1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
----------------------------
(Mark One)
/X/ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 1999 or
/ / Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Transition period from to
--------------------------
COMMISSION FILE NUMBER 0-13305
--------------------------
PARALLEL PETROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 75-1971716
(State of other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
One Marienfeld Place, Suite 465,
Midland, Texas 79701
(Address of principal executive offices) (Zip Code)
(915) 684-3727
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changed since last report)
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
At November 1, 1999, there were 18,331,858 shares of the Registrant's
Common Stock, $0.01 par value, outstanding.
================================================================================
2
INDEX
PART I. - FINANCIAL INFORMATION
Page No.
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Reference is made to the succeeding pages for the
following financial statements:
- Consolidated Balance Sheet as of December 31, 1998 and
September 30, 1999 (unaudited) 3
- Unaudited Consolidated Statements of Operations
for the three months ended September 30, 1998 and 1999
and nine months ended September 30, 1998 and 1999 5
- Unaudited Consolidated Statements of Cash Flows for
the nine months ended September 30, 1998 and 1999 6
- Notes to Consolidated Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 21
PART II. - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 22
3
PARALLEL PETROLEUM CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, September 30, 1999
ASSETS 1998* (Unaudited)
- ------------- ------------ -----------------
Current assets:
Cash and cash equivalents $ 1,178,819 $ 1,175,419
Accounts receivable:
Oil and gas 1,432,659 2,002,115
Others, net of allowance for doubtful accounts
of $71,358 in 1998 and 1999 247,740 587,989
Affiliate 11,844 608
------------ ------------
1,692,243 2,590,712
Other assets 61,504 22,248
Assets held for sale (Note 2) 3,825,000
------------ ------------
Total current assets 2,932,566 7,613,379
------------ ------------
Property and equipment, at cost:
Oil and gas properties, full cost method 65,565,466 84,281,470
Other 287,586 316,821
------------ ------------
65,853,052 84,598,291
Less accumulated depreciation and depletion 22,279,355 25,208,704
------------ ------------
Net property and equipment 43,573,697 59,389,587
------------ ------------
Other assets, net of accumulated amortization of
$86,917 in 1998 and $117,623 in 1999 58,519 345,356
------------ ------------
$ 46,564,782 $ 67,348,322
============ ============
4
PARALLEL PETROLEUM CORPORATION
CONSOLIDATED BALANCE SHEETS
(Continued)
December 31, September 30, 1999
LIABILITIES AND STOCKHOLDERS' EQUITY 1998* (Unaudited)
- ------------------------------------ ---------- ------------------
Current liabilities:
Accounts payable and accrued liabilities:
Current portion of affiliate's long-term
debt (Note 5) $ -- $ 675,000
Subordinated notes payable (Note 6) -- 3,600,000
Trade 2,803,539 2,359,833
Affiliate 214 1,242
Preferred stock dividend -- 170,537
------------ ------------
Total current liabilities 2,803,753 6,806,612
------------ ------------
Long-term debt:
Bank credit facility (Note 5) 18,035,889 18,815,889
Proportionate share of affiliate's long-
term debt, net of current portion(Note 5) -- 15,975,000
------------ ------------
Total long-term debt 18,035,889 34,790,889
Deferred income taxes -- --
Stockholders' equity:
Preferred stock 6% convertible preferred stock
par value $.10 per share(aggregate liquidation
preference of $10) authorized 10,000,000 shares,
issued and outstanding 974,500 in 1998 and 1999 97,450 97,450
Common stock - par value $.01 per share, authorized
60,000,000 shares, issued and outstanding
18,306,858 in 1998 and 18,331,858 in 1999 183,069 183,319
Additional paid-in surplus 32,341,971 31,896,022
Retained deficit (6,897,350) (6,425,970)
------------ ------------
Total stockholders' equity 25,725,140 25,750,821
Contingencies
------------ ------------
$ 46,564,782 $ 67,348,322
============ ============
*The balance sheet as of December 31, 1998 has been derived from Parallel's
audited financial statements. The accompanying notes are an integral part of
these financial statements.
