DEVX ENERGY, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<Table>
<Caption>
PAGE
----
Report of Ernst & Young LLP, Independent Auditors.......................... F-2
Consolidated Financial Statements
Consolidated Balance Sheets as of December 31, 2000 and 1999............... F-3
Consolidated Statements of Operations for the
Years ended December 31, 2000, 1999 and 1998.......................... F-4
Consolidated Statements of Stockholders' Equity (Net Capital
Deficiency) for the Years ended December 31, 2000, 1999 and 1998...... F-5
Consolidated Statements of Cash Flows for the
Years ended December 31, 2000, 1999 and 1998.......................... F-7
Notes to Consolidated Financial Statements................................. F-8
</Table>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
DevX Energy, Inc.
We have audited the accompanying consolidated balance sheets of DevX Energy,
Inc. and subsidiaries as of December 31, 2000 and 1999, and the related
consolidated statements of operations, stockholders' equity (net capital
deficiency), and cash flows for each of the three years in the period ended
December 31, 2000. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of DevX Energy, Inc.
and subsidiaries as of December 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States.
As discussed in Note 1 to the consolidated financial statements, effective July
1, 2000, the Company adopted Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities."
Dallas, Texas
March 1, 2001
F-2
DEVX ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31
------------------------------
2000 1999
------------- -------------
ASSETS
Current assets:
Cash $ 10,985,000 $ 3,376,000
Accounts receivable 10,557,000 4,727,000
Other 183,000 459,000
------------- -------------
Total current assets 21,725,000 8,562,000
------------- -------------
Property and equipment, at cost:
Oil and gas properties, based on full cost accounting method 191,204,000 181,549,000
Other equipment 446,000 402,000
------------- -------------
191,650,000 181,951,000
Less accumulated depreciation and amortization (94,559,000) (85,969,000)
------------- -------------
Net property and equipment 97,091,000 95,982,000
Other assets 2,953,000 8,074,000
Deferred tax asset 1,221,000 --
------------- -------------
$ 122,990,000 $ 112,618,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,004,000 $ 2,328,000
Accrued liabilities 6,503,000 8,721,000
Current portion of long-term obligations -- 877,000
Derivatives 1,507,000 --
------------- -------------
Total current liabilities 9,014,000 11,926,000
Long-term obligations, net of current portion 50,000,000 134,106,000
Derivatives 12,246,000 --
Commitments and contingencies
Stockholders' equity (net capital deficiency):
Preferred stock, $0.01 par value:
Authorized shares - 50,000,000 at December 31, 2000 and 1999
Issued and outstanding shares - 0 and 9,604,248 at December 31,
2000 and 1999, respectively -- 96,000
Aggregate liquidation preference - $0 and $9,678,000 at December 31,
2000 and 1999, respectively
Common stock, $0.234 par value:
Authorized shares - 100,000,000 at December 31, 2000 and 1999
Issued and outstanding shares - 12,748,612 and 236,960 at
December 31, 2000 and 1999, respectively 2,983,000 70,000
Additional paid-in capital 60,159,000 64,945,000
Retained earnings (deficit) ($68,130,000 of accumulated deficit
eliminated in the quasi-reorganization of October 31, 2000) 834,000 (91,274,000)
Accumulated other comprehensive loss (12,246,000)
Treasury stock, at cost -- (7,251,000)
------------- -------------
Total stockholders' equity (net capital deficiency) 51,730,000 (33,414,000)
------------- -------------
Total liabilities and stockholders' equity $ 122,990,000 $ 112,618,000
============= =============
</Table>
See accompanying notes.
F-3
DEVX ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
YEAR ENDED DECEMBER 31
--------------------------------------------
2000 1999 1998
------------ ------------ ------------
Revenues:
Oil and gas sales $ 4,484,000 $ 3,625,000 $ 5,852,000
Net profits and royalty interests 31,507,000 21,955,000 15,947,000
Interest and other 90,000 345,000 156,000
------------ ------------ ------------
Total revenues 36,081,000 25,925,000 21,955,000
------------ ------------ ------------
Expenses:
Production expenses 1,727,000 1,622,000 4,326,000
Depreciation and amortization 8,637,000 9,418,000 10,866,000
Hedge contract termination costs -- 3,328,000 --
Write-down of oil and gas properties -- -- 63,199,000
General and administrative 4,497,000 3,629,000 2,420,000
------------ ------------ ------------
Total expenses 14,861,000 17,997,000 80,811,000
------------ ------------ ------------
Operating income (loss) 21,220,000 7,928,000 (58,856,000)
Other expenses:
Interest and financing costs 17,264,000 18,587,000 12,235,000
Change in fair value of derivatives 1,945,000 -- --
------------ ------------ ------------
Income (loss) before income taxes, extraordinary items,
and cumulative effect of accounting change 2,011,000 (10,659,000) (71,091,000)
Income tax benefit 642,000 -- --
------------ ------------ ------------
Income (loss) before extraordinary items and cumulative
effect of accounting change 2,653,000 (10,659,000) (71,091,000)
Extraordinary gain (loss), net of tax 21,144,000 (1,130,000) (3,549,000)
------------ ------------ ------------
Income (loss) before cumulative effect of accounting change
23,797,000 (11,789,000) (74,640,000)
Cumulative effect of accounting change, net of tax 413,000 -- --
------------ ------------ ------------
Net income (loss) $ 24,210,000 $(11,789,000) $(74,640,000)
============ ============ ============
Basic income (loss) per share amounts:
Income (loss) before cumulative effect of accounting
change and extraordinary items $ 1.12 $ (49.52) $ (414.90)
Extraordinary gain (loss) 8.94 (5.24) (20.71)
------------ ------------ ------------
Income (loss) before cumulative effect of accounting
change 10.06 (54.76) (435.61)
Cumulative effect of accounting change 0.18 -- --
------------ ------------ ------------
Net income (loss) $ 10.24 $ (54.76) $ (435.61)
============ ============ ============
Diluted income (loss) per shares amounts:
Income (loss) before cumulative effect of accounting
change and extraordinary items $ 0.87 $ (49.52) $ (414.90)
Extraordinary gain (loss) 6.95 (5.24) (20.71)
------------ ------------ ------------
Income (loss) before cumulative effect of accounting
change 7.82 (54.76) (435.61)
Cumulative effect of accounting change 0.14 -- --
------------ ------------ ------------
Net income (loss) $ 7.96 $ (54.76) $ (435.61)
============ ============ ============
Weighted average shares outstanding:
Basic 2,364,817 215,268 171,344
Diluted 3,041,386 215,268 171,344
</Table>
See accompanying notes.
