and $7.7 million in costs in 1997, 1996 and 1995, respectively, to plug and abandon wells, dismantle fields, facilities or projects and restore, reclaim and rehabilitate the land associated with those projects.
In October 1996, the Accounting Standards Executive Committee issued Statement of Position 96-1, "Environmental Remediation Liabilities" ("SOP-96- 1"). The provisions of SOP 96-1 includes standards affecting the measurement, recognition and disclosure of environmental remediation liabilities. The adoption in 1997 of the provision of SOP 96-1 had no material impact to the Company's financial position, results of operations and cash flows.
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. TAXES
The components of the income tax benefit were comprised of the following for the years ended December 31:
The major components of the net deferred tax liability at December 31, 1997 and 1996 were as follows:
- ------ (1) See Note 2 of the Notes to Consolidated Financial statements in this Form 10-K relating to an amendment of the Tax Sharing Agreement.
Taxes other than income taxes were comprised of the following for the years ended December 31:
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
11. STOCKHOLDERS' EQUITY
Additional Shares of Common Stock Authorized
At the Annual Meeting of Stockholders held on May 15, 1996, stockholders voted to amend the Company's Restated Certificate of Incorporation to authorize an additional 10 million shares of Common Stock. After adoption of the amendment, the Company had 110 million shares of Common Stock authorized to be issued, of which 97,304,127 shares were issued and outstanding as of December 31, 1997.
Dividends
During 1997, 1996 and 1995, the Company paid quarterly cash dividends on its Common Stock of $0.075 per share totaling $0.30 per share, or $29.2 million, each year.
12. COMMITMENTS AND CONTINGENCIES
The Company and its subsidiaries are involved in a number of lawsuits, all of which have arisen in the ordinary course of the Company's business. The Company believes that any ultimate liability resulting from any of these suits will not have a material adverse effect on its financial position or results of operations.
The operations and financial position of Vastar continue to be affected from time to time in varying degrees by domestic and foreign political developments as well as legislation and regulations pertaining to restrictions on oil and gas production, imports and exports, natural gas regulation, tax increases, environmental regulations and cancellation of contract rights. Both the likelihood of such occurrences and their overall effect on the Company vary greatly and are not predictable. These uncertainties are part of a number of items that Vastar has taken and will continue to take into account in periodically establishing accounting reserves.
Vastar and ARCO have agreements whereby Vastar has agreed to indemnify ARCO against certain claims or liabilities to which ARCO could be subject relating to ARCO's historical ownership and operation of the properties transferred by ARCO to Vastar upon the formation of Vastar, including liabilities under laws relating to the protection of the environment and the workplace and liabilities arising out of certain litigation. ARCO has agreed to indemnify Vastar with respect to other claims and liabilities and other litigation matters not related to Vastar's business or properties as reflected in its consolidated financial statements.
In September 1996, the Company entered into a contract with Diamond Offshore Drilling Company for the major upgrade and operation of a semisubmersible drilling rig, Ocean Victory, for a three-year deepwater drilling program in the Gulf of Mexico. In November 1997, the Company commenced its Gulf of Mexico deepwater drilling program using the Ocean Victory, with the spudding of the King Prospect (Mississippi Canyon 764). See Note 19 of the Notes to Consolidated Financial Statements in this Form 10-K for a discussion of subsequent events relating to the status of the Ocean Victory. Before any reimbursement from partners or potential partners, costs incurred with respect to this contract along with other contracts for committed support equipment are expected to be $54.0 million, $54.0 million and $44.2 million for the years 1998, 1999 and 2000, respectively. During 1997, the Company incurred approximately $10.0 million under the terms of these contracts.
In connection with SCEM's marketing and risk management activities, Vastar and SEI have agreed to guarantee certain obligations of SCEM. The total amount of guarantees which can be issued is set by the Board of Governors of SCEM. Vastar and SEI have agreed, subject to certain limitations, to indemnify each other for their respective pro rata share of any amount paid in connection with these guarantees. Each company's pro rata share is equal to their respective percentage ownership in the Venture at the time the guaranteed obligation is incurred. In addition, Vastar's obligation to indemnify SEI, in any year, is limited, subject to certain limitations, to the amount which Vastar has received from SCEM in excess of the minimum cash distributions described above for that year. Similarly, if Vastar has not received its minimum cash distribution from SCEM in any year, SEI has agreed to indemnify, subject to certain limitations, Vastar for all amounts paid by Vastar under these guarantees for that year.