5
PARALLEL PETROLEUM CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine months Ended
September 30, September 30,
---------------------- ----------------------
1998 1999 1998 1999
---------- --------- ---------- ----------
Oil and gas revenues $2,540,809 $3,792,755 $7,106,512 $7,747,572
---------- ---------- ---------- ----------
Cost and expenses:
Lease operating expense 622,205 1,065,158 1,792,895 2,130,123
General and administrative 227,865 301,761 647,371 725,908
Depreciation, depletion
and amortization 1,114,438 1,067,700 3,108,721 2,928,494
---------- ---------- ---------- ----------
1,964,508 2,434,619 5,548,987 5,784,525
---------- ---------- ---------- ----------
Operating income 576,301 1,358,136 1,557,525 1,963,047
---------- ---------- ---------- ----------
Other income (expense), net:
Interest income 403 10,761 873 37,732
Other income 8,226 116,621 59,337 129,850
Interest expense (396,682) (883,321) (1,042,777) (1,630,449)
Other expense (2,687) (26,290) (11,264) (28,800)
---------- ---------- ---------- ----------
Total other expense, net (390,740) (782,229) (993,831) (1,491,667)
---------- ---------- ---------- ----------
Income before income taxes 185,561 575,907 563,694 471,380
Income tax expense deferred 61,269 -- 185,964 --
---------- ---------- ---------- ----------
Net income $ 124,292 $ 575,907 $ 377,730 $ 471,380
========== ========== ========== ==========
Cumulative preferred stock dividend $ 90,000 $ 146,175 $ 173,000 $ 462,887
========== ========== ========== ==========
Net income available
to common stockholders $ 34,292 $ 429,732 $ 204,730 $ 8,493
========== ========== ========== ==========
Net income per common share
Basic $ .002 $ .023 $ .011 $ .0005
========== ========== ========== ==========
Diluted $ .002 $ .023 $ .011 $ .0005
========== ========== ========== ==========
Weighted average common shares
Outstanding - basic 18,381,967 18,331,858 18,207,852 18,329,759
========== ========== ========== ==========
Outstanding - diluted 18,756,045 18,505,647 18,751,500 18,468,642
========== ========== ========== ==========
The accompanying notes are an integral part of these financial statements.
6
PARALLEL PETROLEUM CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months Ended September 30,
1998 1999
---------- ----------
Cash flows from operating activities:
Net income $ 377,730 $ 471,380
Adjustments to reconcile net income to net cash
Provided by (used in) operating activities:
Depreciation, depletion and amortization 3,108,721 2,928,494
Incomes taxes 185,964 --
Other, net (4,531) (286,837)
Changes in assets and liabilities:
Decrease (increase) in trade receivables 16,622 (898,469)
(Increase) decrease in prepaid expenses and other (61,201) 39,256
Increase (decrease) in accounts payable and accrued
liabilities 612,545 (272,141)
Increase in current portion of affiliate
long-term debt -- 675,000
Increase in subordinated notes payable -- 3,600,000
----------- -----------
Net cash provided by operating activities 4,235,850 6,256,683
----------- -----------
Cash flows from investing activities:
Additions to property and equipment (17,353,375) (23,004,615)
Proceeds from disposition of property
and equipment 883,144 435,231
----------- -----------
Net cash used in investing activities (16,470,231) (22,569,384)
----------- -----------
Cash flows from financing activities:
Proceeds from the issuance of long-term debt 14,307,390 16,755,000
Payment of long-term debt (8,584,000) --
Proceeds from exercise of options and warrants 70,625 17,188
Stock offering costs (80,851) --
Proceeds from common stock issuance -- --
Proceeds from preferred stock issuance 6,000,000 --
Payment of preferred stock dividend (68,000) (462,887)
----------- -----------
Net cash provided by financing activities 11,645,164 16,309,301
----------- -----------
Net increase (decrease) in cash
and cash equivalents (589,217) (3,400)
Beginning cash and cash equivalents 597,149 1,178,819
----------- -----------
Ending cash and cash equivalents $ 7,932 $ 1,175,419
=========== ===========
Non-cash financing activities:
Accrued preferred stock dividend $ -- $ 170,537
=========== ===========
The accompanying notes are an integral part of these financials.