F-4
DEVX ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(NET CAPITAL DEFICIENCY)
YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
<Table>
<Caption>
PREFERRED STOCK COMMON STOCK ADDITIONAL
---------------------------- --------------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL TREASURY
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1997 9,610,400 $ 96,000 144,395 $ 48,000 $ 29,020,000 $ (5,000,000)
Issuance of common
stock for oil and
gas properties -- -- 2,219 1,000 1,751,000 --
Issuance of common
stock for cash -- -- 34,013 8,000 26,972,000 --
Issuance of common
stock upon exercise
of warrants -- -- 15,860 4,000 6,996,000 --
Issuance of common
stock pursuant to
repricing rights -- -- 4,984 1,000 (1,000) --
Issuance of common
stock on conversion
of convertible
preferred stock (2,290) -- 2,534 -- -- --
Issuance of common
stock as stock
dividend -- -- 111 -- 98,000 --
Repurchase of
convertible
preferred stock (2,152) -- -- -- -- (2,251,000)
Net loss -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1998 9,605,958 96,000 204,116 62,000 64,836,000 (7,251,000)
Issuance of common
stock pursuant to
repricing rights -- -- 19,245 5,000 (5,000) --
Issuance of common
stock on
conversion of
convertible preferred
stock (1,710) -- 12,642 3,000 (3,000) --
Issuance of common
stock as stock
dividend -- -- 957 -- 117,000 --
Net loss -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1999 9,604,248 $ 96,000 236,960 $ 70,000 $ 64,945,000 $ (7,251,000)
<Caption>
ACCUMULATED
OTHER RETAINED TOTAL
COMPREHENSIVE EARNINGS STOCKHOLDERS'
LOSS (DEFICIT) EQUITY
------------ ------------ ------------
Balance at December 31, 1997 $ -- $ (4,630,000) $ 19,534,000
------------ ------------ ------------
Issuance of common
stock for oil and
gas properties -- -- 1,752,000
Issuance of common
stock for cash -- -- 26,980,000
Issuance of common
stock upon exercise
of warrants -- -- 7,000,000
Issuance of common
stock pursuant to
repricing rights -- -- --
Issuance of common
stock on conversion
of convertible
preferred stock -- -- --
Issuance of common
stock as stock
dividend -- (98,000) --
Repurchase of
convertible
preferred stock -- -- (2,251,000)
Net loss -- (74,640,000) (74,640,000)
------------ ------------ ------------
Balance at December 31, 1998 -- (79,368,000) (21,625,000)
Issuance of common
stock pursuant to
repricing rights -- -- --
Issuance of common
stock on
conversion of
convertible preferred
stock -- -- --
Issuance of common
stock as stock
dividend -- (117,000) --
Net loss -- (11,789,000) (11,789,000)
------------ ------------ ------------
Balance at December 31, 1999 $ -- $(91,274,000) $(33,414,000)
</Table>
F-5
DEVX ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
(NET CAPITAL DEFICIENCY)
YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
<Table>
<Caption>
PREFERRED STOCK COMMON STOCK ADDITIONAL
---------------------------- --------------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL TREASURY
------------ ------------ ------------ ------------ ------------ ------------
Issuance of common
stock for cash -- $ -- 11,498,878 $ 2,691,000 $ 70,421,000 $ --
Issuance of common
stock pursuant to
repricing rights -- -- 628,962 147,000 (147,000) --
Issuance of common
stock on conversion
of convertible
preferred stock (9,604,248) (96,000) 378,519 89,000 7,000 --
Issuance of common
stock as stock
dividend -- -- 5,293 1,000 231,000 --
Retire treasury stock -- -- -- (15,000) (7,236,000) 7,251,000
Reclassification of
accumulated deficit
pursuant to
quasi-reorganization -- -- -- -- (68,130,000) --
Other -- -- -- -- 68,000 --
Net income -- -- -- -- -- --
Cumulative effect
of accounting change -- -- -- -- -- --
Unrealized losses on
derivatives -- -- -- -- -- --
Comprehensive
income -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance at
December 31, 2000 -- $ -- $ 12,748,612 $ 2,983,000 $ 60,159,000 $ --
============ ============ ============ ============ ============ ============
<Caption>
ACCUMULATED
OTHER RETAINED TOTAL
COMPREHENSIVE EARNINGS STOCKHOLDERS'
LOSS (DEFICIT) EQUITY
------------ ------------ ------------
Issuance of common
stock for cash $ -- $ -- $ 73,112,000
Issuance of common
stock pursuant to
repricing rights -- -- --
Issuance of common
stock on conversion
of convertible
preferred stock -- -- --
Issuance of common
stock as stock
dividend -- (232,000) --
Retire treasury stock -- -- --
Reclassification of
accumulated deficit
pursuant to
quasi-reorganization -- 68,130,000 --
Other -- -- 68,000
Net income 24,210,000 24,210,000
Cumulative effect
of accounting change (5,515,000) -- (5,515,000)
Unrealized losses on
derivatives (6,731,000) -- (6,731,000)
Comprehensive
income -- -- (11,964,000)
------------ ------------ ------------
Balance at
December 31, 2000 $(12,246,000) $ 834,000 $ 51,730,000
============ ============ ============
</Table>
See accompanying notes.
F-6
DEVX ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEAR ENDED DECEMBER 31
-----------------------------------------------
2000 1999 1998
------------- ------------- -------------
OPERATING ACTIVITIES
Income (loss) before extraordinary items and cumulative effect of
change in accounting $ 2,653,000 $ (10,659,000) $ (71,091,000)
Adjustments to reconcile income (loss) to net cash provided by
operating activities:
Deferred tax benefit (1,424,000) -- --
Depreciation and amortization 8,637,000 9,313,000 10,850,000
Amortization of deferred costs 1,605,000 1,242,000 738,000
Write-down of oil and gas properties -- -- 63,199,000
Change in market value of derivatives 1,945,000 -- --
Unrealized foreign currency translation gains (43,000) (131,000) --
Changes in operating assets and liabilities:
Accounts receivable (5,830,000) 246,000 (3,660,000)
Other assets 276,000 4,000 (379,000)
Accounts payable and accrued liabilities (1,305,000) 678,000 8,720,000
------------- ------------- -------------
Net cash provided by operating activities 6,514,000 693,000 8,377,000
INVESTING ACTIVITIES
Additions to oil and gas properties (13,043,000) (7,494,000) (153,961,000)
Proceeds from sales of oil and gas properties 3,386,000 10,236,000 --
Other 84,000 (706,000) (9,623,000)
------------- ------------- -------------
Net cash provided by (used in) investing activities (9,573,000) 2,036,000 (163,584,000)
FINANCING ACTIVITIES
Proceeds from revolving credit facilities 14,000,000 20,032,000 92,800,000
Debt issuance costs -- (1,130,000) --
Termination of LIBOR swap agreement -- -- (3,549,000)
Payment on revolving credit facilities (23,106,000) (21,227,000) (87,671,000)
Proceeds from issuance of 12.5% senior notes -- -- 125,000,000
Redemption of 12.5% senior notes (52,504,000) -- --
Redemption of DEM bonds (791,000) -- (1,206,000)
Payments on notes payable -- -- (1,901,000)
Proceeds from the issuance of common stock 73,112,000 -- 33,980,000
Repurchase of common and preferred stock -- -- (2,251,000)
Payments on capital lease obligation (43,000) (67,000) (71,000)
------------- ------------- -------------
Net cash provided by (used in) financing activities 10,668,000 (2,392,000) 155,131,000
Net increase (decrease) in cash 7,609,000 337,000 (76,000)
Cash at beginning of year 3,376,000 3,039,000 3,115,000
------------- ------------- -------------
Cash at end of year $ 10,985,000 $ 3,376,000 $ 3,039,000
============= ============= =============
</Table>
See accompanying notes.
F-7
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999 AND 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
DevX Energy, Inc. (DEVX or the Company, formerly Queen Sand Resources, Inc.) was
formed on August 9, 1994, under the laws of the State of Delaware. The Company
is engaged in one industry segment: the acquisition, exploration, development,
production and sale of crude oil and natural gas. The Company's business
activities are carried out primarily in Kentucky, Oklahoma and Texas. Effective
December 31, 2000, the Company changed its fiscal year end to December 31. The
accompanying financial statements have been prepared on a calendar year for each
period presented.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.
