================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------ FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2003 ------------ Commission file number: 001-31539 ST. MARY LAND & EXPLORATION COMPANY (Exact name of registrant as specified in its charter) Delaware 41-0518430 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 1776 Lincoln Street, Suite 700, Denver, Colorado 80203 (Address of principal executive offices) (Zip Code) (303) 861-8140 (Registrant's telephone number, including area code) 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 [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ |X| ] No [ ] Indicate the number of shares outstanding of each of the registrant's classes of common stock as of the latest practicable date. As of August 8, 2003, the registrant had 31,525,297 shares of common stock, $.01 par value, outstanding. ================================================================================ST. MARY LAND & EXPLORATION COMPANY --------------------------------------- INDEX ----- Part I. FINANCIAL INFORMATION PAGE ---- Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets - June 30, 2003 and December 31, 2002 ........................................3 Consolidated Statements of Operations - Three and Six Months Ended June 30, 2003 and 2002 ...................................4 Consolidated Statements of Cash Flows - Six Months Ended June 30, 2003 and 2002 ...................................5 Consolidated Statements of Stockholders' Equity and Comprehensive Income - June 30, 2003 and December 31, 2002 ...............................7 Notes to Consolidated Financial Statements - June 30, 2003 ...............................8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ...........................................15 Item 3. Quantitative and Qualitative Disclosures About Market Risk .......................................29 Item 4. Controls and Procedures .................................30 Part II. OTHER INFORMATION Item 1. Legal Proceedings .......................................30 Item 4. Submission of Matters to a Vote of Security Holders .....31 Item 6. Exhibits and Reports on Form 8-K ........................31 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ST. MARY LAND & EXPLORATION COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (In thousands, except share amounts) June 30, December 31, ------------ ------------ ASSETS 2003 2002 ------------ ------------ Current assets: Cash and cash equivalents $ 10,846 $ 11,154 Short term investments 2,281 1,933 Accounts receivable 57,952 35,399 Prepaid expenses and other 6,684 6,510 Accrued derivative asset 288 - Refundable income taxes - 1,031 Deferred income taxes 8,204 3,520 ------------ ------------ Total current assets 86,255 59,547 ------------ ------------ Property and equipment (successful efforts method), at cost: Proved oil and gas properties 806,587 683,752 Less accumulated depletion, depreciation and amortization (283,828) (263,436) Unproved oil and gas properties, net of impairment allowance of $9,838 in 2003 and $8,865 in 2002 65,350 47,984 Other property and equipment, net of accumulated depreciation of $4,026 in 2003 and $3,586 in 2002 4,263 3,639 ------------ ------------ Total property and equipment 592,372 471,939 ------------ ------------ ------------ ------------ Other noncurrent assets 6,577 5,653 ------------ ------------ ------------ ------------ Total Assets $ 685,204 $ 537,139 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 63,050 $ 48,790 Accrued hedge liability 21,239 8,707 ------------ ------------ Total current liabilities 84,289 57,497 ------------ ------------ Noncurrent liabilities: Long-term credit facility 44,000 14,000 Convertible notes 99,649 99,601 Deferred income taxes 71,538 60,156 Asset retirement obligation liability 24,603 - Other noncurrent liabilities 12,375 5,727 ------------ ------------ Total noncurrent liabilities 252,165 179,484 ------------ ------------ Commitments and contingencies ------------ ------------ Minority interest 562 645 ------------ ------------ Temporary equity (Note 8): Common stock subject to put and call options, $0.01 par value issued and outstanding - 3,380,818 shares in 2003 and -0- shares in 2002 71,594 - Note receivable from Flying J (71,594) - ------------ ------------ Total Temporary Equity - - ------------ ------------ Stockholders' equity: Common stock, $0.01 par value: authorized - 100,000,000 shares; issued - 29,147,179 shares in 2003 and 28,983,110 shares in 2002; outstanding, net of treasury shares - 28,144,479 shares in 2003 and 27,973,210 shares in 2002 291 290 Additional paid-in capital 143,662 140,688 Treasury stock - at cost: 1,002,700 shares in 2003 and 1,009,900 shares in 2002 (16,057) (16,210) Retained earnings 238,053 182,512 Accumulated other comprehensive income (loss) (17,761) (7,767) ------------ ------------ Total stockholders' equity 348,188 299,513 ------------ ------------ ------------ ------------ Total Liabilities, Temporary Equity and Stockholders' Equity $ 685,204 $ 537,139 ============ ============ The accompanying notes are an integral part of these consolidated financial statements. -3- ST. MARY LAND & EXPLORATION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (In thousands, except per share amounts) For the Three Months Ended For the Six Months Ended June 30, June 30, --------------------------- --------------------------- 2003 2002 2003 2002 ------------ ------------ ------------ ------------ Operating revenues: Oil and gas production $ 96,134 $ 46,197 $ 191,822 $ 87,290 Gain on sale of proved properties 86 449 122 413 Marketed gas system revenue 3,333 2,939 7,108 3,444 Other oil and gas revenue 595 397 2,040 747 Derivative gain - 2,327 33 1,975 Other revenues 3,638 46 3,783 907 ------------ ------------ ------------ ------------ Total operating revenues 103,786 52,355 204,908 94,776 ------------ ------------ ------------ ------------ Operating expenses: Oil and gas production 23,260 11,531 44,390 25,561 Depletion, depreciation and amortization 21,601 13,279 40,486 26,333 Exploration 6,635 4,297 10,785 11,213 Abandonment and impairment of unproved properties 784 622 1,703 1,319 General and administrative 6,018 3,015 12,164 6,156 Derivative loss 82 - - - Marketed gas system operating expense 3,098 2,662 6,457 3,086 Minority interest and other 299 243 495 620 ------------ ------------ ------------ ------------ Total operating expenses 61,777 35,649 116,480 74,288 ------------ ------------ ------------ ------------ Income from operations 42,009 16,706 88,428 20,488 Nonoperating income (expense): Interest income 344 170 574 280 Interest expense (2,367) (1,018) (4,583) (1,470) ------------ ------------ ------------ ------------ Income before income taxes and cumulative effect of change in accounting principle 39,986 15,858 84,419 19,298 Income tax expense 15,669 5,269 32,740 6,391 ------------ ------------ ------------ ------------ Income before cumulative effect of change in accounting principle 24,317 10,589 51,679 12,907 Cumulative effect of change in accounting principle, net - - 5,435 - ------------ ------------ ------------ ------------ Net income $ 24,317 $ 10,589 $ 57,114 $ 12,907 ============ ============ ============ ============ Basic earnings per common share: Income before cumulative effect of change in accounting principle $ 0.77 $ 0.38 $ 1.67 $ 0.46 Cumulative effect of change in accounting principle - - 0.18 - ------------ ------------ ------------ ------------ Basic net income per common share $ 0.77 $ 0.38 $ 1.85 $ 0.46 ============ ============ ============ ============ Diluted earnings per common share: Income before cumulative effect of change in accounting principle $ 0.71 $ 0.37 $ 1.52 $ 0.46 Cumulative effect of change in accounting principle - - 0.15 - ------------ ------------ ------------ ------------ Diluted net income per common share $ 0.71 $ 0.37 $ 1.67 $ 0.46 ============ ============ ============ ============ Basic weighted average common shares outstanding 31,482 27,825 30,921 27,805 ============ ============ ============ ============ Diluted weighted average common shares outstanding 35,798 28,428 35,222 28,347 ============ ============ ============ ============ Cash dividends declared per common share $ 0.05 $ 0.05 $ 0.05 $ 0.05 ============ ============ ============ ============ The accompanying notes are an integral part of these consolidated financial statements. -4- ST. MARY LAND & EXPLORATION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousands) For the Six Months Ended June 30, --------------------------- Reconciliation of net income to net cash provided 2003 2002 by operating activities: ------------ ------------ Net income $ 57,114 $ 12,907 Adjustments to reconcile net income to net cash provided by operating activities: Gain on sale of proved properties (122) (413) Depletion, depreciation and amortization 40,486 26,333 Exploratory dry hole expense 1,142 6,133 Abandonment and impairment of unproved properties 1,703 1,319 Unrealized derivative gain (33) (1,975) Deferred income taxes 10,886 4,989 Minority interest and other 879 (548) Cumulative effect of change in accounting principle, net of tax (5,435) - ------------ ------------ 106,620 48,745 Changes in current assets and liabilities: Accounts receivable (22,553) 12,490 Prepaid expenses and other (174) 8,436 Refundable income taxes 1,031 - Accounts payable and accrued expenses 5,840 6,399 ------------ ------------ Net cash provided by operating activities 90,764 76,070 ------------ ------------ Cash flows from investing activities: Proceeds from sale of oil and gas properties 2,635 122 Capital expenditures (45,600) (42,577) Acquisition of oil and gas properties, including $71,594 note receivable issued to Flying J (77,677) (13,643) Proceeds from distribution and sale of KMOC stock - 3,114 Deposits to short term investments available-for-sale (1,029) - Proceeds from short term investments available-for-sale 950 (9,370) Other 102 (2,122) ------------ ------------ Net cash used in investing activities (120,619) (64,476) ------------ ------------ Cash flows from financing activities: Proceeds from credit facility 108,811 16,000 Repayment of credit facility (79,820) (80,000) Proceeds (costs) from issuance of convertible notes (73) 96,754 Proceeds from sale of common stock 2,202 783 Dividends paid (1,573) (1,391) ------------ ------------ Net cash provided by financing activities 29,547 32,146 ------------ ------------ Net change in cash and cash equivalents (308) 43,740 Cash and cash equivalents at beginning of period 11,154 4,116 ------------ ------------ Cash and cash equivalents at end of period $ 10,846 $ 47,856 ============ ============ The accompanying notes are an integral part of these consolidated financial statements. -5- ST. MARY LAND & EXPLORATION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Continued) Supplemental schedule of additional cash flow information and noncash investing and financing activities: For the Six Months Ended June 30, --------------------------- 2003 2002 ------------ ------------ In thousands) Cash paid for interest, including amounts capitalized $ 4,851 $ 478 Cash paid (received) for income taxes 16,275 (8,699) In January 2003 the Company issued 7,200 shares of common stock from treasury to its non-employee directors and recorded compensation expense of $153,000. In January 2003 the Company issued 3,380,818 shares of restricted common stock valued at $71,594,000 to Flying J Oil & Gas Inc. and Big West Oil & Gas Inc. in exchange for oil and gas properties and related assets and liabilities. The acquisition was accounted for as a purchase. In June 2002 the Company issued 800 shares of common stock to a non-employee director and recorded compensation expense of $14,763. In April 2002 the Company