The Company has significant credit risk exposure to Southern Company Energy Marketing L.P. ("SCEM") and Southern Energy, Inc. ("SEI"). SEI, a wholly-owned subsidiary of The Southern Company, has not yet obtained a credit rating from any nationally recognized statistical rating organization. The credit risk exposure consists of three principal items. First, SCEM has promised to make certain minimum cash distributions to Vastar. SEI has guaranteed this obligation as well as the amounts due to Vastar upon the exercise of Vastar's option to sell its remaining interest on January 1, 2003. Second, SCEM is obligated to pay, and SEI has guaranteed payment, for gas purchased under the Gas Purchase and Sale Agreement between the Company and SCEM,
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
pursuant to which the Company has agreed to sell substantially all of its production to SCEM. Third, Vastar has been indemnified by SEI, with certain limitations, with respect to amounts which Vastar may be required to pay under guarantees which Vastar has issued to secure certain obligations of SCEM. If at December 31, 1998, SEI has not obtained and does not thereafter maintain in effect an investment grade rating, SEI has agreed to provide certain credit enhancement to secure the payment of SCEM's obligations under the Gas Purchase and Sale Agreement and the minimum cash distributions.
The Company has performed and continues to perform ongoing credit evaluations of its other customers and generally does not require collateral on its credit sales. Any amounts anticipated as uncollectible are charged to income and credited to a valuation account. The amounts included in the allowance for uncollectible accounts at December 31, 1997, 1996 and 1995 were insignificant.
13. EXPLORATION EXPENSE
Exploration expense for the years ended December 31, 1997, 1996 and 1995, was as follows:
14. EARNINGS PER SHARE (EPS)
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
15. RETIREMENT PLANS
Essentially all the Company's employees are covered by defined benefit pension plans sponsored by Vastar. The benefits are based on years of service and the employee's compensation, primarily during the last three years of service. Vastar's funding policy is to make annual contributions as required by applicable regulations. Vastar accrues pension costs based on an actuarial valuation for each plan, and funds qualified benefit plans through contributions to trust funds kept apart from Vastar funds. Nonqualified benefit plans are not funded.
The following table sets forth the plans' funded status and the amounts recognized in Vastar's balance sheet at December 31:
Components of net pension cost for Vastar are as follows for the years ended December 31:
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The assumptions used in determining the pension costs and pension liability shown above were as follows at December 31:
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Net annual postretirement benefit costs for each of the years ended December 31, 1997, 1996 and 1995 included the following components:
The weighted average annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care trend rate) for the health plans is nine percent for 1995 and 1996, seven percent for 1997 to 2001 and five percent thereafter. The effect of a one percentage point increase in the assumed health care cost trend rate would increase the accumulated postretirement benefit obligation as of December 31, 1997 by approximately $2.9 million, and the aggregate of the service and interest cost components of net annual postretirement benefit cost by less than $0.4 million.
17. FINANCIAL INSTRUMENTS
The Company does not hold or issue financial instruments for trading purposes. The Company enters into commodity futures contracts to manage its natural gas and crude oil price risk associated with its proprietary production and to manage its fixed-price purchase and sale commitments, as well as to provide fixed-price physical commitments as a service to its customers and suppliers. The Company realized approximately $34.7 million and $37.1 million of pre-tax losses in 1997 and 1996, respectively, as a result of these various hedging transactions.
In 1997 and 1996, the Company hedged 28 percent and 13 percent of its gas production, respectively, and 32 percent and 17 percent of its crude oil production, respectively. The following table summarizes the Company's open positions as of December 31, 1997.
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Based on forward price quotes from brokers and NYMEX forward prices as of December 31, 1997, the fair value (deferred pre-tax loss or gain to the Company) for the hedged transactions for 1998 would be a $7.9 million loss for natural gas and a $0.8 million gain for crude oil, and approximates carrying value. The actual gains or losses realized by the Company from such hedges may vary significantly from the foregoing amounts due to the fluctuation of prices in the commodity markets. [For example, a hypothetical ten percent increase in the forward price quotes would increase the unrealized loss by approximately $16.7 million for natural gas and decrease the gain by approximately $0.4 million for crude oil. In order to calculate the hypothetical gain or loss, the relevant parameters of the futures contracts are the type of commodity, the delivery price and the delivery location; due to the short period before expiration, time value of money is ignored in the calculation. This analysis includes only the commodity-derivative instrument and not the exposure related to the underlying commodity.] Natural gas spot prices fluctuated between $1.78 per Mcf and $4.55 per Mcf (NYMEX Henry Hub) and crude oil prices fluctuated between $17.63 per Bbl and $26.63 per Bbl (NYMEX-WTI-at-Cushing) in 1997.
The counterparties to these transactions are principally major financial institutions and major oil and gas and other industrial companies; Vastar does not anticipate nonperformance by the counterparties. The Company monitors the credit-worthiness of the counterparties.