PROPERTY AND EQUIPMENT
The Company follows the full cost method of accounting for its oil and gas
activities under which all costs, including general and administrative expenses
directly associated with property acquisition, exploration and development
activities, are capitalized. Capitalized general and administrative expenses
directly associated with acquisitions, exploration and development of oil and
gas properties were approximately $691,000, $813,000 and $1,287,000 for the
years ended December 31, 2000, 1999 and 1998, respectively. Capitalized costs
are amortized by the unit-of-production method using estimates of proved oil and
gas reserves prepared by independent engineers. The costs of unproved properties
are excluded from amortization until the properties are evaluated. Sales of oil
and gas properties are accounted for as adjustments to the capitalized cost
center unless such sales significantly alter the relationship between
capitalized costs and proved reserves of oil and gas attributable to the cost
center, in which case a gain or loss is recognized.
The Company limits the capitalized costs of oil and gas properties, net of
accumulated amortization, to the estimated future net revenues from proved oil
and gas reserves less estimated future development and production expenditures
discounted at 10%, plus the lower of cost or estimated fair value of unproved
properties, as adjusted for related estimated future tax effects. If capitalized
costs exceed this limit (the full cost ceiling), the excess is charged to
depreciation and amortization expense. During the year ended December 31, 1998,
the Company recorded full cost ceiling write-downs of $63,199,000.
Amortization of the capitalized costs of oil and gas properties and limits to
capitalized costs are based on estimates of oil and gas reserves which are
inherently imprecise and are subject to change based on factors such as crude
oil and natural gas prices, drilling results, and the results of production
activities, among others. Accordingly, it is reasonably possible that such
estimates could differ materially in the near term from amounts currently
estimated.
Depreciation of other property and equipment is provided principally by the
straight-line method over the estimated service lives of the related assets.
Equipment under capital lease is recorded at the lower of fair value or the
present value of future minimum lease payments and is depreciated over the lease
term.
Costs incurred to operate, repair and maintain wells and equipment are charged
to expense as incurred.
F-8
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Certain of the Company's oil and gas activities are conducted jointly with
others and, accordingly, the financial statements reflect only the Company's
proportionate interest in such activities.
The Company does not expect future costs for site restoration, dismantlement and
abandonment, postclosure, and other exit costs which may occur in the sale,
disposal or abandonment of a property to be material.
REVENUE RECOGNITION
The Company uses the sales method of accounting for oil and gas revenues. Under
the sales method, revenues are recognized based on actual volumes of oil and gas
sold to purchasers.
ENVIRONMENTAL MATTERS
The Company is subject to extensive federal, state and local environmental laws
and regulations. These laws, which are constantly changing, regulate the
discharge of materials into the environment and may require the Company to
remove or mitigate the environmental effects of the disposal or release of
petroleum or chemical substances at various sites. Environmental expenditures
are expensed or capitalized depending on their future economic benefit.
Expenditures that relate to an existing condition caused by past operations and
that have no future economic benefits are expensed. Liabilities for expenditures
of a noncapital nature are recorded when environmental assessment and/or
remediation is probable and the costs can be reasonably estimated.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. The measurement of deferred tax assets
is adjusted by a valuation allowance, if necessary, to recognize the extent to
which, based on available evidence, the future tax benefits more likely than not
will be realized.
STATEMENT OF CASH FLOWS
The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents.
During 1998, the Company issued an aggregate of 2,219 shares of Common Stock
valued at $1,752,000 in connection with the acquisition of certain interests in
oil and gas properties.
INCOME (LOSS) PER COMMON SHARE
Basic income or loss per share is calculated based on the weighted average
number of common shares outstanding during the period. If applicable, diluted
earnings per share is calculated based on the weighted average number of common
shares outstanding during the period plus any dilutive common equivalent shares
outstanding. As the Company incurred net losses during each of the years ended
December 31, 1999 and 1998, the loss per common
F-9
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
share data is based on the weighted average common shares outstanding and
excludes the effects of the Company's potentially dilutive securities (Note 6).
The following table reconciles basic and diluted weighted average shares
outstanding:
<Table>
<Caption>
2000 1999 1998
--------- --------- ---------
Basic weighted average shares 2,364,817 215,268 171,344
Dilutive effect of:
Common stock repricing rights 673,627 -- --
Employee stock options 2,942 -- --
--------- --------- ---------
Diluted weighted average shares 3,041,386 215,268 171,344
========= ========= =========
</Table>
Losses per common share for periods prior to the completion of the Company's
recapitalization transaction (Note 2) have been restated for the effects of a
156-to-1 reverse stock split.
STOCK COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25), in accounting for its
employee stock options. Under APB 25, if the exercise price of an employee's
stock options equals or exceeds the market price of the underlying stock on the
date of grant and certain other plan conditions are met, no compensation expense
is recognized.
In March 2000, the Financial Accounting Standards Board issued Interpretation
No. 44, Accounting for Certain Transactions Involving Stock Compensation (FIN
44), an interpretation of APB 25. FIN 44, which was adopted prospectively by the
Company as of July 1, 2000, requires certain changes to the previous practice
regarding the accounting for certain stock compensation arrangements. FIN 44
does not change APB 25's intrinsic value method, under which compensation
expense is generally not recognized for grants of stock options to employees
with an exercise price equal to the market price of the stock at the date of
grant, but it has narrowed its application. The adoption of FIN 44 did not have
a significant effect on the Company's existing accounting for its employee stock
options.
CONCENTRATIONS OF RISK
The Company sells crude oil and natural gas to various customers. In addition,
the Company participates with other parties in the operation of crude oil and
natural gas wells. Substantially all of the Company's accounts receivable are
due from either purchasers of crude oil and natural gas or participants in crude
oil and natural gas wells for which the Company serves as the operator.
Generally, operators of crude oil and natural gas properties have the right to
offset future revenues against unpaid charges related to operated wells. The
Company's receivables are generally unsecured.
For the year ended December 31, 2000, four oil and gas companies accounted for
31%, 18%, 14% and 13%, respectively, of the Company's oil and gas sales. For the
year ended December 31, 1999, four oil and gas companies accounted for 29%, 14%,
12% and 9%, respectively, of the Company's oil and gas sales. For the year ended
December 31, 1998, three oil and gas companies accounted for 29%, 12% and 11%,
respectively, of the Company's
F-10
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
oil and gas sales. The Company does not believe that the loss of any of these
buyers would have a material effect on the Company's business or results of
operations as it believes it could readily locate other buyers.
The Company's revenues and profitability are highly dependent upon the
prevailing prices for oil and natural gas. As the Company produces more natural
gas than oil, it faces more risk related to fluctuations in natural gas prices
than oil prices. To reduce the exposure to changes in the price of oil and
natural gas, the Company has entered into certain derivative contracts (Note 5).
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenue and expenses during the reporting period.
Because of the use of estimates inherent in the financial reporting process,
actual results could differ from those estimates.
COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity of a business enterprise
during a period from transactions and other events and circumstances from
non-owner sources. For the year ended December 31, 2000, the Company's
comprehensive income differed from net income by approximately $12,246,000, due
to the recognition in comprehensive income of unrealized losses related to
certain of the Company's derivative instruments which have been designated as
hedges. For the years ended December 31, 1999 and 1998, there were no
differences between the Company's net losses and total comprehensive income.
DERIVATIVES
The Company utilizes certain derivative financial instruments, primarily swaps,
floors and collars, to hedge future oil and gas prices. Effective July 1, 2000,
the Company adopted Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133),
which requires the Company to recognize all derivatives on the balance sheet at
fair value. Prior to adoption of SFAS No. 133, gains and losses arising from the
use of derivative instruments were deferred until realized. The Company
estimates fair value based on quotes obtained from the counterparties to the
derivative contracts. The Company recognizes the fair value of derivative
contracts that expire in less than one year as current assets or liabilities.