accepted 9,472,562 shares of common stock in Constellation Copper Corporation ("Constellation", formerly known as Summo Minerals Corporation) in lieu of cash payment for the relief of a $1,400,000 loan and $15,311 in interest due to the Company. In January 2002 the Company issued 7,200 shares of common stock to its non-employee directors and recorded compensation expense of $129,683. The accompanying notes are an integral part of these consolidated financial statements. -6- ST. MARY LAND & EXPLORATION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (In thousands, except share amounts) Accumulated Common Stock Additional Treasury Stock Other Total ------------------ Paid-in Retained -------------------- Comprehensive Stockholders' Shares Amount Capital Earnings Shares Amount Income (Loss) Equity ---------- ------- ---------- ---------- ---------- --------- ------------- ------------- ---------- ------- ---------- ---------- ---------- --------- ------------- ------------- Balances, December 31, 2001 28,779,808 $ 288 $ 137,384 $ 157,739 (1,009,900) $(16,210) $ 6,916 $ 286,117 ---------- ------- ---------- ---------- ---------- --------- ------------- ------------- Comprehensive income: Net Income - - - 27,560 - - - 27,560 Unrealized net loss on marketable equity securities available for sale - - - - - - (725) (725) Change in derivative instrument fair value - - - - - - (14,644) (14,644) Reclass to earnings - - - - - - 1,447 1,447 Minimum pension liability adjustment - - - - - - (761) (761) ------------- ------------- Total comprehensive income 12,877 ------------- Cash dividends, $ 0.10 per share - - - (2,787) - - - (2,787) Issuance for Employee Stock Purchase Plan 18,217 - 344 - - - - 344 ESPP disqualified distribution - - 21 - - - - 21 Sale of common stock, including income tax benefit of stock option exercises 177,085 2 2,743 - - - - 2,745 Accelerated vesing of retiring director options - - 52 - - - - 52 Directors' stock compensation 8,000 - 144 - - - - 144 ---------- ------- ---------- ---------- ---------- --------- ------------- ------------- Balances, December 31, 2002 28,983,110 $ 290 $ 140,688 $ 182,512 (1,009,900) $(16,210) $ (7,767) $ 299,513 ---------- ------- ---------- ---------- ---------- --------- ------------- ------------- Comprehensive income: Net Income - - - 57,114 - - - 57,114 Unrealized net loss on marketable equity securities available for sale - - - - - - 303 303 Change in derivative instrument fair value - - - - - - (25,351) (25,351) Reclass to earnings - - - - - - 15,054 15,054 ------------- Total comprehensive income 47,120 ------------- Cash dividends, $ 0.05 per share - - - (1,573) - - - (1,573) Issuance for Employee Stock Purchase Plan 10,018 - 213 - - - - 213 Sale of common stock, including income tax benefit of stock option exercises 154,051 1 2,761 - - - - 2,762 Directors' stock compensation - - - - 7,200 153 - 153 ---------- ------- ---------- ---------- ---------- --------- ------------- ------------- Balances, June 30, 2003 29,147,179 $ 291 $ 143,662 $ 238,053 (1,002,700) $(16,057) $ (17,761) $ 348,188 ========== ======= ========== ========== ========== ========= ============= ============= The accompanying notes are an integral part of these consolidated financial statements. -7- ST. MARY LAND & EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) ------------------------------- June 30, 2003 Note 1 - Basis of Presentation The accompanying unaudited condensed consolidated financial statements of St. Mary Land & Exploration Company and Subsidiaries ("St. Mary" or the "Company") have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. They do not include all information and notes required by generally accepted accounting principles for complete financial statements. However, except as disclosed herein, there has been no material change in the information disclosed in the notes to consolidated financial statements included in St. Mary's Annual Report on Form 10-K for the year ended December 31, 2002. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the periods presented are not necessarily indicative of the results that may be expected for the full year. The accounting policies followed by the Company are set forth in Note 1 to the Company's consolidated financial statements in the Form 10-K for the year ended December 31, 2002. It is suggested that these unaudited condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes included in the Form 10-K. Note 2 - Earnings Per Share Basic net income per common share of stock is calculated by dividing net income by the weighted average of common shares outstanding during each period. During the first quarter of 2003, the Company issued 3,380,818 shares of common stock as part of an acquisition (see Note 8). These shares are considered outstanding for purposes of calculating basic and diluted net income per common share and are weighted accordingly in the calculation of common shares outstanding. Additionally, these shares are included in the temporary equity section of the accompanying consolidated balance sheets. Following is a reconciliation of total shares outstanding as of June 30, 2003. Common shares outstanding in Stockholders' equity 28,144,479 Common shares outstanding in Temporary equity 3,380,818 -------------- Total common shares outstanding 31,525,297 ============== Diluted net income per common share of stock is calculated by dividing adjusted net income by the weighted average of common shares outstanding and other dilutive securities. Adjusted net income is used for the if-converted method discussed below and is derived by subtracting interest expense paid on the Company's 5.75% Senior Convertible Notes due 2022 (the "Convertible Notes") from net income and then adjusting for nondiscretionary items including the related income tax effect. Potentially dilutive securities of the Company consist of in-the-money outstanding options to purchase the Company's common stock, shares into which the Convertible Notes that were issued in 2002 may be converted, and incremental shares that would be issued under the reverse-treasury method assumptions if the put option described in Note 8 is exercised. The treasury stock method is used to measure the dilutive impact of stock options. The following table details the weighted-average dilutive and anti-dilutive securities related to stock options for the periods presented. -8- Three Months Ended Six Months Ended June 30, June 30, --------------------------- --------------------------- 2003 2002 2003 2002 ------------ ------------ ------------ ------------ Dilutive 469,911 439,904 454,483 403,839 Anti-dilutive 615,190 628,416 614,181 684,016 Shares associated with the conversion feature of the Convertible Notes are accounted for using the if-converted method. Under the if-converted method, income used to calculate diluted earnings per share is adjusted for the interest charges and nondiscretionary adjustments based on income that would have changed had the Convertible Notes been converted at the beginning of the period. Potentially dilutive shares of 3,846,153 related to the Convertible Notes were included in the calculation of diluted net income per share for the three and six months ended June 30, 2003. The Convertible Notes were issued in March 2002. Shares related to the put option that was granted on January 29, 2003, are accounted for using the reverse-treasury method. There is no dilutive effect for the put option in the current quarter or year to date as the average market value of the Company's stock exceeded the strike price of the put option. Note 3 - Compensation Plans The Company accounts for stock-based compensation using the intrinsic value recognition and measurement principles prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") and related interpretations. No stock-based employee compensation expense is reflected in net income as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation (in thousands, except per share amounts). For the Three Months For the Six Months Ended June 30, Ended June 30, --------------------- --------------------- 2003 2002 2003 2002 ---------- ---------- ---------- ---------- Net income As reported $ 24,317 $ 10,589 $ 57,114 $ 12,907 Pro forma 22,046 8,844 54,543 10,723 Basic earnings per share As reported $ 0.77 $ 0.38 $ 1.85 $ 0.46 Pro forma 0.70 0.32 1.76 0.39 Diluted earnings per share As reported $ 0.71 $ 0.37 $ 1.67 $ 0.46 Pro forma 0.64 0.31 1.60 0.38 For purposes of pro forma disclosures, the estimated fair values of the options are amortized to expense over the options' vesting periods. The effects of applying SFAS No. 123 in the pro forma disclosure are not necessarily indicative of actual future amounts. Additional awards in future years are anticipated. The fair value of options is measured at the date of grant using the Black-Scholes option-pricing model. The fair values of options granted in 2003 and 2002 were estimated using the following weighted-average assumptions. -9- For the Three Months For the Six Months Ended June 30, Ended June 30, --------------------- --------------------- 2003 2002 2003 2002 ---------- ---------- ---------- ---------- Risk free interest rate 3.37% 4.29% 3.05% 4.33% Dividend yield 0.38% 0.42% 0.39% 0.44% Volatility factor of the expected market price of the Company's common stock 49.50% 45.35% 48.41% 46.73% Expected life of the options (in years) 7.7 6.8 6.3 6.4 Note 4 - Income Taxes Income tax expense for the three and six months ended June 30, 2003 and 2002 differ from the amounts that would be provided by applying the statutory U.S. Federal income tax rate to income before income taxes primarily due to the effect of state income taxes, percentage depletion, Internal Revenue Code Section 29 credits, valuation allowance adjustments against prior year credits, and changes in the composition of income tax rates. For the three and six months ended June 30, 2003, the Company's current portion of income tax expense was $10,536,000 and $21,854,000, respectively, compared to $197,000 and $1,402,000 for the same respective periods in 2002. Note 5 - Long-term Debt In January 2003 the Company entered into a new long-term revolving credit agreement with a group of banks that replaced the prior credit agreement dated June 30, 1998. The new credit agreement specifies a maximum loan amount of $300,000,000 and has a maturity date of January 27, 2006. Borrowings under the facility are secured by a pledge of collateral against certain oil and gas properties in favor of the lenders and by common stock of material subsidiaries of the Company. The borrowing base is currently $275,000,000 and is subject to periodic re-determination by the lenders based on the value of St. Mary's oil and gas properties and other assets, as determined by the bank syndicate. We have elected an aggregate commitment amount of $150,000,000 as of June 30, 2003. The Company must comply with certain financial and non-financial covenants. Interest and commitment fees are accrued based on the borrowing base utilization percentage table below. Eurodollar loans accrue interest at LIBOR plus the applicable margin from the utilization table, and Alternative Base Rate (ABR) loans accrue interest at Prime plus the applicable margin from the utilization table. Borrowing base utilization percentage <50% =>50%<75% =>75%<90% >90% --------------------------------------------------------------------------- Eurodollar Loans 1.25% 1.50% 1.75% 2.00% ABR Loans 0.00% 0.25% 0.50% 0.75% Commitment Fee Rate 0.30% 0.38% 0.38% 0.50% At June 30, 2003, the Company's borrowing base utilization percentage as defined under the credit agreement was 29%. The Company had $44,000,000 in Eurodollar loans and no ABR loans outstanding under its revolving credit agreement as of June 30, 2003. As of June 