10-Q 1 l95354ae10vq.txt NORTH COAST ENERGY, INC. 10-Q FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to __________________ COMMISSION FILE NUMBER 0-18691 NORTH COAST ENERGY, INC. (Exact name of Registrant as specified in its charter) DELAWARE 34-1594000 (State of incorporation) (I.R.S. Employer Identification No.) 1993 CASE PARKWAY TWINSBURG, OHIO 44087-2343 (Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (330) 425-2330 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X . No . ------ ------ APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date. Class Outstanding at June 30, 2002 -------------------------------- ---------------------------------- Common Stock, $.01 par value 15,208,516 NORTH COAST ENERGY, INC. AND SUBSIDIARIES Page No. ------- PART I - FINANCIAL INFORMATION Consolidated Balance Sheets - 3 June 30, 2002 (Unaudited) and December 31, 2001 Unaudited Consolidated Statements of Income - 5 For the Three and Six Months Ended June 30, 2002 and 2001 Unaudited Consolidated Statements of Cash Flows - 6 For the Six Months Ended June 30, 2002 and 2001 Unaudited Notes to Consolidated Financial Statements 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Quantitative and Qualitative Disclosures About Market Risk 20 PART II - OTHER INFORMATION 21 2 NORTH COAST ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS June 30, 2002 and December 31, 2001

The accompanying notes are an integral part of these consolidated financial statements. 3 NORTH COAST ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS June 30, 2002 and December 31, 2001

The accompanying notes are an integral part of these consolidated financial statements. 4 NORTH COAST ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME For the Three and Six Months Ended June 30, 2002 and 2001 (Unaudited)

The accompanying notes are an integral part of these consolidated financial statements. 5 NORTH COAST ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Six Months Ended June 30, 2002 and 2001 (Unaudited)

The accompanying notes are an integral part of these consolidated financial statements. 6 NORTH COAST ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1. Summary of Accounting Policies A. General The accompanying unaudited consolidated financial statements included herein, have been prepared by North Coast Energy, Inc. in accordance with accounting principles generally accepted in the United States of America for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included. These financial statements should be read in conjunction with the financial statements and notes thereto which are in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001. The balance sheet at December 31, 2001 presented in this report, has been derived from the audited financial statements at that date but does not include all of the information and footnotes included in the Company's annual report on Form 10-K for the year ended December 31, 2001. The results of the operations for the interim periods may not necessarily be indicative of the results to be expected for the full year. In addition, the preparation of these financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities at the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. B. Per Share Amounts The average number of shares used in computing basic and diluted net income per share was 15,208,516 and 15,242,401 and 15,208,031 and 15,249,444 for the three months ended June 30, 2002 and 2001, respectively and 15,208,340 and 15,241,991 and 15,207,493 and 15,248,432 for the six months ended June 30, 2002 and 2001, respectively. C. Reclassifications Certain reclassifications were made to prior period financial statement presentations to conform with current period presentations. Note 2. Preferred Dividends The Company paid a dividend of $58,167 and $116,432 on the Cumulative Convertible Series B Preferred Stock during the six months ended June 30, 2002 and 2001, respectively. All dividends in arrears attributable to Series B Preferred were paid in December 2001. All Series B Preferred Shares were redeemed on March 31, 2002. 7 NORTH COAST ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 3. Related Party Transactions Prior to January 2002, a large portion of the Company's revenues, other than oil and gas production revenue, was generated from, or was a result of, the organization and management of oil and gas partnerships sponsored by the Company. The Company has since ceased to offer oil and gas partnership investments. The Company believes that the terms of any remaining related party transactions are consistent with terms that could have been obtained from unaffiliated third parties. Accounts receivable from affiliates amounted to $699,020 and $985,559 at June 30, 2002 and December 31, 2001, respectively, consist primarily of receivables paid on behalf of the partnerships that are managed by the Company and for administrative fees charged to the partnerships. During the six months ended June 30, 2002 and 2001, the Company acquired limited partnership interests in oil and gas partnerships that it had sponsored at a cost of approximately $290,000 and $676,000 respectively. Note 4. Financial Instruments Derivative Financial Instruments: The Company uses derivatives solely for hedging purposes. The following is a summary of the Company's risk management strategies and the effect of these strategies on the Company's consolidated financial statements. Cash Flow Hedging Strategy: The Company is exposed to commodity price risks related to natural gas and oil. The Company's financial results can be significantly impacted by changes in commodity prices. "Costless collars" consist of a sold call option and a purchased put option such that the combined revenue and cost of these individual transactions is equal to or near zero. During 2001 and 2002, the Company entered into the following costless collar arrangements:

Gains or losses on the hedge relative to the market are recognized monthly as additions to or subtractions from oil and gas sales. To lessen its exposure to commodity price risk, NCE expects to continue to sell natural gas under fixed 8 NORTH COAST ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 4. Financial Instruments (Cont'd) price contracts, on the spot market and to use financial hedging instruments to realize a fixed price on a portion of its production. The following table reflects the natural gas volumes and the weighted average prices under financial hedges and fixed price contracts at June 30, 2002:

Interest Rate Swap: During 2001 and the first six months of 2002, the Company entered into interest rate swap agreements that effectively convert a portion of its variable-rate-long-term-debt to fixed rate debt for periods of up to two years, thus reducing the impact of interest rate changes on future income. At June 30, 2002, the following contracts were outstanding:

9 NORTH COAST ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 4. Financial Instruments (Cont'd) On April 1, 2001, the Company adopted Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging Activities" (as amended). SFAS 133 establishes accounting and reporting standards for hedging activities and derivative instruments, including certain derivative instruments embedded in other contracts. The Company qualifies for special hedge accounting treatment under SFAS 133, whereby the fair value of the hedge is recorded in the balance sheet as either an asset or liability and changes in fair value are recognized in other comprehensive income until settled, when the resulting gains and losses are recorded in earnings. Any hedge ineffectiveness is charged to earnings. The Company believes that any ineffectiveness of its hedges is immaterial. The effect on earnings and other comprehensive income as a result of SFAS 133 will vary from period to period and will be dependent upon prevailing oil and gas prices and interest rates, the volatility of forward prices for such commodities, the amount the Company hedges and the time periods covered by such hedges. The following tables summarize other comprehensive income of the Company for the three and six months ended June 30, 2002 and 2001.

10 NORTH COAST ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 5. Accounting Standards Effective January 1, 2002, the Company adopted the following standards: In June 2001, the Financial Accounting Standards Board ("FASB") issued Statements of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations." SFAS No. 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interest method and further clarifies the criteria to recognize intangible assets separately from goodwill. In June 2001, FASB issued SFAS No.142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to periodic impairment tests. Other intangible assets will continue to be amortized over their useful lives. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. In August 2001, FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-lived Assets," which is effective the first quarter of fiscal year 2002. SFAS No. 144 modifies and expands the financial accounting and reporting for the impairment or disposal of long-lived assets other than goodwill. The adoption of the standards had no impact on the Company's financial position or results of operations. 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL North Coast Energy, Inc., a Delaware corporation ("NCE" or the "Company"), is an affiliate of nv NUON ("NUON"), a limited liability company organized under the laws of the Netherlands. NCE and its subsidiaries are engaged in the acquisition and enhancement of developed producing natural gas and oil properties and the exploration, development and production of undeveloped natural gas and oil properties. NCE derives its revenues from its own oil and gas production and turnkey drilling, well operations, gas gathering and gas marketing services it provides for third parties. The following tables review the results of operations of the Company for the three and six months ended June 30, 2002 and 2001.