Those that expire in more than one year are recognized as long-term assets or
liabilities. Derivatives that are not accounted for as hedges are adjusted to
fair value through other income. If the derivative is a hedge, depending on the
nature of the hedge, changes in fair value are either offset against the change
in fair value of the hedged assets, liabilities, or firm commitments through
earnings or recognized in other comprehensive income until the hedged item is
recognized in earnings.
Upon adoption of SFAS No. 133, the Company had four open derivative contracts.
One contract, a natural gas swap, has been designated as a cash flow hedge. For
derivatives classified as cash flow hedges, changes in fair value are recognized
in other comprehensive income until the hedged item is recognized in earnings.
The ineffective portion of any change in the fair value of a derivative
designated as a hedge is immediately recognized in earnings. Hedge effectiveness
is measured quarterly based on the relative fair value between the derivative
contract and the hedged
F-11
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
item over time. At adoption, the Company recognized a derivative liability and a
reduction in other comprehensive income of approximately $5,515,000 as a
cumulative effect of accounting change for this cash flow hedge. During the six
months ended December 31, 2000, the Company recognized an increase in the
derivative liability and an associated other comprehensive loss totaling
approximately $6,731,000. No amounts were recognized in earnings for hedging
ineffectiveness during 2000.
Additionally upon adoption, the Company recognized a net derivative asset of
approximately $651,000 for the remaining three open derivative contracts, and a
related gain of approximately $413,000 as a cumulative effect of accounting
change in earnings. During the six months ended December 31, 2000, the Company
recognized a loss of approximately $1,945,000 related to the net change in the
fair value of derivative contracts which have not been designated as hedges.
Gains and losses from settlements of hedges of oil and gas prices are reported
as oil and gas sales. Gains and losses from settlements of interest rate hedges
are reported in interest expense.
2. QUASI-REORGANIZATION
On October 31, 2000, the Company completed a public offering of 10,000,000
shares of its common stock at a price per share to the public of $7.00. An
additional 1,500,000 shares were sold during November 2000 upon the
underwriter's exercise of its over-allotment option. The aggregate net proceeds
to the Company (after deducting underwriter discount and expenses, and costs to
repurchase fractional shares aggregating 1,122 shares of common stock) were
approximately $73,112,000. Simultaneously with the closing of the October 31,
2000 offering, the Company completed a recapitalization transaction which
included: (a) a reverse stock split of every 156 outstanding shares of common
stock into one share; (b) the exchange of all preferred stock, all warrants
exercisable for shares of common stock and all unexercised common stock
repricing rights (Note 6) for 732,500 shares of post reverse-split common stock;
(c) the repurchase of $75 million face value of 12.5% senior notes (Note 4) for
$52,504,000; and (d) the Company used proceeds from the offering to pay down the
balance on its revolving credit facility by $14 million ($11 million at closing
and $3 million from the exercise of the over-allotment option) (the
Recapitalization).
The Company's board of directors decided to effect a quasi-reorganization given
the infusion of new equity capital, the reduction in debt, changes in management
and changes in the Company's operations. Accordingly, the Company's accumulated
deficit as of the date of the Recapitalization, $68,130,000, was eliminated
against additional paid-in capital. The historical carrying values of the
Company's assets and liabilities were not adjusted in connection with the
quasi-reorganization.
Information presented for shares of common stock for all periods prior to the
Recapitalization has been restated to retroactively reflect the effects of the
reverse stock split.
3. NET PROFITS AND ROYALTY INTERESTS
During 1998, the Company acquired certain nonoperated net profits interests and
royalty interests (collectively, the Morgan Properties) from pension funds
managed by J.P. Morgan Investments. The Company's interest in the Morgan
Properties primarily takes the form of nonoperated net profits overriding
royalty interests, whereby the Company is entitled to a percentage of the net
profits from the operations of the properties. The oil and gas properties
burdened by the Morgan Properties are primarily located in East Texas, South
Texas and the mid-continent region of the United States.
F-12
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. NET PROFITS AND ROYALTY INTERESTS (CONTINUED)
Presented below are the oil and gas sales and associated production expenses
associated with the Company's net profits and royalty interests, which are
presented in the accompanying consolidated statements of operations for the
years ended December 31, 2000, 1999 and 1998, respectively, as net profits and
royalty interests revenues.
<Table>
<Caption>
YEAR ENDED DECEMBER 31
---------------------------------------
2000 1999 1998
----------- ----------- -----------
Oil and gas sales $37,721,000 $26,741,000 $21,913,000
Production expenses 6,214,000 4,786,000 5,966,000
----------- ----------- -----------
Net profits and royalty interests $31,507,000 $21,955,000 $15,947,000
=========== =========== ===========
</Table>
4. CURRENT AND LONG-TERM DEBT
A summary of current and long-term debt follows:
<Table>
<Caption>
DECEMBER 31
---------------------------
2000 1999
------------ ------------
12.5% senior notes, due July 2008 $ 50,000,000 $125,000,000
12% unsecured DEM bonds, due July 2000 -- 834,000
Revolving credit agreement -- 9,106,000
Capital lease obligations -- 43,000
------------ ------------
50,000,000 134,983,000
Less current portion of debt and capitalized lease
obligation -- 877,000
------------ ------------
Total long-term obligations $ 50,000,000 $134,106,000
============ ============
</Table>
During October 1999, the Company entered into an amended and restated revolving
credit agreement (the Credit Agreement) with new lenders. In connection with
entering into the Credit Agreement, the Company retired borrowings under its
previous credit agreement, terminating the arrangement. As a result, the Company
recorded an extraordinary loss of $1,130,000 relating to the write-off of the
unamortized deferred costs of the previous agreement. The Credit Agreement
allows the Company to borrow up to $43.5 million (subject to borrowing base
limitations). Borrowings under the Credit Agreement are secured by a first lien
on the Company's oil and natural gas properties. Borrowings under the Credit
Agreement bear interest at prime plus 2% on borrowings under $25 million and
prime plus 4.5%, if borrowings exceed $25 million. There were no outstanding
borrowings under the Credit Agreement at December 31, 2000. The interest rate at
December 31, 2000, was 11.5%. The loan under the Credit Agreement expires on
October 22, 2001. The Company is subject to certain affirmative and negative
financial and operating covenants under the Credit Agreement, including
maintaining a minimum interest coverage ratio, a minimum working capital ratio
and certain limitations on capital spending. At December 31, 2000, the Company
exceeded the capital spending limitation, for which the lender issued a waiver.
Letters of credit up to a maximum of $12 million may be issued on behalf of the
Company under the Credit Agreement, which bear interest at 3%. Any outstanding
letters of credit reduce the Company's ability to borrow
F-13
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. CURRENT AND LONG-TERM DEBT
under the Credit Agreement. At December 31, 2000, the Company had a letter of
credit outstanding in the amount of $8.5 million to secure a swap exposure (Note
5).
Effective January 31, 2001, the Credit Agreement was amended to extend the
maturity date to April 22, 2003, increase the capital spending limitation and
modify the interest rate. Borrowings under the amended Credit Agreement bear
interest as follows: when the borrowings are less than $30 million or borrowings
are less than 67% of the borrowing base as defined in the agreement, bank prime
plus 2%; when the borrowings are $30 million or greater and borrowings exceed
67% of the borrowing base as defined in the agreement, bank prime plus 3.5%; and
on amounts securing letters of credit issued on our behalf, 3%.