30, 2003, the Company also had $100,000,000 in outstanding borrowings under the Convertible Notes due 2022. The Convertible Notes carry a -10- contingent interest provision of 0.5% based on the note price in effect over a period of time. Accordingly, interest was accrued at a rate of 6.25% for the quarter and six-month periods ended June 30, 2003. The weighted average interest rates paid for the second quarter of 2003 and for the six months ended June 30, 2003 were 6.2% and 5.9%, respectively, including commitment fees paid on the unused portion of the credit facility borrowing base, amortization of deferred financing costs, and amortization of the contingent interest embedded derivative. Note 6 - Derivative Financial Instruments The Company realized a net loss of $15,069,000 from its derivative contracts for the six months ended June 30, 2003, and a net gain of $5,460,000 for the six months ended June 30, 2002. Comparative amounts for the three months ended June 30, 2003 and 2002 were a net loss of $4,522,000 and a net gain of $1,981,000, respectively. The Convertible Notes contain a provision for payment of contingent interest if certain conditions are met. Under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," this provision is considered an embedded equity-related derivative that is not clearly and closely related to the fair value of an equity interest and therefore must be separately treated as a derivative instrument. The value of the derivative at issuance of the Convertible Notes in March 2002 was $474,000. This amount was recorded as a decrease to the Convertible Notes payable in the consolidated balance sheets. Of this amount, $48,000 and $28,000 was amortized through interest expense for the six-month periods ended June 30, 2003 and 2002, respectively. Interest expense for each of the three-month periods ended June 30, 2003 and 2002 includes $24,000 of amortization. Derivative gain in the consolidated statements of operations for the six-month periods ended June 30, 2003 and 2002 includes net losses of $14,000 and $322,000, respectively, from mark-to-market adjustments for this derivative. Derivative loss for the three months ended June 30, 2003, contains $141,000 of net loss from mark-to-market adjustments and derivative gain for the three months ended June 30, 2002 contains $202,000 of net loss. The Company's previous fixed-rate to floating-rate interest rate swap on $50,000,000 of the Convertible Notes did not qualify for cash flow or fair value hedge accounting treatment under SFAS No. 133. This contract was entered into on March 25, 2002, and was closed out on December 3, 2002. Derivative gain in the consolidated statement of operations for the period ended June 30, 2002, includes $2,244,000 of net unrealized mark-to-market gain from the interest rate swap contract. The Company has in place derivative contracts for the sale of oil and natural gas. These contracts include traditional swap and collar arrangements. The Company attempts to qualify the majority of these instruments as cash flow hedges for accounting purposes. -11- The following table summarizes all derivative instrument activity (in thousands). For the Three Months Ended For the Six Months Ended June 30, June 30, -------------------------- -------------------------- 2003 2002 2003 2002 ------------ ------------ ------------ ------------ Gain (Loss) Gain (Loss) Derivative contract settlements included in oil and gas production revenues $(4,416) $ (322) $(15,054) $3,513 Ineffective portion of hedges qualifying for hedge accounting included in derivative loss 60 133 47 54 Non-qualified derivative contracts included in derivative gain (loss) (142) 2,194 (14) 1,921 Amortization of contingent interest derivative through interest expense (24) (24) (48) (28) ------------ ------------ ------------ ------------ Total $(4,522) $ 1,981 $(15,069) $5,460 ============ ============ ============ ============ On June 30, 2003, St. Mary's cash flow hedges resulted in a net pre-tax liability of $27,490,000. The Company will reclassify $27,380,000 of this amount to gains or losses included in oil and gas production operating revenues as the hedged production quantity is produced. The remaining amount relates to an undesignated collar that will be marked to market through the statement of operations until it expires on December 31, 2003. Based on current prices the net amount of existing unrealized after-tax loss as of June 30, 2003, to be reclassified from accumulated other comprehensive income to oil and gas production operating revenues in the next twelve months would be $16,587,000, net of deferred income taxes. The Company anticipates that all original forecasted transactions will occur by the end of the originally specified time periods. Note 7 - Asset Retirement Obligations Effective January 1, 2003, the Company adopted the provisions of SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 generally applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset. SFAS No. 143 requires the Company to recognize an estimated liability for costs associated with the abandonment of its oil and gas properties. As of January 1, 2003, the Company recognized the future cost to abandon oil and gas properties over the estimated economic life of the oil and gas properties in accordance with the provisions of SFAS No. 143. A liability for the fair value of an asset retirement obligation with a corresponding increase to the carrying value of the related long-lived asset is recorded at the time a well is completed or acquired. The Company depletes the amount added to proved oil & gas property costs and recognizes accretion expense in connection with the discounted liability over the remaining life of the respective oil and gas properties. Prior to the adoption of SFAS No. 143 the Company had recognized an abandonment liability for its offshore wells. These offshore liabilities were reversed upon adoption of SFAS No. 143, and the methodology described above was used to determine the liability associated with abandoning all wells, including those offshore. The estimated liability is based on historical experience in abandoning wells, estimated economic lives, external estimates as to the cost to abandon the wells in the future and federal and state regulatory requirements. The -12- liability is discounted using a credit-adjusted risk-free rate of approximately 7.25%. Revisions to the liability could occur due to changes in estimated abandonment costs or well economic lives, or if federal or state regulators enact new requirements regarding the abandonment of wells. Upon adoption of SFAS No. 143, the Company recorded a discounted liability of $21,403,000, reversed the existing offshore abandonment liability of $9,144,000, increased property and equipment by $12,827,000, decreased accumulated DD&A by $8,280,000 and recognized a one-time cumulative effect gain of $5,435,000 (net of deferred tax benefit of $3,414,000). The Company depletes the amount added to property costs and recognizes accretion expense in connection with the discounted liability over the remaining economic lives of the respective oil and gas properties. As of June 30, 2003, the Company's capitalized proved oil and gas properties included $42,991,000 of estimated salvage value, which is excluded from the Company's DD&A calculation. A reconciliation of the Company's liability for the three and six months ended June 30, 2003, is as follows (in thousands). Three Months Ended Six Months Ended June 30, 2003 June 30, 2003 ------------------ ------------------ Beginning Asset Retirement Obligation $ 23,734 $ - Liability from SFAS 143 adoption - 21,403 Liabilities incurred 956 2,892 Liabilities settled (530) (530) Accretion expense 443 838 ------------------ ------------------ Ending Asset Retirement Obligation $ 24,603 $ 24,603 ================== ================== The following tables illustrate the effect on the asset retirement obligation liability, net income and earnings per share if the Company had adopted the provisions of SFAS No. 143 on January 1, 2002. The pro forma amounts of the liability are measured using current information, assumptions and interest rates as of January 1, 2003 (in thousands, except per share amounts). January 1, 2002 December 31, 2002 -------------------- ------------------- Asset retirement obligation liability $20,358 $21,829 Three Months Ended Six Months Ended June 30, 2002 June 30, 2002 -------------------- ------------------- Net Income As reported $10,589 $12,907 Pro forma $10,359 $12,436 Basic EPS As reported $ 0.38 $ 0.46 Pro forma $ 0.37 $ 0.45 Diluted EPS As reported $ 0.37 $ 0.46 Pro forma $ 0.36 $ 0.45 -13- Note 8 - Flying J Acquisition On January 29, 2003, the Company acquired oil and gas properties from Flying J Oil & Gas Inc. and Big West Oil & Gas Inc. (collectively, "Flying J"). St. Mary issued 3,380,818 shares of its restricted common stock valued at $71,594,000 for proved reserves and unproved acreage, $445,000 of other assets, a $1,936,000 asset retirement liability, a $2,012,000 hedge liability, and $3,861,000 in cash received for net purchase price adjustments. In addition, St. Mary made a non-recourse loan to Flying J and Big West of $71,594,000 at LIBOR plus 2% for up to a 39-month period that is secured by a pledge of the shares of St. Mary common stock issued to Flying J. During the 39-month loan period Flying J and Big West can elect to put their shares of St. Mary stock to the Company for $71,594,000 plus accrued interest on the loan for the first thirty months, and St. Mary can elect to call the shares for an amount of $97,447,000, with the proceeds applied to the repayment of the loan and accrued interest. The acquisition was accounted for using the purchase method of accounting. Operating results from the acquired properties have been included in the statements of operations only from the date of closing. The common stock that was issued in this transaction has been recorded as temporary equity because the Company can be required to repurchase these shares. The shares of common stock are considered outstanding for basic and diluted earnings per share calculations. These shares could potentially become part of permanent stockholders' equity in the future. The loan arising from this transaction is considered a contra-temporary equity item on the consolidated balance sheets, as opposed to an asset, since the loan is secured by the common stock issued as part of this transaction. Since the loan is considered to be contra-equity and because there are uncertainties related to how the loan will be repaid, no interest revenue will be recorded in connection with the loan until the Company receives such interest. At June 30, 2003, the cumulative amount of interest receivable but not recorded as income was $1,029,000. Note 9 - Recently Issued Accounting Standards In May 2003 the Financial Accounting Standards Board ("FASB") issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and requires that such financial instruments be classified as a liability (or as an asset in certain circumstances). SFAS No. 150 is effective for all freestanding instruments entered into or modified after May 31, 2003. Otherwise, it became effective for the Company as of July 1, 2003. St. Mary currently has no financial instruments that fall within the scope of SFAS No. 150. As a result, the adoption of this Statement is not expected to have an impact on the Company's financial position or results of operations. In April 2003 the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This Statement amends and clarifies technical aspects of financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The FASB and representatives of the accounting staff of the Securities and Exchange Commission are currently engaged in discussions regarding the application of certain provisions of SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets," to companies in the extractive industries, including oil and gas companies. The FASB and the SEC staff are considering whether the provisions of SFAS No. 141 and SFAS No.142 require registrants to classify costs associated with mineral rights, including both proved and unproved lease acquisition costs, as intangible assets in the balance sheet, apart from other capitalized oil and gas property costs, and provide specific footnote disclosures. Historically, the Company has included oil and gas lease acquisition costs as a component of oil and gas properties. In -14- the event the FASB and SEC staff determine that costs associated with mineral rights are required to be classified as intangible assets, a substantial portion of the Company's oil and gas property acquisition costs would be separately classified on its balance sheets as intangible assets. However, the Company's results of operations would not be affected since such intangible assets would continue to be depleted and assessed for impairment in accordance with existing successful efforts accounting rules and impairment standards. Further, the Company does not believe the classification of oil and gas lease acquisition costs as intangible assets would have any impact on the Company's compliance with covenants under its debt agreements. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Cautionary Note About Forward - Looking Statements This Quarterly Report on Form 10-Q includes certain statements that may be deemed to be "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical facts, included in this Form 10-Q that address activities, events or developments that St. Mary management expects, believes or anticipates will or may occur in the future are forward-looking statements. The words "will," "believe," "anticipate," "intend," "estimate," "expect," "project," and similar expressions are intended to identify forward - looking statements, although not all forward - looking statements contain such identifying words. Examples of forward-looking statements may include discussion of such matters as: o the amount and nature of future capital, development and exploration expenditures, o the drilling of wells, o reserve estimates and the estimates of both future net revenues and the present value of future net revenues that are included in their calculation, o future oil and gas production estimates, o repayment of debt, o business strategies, o expansion and growth of operations, o recent legal developments, and o other similar matters. These statements are based on certain assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. Such statements are subject to a number of assumptions, risks and uncertainties, including such factors as the volatility and level of oil and natural gas prices, unexpected drilling conditions and results, production rates and reserve replacement, reserve estimates, drilling and operating service availability and risks, uncertainties in cash flow, the financial strength of hedge contract counterparties, the availability of attractive exploration, development and property acquisition opportunities, financing requirements, expected acquisition benefits, competition, litigation, environmental matters, the potential impact of government regulations, and other matters discussed under the "Risk Factors" section of our 2002 Annual Report on Form 10-K. Readers are cautioned that forward-looking statements are not guarantees of future performance and that actual results or developments may differ materially from those expressed or implied in the forward-looking statements. Although we may from time to time voluntarily update our prior forward - looking statements, we disclaim any commitment to do so except as required by securities laws. -15- Financial Results Three Months Ended Six Months Ended June 30, June 30, ---------------------- ---------------------- 2003 2002 2003 2002 ---------- ---------- ---------- ---------- (In thousands, except per share data) Oil and gas production revenues $ 96,134 $ 46,197 $191,822 $ 87,290 Net income $ 24,317 $ 10,589 $ 57,114 $ 12,907 Per share - basic $ 0.77 $ 0.38 $ 1.85 $ 0.46 Per share - diluted $ 0.71 $ 0.37 $ 1.67 $ 0.46 Net Income We generated net income of $24.3 million or $0.71 per diluted share for the second quarter of 2003 compared with net income of $10.6 million or $0.37 per diluted share for the same quarter of 2002. Comparing the six-months ended June 30, 2003 to June 30, 2002, net income and diluted earnings per share were $57.1 million and $1.67 per share versus $12.9 million and $0.46 per share, respectively. Included in net income for the six-months ended June 30, 2003, is $5.4 million, or $0.15 per diluted share, associated with the cumulative effect of a change in accounting principle required upon the adoption of Statement of Financial Accounting Standards No. 143 "Accounting for Asset Retirement Obligations." The increase in net income over the comparative periods is a result of increased oil and gas prices and higher production volumes associated with successful drilling results, the acquisition of the Burlington properties acquired in December 2002 and the Flying J properties acquired in January 2003. -16- Results of Operations The following table sets forth selected operating data for the periods indicated. Three Months Ended Six Months Ended June 30, June 30, --------------------------- --------------------------- 2003 2002 2003 2002 ------------ ------------ ------------ ------------ (In thousands, except volume and per volume data) Oil and gas production revenues: Gas production $ 65,650 $ 29,113 $ 131,581 $ 53,734 Oil production 30,484 17,084 60,241 33,556 ------------ ------------ ------------ ------------ Total $ 96,134 $ 46,197 $ 191,822 $ 87,290 ============ ============ ============ ============ Net production: Gas (MMcf) 13,614 9,618 25,318 19,173 Oil (MBbls) 1,164 673 2,205 1,378 MMCFE 20,595 13,655 38,546 27,440 Net daily production: Gas (MMcf) 149.6 105.7 139.9 105.9 Oil (MBbls) 12.8 7.4 12.2 7.6 MMCFE 226.3 150.1 213.0 151.6 Average realized sales price (1): Gas (per Mcf) $ 4.82 $ 3.03 $ 5.20 $ 2.80 Oil (per Bbl) $ 26.20 $ 25.39 $ 27.32 $ 24.35 Oil and gas production costs: Lease operating expense $ 15,149 $ 8,177 $ 29,020 $ 18,626 Transportation costs 1,941 761 3,331 1,577 Production taxes 6,170 2,593 12,039 5,358 ------------ ------------ ------------ ------------ Total $ 23,260 $ 11,531 $ 44,390 $ 25,561 ============ ============ ============ ============ Additional per MCFE data: Sales price $ 4.67 $ 3.38 $ 4.98 $ 3.18 Lease operating expense 0.74 0.60 0.75 0.68 Transportation costs 0.09 0.06 0.09 0.06 Production taxes 0.30 0.18 0.31 0.19 ------------ ------------ ------------ ------------ Operating margin $ 3.54 $ 2.54 $ 3.83 $ 2.25 ============ ============ ============ ============ Depletion, depreciation and amortization $ 1.05 $ 0.97 $ 1.05 $ 0.96 General and administrative $ 0.29 $ 0.22 $ 0.32 $ 0.22 ----------------------- (1)Includes the effects of St. Mary's hedging activities. -17- Three-Month Comparison Oil and Gas Production Revenues. Our quarterly oil and gas production revenues increased $49.9 million, or 108% to $96.1 million for the three months ended June 30, 2003. The following table presents components of the increase in total production revenues between 2003 and 2002. Production Price Price % Change $ Change % Change ------------------------------------------------- o Natural Gas 42% $1.80/Mcf 59% o Oil 73% $0.81/Bbl 3% Following is our product mix. Percentage of Revenue Percentage of Production --------------------- ------------------------ Three Months Ended June 30 2003 2002 2003 2002 ----------------------------------------------------------------------------- o Natural Gas 68% 63% 66% 70% o Oil 32% 37% 34% 30% Average net daily production was 226.3 MMCFE for 2003 compared with 150.1 MMCFE in 2002, an increase of 51%. Included in our 2003 production volumes are 10.5 MMcf per day and 4.8 MBbls per day from the Burlington and Flying J acquisitions. Wells completed in 2002 and 2003 and properties acquired in the last two quarters of 2002 and during 2003 have added revenue of $34.2 million and average net daily production of 79.9 MMCFE in 2003 over the comparable 2002 period. Projections of pricing for oil and natural gas for the remainder of the year lead us to believe that our average realized price for each product will be higher in 2003 than for comparable periods of 2002. However, since the end of June 2003, the forward prices have decreased relative to the prices in effect for most of the second quarter of 2003. The prices we receive reflect the impact of market forces, which are influenced by many factors including: political events, economic growth, supply, fuel demand, electricity demand, weather, Organization of Petroleum Exporting Countries policies and others. Information regarding the current effects of oil and gas hedging activity is included in the table below, which reflects increased hedging of oil production as a result of our Burlington and Flying J acquisitions. Three Months Ended June 30 2003 2002 -------------------------------------------------------------------------- o Percentage of oil production hedged 57% 39% o Oil volumes hedged (MBbls) 661 260 o Increase (decrease) in oil revenue ($1.3 million) $1.2 million o Average realized oil price per Bbl without hedging $27.30 $23.64 o Percentage of gas production hedged 39% 44% o Natural gas MMBtu hedged 5.9 million 4.6 million o Decrease in gas revenue ($2.9 million) ($1.5 million) o Average realized gas price per Mcf without hedging $5.03 $3.18 Marketed Gas Revenue and Gas System Operating Expense. As a result of our acquisition of gas gathering system lines in Coal County, Oklahoma, in February 2002 we began taking title to and marketing natural gas for third parties. For the three months ended June 30, 2003, we received $3.3 million from the sale of this natural gas compared to $2.9 million for the same period in 2002. Operating costs associated with these revenues totaled $3.1 million for the three months ended June 30, 2003 compared to $2.7 million for the same period in 2002. The higher natural gas prices in 2003 are the primary reason the revenues and costs -18- are higher in 2003. Due to fluctuations in natural gas prices, cost inflation and the variability of production from oil and gas wells, we may not always have a positive gross margin from gas marketing. Oil and Gas Production Expenses. Oil and gas production costs consist of lease operating expense, production taxes and transportation expenses. Total production costs increased $11.7 million or 102% to $23.3 million for the three months ended June 30, 2003, from $11.5 million in the same period of 2002. Our acquisition of properties from Burlington and Flying J added $6.5 million of production costs, and wells completed in later 2002 and in 2003 added $2.1 million of production costs in 2003 that were not reflected in 2002. Additionally, we experienced a general increase in production taxes on higher revenue from higher realized prices. Total oil and gas production costs per MCFE increased $0.29 to $1.13 for the second quarter of 2003 compared with $0.84 for the second quarter of 2002. This increase is comprised of the following: o A $0.12 increase in production taxes due to higher per MCFE prices. o A $0.03 increase in transportation costs. o A $0.07 increase in LOE that reflects our additions of higher cost oil production properties in the Williston Basin through our acquisitions from Burlington and Flying J. o A $0.07 increase in LOE due to a one-time Authorization for Expenditure adjustment to decrease workover expenses