7
PARALLEL PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation
Parallel's proportionate share of the assets, liabilities, revenues and
expenses of an affiliated limited liability company are included in the
accompanying consolidated financial statements. On June 25, 1999, we acquired a
22.5% interest in First Permian, LLC, a Delaware limited liability company.
Subsequently, on June 30, 1999, First Permian merged with a wholly owned
subsidiary of Fina Oil and Chemical Company. The assets acquired by First
Permian in the merger consisted primarily of producing oil and gas properties in
the Permian Basin of west Texas. The transaction was accounted for by the
purchase method of accounting for business combinations. Accordingly, the
accompanying consolidated financial statements before July 1, 1999 do not
include any revenues or expenses associated with our 22.5% interest in First
Permian. See Note 3 to Consolidated Financial Statements.
The financial information included herein, with the exception of the
balance sheet as of December 31, 1998, is unaudited. However, such information
includes all adjustments (consisting solely of normal recurring adjustments)
which are, in the opinion of management, necessary for a fair statement of the
results of operations for the interim periods. The results of operations for the
interim period are not necessarily indicative of the results to be expected for
an entire year.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted in this Form 10-Q Report pursuant to certain
rules and regulations of the Securities and Exchange Commission. These
consolidated financial statements should be read in conjunction with the
financial statements and notes included in Parallel's 1998 Annual Report and
1998 Form 10-K.
NOTE 2. ASSETS HELD FOR SALE
In the normal course of business, we review opportunities for the possible
sale of certain non-core oil and gas properties. If the bids or offers submitted
are acceptable and consistent with our growth strategy, we may elect to sell the
property to raise additional capital. Likewise, we review opportunities for the
possible acquisition of oil and gas reserves. When possible acquisition
opportunities are consistent with our growth strategy, we may submit bids or
offers in amounts and with terms consistent with our growth strategy. Such
acquisitions would require additional financing.
Because of the protracted period of low prices and the resultant negative
effect on cash flows and our line of credit, a part of our longer term business
strategy is to sell certain non-core assets, which may include producing oil and
gas properties, undeveloped leasehold acreage and other assets, to raise
additional capital and reduce debt. Accordingly, we have classified the basis in
these assets as assets held for sale within the balance sheet.
NOTE 3. RECENT EVENTS
On November 12, 1999, we terminated the offering period for a private
placement of 2,000,000 shares of common stock. Stock Purchase Agreements
covering a total of 2,000,000 shares were received from 22 accredited investors
and eight unaccredited investors. The offering price of the stock was $1.60 per
share. After deducting estimated expenses in the amount of $27,000 payable by us
and sales commissions in the amount of $26,000 payable to Netherland Securities,
Inc. and $4,000 payable to Everen Securities, Inc., net proceeds are estimated
to be $3,143,000, of which approximately $1,500,000 million will be used to
reduce bank debt and the remaining amount will be used to fund capital
expenditures and for general corporate purposes. Upon issuance of the 2,000,000
shares of common stock, we will have 20,338,858 shares of common stock
outstanding. The private placement was made in reliance on the exemptions from
registration under the Securities Act of 1933 pursuant to Section 4 (2) and Rule
506 of Regulation D under the Securities Act.
On June 30, 1999, First Permian, LLC and a wholly owned subsidiary of Fina
Oil and Chemical Company consummated a cash merger. First Permian was the
8
surviving entity. The transaction was accounted for as a purchase. The assets
acquired consisted primarily of producing oil and gas properties located in the
Permian Basin of west Texas. After giving effect to purchase price adjustments,
First Permian paid to Fina cash in the aggregate amount of approximately $92.0
million.