On July 8, 1998, the Company completed a private placement of $125,000,000
principal amount of 12.5% senior notes (the Notes) due July 1, 2008. Interest on
the Notes is payable semiannually on January 1 and July 1 of each year,
commencing January 1, 1999, at the rate of 12.5% per annum. The Notes are senior
unsecured obligations of the Company and rank pari passu with any existing and
future unsubordinated indebtedness of the Company. The Notes rank senior to all
unsecured subordinated indebtedness of the Company. The Notes contain customary
covenants that limit the Company's ability to incur additional debt, pay
dividends and sell assets of the Company. Substantially all of the proceeds from
the issuance of the Notes were used to retire indebtedness incurred in
connection with the acquisition of the Morgan Properties. In connection with the
Recapitalization, the Company retired $75,000,000 face amount of the Notes,
recognizing an extraordinary gain of $21,144,000 (Note 2).
The Company's payment obligations under the Notes are jointly, severally and
unconditionally guaranteed by the Company's subsidiaries. The Company has no
significant assets and no operations other than those conducted by its
subsidiaries. No restrictions exist on the ability of the subsidiaries to make
loans or pay dividends to the Company.
Beginning in July 1995, the Company initiated private debt offerings whereby it
could issue up to a maximum of 5,000,000 Deutschmark (DEM) denominated 12% notes
due on July 15, 2000, of which DEM 1,600,000 were outstanding at December 31,
1999. During 2000, the Company retired all remaining outstanding notes for
approximately $791,000.
During the years ended December 31, 2000, 1999 and 1998, the Company made cash
payments of interest totaling approximately $15,800,000, $16,402,000 and
$3,953,000, respectively.
5. DERIVATIVES AND HEDGING ACTIVITIES
The Company uses swaps, floors and collars to hedge oil and natural gas prices.
Swaps are settled monthly based on differences between the prices specified in
the instruments and the settlement prices of futures contracts quoted on the New
York Mercantile Exchange (NYMEX). Generally, when the applicable settlement
price is less than the price specified in the contract, the Company receives a
settlement from the counterparty based on the difference multiplied by the
volume hedged. Similarly, when the applicable settlement price exceeds the price
specified in the contract, the Company pays the counterparty based on the
difference. The Company generally receives a settlement from the counterparty
for floors when the applicable settlement price is less than the price specified
in the contract, which is based on the difference multiplied by the volumes
hedged. For collars, generally the Company receives a settlement from the
counterparty when the settlement price is below the floor and pays a settlement
to the counterparty when the settlement price exceeds the cap. No settlement
occurs when the settlement price falls between the floor and cap.
F-14
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. DERIVATIVES AND HEDGING ACTIVITIES (CONTINUED)
The Company had a collar with an affiliate of Enron Corp. (Enron), a stockholder
of the Company, to hedge 50,000 MMBtu of natural gas production and 10,000
barrels of oil production monthly. The agreements, effective September 1, 1997,
and terminating August 31, 1998, called for a natural gas and oil ceiling and
floor price of $2.66 and $1.90 per MMBtu and $20.40 and $18.00 per barrel,
respectively. During the year ended December 31, 1998, the Company recognized
net hedging gains of approximately $233,000 relating to these agreements, which
are included in oil and gas sales.
The table below sets out volumes of natural gas hedged with a floor price of
$1.90 per MMBtu with Enron, which received a fee of $478,000 during the year
ended December 31, 1998 for entering into this agreement. The volumes presented
in this table are divided equally over the months during the period.
<Table>
<Caption>
VOLUME
PERIOD BEGINNING PERIOD ENDING (MMBtu)
- ---------------- ----------------- ---------
May 1, 1998 December 31, 1998 885,000
January 1, 1999 December 31, 1999 1,080,000
January 1, 2000 December 31, 2000 880,000
January 1, 2001 December 31, 2001 740,000
January 1, 2002 December 31, 2002 640,000
January 1, 2003 December 31, 2003 560,000
</Table>
The table below sets out volumes of natural gas hedged with a swap at $2.40 per
MMBtu with Enron. The volumes presented in this table are divided equally over
the months during the period.
<Table>
<Caption>
VOLUME
PERIOD BEGINNING PERIOD ENDING (MMBtu)
- ---------------- ----------------- ---------
May 1, 1998 December 31, 1998 2,210,000
January 1, 1999 December 31, 1999 2,710,000
January 1, 2000 December 31, 2000 2,200,000
January 1, 2001 December 31, 2001 1,850,000
January 1, 2002 December 31, 2002 1,600,000
January 1, 2003 December 31, 2003 1,400,000
</Table>
Effective November 1, 1999, the Company unwound the ceiling price limitation of
this collar at a cost of $3.3 million. The table below sets out volumes of
natural gas that remains under contract at a floor price of $2.00 per MMBtu. The
volumes presented in this table are divided equally over the months during the
period.
<Table>
<Caption>
VOLUME
PERIOD BEGINNING PERIOD ENDING (MMBtu)
- ---------------- ----------------- ---------
November 1, 1999 December 31, 1999 722,000
January 1, 2000 December 31, 2000 3,520,000
January 1, 2001 December 31, 2001 2,970,000
January 1, 2002 December 31, 2002 2,550,000
January 1, 2003 December 31, 2003 2,250,000
</Table>
F-15
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. DERIVATIVES AND HEDGING ACTIVITIES (CONTINUED)
During the years ended December 31, 2000, 1999 and 1998, the Company recognized
hedging gains (losses) of approximately $(3,324,000), $644,000 and $803,000,
respectively, relating to cash settlements under these agreements, which are
included in net profits and royalty interests revenues.
During the year ended December 31, 1998, the Company entered into a swap
agreement with Enron to hedge 12,000 barrels of oil production monthly at $17.00
per barrel, for the months of October, November and December 1998. The Company
recognized hedging gains of approximately $147,000 relating to this agreement,
which are included in net profits and royalty interests revenues.
During the year ended December 31, 1999, the Company entered into a swap
agreement with Enron to hedge 10,000 barrels of oil production monthly at $13.50
per barrel for the six months March through August 1999, and for 5,000 barrels
of oil production monthly at $14.35 per barrel, and for 5,000 barrels of oil
production monthly at $14.82 per barrel for the six months April through
September 1999. During the year ended December 31, 1999, the Company recognized
hedging losses of approximately $589,000 relating to this agreement, which are
included in net profits and royalty interests revenues.
The table below sets out volumes of oil hedged with a collar with Enron
involving floor and ceiling prices as set out in the table below. The volumes
presented in this table are divided equally over the months during the period.
<Table>
<Caption>
VOLUME FLOOR CEILING
PERIOD BEGINNING PERIOD ENDING (MMBtu) PRICE PRICE
- ---------------- ----------------- ------ ------ ---------
December 1, 1999 March 31, 2000 40,000 $22.90 $25.77
April 1, 2000 June 30, 2000 15,000 $23.00 $28.16
July 1, 2000 December 31, 2000 30,000 $22.00 $28.63
</Table>
During the years ended December 31, 2000 and 1999, the Company recognized
hedging losses of approximately $3,000 and $203,000, respectively, relating to
this contract.
During the year ended December 31, 2000, the Company entered into a series of
collars to hedge a portion of future natural gas production involving floor and
ceiling prices as set out below. The volumes presented in this table are divided
equally over the months during the period.
<Table>
<Caption>
VOLUME FLOOR CEILING
PERIOD BEGINNING PERIOD ENDING (MMBtu) PRICE PRICE
- ---------------- ----------------- ------ ------ ---------
January 1, 2001 March 31, 2001 1,125,000 $5.44 $8.29
April 1, 2001 June 30, 2001 675,000 $4.07 $6.42
July 1, 2001 December 31, 2001 1,350,000 $4.07 $6.51
</Table>
The aggregate fair value of the Company's derivative contracts at December 31,
2000 represented a net liability of $13,540,000.