12 All items in the following table are calculated as a percentage of total revenues.

The following discussion and analysis reviews the results of operations and the financial condition for the Company for three and six months ended June 30, 2002 and 2001. The review should be read in conjunction with the financial information presented elsewhere herein. 13 COMPARISON OF THREE MONTHS ENDED JUNE 30, 2002 TO JUNE 30, 2001 REVENUES Oil and gas revenues increased $1,049,726 (14%) to $8,663,655 for the three months ended June 30, 2002, from $7,613,929 for the three months ended June 30, 2001. The increase in oil and gas revenues reflects higher volumes of gas production partially offset by lower prices received for natural gas and oil. The Company's production volumes for the three months ended June 30, 2002 were 2,412,522 MCFE (MCF equivalents) of natural gas compared to 2,108,150 MCFE for the three months ended June 30, 2001. The Company recognizes a portion of the wellhead price it receives as gas gathering and other revenues to offset a portion of its costs related to its gathering systems and compression facilities. Excluding the portion attributable to gas gathering and compression revenues, the Company received an average price of $3.59 and $3.61 per MCFE for oil and natural gas sold for the three months ended June 30, 2002 and 2001, respectively. Drilling revenues decreased $1,175,720 (100%) to $0 for the three months ended June 30, 2002, compared to $1,175,720 for the three months ended June 30, 2001. There were no wells drilled for third parties in the June 30, 2002 quarter compared to seven wells in 2001. This decrease results from the Company's exodus from the drilling program business and its shift to its core business of exploration and production. Well operating, gathering and other revenue decreased $710,377 (29%) to $1,713,078 for the three months ended June 30, 2002, compared to $2,423,455 for the three months ended June 30, 2001. This decrease results from lower natural gas gathering revenue (due to lower prices), and lower gas marketing revenues due to a significant reduction in gas purchased and sold to third parties because of reduced demand in 2002. EXPENSES Oil and gas production expenses decreased $171,167 (8%) to $2,025,199 for the three months ended June 30, 2002, from $2,196,366,for the three months ended June 30, 2001, reflecting ongoing efficiencies in field operations and lower production taxes resulting from lower prices. Drilling costs decreased $1,185,830 (100%) to $0 for the three months ended June 30, 2002, compared to $1,185,830 at June 30, 2001 due to no wells being drilled for drilling programs in the second quarter ending June 30, 2002. Well operating, gathering, and other decreased $251,777 (16%) for the three months ended June 30, 2002 to $1,306,518 from $1,558,295 at June 30, 2001 primarily as a result of decreased costs and amounts of gas purchased and sold to third parties. General and administrative expenses increased $97,491 (10%) to $1,064,343 for the three months ended June 30, 2002, from $966,852 for the three months ended June 30, 2001 primarily due to compensation and benefit related expenses. The increase in depreciation, depletion and amortization (DD&A) of $186,840 (10%) to $2,099,758 for the three months ended June 30, 2002, from $1,912,918 for the three months ended June 30, 2001, is the result of increased production volumes in the 14 quarter ending June 30, 2002. DD&A per unit of production decreased 4% to $0.87 per Mcfe in the quarter ending June 30, 2002. For the three months ended June 30, 2002, net interest expense decreased $438,568 to $708,621 compared to $1,147,189 for the three months ended June 30, 2001. The decrease reflects lower interest rates on the Company's long-term debt partially offset by lower interest income resulting from lower rates earned on amounts invested in 2002 compared to 2001. Net income for the three months ended June 30, 2002 increased $576,640 (38%) to $2,109,294 from $1,532,654 for the three months ended June 30, 2001 due primarily to increased production volumes coupled with decreases in other areas of expense. The Company's net income attributable to common stock was $2,109,294 ($0.14/share) for the three months ended June 30, 2002, compared to $1,474,438 ($0.10/share) for the three months ended June 30, 2001. 15 COMPARISON OF SIX MONTHS ENDED JUNE 30, 2002 TO JUNE 30, 2001 REVENUES Oil and gas revenues increased $1,369,891 (9%) to $17,051,770 for the six months ended June 30, 2002, from $15,681,879 for the six months ended June 30, 2001. The increase in oil and gas revenues reflects higher volumes of gas and oil production partially offset by lower prices received for natural gas and oil. The Company's production volumes for the six months ended June 30, 2002 were 4,808,136 MCFE (MCF equivalents) of natural gas compared to 4,198,473 MCFE for the six months ended June 30, 2001. The Company recognizes a portion of the wellhead price it receives as gas gathering and other revenues to offset a portion of its costs related to its gathering systems and compression facilities. Excluding the portion attributable to gas gathering and compression revenues, the Company received an average price of $3.55 and $3.74 per MCFE for oil and natural gas sold for the six months ended June 30, 2002 and 