18. STOCK OPTIONS
Options to purchase shares of Vastar's Common Stock have been granted to executives, outside directors and key employees. Generally, the exercise price of each option is equal to or greater than the fair market value of the Company's Common Stock, $0.01 par value, at the date of grant and options vest one year after the date of grant, become exercisable in increments of 25 percent per year and expire ten years after the date of grant. However, certain stock options granted to certain executive officers under Stock Option Conversion Agreements in connection with Vastar's Initial Public Offering in 1994, (the "Offering"), were granted at less than the $28.00 Offering price and/or were exercisable upon the closing date of the Offering. In addition, stock options granted to outside directors vest 30 days after grant and are exercisable six months after the date of grant. Transactions during 1997, 1996 and 1995 were as follows:
As of December 31, 1997, 1996 and 1995, there were 686,550, 190,800 and 525,450 of registered shares of Common Stock available for option, respectively. The weighted average fair value for options granted in 1997, 1996 and 1995 are $12.49 per share, $13.72 per share and $11.01 per share, respectively.
A summary of the status of Vastar's fixed stock options as of December 31, 1997 were as follows:
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A summary of the status of Vastar's fixed stock options as of December 31, 1996 were as follows:
Vastar applies Accounting Principles Board Opinion No. 25, in accounting for its fixed stock options. Accordingly, no compensation cost for options granted has been recognized in the financial statements. Had compensation cost for stock options been determined consistent with Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation," Vastar's net income and earnings per share for the years ended December 31, 1997, 1996 and 1995 would have been the pro forma amounts indicated below:
For purposes of determining the pro forma amounts presented above, the fair value of each stock option grant is estimated on the American binomial option pricing model with the following approximate weighted average assumptions used for grants in 1997, 1996 and 1995, respectively: dividend yield of 1.0 percent, 0.87 percent and 0.87 percent; expected volatility of 23.3 percent, 25.6 percent and 22.6 percent; interest rate of 6.6 percent, 6.2 percent and 7.4 percent; and an expected term of eight years in all years.
19. SUBSEQUENT EVENTS
On January 7, 1998, the "second closing" under the Formation Agreement, dated August 8, 1997, with Southern Energy, Inc. (formerly known as SEI Holdings, Inc.) ("SEI") occurred and was effective January 1, 1998. At the second closing, the $40 million of escrowed funds, along with interest, were released to Vastar, and Vastar contributed additional gas marketing assets and its power marketing operations and SEI contributed its power marketing operations to Southern Company Energy Marketing L.P.
On January 21, 1998, the Board of Directors of the Company declared a cash dividend of $0.075 per share on the Common Stock to be paid on March 10, 1998, to stockholders of record as of February 13, 1998.
During January 1998, the Company issued $50 million of 6.39 percent 10-year notes due in January 2008 pursuant to the Medium-Term Note program. To date, a total of $200 million of Medium-Term Notes have been issued, leaving $50 million of notes available under this program.
In February 1998, the Company decided that an exploratory well testing the Kilmarnock prospect on Garden Banks Block 258 in the Gulf of Mexico will be plugged and abandoned, after finding non-commercial quantities of hydrocarbons. The Company held a 30 percent working interest in the Kilmarnock well, which was operated by British-Borneo Exploration, Inc. The well was drilled at a cost of approximately $13 million after tax to Vastar and will be included in Vastar's 1998 results of operations.
In February 1998, the Company announced that an exploratory well testing the King prospect on Mississippi Canyon Block 764 in the Gulf of Mexico deepwater area was a discovery. The well encountered approximately 200 feet of net oil pay before drilling was suspended due to an engine room fire on the Ocean Victory drilling rig, which is owned by Diamond Offshore Drilling, Inc.
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VASTAR RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
20. SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
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VASTAR RESOURCES, INC.
SUPPLEMENTAL INFORMATION
OIL & GAS PRODUCING ACTIVITIES (UNAUDITED)
The Securities and Exchange Commission (the "SEC") defines proved oil and gas reserves as those estimated quantities of crude oil, natural gas, and NGLs 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 developed oil and gas reserves are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. These estimates of petroleum reserves do not include probable or possible reserves.
With regard to the Company's reserve estimates for natural gas and NGLs, the Company owns interests in ten gas processing plants in the Gulf of Mexico, Gulf Coast and Mid-Continent producing areas. As a result of this ownership interest, the Company has natural gas processing rights for proved reserves contractually or economically committed to these plants. These processing rights stem from a variety of contracts, including wet gas purchase, Btu keep- whole, and processing type agreements, that the Company is a party to as a plant owner. NGLs quantities include those volumes allocated to the Company's leasehold interest (equity) in gas that is processed and those volumes attributable to the Company's plant ownership resulting from processing equity and third-party gas. The related shrinkage in natural gas volumes resulting from processing has been excluded from the natural gas reserve quantities. Approximately seven percent of the Company's total reserves are attributable to the Company's ownership in gas processing plants.