The Company entered into a forward LIBOR interest rate swap effective for the
period June 30, 1998 through June 29, 2009 at a rate of 6.3% on $125 million,
which could be unwound at any time at the option of the Company. On July 9,
1998, as a result of the retirement of the Bridge Facilities and borrowings
under the Credit Agreement, the
F-16
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. DERIVATIVES AND HEDGING ACTIVITIES (CONTINUED)
Company terminated the agreement at a cost of $3,549,000. The cost of
termination has been reflected as an extraordinary loss in the accompanying
consolidated statement of operations for the year ended December 31, 1998.
6. STOCKHOLDERS' EQUITY
GENERAL
The Company's Certificate of Incorporation authorizes the issuance of: (a)
50,000,000 shares of preferred stock of the Company, par value $.01 per share
(the Preferred Stock), of which 9,600,000 shares have been designated as Series
A Preferred Stock, 9,600,000 shares have been designated as Series B Preferred
Stock and 10,400 shares have been designated as Series C Preferred Stock and (b)
100,000,000 shares of Common Stock, par value $0.234.
Any authorized but unissued or unreserved Common Stock and undesignated
Preferred Stock is available for issuance at any time, on such terms and for
such purposes as the Board of Directors may deem advisable in the future without
further action by stockholders of the Company, except as may be required by law
or the Series A or Series C Certificate of Designation. The Board of Directors
of the Company has the authority to fix the rights, powers, designations and
preferences of the undesignated Preferred Stock and to provide for one or more
series of undesignated Preferred Stock. The authority will include, but will not
be limited to: determination of the number of shares to be included in the
series; dividend rates and rights; voting rights, if any; conversion privileges
and terms; redemption conditions; redemption values; sinking funds; and rights
upon involuntary or voluntary liquidation.
In connection with the Recapitalization, the Company implemented a 156-to-1
reverse split of its common stock which reduced the total number of shares of
common stock outstanding from 80,688,538 pre-split shares (par value $0.0015) to
517,234 post-split shares (par value $0.234).
In connection with the Recapitalization, the holders of the Series A Preferred
Stock and the Series C Preferred Stock and common stock repricing rights
exchanged all their remaining shares of the Series A Preferred Stock, Series C
Preferred Stock and common stock repricing rights, together with all their
respective warrants and non-dilution rights for an aggregate of 732,500 shares
of post reverse-split common stock.
As of December 31, 2000, there were no shares of Preferred Stock, no common
stock repricing rights, no stock purchase warrants and 12,748,612 shares of
common stock outstanding.
SERIES A PREFERRED STOCK
In March 1997, the Company entered into a Securities Purchase Agreement with
Joint Energy Development Limited Partnership II, an affiliate of Enron
(respectively the "JEDI Purchase Agreement and "JEDI") under which JEDI acquired
9,600,000 shares of Series A Preferred Stock, certain warrants to purchase
common stock and nondilution rights in regards to future stock issuances by the
Company. The aggregate consideration received by the Company consisted of
$5,000,000.
In connection with the Recapitalization, JEDI accepted 212,500 shares of post
reverse-split common stock in exchange for all 9,600,000 shares of Series A
Preferred Stock and stock warrants that it then held, and the surrender of all
its remaining nondilution and other rights under the JEDI Purchase Agreement. As
a result of that transaction, the JEDI Purchase Agreement was terminated. As of
December 31, 2000, there were no shares of Series A Preferred Stock outstanding.
F-17
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. STOCKHOLDERS' EQUITY (CONTINUED)
SERIES B PREFERRED STOCK
No shares of Series B Preferred Stock have been issued.
SERIES C PREFERRED STOCK
In December 1997, the Company sold 10,000 shares of Series C Preferred Stock to
various investors in a private placement for gross proceeds of $10,000,000. The
investors also received warrants to purchase 2,180 shares of common stock in the
transaction. The Company issued an additional 400 shares of Series C Preferred
Stock in consideration of placement agent fees incurred with respect to the
transaction.
During the year ended December 31, 1998, the Company repurchased for cash a
total of 2,152 shares of Series C Preferred Stock. In addition, an aggregate of
2,290 shares of Series C Preferred Stock was converted into 2,534 shares of
common stock and 111 shares of common stock were issued in payment of dividends
that had accrued in respect of the 2,290 shares of Series C Preferred Stock that
were converted during the year.
During the year ended December 31, 1999, an aggregate of 1,710 shares of Series
C Preferred Stock was converted into 12,642 shares of common stock. In addition,
957 shares of common stock were issued in payment of dividends that had accrued
in respect of the 1,710 shares of Series C Preferred Stock that were converted
during the year.
During the year ended December 31, 2000, an aggregate of 2,075 shares of Series
C Preferred Stock was converted into 46,019 shares of common stock. In addition,
5,293 shares of common stock were issued in payment of dividends that had
accrued in respect of the 2,075 shares of Series C Preferred Stock that were
converted during the year.
In connection with the Recapitalization, the Company issued 120,000 shares of
common stock in exchange for the 2,173 shares of Series C Preferred Stock that
remained outstanding at the time plus the warrants. As of December 31, 2000,
there were no shares of Series C Preferred Stock or related stock purchase
warrants outstanding.
COMMON STOCK
During 1998, the Company completed the private placement of an aggregate of
34,013 shares of the Company's Common Stock for aggregate net proceeds of
approximately $26,980,000 (the Equity Offerings). In connection with the sale of
24,841 shares in the Equity Offerings, the Company granted certain common stock
reset rights (the Repricing Rights) for each share sold. Each Repricing Right
granted the holder the right to receive, in certain circumstances, additional
shares of common stock for no consideration. Additionally, warrants to purchase
an aggregate of 8,278 shares of the Company's common stock were granted to
purchasers of common stock.
During 1998, 15,860 shares of common stock were issued upon the exercise of
certain stock purchase warrants. The Company received aggregate net proceeds of
$7,000,000 from these exercises.
During 1998, the Company issued a total of 4,984 shares of common stock pursuant
to the exercise of 6,939 Repricing Rights. During 1999, the Company issued a
total of 19,245 shares of common stock pursuant to the exercise of 1,294
Repricing Rights. In 2000, the Company issued a total of 228,962 shares of
common stock pursuant to the exercise of 6,199 Repricing Rights.
F-18
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. STOCKHOLDERS' EQUITY (CONTINUED)
In connection with the Recapitalization, the holders of all remaining Repricing
Rights exchanged all their remaining Repricing Rights, together with all
outstanding warrants that had been issued as part of the Equity Offerings, for
an aggregate of 400,000 shares of common stock.
As of December 31, 2000, there were no Repricing Rights or stock purchase
warrants outstanding.
STOCK OPTIONS
<Table>
<Caption>
YEAR ENDED DECEMBER 31
---------------------------------------------------------------------
2000 1999 1998
--------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
-------- --------- ------- --------- ------- ---------
Outstanding at January 1 4,894 $1,071.04 4,894 $1,071.04 1,173 $ 819.00
Granted 732,500 7.01 -- -- 3,721 1,150.50
Exercised -- -- -- -- -- --
Canceled (4,894) 1,071.04 -- -- -- --
-------- ----- ----
Outstanding at December 31 732,500 $ 7.01 4,894 $1,071.04 4,894 $1,071.04
======== ===== =====
Exercisable options outstanding
at December 31 -- $ -- 640 $ 998.65 293 $ 819.00
======== ===== =====
</Table>
The weighted average grant date fair values of stock options granted during 2000
and 1998 were $2.10 and $971.88, respectively. The grant date fair values were
estimated at the date of grant using the Black-Scholes option pricing model. As
of December 31, 2000, the weighted average remaining contractual life of
outstanding stock options was 9.8 years.