2001, respectively. Drilling revenues decreased $4,132,169 (66%) to $2,082,351 for the six months ended June 30, 2002, compared to $6,214,520 for the six months ended June 30, 2001. This decrease results from significantly less money raised in the private drilling programs, reflecting the Company's exodus from the fund raising business to focus on its core business of exploration and production. Well operating, gathering and other revenue decreased $2,977,178 (47%) to $3,391,358 for the six months ended June 30, 2002, compared to $6,368,536 for the six months ended June 30, 2001. This decrease results from lower natural gas gathering revenue (due to lower prices), and lower gas marketing revenues due to a significant reduction in gas purchased and sold to third parties because of reduced demand in 2002. EXPENSES Oil and gas production expenses decreased $961,635 (20%) to $3,943,679 for the six months ended June 30, 2002, from $4,905,314 for the six months ended June 30, 2001, reflecting ongoing efficiencies in field operations and lower production taxes resulting from lower average gas prices. Drilling costs decreased $2,877,430 (62%) to $1,752,456 for the six months ended June 30, 2002, compared to $4,629,886 at June 30, 2001, reflecting the lower costs and a significantly reduced number of wells drilled and completed for drilling programs. Well operating, gathering, and other decreased $1,137,468 (33%) for the six months ended June 30, 2002 to $2,334,743 from $3,472,211 at June 30, 2001 primarily as a result of decreased costs and amounts of gas purchased and sold to third parties. General and administrative expenses decreased $137,186 (6%) to $1,974,076 for the six months ended June 30, 2002, from $2,111,262 for the six months ended June 30, 2001. The decrease in G&A expense primarily reflects the elimination of costs 16 incurred in the quarter ended March 31, 2001, associated with the business process reengineering activities with business consultants and the implementation of a new computer system. The increase in depreciation, depletion and amortization (DD&A) of $879,688 (26%) to $4,205,734 for the six months ended June 30, 2002, from $3,326,046 for the six months ended June 30, 2001, is the result of higher volumes of oil and gas produced during the six months ended June 30, 2002. DD&A per unit of production increased 11% to $0.88 per Mcfe for the six months ended June 30, 2002. For the six months ended June 30, 2002, net interest expense decreased $979,000 to $1,414,298 compared to $2,393,298 for the six months ended June 30, 2001. The decrease reflects lower interest rates on the Company's long-term debt partially offset by lower interest income resulting from lower rates earned on amounts invested in 2002 compared to 2001. Net income for the six months ended June 30, 2002 decreased $394,634 (8%) to $4,569,284 from $4,963,918 for the six months ended June 30, 2001 primarily reflecting lower prices received as well as decreases in other areas of income attributable to the Company's drilling and operating activities. The Company's net income attributable to common stock was $4,511,117 ($0.30/share) for the six months ended June 30, 2002, compared to $4,847,486 ($0.32/share) for the six months ended June 30, 2001. INFLATION AND CHANGES IN PRICES Inflation affects the Company's operating expenses as well as interest rates, both of which may have an effect on the Company's profitability. Oil and gas prices have not followed inflation and have fluctuated during recent years as a result of other forces such as OPEC, economic factors, demand for and supply of natural gas in the United States and within the Company's regional area of operation. Oil prices have increased as a result of continued production quotas by members of OPEC, and the available supply of crude oil to world markets. Natural gas prices have decreased during the six months ended June 30, 2002, compared to the natural gas prices for the six months ended June 30, 2001. These decreases in price are attributed to higher storage supplies entering the winter of 2001/2002, lower natural gas demand for industrial use and warm weather curtailing demand for heating fuel in the United States in the June 2002 period. As a result of these market forces, the Company received an average price of $19.81 per barrel of oil for the six months ended June 30, 2002 compared to $24.17 for the six months ended June 30, 2001. The Company received an average price after recognition of a portion of the wellhead price in gas gathering and other revenues of $3.56 per MCF for its natural gas for the six months ended June 30, 2002, compared to $3.72 for the six months ended June 30, 2001. The Company cannot predict the future direction of oil and gas markets and prices, as the forces noted above as well as other variables are subject to change. LIQUIDITY AND CAPITAL RESOURCES The Company's working capital was $10,700,166 at June 30, 2002, compared to $16,443,735 at December 31, 2001. The decrease of $5,743,569 in working capital at June 30, 2002 is due mainly to the use of cash in the Company's drilling program, the acquisition of certain oil and gas properties and the redemption of the Company's Series B Preferred Shares. 17 The following table summarizes the Company's financial position at June 30, 2002 and December 31, 2001 (amounts in thousands):