at the Judge Digby field that occurred in the second quarter of 2002. We continue to believe that our workover activity in the Williston Basin will increase over the remainder of the summer. Since production increases resulting from workover activity are not likely to appear in the period those costs are incurred, we believe that our LOE per MCFE will increase during the remainder of 2003. These increases could be offset in part by decreases in production taxes due to possible decreases in oil and gas prices. Depreciation, Depletion, Amortization and Impairment. Depreciation, depletion and amortization expense ("DD&A") increased $8.3 million or 63% to $21.6 million for the three months ended June 30, 2003, from $13.3 million in the same period of 2002. DD&A per MCFE increased by 8% to $1.05 for the second quarter of 2003 compared with $0.97 in 2002. The increase in expense is a result of both higher production volumes in 2003 and the higher per unit rate which reflects acquisitions and drilling results in 2002 and 2003. Exploration. Exploration expense increased $2.3 million or 54% to $6.6 million for the three months ended June 30, 2003, compared with $4.3 million in 2002. In 2003 we have had a lesser ownership interest in lower cost exploratory dry holes than in 2002, offsetting in part increased exploration overhead due to increases in our geologic and exploration staff as a result of the acreage we have acquired in the Williston, Green River and Powder River basins. Components of total exploration expense are as follows (in thousands). Three Months Ended June 30, --------------------------- 2003 2002 ------------ ------------ o Geological and geophysical expenses $ 2,301 $ 495 o Exploratory dry holes 681 1,955 o Overhead and other expenses 3,653 1,847 ------------ ------------ $ 6,635 $ 4,297 ============ ============ -19- General and Administrative. General and administrative expenses increased $3.0 million or 100% to $6.0 million for the three months ended June 30, 2003, compared with $3.0 million in 2002. The increase in cost on a per MCFE basis is primarily due to our compensation expense. Our employee count increased by 19% from June 30, 2002 to June 30, 2003. This change has resulted in a general increase in G&A of $1.4 million between the quarters ending on those dates. That increase plus a $3.8 million increase in compensation expense associated with our incentive compensation plans, a $245,000 increase in charitable contributions expense and a $117,000 increase in insurance and corporate governance costs were partially offset by a $2.7 million increase in COPAS overhead reimbursement from operations and G&A we allocated to exploration expense. COPAS overhead reimbursement from operations has increased as a result of an increase in the number of properties we operate in our Rockies region due to our Burlington and Flying J acquisitions. The increase in compensation expense associated with our incentive compensation plans reflects both the benefit we have received from the current price environment for past employee performance and the performance of our employees during the current year. As we continue our expected growth in size and number of personnel and if oil and gas prices perform as expected, we anticipate that G&A will continue to increase in total. However, we expect G&A to remain relatively flat on a per MCFE basis. Interest Expense. Interest expense increased by $1.3 million to $2.4 million for the quarter ended June 30, 2003 compared to $1.0 million for the quarter ended June 30, 2002. This difference reflects the benefit of an interest rate swap on our 5.75% convertible notes that reduced interest expense by $383,000 in 2002, the 0.5% contingent interest provision on our convertible notes which applied in 2003 but not in 2002 and increased borrowings under our credit facility. We anticipate that quarterly interest expense in 2003 will continue to be higher than in 2002 due to the termination in December 2002 of the interest rate swap. Income Taxes. Income tax expense totaled $15.7 million for the three months ended June 30, 2003, and $5.3 million in 2002, resulting in effective tax rates of 39.2% and 33.2%, respectively. The effective rate change from 2002 reflects an increase in our highest marginal federal tax rate, the expiration of the Section 29 tax credit, adjustments to valuation allowances to reflect the likelihood that prior Alternative Minimum Tax credits created by Section 29 credits will not be used, changes in the composition of the highest marginal state tax rates as a result of our recent acquisitions and the 2002 adjustment to valuation allowances against state income taxes from net operating loss carryovers. Six-Month Comparison Oil and Gas Production Revenues. We experienced an increase in oil and gas production revenues of $104.5 million, or 120% to $191.8 million for the six months ended June 30, 2003, compared with $87.3 million for the same period in 2002. The following table presents the components of increases or (decreases) between 2003 and 2002. Production Price Price % Change $ Change % Change ------------------------------------------------- o Natural Gas 32% $2.39/Mcf 85% o Oil 60% $2.97/Bbl 12% Following is our product mix. Percentage of Revenue Percentage of Production --------------------- ------------------------ Six Months Ended June 30 2003 2002 2003 2002 ----------------------------------------------------------------------------- o Natural Gas 69% 62% 66% 70% o Oil 31% 38% 34% 30% Average net daily production increased 40% to 213.0 MMCFE for the first six months of 2003 compared with 151.6 MMCFE in 2002. Included in our 2003 production volumes are 9.7 MMcf per day and 4.2 Mbbls per day from the -20- Burlington and Flying J acquisitions. Wells completed in 2002 and 2003 and properties acquired in the last two quarters of 2002 and during 2003 have added revenue of $70.5 million and average net daily production of 72.8 MMCFE in the first six months of 2003 over the comparable 2002 period. Information regarding the current effects of oil and gas hedging activity is included in the table below, which reflects increased hedging of oil production as a result of our Burlington and Flying J acquisitions. Six Months Ended June 30 2003 2002 -------------------------------------------------------------------------- o Percentage of oil production hedged 57% 39% o Oil volumes hedged (MBbls) 1,262 542 o Increase (decrease) in oil revenue ($5.2 million) $2.6 million o Average realized oil price per Bbl without hedging $29.69 $22.46 o Percentage of gas production hedged 35% 43% o Natural gas MMBtu hedged 9.7 million 9.0 million o Decrease in gas revenue ($9.8 million) $904,000 o Average realized gas price per Mcf without hedging $5.03 $3.18 Marketed Gas System Revenue and Gas System Operating Expense. For the six months ended June 30, 2003, we received $7.1 million from the sale of this natural gas compared to $3.4 million in the same period of 2002. Operating costs associated with these revenues totaled $6.5 million for the period ended June 30, 2003, compared to $3.1 million for the same period in 2002. Our gas marketing activities for third parties began in February 2002. The increase in 2003 as compared to 2002 is a result of a full six months of activity and relatively higher gas prices. Oil and Gas Production Expenses. Total production costs increased $18.8 million to $44.4 million for the six months ended June 30, 2003, from $25.6 million in 2002. Our acquisition of properties from Burlington and Flying J added $11.4 million of production costs, and wells completed in 2002 and 2003 added $3.6 million of production costs in 2003 that were not reflected in 2002. Additionally, we experienced a general increase in production taxes on higher revenue from higher realized prices. Total oil and gas production costs per MCFE increased $0.22 to $1.15 for the six months ended June 30, 2003 compared with $0.93 for 2002. This increase is comprised of the following: o A $0.12 increase in production taxes due to higher per MCFE prices. o A $0.03 increase in transportation costs. o A $0.07 increase in LOE that reflects our additions of higher cost oil properties in the Williston Basin through our acquisitions from Burlington and Flying J. Depreciation, Depletion, Amortization and Impairment. DD&A increased $14.2 million or 54% to $40.5 million for the six months ended June 30, 2003, from $26.3 million in 2002. DD&A per MCFE increased by 9% to $1.05 for the six months ended June 30, 2003 compared with $0.96 in 2002. The increase in expense is a result of both higher production volumes in 2003 and the higher per unit rate which reflects acquisitions and drilling results in 2002 and 2003. Exploration. Exploration expense decreased $428,000 or 4% to $10.8 million for the six months ended June 30, 2003, compared with $11.2 million in 2002. In 2003 we have had a lesser ownership interest in lower-cost exploratory dry holes than in 2002, offsetting in part increased exploration overhead due to increases in our geologic and exploration staff as a result of the acreage we have -21- acquired in the Williston, Green River and Powder River basins. Components of total exploration expense are as follows (in millions). Six Months Ended June 30, --------------------------- 2003 2002 ------------ ------------ o Geological and geophysical expenses $ 3.7 $ 1.3 o Exploratory dry holes 1.2 6.1 o Overhead and other expenses 5.9 3.8 ------------ ------------ $ 10.8 $ 11.2 ============ ============ General and Administrative. General and administrative expenses increased $6.0 million or 98% to $12.2 million for the six months ended June 30, 2003, compared with $6.2 million in 2002. The increase in cost on a per MCFE basis is primarily due to an increase in our compensation expense. The increase in our employee count has resulted in a general increase in G&A of $2.7 million between six-month periods ending on June 30, 2003 and June 30, 2002. That increase plus a $5.9 million increase in expense associated with our incentive compensation plans, a $664,000 increase in accrued charitable contributions expense and a $396,000 increase in insurance and corporate governance costs were partially offset by a $3.9 million increase in COPAS overhead reimbursement from operations and G&A we allocated to exploration expense. COPAS overhead reimbursement from operations has increased due to an increase in the number of properties we operate in our Rockies region as a result of our Burlington and Flying J acquisitions. The increase in expense associated with our incentive compensation plans reflects both the benefit we have received from the current price environment for past employee performance and the performance of our employees during the current year. Interest Expense. Interest expense increased by $3.1 million to $4.6 million for the six months ended June 30, 2003 compared to $1.5 million for the period ended June 30, 2002. The increase reflects a full six months of accrued interest in 2003 on our 5.75% convertible notes that were issued in March 2002, the benefit of an interest rate swap on those notes that reduced interest expense by $446,000 in 2002, the 0.5% contingent interest provision on the notes which applied in 2003 but not in 2002, and increased borrowings under our credit facility. We anticipate that interest expense in 2003 will be higher than the 2002 amount due to the termination of the interest rate swap in December 2002 and since we have increased borrowings under our credit facility in 2003. Income Taxes. Income tax expense totaled $32.7 million for the six months ended June 30, 2003, and $6.4 million in 2002, resulting in effective tax rates of 38.8% and 33.1%, respectively. The effective rate change from 2002 reflects an increase