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS 123), requires the disclosure of pro forma net income and
earnings per share information computed as if the Company had accounted for its
employee stock options under the fair value method set forth in SFAS 123. The
fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted average
assumptions, respectively: a risk-free interest rate of 5.75% and 6.00% during
2000 and 1998, respectively; a dividend yield of 0%; and a volatility factor of
0.256 and 0.792 during 2000 and 1998, respectively. In addition, the fair value
of these options was estimated based on an expected weighted average life of 4
years and 10 years during 2000 and 1998, respectively.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
F-19
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. STOCKHOLDERS' EQUITY (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31
--------------------------------------------
2000 1999 1998
----------- ------------- -------------
Pro forma net income/(loss) $22,797,000 $(12,573,000) $(74,674,000)
Basic income/(loss) per share $ 9.64 $ (58.41) $ (435.81)
Diluted income/(loss) per share $ 7.50 $ (58.41) $ (435.81)
</Table>
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company defines the fair value of a financial instrument as the amount at
which the instrument could be exchanged in a current transaction between willing
parties. The carrying value of accounts receivable, accounts payable and accrued
liabilities approximates fair value because of the short maturity of those
instruments. The estimated fair value of the Company's long-term obligations is
estimated based on the current rates offered to the Company for similar
maturities. At December 31, 2000, 1999 and 1998, the carrying value of long-term
obligations exceeded their fair values by approximately $14,500,000, $62,500,000
and $22,500,000, respectively. The estimated fair value of the Company's
derivative contracts at December 31, 2000 represented a net liability of
approximately $13,540,000.
8. RELATED PARTY TRANSACTIONS
The Company has entered into various hedging arrangements with affiliates of
Enron (Note 4).
The Company had entered into a revolving credit facility with ECT, an affiliate
of Enron. During the year ended December 31, 1998, commitment fees of
approximately $200,000 and interest totaling approximately $9,000 were paid to
ECT in connection with this facility. This agreement was terminated in October
1999.
Enron, through its affiliates, participated in indebtedness incurred in
connection with the acquisition of the Morgan Properties. During the year ended
December 31, 1999, Enron received interest payments of approximately $286,000
from the Company relating to such participation.
The Company paid Enron approximately $75,000 and $100,000 during the years ended
December 31, 2000 and 1999, respectively, under the terms of an agreement which
allows the Company to consult, among other things, with Enron's engineering
staff.
F-20
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. INCOME TAXES
The provision (benefit) for income taxes attributable to continuing operations
is as follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31
----------------------------------------
2000 1999 1998
----------- ----------- -----------
Current $ 782,000 $ -- $ --
Deferred (1,424,000) -- --
----------- ----------- -----------
$ (642,000) $ -- $ --
=========== =========== ===========
</Table>
The provision for income taxes differs from amounts computed at the statutory
federal income tax rate for the year ended December 31, 2000 as follows:
<Table>
Statutory income tax provision $ 716,000
State income taxes, net of federal benefit 63,000
Change in valuation allowance (1,221,000)
Utilization of net operating loss carryforwards (203,000)
Other, net 3,000
-----------
$ (642,000)
===========
</Table>
The Company's effective tax rate differs from the U.S. statutory rate for each
of the years ended December 31, 1999 and 1998 due to losses for which no
deferred tax benefit was recognized. The tax effects of the primary temporary
differences giving rise to the deferred federal income tax assets and
liabilities at December 31, 2000 and 1999, follow:
<Table>
<Caption>
2000 1999
------------ ------------
Deferred income tax assets (liabilities):
Unrealized derivative losses $ 5,097,000 $ --
Net operating loss carryforwards 8,116,000 21,576,000
Oil and gas properties, principally due to differences in
depreciation and amortization 212,000 3,438,000
Other (3,000) (76,000)
------------ ------------
13,422,000 24,938,000
Less valuation allowance (12,201,000) (24,938,000)
------------ ------------
Net deferred income tax asset $ 1,221,000 $ --
============ ============
</Table>
The net changes in the total valuation allowance for the years ended December
31, 2000 and 1999 were a decrease and an increase of $12,737,000 and $3,000,000,
respectively. The Company's net operating loss carryforwards (NOLs) begin
expiring in 2018. The Company is limited to an annual utilization of its NOLs of
approximately $1,100,000 as a result of the Recapitalization. To the extent that
the Company utilizes in the future NOLs existing as of the date of the
Recapitalization but which were not recognized as deferred tax assets prior to
the Recapitalization, the benefit of the NOLs will be credited to additional
paid-in capital. During 2000, the Company utilized NOLs approximating $68,000
(tax effected), which was credited to additional paid-in capital.
F-21
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. INCOME TAXES (CONTINUED)
During 2000, NOLs of approximately $21,144,000 were used to offset taxable
income associated with the extraordinary gain recognized upon the retirement of
$75,000,000 of Notes (Note 4).
10. COMMITMENTS AND CONTINGENCIES
The Company is involved in certain disputes and other matters arising in the
normal course of business. Although the ultimate resolution of these matters
cannot be reasonably estimated at this time, management does not believe that
they will have a material adverse effect on the financial condition or results
of operations of the Company.
11. OIL AND GAS PRODUCING ACTIVITIES
The following tables set forth supplementary disclosures for oil and gas
producing activities in accordance with Statement of Financial Accounting
Standards No. 69.
RESULTS OF OPERATIONS FOR PRODUCING ACTIVITIES
The following sets forth certain information with respect to results of
operations from oil and gas producing activities for the years ended December
31, 2000, 1999 and 1998:
<Table>
<Caption>
2000 1999 1998
------------ ------------ ------------
Oil and gas sales $ 4,484,000 $ 3,625,000 $ 5,852,000
Net profits and royalty interests revenues 31,507,000 21,955,000 15,947,000
Production expenses (1,727,000) (1,622,000) (4,326,000)
Depreciation and amortization (8,560,000) (9,281,000) (10,749,000)
Write-down of oil and gas properties -- -- (63,199,000)
------------ ------------ ------------
Results of operations (excludes corporate
overhead and interest expense) $ 25,704,000 $ 14,677,000 $(56,475,000)
============ ============ ============
</Table>
Depreciation and amortization of oil and gas properties was $0.78, $0.70, and
$0.85 per Mcfe produced for the years ended December 31, 2000, 1999 and 1998,
respectively.
The following table summarizes capitalized costs relating to oil and gas
producing activities and related amounts of accumulated depreciation and
amortization at December 31, 2000 and 1999:
<Table>
<Caption>
2000 1999
------------- -------------
Oil and gas properties - proved $ 191,204,000 $ 181,549,000
Accumulated depreciation and amortization (94,214,000) (85,771,000)
------------- -------------
Net capitalized costs $ 96,990,000 $ 95,778,000
============= =============
</Table>
F-22
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. OIL AND GAS PRODUCING ACTIVITIES (CONTINUED)
COSTS INCURRED
The following sets forth certain information with respect to costs incurred,
whether expensed or capitalized, in oil and gas activities for the years ended
December 31, 2000, 1999 and 1998:
<Table>
<Caption>
2000 1999 1998
------------ ------------- ------------
Property acquisition costs $ -- $ -- $141,262,000
============ ============= ============
Development costs $ 13,043,000 $ 7,494,000 $ 12,699,000
============ ============= ============
</Table>
12. SUPPLEMENTARY OIL AND GAS DATA (UNAUDITED)
RESERVE QUANTITY INFORMATION
The following table presents the Company's estimate of its proved oil and gas
reserves, all of which are located in the United States. The Company emphasizes
that reserve estimates are inherently imprecise and that estimates of new
discoveries are more imprecise than those of producing oil and gas properties.