The oil and gas exploration and development activities of NCE historically have been financed through the drilling programs, internally generated funds, and from bank and equity financing. The following table summarizes the Company's Statements of Cash Flows for the six months ended June 30, 2002 and 2001 (amounts in thousands):

As the above table indicates, the Company's cash provided by operating activities was $6,583,953 and $10,422,524 for the six months ended June 30, 2002, and 2001, respectively. This decrease reflects a slightly lower level of earnings combined with an increase in depreciation, depletion and amortization expense, reduced activities associated with its drilling programs and changes in accrued expenses. Net income decreased by $394,634, depreciation, depletion, and amortization increased by $879,688, and reduced activities associated with its drilling programs decreased approximately $2,400,000. Net cash used for investing activities was $13,350,179 for the six months ended June 30, 2002, compared to $7,341,105 for the six months ended June 30, 2001 reflecting the Company's increased drilling for its own account and the acquisition of producing oil and gas properties. 18 Net cash used in financing activities was $2,384,806 for the six months ended June 30, 2002, and $3,479,253 for the six months ended June 30, 2001. The amount used in 2002 was primarily for the redemption of the Company's Series B Preferred Shares while the amount used in 2001 was primarily used for repayment of long-term debt. At June 30, 2002, the company has $8,000,000 available on its revolving line of credit and cash balances totaling $12,884,892. The Company believes that its cash, cash flow from operations and available borrowing capacity are adequate to fund its planned capital expenditures and operations. FORWARD LOOKING INFORMATION The forward looking statements regarding future operations and financial performance contained in this report involve risks and uncertainties that include, but are not limited to the supply of and market demand for natural gas and oil, levels of natural gas and oil production and cost of operations, results of the Company's drilling, availability of capital to the Company, uncertainties associated with reserve estimates, environmental risks and other factors included in the Company's filings with the SEC. Actual results may differ materially from forward-looking information included in this report. 19 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to commodity price interest rate and credit risks. The Company's primary interest rate risk exposure results from floating rate debt including debt under the Company's revolving Credit Facility and the Subordinated Promissory Note between the Company and NUON. The Company is exposed to commodity price risks related to natural gas and oil. The Company has entered into contracts to reduce its exposure to these risks, as discussed in the Company's financial statements filed herein. In addition, quantitative and qualitative disclosures about market risk were included in the Company's form 10-K (Item 7A) and the financial statements included therein for the fiscal year ended December 31, 2001. 20 NORTH COAST ENERGY, INC. AND SUBSIDIARIES PART II OTHER INFORMATION Item 1. Legal Proceedings Not applicable Item 2. Changes in Securities Not applicable Item 3. Defaults Upon Senior Securities Not applicable Item 4. Submission of Matters to a Vote of Security Holders Not applicable Item 5. Other Information Not applicable Item 6. Exhibits and Reports on Form 8-K a.) Exhibits None b) Reports on Form 8-K: No reports on Form 8-K have been filed during the quarter for which this report was filed. 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NORTH COAST ENERGY, INC. August 1, 2002 /s/ Omer Yonel --------------------------------------- Omer Yonel President, Chief Executive Officer and Director NORTH COAST ENERGY, INC. August 1, 2002 /s/ Dale E. Stitt --------------------------------------- Dale E. Stitt Chief Financial Officer and Principal Accounting Officer 22

NORTH COAST ENERGY INC / DE/ 10-Q