First Permian is owned by Parallel, Baytech, Inc., Tejon Exploration
Company and Mansefeldt Investment Corporation. Baytech, Tejon and Mansefeldt are
privately held oil and gas companies. Parallel and Baytech are the managers of
First Permian and each owns a 22.5% membership interest. Tejon Exploration and
Mansefeldt Investment each own a 27.5% interest in First Permian. If certain
conditions are met regarding the prepayment of $16.0 million aggregate principal
amount of subordinated unsecured notes made by First Permian and payable to
Tejon and Mansefeldt, the proceeds of which were used to help finance the
acquisition, Parallel's interest in First Permian could increase to 37.5% for a
nominal fee per membership unit.
The purchase was financed, in part, with the proceeds of the revolving
credit facility provided by Bank One, Texas, N.A. to First Permian. On June 30,
1999, Parallel and Baytech entered into a credit agreement with Bank One, Texas,
N.A. providing for a $110.0 million revolving credit facility. The principal
amount of the initial loan from Bank One was $74.0 million. Parallel's
obligation is limited to a guaranty of $10.0 million of the bank borrowings. See
Note 5 to Consolidated Financial Statements for further discussion of the credit
facility.
Additional financing for the cash merger was obtained through subordinated
debt borrowings, which included an $8.0 million loan from Tejon Exploration
Company and an additional $8.0 million loan from Mansefeldt Investment. The
terms of the subordinated debt and the effect on Parallel's balance sheet are
discussed in Note 6 to Consolidated Financial Statements.
NOTE 4. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Although Parallel has not entered into any derivative instruments or
hedging arrangements, First Permian uses swap agreements and other financial
instruments in an attempt to reduce the risk of fluctuating oil and gas prices
and interest rates. Effective July 1, 1999, a portion of the future crude oil
production associated with our proportionate interest in First Permian was
hedged against price risks through the use of swap contracts. Settlements on
price swap contracts are realized monthly, generally based upon the difference
between the contract price and the average closing NYMEX price and are reported
as a component of oil and gas revenues and operating cash flows in the period
realized.
Effective August 6, 1999, approximately 54% of the long term debt
associated with our proportionate share in First Permian was hedged against the
impact of interest rate changes through an interest rate swap agreement. The
principal amount of the swap agreement is $40 million, or $9 million net to our
interest. The agreement terminates on July 1, 2002. The terms of the agreement
provide for quarterly payments either to or from First Permian, determined by
whether the quarterly London Interbank Offered Rate (LIBOR) in effect at the
beginning of each quarterly calculation period is greater or less than 6.52%.
The calculation periods begin on the first day of each January, April, July and
October of each year during the term of the agreement, commencing on October 1,
1999. If, on the date of the beginning of the calculation period, the monthly
LIBOR exceeds 6.52%, Bank One, Texas, N.A. (the Lendor) will owe First Permian
the quarterly amount of the excess rate applied to $40 million. Alternatively,
if the monthly LIBOR rate on the applicable monthly date is less than 6.52%,
First Permian will owe the Lender. The swap agreement is accounted for as a
hedge, with the amount which is either due to or from First Permian recorded as
a reduction or increase in interest expense.
NOTE 5. LONG TERM DEBT
Our long term debt at September 30, 1999 consisted of the following:
Revolving credit facility note payable to bank at the bank's
base lending rate plus .25% (8.5% at September 30, 1999) $18,815,889
Affiliate debt: Parallel's proportionate share (22.5%) of
the First Permian, LLC revolving credit facility note
payable to bank at bank's base lending rate
plus 1.5% (9.75% at September 30, 1999) 16,650,000
-----------
$35,465,889
Less: Parallel's proportionate share of current
maturities of affiliate debt 675,000
-----------
Total long term debt $34,790,889
===========
9
Scheduled maturities of Parallel's debt and our proportionate share of
affiliate's debt at September 30, 1999 are as follows:
2000 $ 675,000
2001 19,490,889
2002 15,300,000
-------------
$ 35,465,889
=============
Revolving Credit Facility. At September 30, 1999, Parallel was a party to a
loan agreement with Bank One, Texas, N.A. which provides for a revolving credit
facility (the "Revolving Facility") under which we may borrow up to the lesser
of $30,000,000 or the "borrowing base" then in effect. The borrowing base in
effect at September 30, 1999 was $18,815,889. The borrowing base was subject to
reduction by a monthly commitment reduction of $380,000. However, effective
March 23, 1999, the monthly commitment reduction was suspended by the bank until
May 1, 1999 at which time the borrowing base and monthly commitment reduction
were scheduled for redetermination. The loan agreement provides for a
redetermination of the borrowing base and monthly commitment reduction every six
months on April 1 and October 1 of each year or at such other times as the bank
elects. As of the date of this Form 10-Q Report, we had not received from the
bank the redetermined borrowing base or monthly reduction amount. At September
30, 1999, we had borrowed all the funds currently available under the Revolving
Facility. All indebtedness under the Revolving Facility matures July 1, 2001.