Proved oil and gas reserve quantities are based on estimates prepared by the Company's engineers in accordance with guidelines established by the SEC and approximately 61 percent were reviewed by Ryder Scott Company Petroleum Engineers, who are independent petroleum engineers. There are numerous uncertainties inherent in estimating quantities of proved reserves and projecting future rates of production and timing of development expenditures. The following reserve data represents estimates only and should not be construed as being exact. Estimated net quantities of proved oil and gas reserves of Vastar were as follows:
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The changes in proved reserves for each of the three years in the period ended December 31, 1997, were as follows:
Costs, both capitalized and expensed, incurred in oil and gas producing activities (including operating overhead) were as follows for the years ended December 31:
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Results of operations for oil and gas producing activities (including operating overhead) were as follows for the years ended December 31:
Primary changes in the standardized measure of discounted estimated future net cash flows are as follows:
Vastar's estimate of future cash inflows was generated by applying year-end prices to the projected future sale of proved reserves, plus incremental revenue from long-term contractual arrangements existing at year end. Year-end cash market natural gas prices for eight trading hubs for the week of December 30, 1997, formed the basis for regional natural gas pricing standards. The year-end cash market crude oil price for West Texas Intermediate on the last trading day of 1997 formed the basis for the crude oil price standard. Individual wellhead prices were generated against these pricing standards using historical processing and transportation differentials.
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Estimated future development and production costs are determined by estimating the expenditures to be incurred in developing and producing the proved oil and gas reserves at the end of the year, based on year-end costs and assuming continuation of existing economic conditions.
Estimated future income tax expense is calculated by applying the year-end statutory tax rate (adjusted for permanent differences and tax credits) to estimated future pre-tax net cash flow related to proved oil and gas reserves, less the tax basis of the properties involved.
These estimates are furnished and calculated in accordance with requirements of the Financial Accounting Standards Board and the SEC. Estimates of future net cash flows presented do not represent management's assessment of future profitability or future cash flow to Vastar. Management's investment and operating decisions are based on reserve estimates that include proved reserves as well as probable reserves, and on different price and cost assumptions from those used here.
It should be recognized that applying current costs and prices and a ten percent standard discount rate does not convey absolute value. The discounted amounts arrived at are only one measure of the value of proved reserves.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None
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PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information regarding executive officers of the Company is included in Part I. For the other information called for by Items 10, 11, 12 and 13, reference is made to the Company's definitive proxy statement for its 1998 Annual Meeting of Stockholders, to be held on May 20, 1998, which will be filed with the SEC within 120 days after December 31, 1997, and which is incorporated herein by reference, except for the material included under the captions "Report of Compensation Committee" and "Performance Graph."
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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:
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- ------ (1) Filed herewith. (2) Management contract or compensatory plan or arrangement required to be filed as an exhibit to this form pursuant to Item 14(c) of Form 10-K.
Copies of exhibits will be furnished upon prepayment of 25 cents per page. Requests should be addressed to the Corporate Secretary.
(b) Reports on Form 8-K.
No reports on Form 8-K have been filed during the last quarter of 1997 or from the end of such period to date.
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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.
VASTAR RESOURCES, INC. (Registrant)
By: /s/ Charles D. Davidson ------------------------- Charles D. Davidson President and Chief Executive Officer
Date: March 6, 1998
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 in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
/s/ Jimmie D. Callison Director March 6, 1998 - ---------------------------- JIMMIE D. CALLISON
Director - ---------------------------- TERRY G. DALLAS
/s/ Charles D. Davidson President, Chief March 6, 1998 - ---------------------------- Executive CHARLES D. DAVIDSON Officer and (PRINCIPAL EXECUTIVE Director OFFICER)
/s/ Marie L. Knowles Director March 6, 1998 - ---------------------------- MARIE L. KNOWLES
/s/ Robert C. LeVine Director March 6, 1998 - ---------------------------- ROBERT C. LEVINE
/s/ Joseph P. McCoy Vice President March 6, 1998 - ---------------------------- and Controller JOSEPH P. MCCOY (PRINCIPAL ACCOUNTING OFFICER)
Director - ---------------------------- WILLIAM D. SCHULTE
/s/ Steven J. Shapiro Senior Vice March 6, 1998 - ---------------------------- President, STEVEN J. SHAPIRO Chief (PRINCIPAL FINANCIAL Financial OFFICER) Officer and Director
/s/ William E. Wade, Jr. Director March 6, 1998 - ---------------------------- WILLIAM E. WADE, JR.
/s/ Michael E. Wiley Chairman of the March 6, 1998 - ---------------------------- Board MICHAEL E. WILEY
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INDEX TO EXHIBITS
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