Is Chesapeake financially stable enough to keep investing and paying its obligations?

The company is in a fragile but improving position. It had $38.7 million of cash, $964 million of long-term debt, and a stockholders' deficit, and its senior note ratings were B and B3. Its 2000 drilling budget is designed to match operating cash flow, which was $145 million in 1999. However, the debt covenant restrictions and suspended preferred dividends limit its financing flexibility, and its $50 million revolver matures in January 2001.

Why did earnings swing so sharply between 1998 and 1999?

The 1998 results included an $826 million full-cost writedown and a $55 million impairment of other assets, which produced a $933.9 million net loss. In 1999 there were no impairments, DD&A fell to $0.71 per Mcfe from $1.13, and G&A was cut to $13.5 million from $19.9 million. Earnings are therefore sensitive to commodity prices, since a future price drop below year-end levels could trigger new writedowns.

What risks should investors weigh from the reserve base?

About 28% of proved reserves by volume (20% by value) were undeveloped, and these are inherently less certain and require about $212.5 million of future development capital. Reserve estimates are based on year-end prices of $24.72 per barrel and $2.25 per Mcf, so lower prices would reduce reported reserves and standardized measure. Chesapeake also must keep replacing reserves to sustain production, and it has a 2000 production outlook of roughly 140 Bcfe.

What is the status of the preferred stock and dividend policy?

The 7% cumulative convertible preferred stock had a liquidation value of about $198.7 million after the early-2000 exchanges. Dividends are restricted until the company meets the debt incurrence test, and the company does not expect to pay the May 1, 2000 dividend. Common dividends were cancelled in September 1998 and are not expected to resume soon. Preferred holders would elect two new directors if six quarterly dividends go unpaid.

Are there material legal exposures?

The company won dismissal of the UPRC patent suit (under appeal) and the 1997 securities class action. Its main exposure is the West Panhandle Field lease-cancellation litigation, where judgments have been entered against its subsidiary CP, including about $1.3 million of actual damages and $1.2 million of exemplary damages in one set of cases, with appeals pending. The Bayard securities suit is still pending with no estimate of loss. Accrued liabilities are believed sufficient for the current cases.

EXE 10-K FY1999 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 30, 2000. Cited figures are marked; the original filing is the authoritative source.

This 10-K covers fiscal 1999 for Chesapeake Energy Corporation (NYSE: CHK), an independent natural gas and oil producer in Oklahoma, Texas, Louisiana, and western Canada.

The filing is from Chesapeake, the predecessor of today's Expand Energy (EXE). The company returned to profitability in 1999, reporting net income of $33.3 million^a ($0.16 diluted EPS) versus a $933.9 million net loss in 1998, which had been driven by an $826 million full-cost writedown. Revenue rose to $354.9 million, and oil and gas sales increased 9% to $280.4 million on 133.5 Bcfe of production, with an average realized price of $2.10 per Mcfe.

Proved reserves grew 11% to 1,206 Bcfe, with a 186% reserve replacement ratio at a finding cost of $0.65^b per Mcfe, and the standardized present value (10%) of proved reserves was $1.09 billion. Balance sheet strain remains the central investor concern. Long-term debt was $964.1 million and stockholders' equity was a deficit of $217.5 million.

Chesapeake failed the debt incurrence test under two senior note indentures, so it cannot incur unsecured non-bank debt or pay preferred dividends. Preferred dividends of $19.3 million^c were in arrears, and management did not expect to pay the May 1, 2000 dividend. Holders would gain the right to elect two directors after six missed quarterly payments.

In early 2000 the company retired 625,000 preferred shares by issuing 8.8 million common shares, reducing the liquidation preference by $31.3 million^d. The 2000 capital budget is $170–190 million, of which $130–140 million is for drilling, and it is planned to be funded from operating cash flow and asset sales. Management also cited improving natural gas fundamentals and a 2000 strategy of maintaining low operating costs ($1.26 per Mcfe in 1999).

Litigation has been mixed. The company won dismissal of the UPRC horizontal drilling patent suit and the 1997 securities class action, but it lost several West Panhandle Field lease-cancellation cases in Texas, which carried judgments totaling several million dollars. Ongoing Bayard securities litigation remains unresolved, with no estimate of loss.

02—Key points

Key Highlights

Swung to 1999 net income of $33.3 million (EPS $0.16 diluted) from a $933.9 million net loss in 1998, with no impairment charge recorded in 1999.
Oil and gas sales rose 9% to $280.4 million on 133.5 Bcfe of production (up 3%), with average price of $2.10 per Mcfe versus $1.97 in 1998.
Proved reserves increased 11% to 1,206 Bcfe; reserve replacement was 186% at $0.65 per Mcfe, and 80% of reserve PV was proved developed.
Operating margin of $0.84 per Mcfe on $1.26 per Mcfe unit costs, which management says remains among the lowest of U.S. independent producers.
Stockholders' deficit of $217.5 million and long-term debt of $964.1 million; failed debt incurrence test blocks unsecured debt and preferred dividend payments.
Preferred dividends of $19.3 million in arrears; the May 2000 payment is not expected, and holders gain two board seats after six missed quarters.
2000 capital budget of $170–190 million (about $130–140 million for drilling), with production guided to roughly 140 Bcfe led by the Mid-Continent (about 79 Bcfe).

03—Questions

Frequently Asked Questions

Is Chesapeake financially stable enough to keep investing and paying its obligations?
The company is in a fragile but improving position. It had $38.7 million of cash, $964 million of long-term debt, and a stockholders' deficit, and its senior note ratings were B and B3. Its 2000 drilling budget is designed to match operating cash flow, which was $145 million in 1999. However, the debt covenant restrictions and suspended preferred dividends limit its financing flexibility, and its $50 million revolver matures in January 2001.
Why did earnings swing so sharply between 1998 and 1999?
The 1998 results included an $826 million full-cost writedown and a $55 million impairment of other assets, which produced a $933.9 million net loss. In 1999 there were no impairments, DD&A fell to $0.71 per Mcfe from $1.13, and G&A was cut to $13.5 million from $19.9 million. Earnings are therefore sensitive to commodity prices, since a future price drop below year-end levels could trigger new writedowns.
What risks should investors weigh from the reserve base?
About 28% of proved reserves by volume (20% by value) were undeveloped, and these are inherently less certain and require about $212.5 million of future development capital. Reserve estimates are based on year-end prices of $24.72 per barrel and $2.25 per Mcf, so lower prices would reduce reported reserves and standardized measure. Chesapeake also must keep replacing reserves to sustain production, and it has a 2000 production outlook of roughly 140 Bcfe.
What is the status of the preferred stock and dividend policy?
The 7% cumulative convertible preferred stock had a liquidation value of about $198.7 million after the early-2000 exchanges. Dividends are restricted until the company meets the debt incurrence test, and the company does not expect to pay the May 1, 2000 dividend. Common dividends were cancelled in September 1998 and are not expected to resume soon. Preferred holders would elect two new directors if six quarterly dividends go unpaid.
Are there material legal exposures?
The company won dismissal of the UPRC patent suit (under appeal) and the 1997 securities class action. Its main exposure is the West Panhandle Field lease-cancellation litigation, where judgments have been entered against its subsidiary CP, including about $1.3 million of actual damages and $1.2 million of exemplary damages in one set of cases, with appeals pending. The Bayard securities suit is still pending with no estimate of loss. Accrued liabilities are believed sufficient for the current cases.

04—Continue

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