Accordingly, the estimates are expected to change as future information becomes
available. The estimates at December 31, 1999 and 2000 have been prepared by
independent petroleum reservoir engineers. The estimates at December 31, 1997
and 1998 have been prepared by the Company's petroleum engineers.
<Table>
<Caption>
OIL (Bbls) GAS (Mcf)
------------ ------------
Proved reserves:
Balance at December 31, 1997 7,115,000 20,979,000
Purchases of minerals in place 3,579,000 160,913,000
Revisions of previous estimates and other (3,334,000) 44,000
Production 481,000 9,931,000
------------ ------------
Balance at December 31, 1998 6,879,000 172,005,000
Sales of minerals in place (2,735,000) (18,243,000)
Revisions of previous estimates and other 648,000 (2,323,000)
Production 339,000 11,441,000
------------ ------------
Balance at December 31, 1999 4,453,000 139,998,000
Sales of minerals in place (1,000) (7,035,000)
Revisions of previous estimates and other (2,875,000) 6,610,000
Production 216,000 9,797,000
------------ ------------
Balance at December 31, 2000 1,361,000 129,776,000
============ ============
Proved developed reserves:
Balance at December 31, 1997 2,352,000 12,566,000
============ ============
Balance at December 31, 1998 4,317,000 120,373,000
============ ============
Balance at December 31, 1999 1,937,000 86,044,000
============ ============
Balance at December 31, 2000 1,253,000 84,669,000
============ ============
</Table>
F-23
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. SUPPLEMENTARY OIL AND GAS DATA (UNAUDITED) (CONTINUED)
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO PROVED OIL
AND GAS RESERVES
The Standardized Measure of Discounted Future Net Cash Flows Relating to Proved
Oil and Gas Reserves (Standardized Measure) is a disclosure requirement under
Statement of Financial Accounting Standards No. 69.
The Standardized Measure of discounted future net cash flows does not purport to
be, nor should it be interpreted to present, the fair value of the Company's oil
and gas reserves. An estimate of fair value would also take into account, among
other things, the recovery of reserves not presently classified as proved, the
value of unproved properties and consideration of expected future economic and
operating conditions.
Under the Standardized Measure, future cash flows are estimated by applying
year-end prices, adjusted for fixed and determinable escalations, to the
estimated future production of year-end proved reserves. Future cash inflows are
reduced by estimated future production and development costs based on period-end
costs to determine pretax cash inflows. Future income taxes are computed by
applying the statutory tax rate to the excess of pretax cash inflows over the
Company's tax basis in the associated properties. Tax credits, net operating
loss carryforwards and permanent differences are also considered in the future
tax calculation. Future net cash inflows after income taxes are discounted using
a 10% annual discount rate to arrive at the Standardized Measure.
The Standardized Measure of discounted future net cash flows relating to proved
oil and gas reserves as of December 31, 2000 and 1999, is as follows:
<Table>
<Caption>
2000 1999
--------------- ---------------
Future cash inflows $ 1,451,177,000 $ 435,370,000
Future costs and expenses:
Production expenses (223,812,000) (133,463,000)
Development costs (21,441,000) (24,984,000)
Future income taxes (370,200,000) (30,500,000)
--------------- ---------------
Future net cash flows 835,724,000 246,423,000
10% annual discount for estimated timing of cash flows (465,502,000) (129,744,000)
--------------- ---------------
Standardized Measure of discounted future net cash flows $ 370,222,000 $ 116,679,000
=============== ===============
</Table>
F-24
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. SUPPLEMENTARY OIL AND GAS DATA (UNAUDITED) (CONTINUED)
Changes in the Standardized Measure of discounted future net cash flows relating
to proved oil and gas reserves for the years ended December 31, 2000, 1999 and
1998 are as follows:
<Table>
<Caption>
2000 1999 1998
------------- ------------- -------------
Beginning balance $ 116,679,000 $ 108,287,000 $ 28,111,000
Purchases of minerals in place -- -- 135,418,000
Sales of minerals in place (12,953,000) (16,035,000) --
Developed during the period 13,043,000 7,494,000 12,699,000
Net change in prices and costs 501,474,000 62,102,000 (70,744,000)
Revisions of previous estimates (74,940,000) (21,368,000) 6,665,000
Accretion of discount 11,668,000 10,829,000 2,811,000
Net change in income taxes (150,485,000) (10,672,000) 10,800,000
Sales of oil and gas produced, net of
production expenses (34,264,000) (23,958,000) (17,473,000)
============= ============= =============
Balance at December 31 $ 370,222,000 $ 116,679,000 $ 108,287,000
============= ============= =============
</Table>
The weighted average prices of oil and gas used in calculating the Standardized
Measure at December 31, 2000, 1999 and 1998 were as follows:
<Table>
<Caption>
2000 1999 1998
-------- -------- --------
Natural gas (Per MCF) $ 10.92 $ 2.35 $ 1.84
Oil (per Bbl) $ 25.88 $ 23.91 $ 10.79
</Table>
The future cash flows shown above for 2000 include amounts attributable to
proved undeveloped reserves requiring approximately $20,648,000 of future
development costs. If these reserves are not developed, the future net cash
flows shown above would be significantly reduced.
Estimates of economically recoverable oil and natural gas reserves and of future
net revenues are based upon a number of variable factors and assumptions, all of
which are to some degree speculative and may vary considerably from actual
results. Therefore, actual production, revenues, taxes, development and
operating expenditures may not occur as estimated. The reserve data are
estimates only, are subject to many uncertainties and are based on data gained
from production histories and on assumptions as to geologic formations and other
matters. Actual quantities of oil and natural gas may differ materially from the
amounts estimated.
F-25
DEVX ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
<Table>
<Caption>
2000
------------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
------------ ------------ ------------ ------------
Total revenues $ 6,673,000 $ 8,231,000 $ 10,276,000 $ 10,901,000
Operating income $ 6,101,000 $ 7,709,000 $ 9,812,000 $ 10,732,000
Income (loss) before extraordinary
item and cumulative effect of
accounting change $ (1,618,000) $ 190,000 $ 1,377,000 $ 2,704,000
Extraordinary gain $ -- $ -- $ 21,144,000
Cumulative effect of accounting
change, net of tax $ -- $ -- $ 413,000 $ --
Net income (loss) $ (1,618,000) $ 190,000 $ 1,790,000 $ 23,848,000
Income (loss) before extraordinary
item and cumulative effect of
accounting change per common share
$ (5.59) $ 0.15 $ 0.83 $ 0.30
Net income (loss) per common share $ (5.59) $ 0.15 $ 1.08 $ 2.69
</Table>
<Table>
<Caption>
1999
------------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
------------ ------------ ------------ ------------
Total revenues $ 6,734,000 $ 6,986,000 $ 5,543,000 $ 6,653,000
Operating income $ 6,015,000 $ 6,363,000 $ 5,385,000 $ 6,533,000
Loss before extraordinary item $ (1,977,000) $ (2,183,000) $ (2,242,000) $ (4,258,000)
Extraordinary loss $ -- $ -- $ -- $ (1,130,000)
Net loss $ (1,977,000) $ (2,183,000) $ (2,242,000) $ (5,388,000)
Loss before extraordinary item per
common share $ (0.06) $ (0.07) $ (0.07) $ (0.12)
Net loss per common share $ (0.06) $ (0.07) $ (0.07) $ (0.15)
</Table>
F-26