in our highest marginal federal tax rate, the expiration of the Section 29 tax credit, adjustments to valuation allowances to reflect the likelihood that prior Alternative Minimum Tax credits created by Section 29 credits will not be used, changes in the composition of the highest marginal state tax rates as a result of our recent acquisitions and the 2002 adjustment to valuation allowances against state income taxes from net operating loss carryovers. The current portion of the income tax expense in 2003 is $21.9 million compared to $1.5 million in 2002. These amounts are 66% and 23% of the total tax for the respective periods. The difference results from increased taxable income caused by significantly higher oil and gas prices and production, a reduction in the percentage of deductible intangible drilling costs relative to total income and interest income recognized for tax purposes from our Flying J transaction. Cumulative Effect of Change in Accounting Principle, net. On January 1, 2003, we adopted SFAS No. 143. The impact of adoption resulted in income to us of $8.8 million offset by the deferred income tax effect of $3.4 million. See -22- Note 7 of the Notes to Consolidated Financial Statements under Part I, Item 1 of this report. Liquidity and Capital Resources Our primary sources of liquidity are the cash provided by operating activities, debt financing, sales of non-strategic properties and access to the capital markets. All of these sources can be impacted by significant fluctuations in oil and gas prices and the availability of financing to oil and gas producers in the market. An unexpected decrease in oil and gas prices would reduce expected cash flow from operating activities, might reduce the borrowing base on our credit facility, could reduce the value of our non-strategic properties and historically has limited our industry's access to the capital markets. We use cash for the acquisition, exploration and development of oil and gas properties and for the payment of debt obligations, trade payables and stockholder dividends. Exploration and development programs are generally financed from internally generated cash flow, debt financing and cash and cash equivalents on hand. Cash uses for the acquisition of oil and gas properties and the payment of stockholder dividends are discretionary and can be reduced or eliminated in the event of an unexpected decrease in oil and gas prices. At any given point in time we may be obligated to pay for commitments to explore for or develop oil and gas properties or incur trade payables. However, future obligations can be reduced or eliminated when necessary. We are currently only required to make interest payments on our debt obligations, although we have voluntarily been reducing our outstanding borrowings under our revolving credit facility. As of the date of filing this report, the outstanding balance of the revolving credit facility was $24 million, representing a $20.0 million reduction from the $44.0 million outstanding balance at June 30, 2003. An unexpected increase in oil and gas prices would provide increased flexibility to modify our uses of cash flow. We continually review our capital expenditure budget to reflect changes in current and projected cash flow, drilling and acquisition opportunities, debt requirements and other factors. Cash Flow. Net cash provided by operating activities increased $14.7 million or 19% to $90.8 million for the six months ended June 30, 2003 compared with $76.1 million in 2002. Our $34.2 million increase in net income between the two periods combined with a $13.5 million increase in the effect of non-cash items were offset by a $43.0 million change in current assets and liabilities relating to increased accounts receivables offset by decreased prepaid expenses, and collections of refundable income taxes. We anticipate increased cash flow from operations in 2003 as a result of higher oil and gas prices in 2003 and increased production attributable to our property acquisitions and drilling activities in late 2002 and early 2003. Net cash used in investing activities increased $56.1 million or 87% to $120.6 million for the six months ended June 30, 2003, compared with net cash used of $64.5 million in 2002. This increase results from additional capital expenditures and acquisition costs. Total capital expenditures, including acquisitions of oil and gas properties, in the first six months of 2003 increased $67.1 million or 119% to $123.3 million compared with $56.2 million in the first six months of 2002. This increase reflects the utilization of $71.6 million in short term investments, cash equivalents and increased borrowings under our credit facility to provide a loan to Flying J as part of our acquisition of properties from Flying J in January 2003. This loan is secured by our common stock issued in the transaction. Net cash provided by financing activities decreased $2.6 million to $29.5 million for the six months ended June 30, 2003, compared with $32.1 million in 2002. This decrease reflects the 2002 issuance of our 5.75% convertible notes and the use of proceeds to pay down our credit facility, partially offset by additional borrowing on our credit facility to fund our 2003 acquisitions. -23- St. Mary had $10.8 million in cash and cash equivalents and had working capital of $2.0 million as of June 30, 2003, compared with $11.2 million in cash and cash equivalents and working capital of $2.1 million at December 31, 2002. Senior Convertible Notes. In March 2002 we issued in a private placement a total of $100.0 million of 5.75% senior convertible notes due 2022 with a 0.5 percent contingent interest provision. Interest payments are due on March 15 and September 15 of every year. We received net proceeds of $96.8 million after deducting the initial purchasers' discount and estimated offering expenses payable by us. The notes are general unsecured obligations and rank on a parity in right of payment with all our existing and future senior indebtedness and other general unsecured obligations, and are senior in right of payment with all our future subordinated indebtedness. The notes are convertible into our common stock at a conversion price of $26.00 per share, subject to adjustment. We can redeem the notes with cash in whole or in part at a repurchase price of 100% of the principal amount plus accrued and unpaid interest including contingent interest beginning on March 20, 2007. The note holders have the option of requiring us to repurchase the notes for cash at 100% of the principal amount plus accrued and unpaid interest including contingent interest upon (1) a change in control of St. Mary or (2) on March 20, 2007, March 15, 2012 and March 15, 2017. If the note holders request repurchase on March 20, 2007, we may pay the repurchase price with cash, shares of our common stock valued at a discount to the market price at the time of repurchase or any combination of cash and our discounted common stock. We are not restricted from paying dividends, incurring debt, or issuing or repurchasing our securities under the indenture for the notes. There are no financial covenants in the indenture. We used a portion of the net proceeds from the notes to repay our credit facility balance and used the remaining net proceeds to fund a portion of our 2002 capital expenditures. On March 25, 2002, we entered into a five-year fixed-rate to floating-rate interest rate swap on $50.0 million of the notes. The floating rate was determined as LIBOR plus 0.36%. We elected to terminate this swap on December 3, 2002, and received proceeds of $4.0 million. Credit Facility. On January 29, 2003, we entered into a new $300.0 million credit facility with Wachovia Bank as Administrative Agent and eight other participating banks. This new credit facility replaced our previous $200.0 million credit facility and has a maturity date of January 27, 2006. The calculated borrowing base is currently $275.0 million. We have elected a commitment amount of $150.0 million under this facility. We believe this commitment level is adequate for our current liquidity needs and results in lower commitment fees payable to the bank syndicate. We are required to comply with certain financial and non-financial covenants, and we are currently in compliance with all covenants under the credit facility. Interest and commitment fees are accrued based on the borrowing base utilization percentage table below. Eurodollar loans accrue interest at LIBOR plus the applicable margin from the utilization table, and Alternative Base Rate (ABR) loans accrue interest at Prime plus the applicable margin from the utilization table. Borrowing base utilization percentage <50% =>50%<75% =>75%<90% >90% --------------------------------------------------------------------------- Eurodollar Loans 1.250% 1.500% 1.750% 2.000% ABR Loans 0.000% 0.250% 0.500% 0.750% Commitment Fee Rate 0.300% 0.375% 0.375% 0.500% Our loan balance of $44.0 million is comprised of LIBOR based traunches at June 30, 2003. Our weighted average interest rates paid for the second quarter of 2003 and for the six months ended June 30, 2003 were 6.2% and 5.9%, respectively, including commitment fees paid on the unused portion of the credit facility borrowing base, amortization of deferred financing costs, and amortization of the contingent interest embedded derivative. -24- Schedule of Contractual Obligations. The following table summarizes our future estimated principal payments for the periods specified (in millions). Long-Term Operating Total Cash Contractual Obligations Debt Leases Obligation ---------------------------- ------------ ------------ ------------ Less than 1 year $ - $ 1.9 $ 1.9 1-3 years 44.0 2.9 46.9 4-5 years - 2.2 2.2 After 5 years 100.0 3.2 103.2 ------------ ------------ ------------ $ $ Total $ 144.0 $ 10.2 $ 154.2 ============ ============ ============ In the period from 1-3 years, we have one lease of office space for our regional offices that will expire. A third lease for office space will expire in year 4. Estimated costs to replace these leases are not included in the table above. For purposes of the table we assume that the holders of our 5.75% convertible notes will not exercise the conversion or redemption features until final maturity. Common Stock. In 1998 St. Mary's Board of Directors authorized a stock repurchase program whereby we may purchase from time-to-time, in open market transactions or negotiated sales, up to two million of our common shares. Through June 30, 2003, we have repurchased a cumulative total of 1,009,900 shares of St. Mary's common stock under the program. We anticipate that additional purchases of shares may occur as market conditions warrant. Any future purchases will be funded with internal cash flow and borrowings under our credit facility. On January 29, 2003, we issued a total of 3,380,818 restricted shares of our common stock valued at $71.6 million to Flying J Oil & Gas Inc. and Big West Oil & Gas Inc. (collectively Flying J) for the acquisition of oil and gas properties, and we made a non-recourse loan to Flying J in the amount of $71.6 million at LIBOR plus 2% for up to a 39-month period. The loan is secured by a pledge of the 3,380,818 shares and during the 39-month loan period Flying J can elect to sell these shares to St. Mary for $71.6 million plus accrued interest on the loan for up to the first 30 months, and we can elect to repurchase the shares for $97.4 million with the proceeds applied to repayment of the loan. The shares are subject to contractual restrictions on transfer for a period of two years. Flying J cannot increase their ownership percentage in St. Mary for a period of 30 months. For accounting purposes the stock and the loan are reflected in the temporary equity section of our consolidated balance sheets. Because the loan is reflected in temporary equity we will not record interest income from the loan until such time as Flying J and Big West make actual payment of the interest to us. At June 30, 2003, the cumulative amount of interest receivable but not recorded as income by us was $1.0 million. Capital and Exploration Expenditures Incurred. Expenditures for exploration and development of oil and gas properties and acquisitions are the primary use of our capital resources. The following table sets forth certain information regarding the costs incurred by us in our oil and gas activities during the periods indicated. These expenditures include the value of the stock issued in the Flying J transaction. -25- Six Months Ended June 30, -------------------------- 2003 2002 ------------ ------------ (In thousands) Development $ 42,164 $ 30,444 Exploration 19,176 9,034 Acquisitions: Proved 77,676 7,040 Unproved 4,096 8,597 ------------ ------------ Total $ 143,112 $ 55,115 ============ ============ We continuously evaluate opportunities in the marketplace for oil and gas properties and, accordingly, may be a buyer or a seller of properties at various times. We will continue to emphasize acquisitions in our core areas utilizing St. Mary's technical expertise, financial flexibility and structuring experience. In addition, we are also actively seeking larger acquisitions of assets or companies that would afford opportunities to expand our existing core areas, to acquire additional geoscientists or to gain a significant acreage and production foothold in a new basin. St. Mary's total costs incurred in the first six months of 2003 increased $88.0 million or 160% compared to the first six months of 2002. We spent $65.4 million in the first six months of 2003 for unproved property acquisitions and domestic exploration and development compared to $48.1 million for the comparable period in 2002. We continue to evaluate the results of our two coalbed methane pilot programs located in the Hanging Woman Basin. On April 30, 2003, the Bureau of Land Management issued its record of decision approving the two environmental impact statements that considered coalbed methane development in northeast Wyoming and southeast Montana, and the BLM is now issuing drilling permits on federal acreage in Wyoming. We hope the two environmental impact statements will also open the door for new coalbed methane development on federal acreage in this area of Montana. Immediately after the decision was issued several environmental groups filed multiple challenges. These challenges and a previously reported environmental public interest group lawsuit by the Northern Plains Resource Council, Inc. affect 89,700 gross acres related to this project. Capital Expenditure Budget. We anticipate spending approximately $233 million for capital and exploration expenditures in 2003 with $90 million allocated for acquisitions, which includes the $71.6 million acquisition of properties from Flying J in January 2003. Budgeted ongoing exploration and development expenditures in 2003 for each of our core areas is as follows (in millions). o Mid-Continent region $ 51 o Williston Basin 35 o ArkLaTex region 21 o Gulf Coast and Gulf of Mexico region 15 o Permian Basin 12 o Other 9 -------- Total $ 143 ======== -26- We believe the amount not funded from our internally generated cash flow in 2003 can be funded from our existing cash and our credit facility. The amount and allocation of future capital and exploration expenditures will depend upon a number of factors including the number and size of available acquisition opportunities and our ability to assimilate these acquisitions. Also, the impact of oil and gas prices on investment opportunities, the availability of capital and borrowing capability and the success of our development and exploratory activity could lead to funding requirements for further development. If additional development or attractive acquisition opportunities arise, we may consider other forms of financing, including the public offering or private placement of equity or debt securities. Derivatives. We seek to protect our rate of return on acquisitions of producing properties by hedging cash flow when the economic criteria from our evaluation and pricing model indicate it would be appropriate. Management's strategy is generally to hedge cash flows from acquisitions for up to 24 months in order to meet minimum rate-of-return criteria. Management reviews these hedging parameters on a quarterly basis. We may periodically hedge additional production when we view the price environment to be favorable for hedging. We generally limit our aggregate hedge position to no more than 50% of total production but will hedge larger percentages of total production in certain circumstances. We seek to minimize basis risk and index the majority of oil hedges to NYMEX prices and the majority of gas hedges to various regional index prices associated with pipelines in proximity to our areas of gas production. Our policy requires that we diversify our hedge positions with various counterparties and requires that such counterparties have clear indications of financial strength. Including hedges entered into since June 30, 2003 we have the following swaps and collars in place: Swaps ----- Average Quantity Average Fixed Product Volumes/month Type Contract Price Duration ----------------------------------------------------------------------------------------- Natural Gas 1,845,000 MMBtu $4.49 07/03 - 12/03 Natural Gas 869,000 MMBtu $4.08 01/04 - 12/04 Oil 202,000 Bbls $25.57 07/03 - 12/03 Oil 144,500 Bbls $23.71 01/04 - 12/04 Collars ------- Average Floor Ceiling Product Volumes/month Price Price Duration ----------------------------------------------------------------------------------------- Natural Gas 152,000 MMbtu $2.50 $5.96 07/03 - 12/03 Other Derivatives. Our 5.75% convertible notes contain a provision for payment of contingent interest if certain conditions are met. Under SFAS No. 133 this provision is considered an embedded equity-related derivative that is not clearly and closely related to the fair value of an equity interest and therefore must be separated and accounted for as a derivative instrument. The value of the derivative at issuance in March 2002 was $474,000. This amount was recorded as a decrease to the 5.75% convertible notes payable in the consolidated balance sheets. Of this amount, $47,000 has been amortized through interest expense in 2003. Derivative loss in the consolidated statements of operations includes $14,000 of net loss from mark-to-market adjustments for this derivative at June 30, 2003, compared to a net loss of $245,000 included in derivative loss at June 30, 2002. Critical Accounting Policies and Estimates We refer you to the corresponding section of our Annual Report on Form 10-K for the year ended December 31, 2002. -27- Accounting Matters New Accounting Standards In May 2003 the Financial Accounting Standards Board issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and requires that such financial instruments be classifies as a liability (or as an asset in certain circumstances). SFAS No. 150 is effective for all freestanding instruments entered into or modified after May 31, 2003. Otherwise, it became effective for us as of July 1, 2003. We currently have no financial instruments that fall within the scope of SFAS No. 150. As a result, the adoption of this Statement is not expected to have an impact on our financial position or results of operations. In April 2003 the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This Statement amends and clarifies technical aspects of financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, except in certain limited circumstances, all provisions of this Statement should be applied prospectively. Effective January 1, 2003, we adopted the provisions of SFAS No. 143, "Accounting for Asset Retirement Obligations." Upon adoption of SFAS No. 143, we recorded a discounted liability of $21.4 million, reversed the existing offshore abandonment liability of $9.1 million, increased net property and equipment by $21.1 million and recognized a one-time cumulative effect gain of $5.4 million (net of deferred tax benefit of $3.4 million). We will deplete the amount added to property and equipment and recognize accretion expense in connection with the discounted liability over the remaining economic lives of the respective oil and gas properties. Prior to the adoption of SFAS No. 143, we assumed that salvage value approximated abandonment costs and therefore salvage value was not reflected in the DD&A calculation. As a result of adopting SFAS No. 143 and the discounting of the asset retirement obligation, the salvage value must now be reflected in the DD&A rate. Accordingly, $13.7 million was reversed from accumulated DD&A and is included as a part of the increase in net property and equipment in the cumulative effect adjustment. This adjustment to accumulated DD&A relates to prior depletion of salvage value that would have been excluded from the DD&A calculation if the abandonment liability had been separately recognized. As of June 30, 2003, our capitalized proved oil and gas properties included $43.0 million of estimated salvage value, which is not included in our DD&A calculation. The FASB and representatives of the accounting staff of the Securities and Exchange Commission are currently engaged in discussions regarding the application of certain provisions of SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets," to companies in the extractive industries, including oil and gas companies. The FASB and the SEC staff are considering whether the provisions of SFAS No. 141 and SFAS No.142 require registrants to classify costs associated with mineral rights, including both proved and unproved lease acquisition costs, as intangible assets in the balance sheet, apart from other capitalized oil and gas property costs, and provide specific footnote disclosures. Historically, we have included oil and gas lease acquisition costs as a component of oil and gas properties. In the event the FASB and SEC staff determine that costs associated with mineral rights are required to be classified as intangible assets, a substantial portion of our oil and gas property acquisition costs would be separately classified on our balance sheets as intangible assets. However, our results of operations would not be affected since such intangible assets would continue to be depleted and assessed for impairment in accordance with existing successful efforts accounting rules and impairment standards. Further, we do not believe the -28- classification of oil and gas lease acquisition costs as intangible assets would have any impact on our compliance with covenants under its debt agreements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We hold derivative contracts and financial instruments that have cash flow and net income exposure to changes in commodity prices or interest rates. Financial and commodity-based derivative contracts are used to limit the risks inherent in some crude oil and natural gas price changes that have an effect on us. Our board of directors has adopted a policy regarding the use of derivative instruments. This policy requires every derivative used by St. Mary to relate to underlying offsetting positions, anticipated transactions or firm commitments. It prohibits the use of speculative, highly complex or leveraged derivatives. Under the policy, the Chief Executive Officer and Vice President - Finance must review and approve all risk management programs that use derivatives. The board of directors periodically reviews these programs. Commodity Price Risk. We use various hedging arrangements to manage our exposure to price risk from natural gas and crude oil production. These hedging arrangements have the effect of locking in for specified periods, at predetermined prices or ranges of prices, the prices we will receive for the volumes to which the hedge relates. Consequently, while these hedging arrangements are structured to reduce our exposure to decreases in prices associated with the hedged commodity, they also limit the benefit we might otherwise receive from any price increases associated with the hedged commodity. The derivative gain or loss effectively offsets the loss or gain on the underlying commodity exposures that have been hedged. The fair value of the swaps are estimated based on quoted market prices of comparable contracts and approximate the net gains or losses that would have been realized if the contracts had been closed out at quarter-end. The fair value of the futures are based on quoted market prices obtained from the New York Mercantile Exchange and have been adjusted for our hedging of the basis differential accorded to the pipelines relative to our areas at production. A hypothetical $0.10 per MMBtu change in our quarter-end market prices for natural gas swaps and futures contracts on a notional amount of 22.4 million MMBtu would cause a potential $1.8 million change in net income before income taxes over the remaining life of the contracts in place on June 30, 2003 and a potential $875,000 change for the last six months of 2003. A hypothetical $1.00 per Bbl change in our quarter-end market prices for crude oil swaps and future contracts on a notional amount of 2.9 million Bbls would cause a potential $2.7 million change in net income before income taxes over the remaining life of the contracts in place on June 30, 2003 and a potential $1.2 million change for the last six months of 2003. These hypothetical changes were discounted to present value using a 7.5% discount rate since the latest expected maturity date of certain swaps and futures contracts is greater than one year from the reporting date. Interest Rate Risk. Market risk is estimated as the potential change in fair value resulting from an immediate hypothetical one percentage point parallel shift in the yield curve. A sensitivity analysis presents the hypothetical change in fair value of those financial instruments held by St. Mary at June 30, 2003, which are sensitive to changes in interest rates. For fixed-rate debt, interest rate changes affect the fair market value but do not impact results of operations or cash flows. Conversely for floating rate debt, interest rate changes generally do not affect the fair market value but do impact future results of operations and cash flows, assuming other factors are held constant. The carrying amount of our floating rate debt approximates its fair value. At June 30, 2003, we had floating rate debt of $44.0 million and $100.0 million of fixed rate debt. Assuming constant debt levels, the impact on results of operations and cash flows for the remainder of the year resulting from a one-percentage-point change in interest rates would be approximately $220,000 before taxes. -29- ITEM 4. CONTROLS AND PROCEDURES We maintain a system of disclosure controls and procedures that are designed for the purposes of ensuring that information required to be disclosed in our SEC reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Vice-President - Finance, as appropriate to allow timely decisions regarding required disclosure. We carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and the Vice-President - Finance, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, the Chief Executive Officer and the Vice-President - Finance concluded that our disclosure controls and procedures are effective for the purposes discussed above as of the end of the period covered by this Quarterly Report on Form 10-Q. There was no significant change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. PART II. OTHER INFORMATION ITEM 1. Legal Proceedings ----------------- The previously reported legal proceeding involving Nance Petroleum Corporation and the Northern Plains Resource Council, Inc. in the U.S. District Court for the District of Montana had no significant developments during the quarterly period ended June 30, 2003. For a description of this proceeding, please see the "Legal Proceedings" section of St. Mary's Annual Report on Form 10-K for the year ended December 31, 2002. On August 4, 2003, the Company received a copy of an Administrative Order (the "Order") by the U.S. Environmental Protection Agency (Docket No. CWA-06-2003-1995) related to certain oil and gas properties in the Gulf of Mexico that are or were owned, operated or leased by St. Mary Energy Company. Interests in these properties were acquired by the Company through its acquisition of St. Mary Energy Company, formerly named King Ranch Energy, Inc., on December 17, 1999. The Order alleges violations of the Clean Water Act through certain violations of EPA reporting rules with respect to such properties under applicable EPA permits during reporting monitoring periods from July 1, 1998 to December 31, 1999. Based on a preliminary internal review to date, the Company believes that any reporting discrepancies were inadvertent and did not involve any improper discharge of pollutants into the environment, and the Company plans to fully cooperate with the EPA to appropriately correct and remedy any reporting discrepancies. Due to the preliminary nature of this matter, the Company cannot predict whether any monetary or other penalties will be imposed. However, the Company does not currently expect that such penalties, if any, would have a material effect on the Company's financial condition, results of operations or cash flows. -30- ITEM 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- At the Company's annual stockholders' meeting on May 21, 2003, the stockholders approved management's current slate of directors. The directors elected and the vote tabulation for each director are as follows: Director For Withheld -------- --- --------- Barbara M. Baumann 28,792,078 171,902 Larry W. Bickle 28,772,485 191,495 Ronald D. Boone 28,772,485 191,495 Thomas E. Congdon 28,772,485 191,495 William J. Gardiner 28,772,397 191,583 Mark A. Hellerstein 28,772,485 191,495 Arend J. Sandbulte 28,435,397 528,583 John M. Seidl 28,435,397 528,583 Also at the Company's annual stockholders' meeting on May 21, 2003, the stockholders approved an amendment to the Company's stock option plans to increase the total number of shares issuable under those plans by 1,300,000 shares to a total of 5,600,000. The tabulation of votes for that proposal is as follows: For 16,898,695 Against 11,374,779 Abstain 690,506 Also at the Company's annual stockholders' meeting on May 21, 2003, the stockholders approved a non-employee director stock compensation plan for the issuance of up to a total of 30,000 shares of St. Mary common stock to non-employee directors as part of their annual or other compensation over an anticipated period of up to five years. The tabulation of votes for that proposal is as follows: For 25,297,824 Against 2,874,837 Abstain 791,319 ITEM 6. Exhibits and Reports on Form 8-K -------------------------------- (a) Exhibits The following exhibits are furnished as part of this report: Exhibit Description ------- ----------- 10.1* St. Mary Land & Exploration Company Non-Employee Director Stock Compensation Plan as adopted on March 27, 2003 10.2 St. Mary Land & Exploration Company Stock Option Plan, As Amended on March 25, 1999, January 27, 2000, March 29, 2001, March 27, 2003 and May 22, 2003 (filed as Exhibit 99.1 to registrant's -31- Exhibit Description ------- ----------- Registration Statement on Form S-8 (Registration No. 333-106438) and incorporated herein by reference) 10.3 St. Mary Land & Exploration Company Incentive Stock Option Plan, As Amended on March 25, 1999, January 27, 2000, March 29, 2001, March 27, 2003 and May 22, 2003 (filed as Exhibit 99.2 to registrant's Registration Statement on Form S-8 (Registration No. 333-106438) and incorporated herein by reference) 10.4* Guaranty Agreement by St. Mary Energy Company in favor of Wachovia Bank, National Association, as Administrative Agent, dated January 27, 2003 10.5* Guaranty Agreement by St. Mary Operating Company in favor of Wachovia Bank, National Association, as Administrative Agent, dated January 27, 2003 10.6* Guaranty Agreement by Nance Petroleum Corporation in favor of Wachovia Bank, National Association, as Administrative Agent, dated January 27, 2003 10.7* Guaranty Agreement by NPC Inc. in favor of Wachovia Bank, National Association, as Administrative Agent, dated January 27, 2003 10.8* Pledge and Security Agreement between St. Mary Land & Exploration Company and Wachovia Bank, National Association, as Administrative Agent, dated January 27, 2003 10.9* Pledge and Security Agreement between Nance Petroleum Corporation and Wachovia Bank, National Association, as Administrative Agent, dated January 27, 2003 10.10* First Supplement and Amendment to Deed of Trust, Mortgage, Line of Credit Mortgage, Assignment, Security Agreement, Fixture Filing and Financing Statement for the benefit of Wachovia Bank, National Association, as Administrative Agent, dated effective as of January 27, 2003 10.11* Deed of Trust - St. Mary Land & Exploration to Wachovia Bank, National Association, as Administrative Agent, dated effective as of January 27, 2003 10.12* Deed of Trust (CO, NV, SD) to Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 2003 10.13* Deed of Trust (LA, MT, ND, NM, OK, TX, UT, WY) to Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 2003 10.14* First Supplement and Amendment to Deed of Trust, Mortgage, Line of Credit Mortgage, Assignment, Security Agreement, Fixture Filing and Financing Statement for the benefit of Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 2003 10.15* Second Supplement and Amendment to Deed of Trust, Mortgage, Line of Credit Mortgage, Assignment, Security Agreement, Fixture Filing and Financing Statement for the benefit of Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 2003 31.1* Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes - Oxley Act of 2002 31.2* Certification of Vice President - Finance pursuant to Section 302 of the Sarbanes - Oxley Act of 2002 32.1* Certification pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 -------------------------- * Filed with this Form 10-Q. -32- (b) Reports on Form 8-K St. Mary Land & Exploration Company filed the following current reports on Form 8-K during the quarter ended June 30, 2003: o On April 21, 2003, we filed a current report on Form 8-K reporting under Item 9 pursuant to Item 12 that we had issued a press release announcing an update of our operations for the first quarter of 2003. o On April 29, 2003, we filed a current report on Form 8-K reporting under Item 9 that we had issued a press release announcing a regular semi-annual 5-cent per share cash dividend. o On May 7, 2003, we filed a current report on Form 8-K reporting under Item 9 pursuant to Item 12that we had issued a press release announcing our first quarter 2003 financial results and an updated forecast of our second quarter and full year of 2003. -33- 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 hereunto duly authorized. ST. MARY LAND & EXPLORATION COMPANY August 12, 2003 By: /s/ MARK A. HELLERSTEIN ------------------------------------ Mark A. Hellerstein President and Chief Executive Officer August 12, 2003 By: /s/ DAVID W. HONEYFIELD ------------------------------------- David W. Honeyfield Vice President - Finance, Secretary and Treasurer August 12, 2003 By: /s/ GARRY A. WILKENING ------------------------------------- Garry A. Wilkening Vice President - Administration and Controller