The loan is secured by substantially all of our oil and gas properties.
Commitment fees of .25% per annum on the difference between the commitment and
the average daily amount outstanding are due quarterly.
The unpaid principal balance of the Revolving Facility bears interest at
our election at a rate equal to (i) the bank's base lending rate plus .25% or
(ii) the bank's Eurodollar rate plus a margin of 2.5%. Interest under the
Revolving Facility is due and payable monthly. At September 30, 1999, the
interest rate was the bank's base rate plus .25% or 8.5%.
The loan agreement contains various restrictive covenants and compliance
requirements, which include (1) maintenance of certain financial ratios, (2)
limiting the incurrence of additional indebtedness, (3) prohibiting payment of
dividends on common stock, and (4) prohibiting the payment of dividends on
preferred stock when an event of default under the loan agreement is in
existence.
Long Term Debt of Affiliate. On June 30, 1999, Parallel, Baytech and First
Permian entered into a credit agreement, dated as of June 30, 1999, with Bank
One, Texas, N.A. that established a $110.0 million revolving credit facility to
finance, in part, the merger of a subsidiary of Fina Oil and Chemical Company
with and into First Permian. The principal amount of the initial loan from Bank
One was $74.0 million. Under terms of the credit agreement, as restated on
August 16, 1999, the principal amount outstanding under the revolving credit
facility bears interest, at First Permian's election, at Bank One's base rate
plus 1.50% or the Eurodollar rate plus 3.25% until such time that subordinated
debt in the principal amount of $16.0 million has been paid in full. When these
subordinated unsecured loans have been paid in full, amounts outstanding under
the revolving credit facility will bear interest at Bank One's base rate plus a
margin ranging from .25% to .75%, depending upon the principal amount then
outstanding, or the Eurodollar rate plus a margin ranging from 2.00% to 2.50%,
depending upon the principal amount then outstanding.
The credit facility provides for revolving loans subject to a borrowing
base and a monthly commitment reduction. The initial borrowing base is $74.0
million and the initial monthly commitment reduction amount is $250,000. The
monthly commitment reduction commenced on October 1, 1999 and continues with a
like reduction on the first day of each following month. The borrowing base and
the monthly commitment reduction amount may be redetermined by the bank on
January 1 and July 1 of each year or at other times requested by First Permian.
All outstanding principal under the revolving credit facility is due and payable
on July 1, 2002. Interest is payable on the last day of each month. The loan is
secured by substantially all of the oil and gas properties First Permian
acquired from Fina Oil and Chemical Company. Parallel and Baytech each
guaranteed $10.0 million of the loans from Bank One. Our proportionate share of
First Permian's long term debt is $16,650,000.
OTE 6. AFFILIATE SUBORDINATED UNSECURED LOANS
10
NOTE 6. AFFILIATE SUBORDINATED UNSECURED LOANS
In addition to the $74.0 million loan from Bank One, First Permian borrowed
$8.0 million from Tejon Exploration Company and $8.0 million from Mansefeldt
Investment Corporation to help finance the acquisition of oil and gas properties
from Fina Oil and Chemical Company. Under terms of an Intercreditor Agreement,
dated June 30, 1999, the loans made by Tejon and Mansefeldt are unsecured and
subordinate in all respects to the senior loans made by Bank One.
Each subordinated loan requires a principal payment of $2.5 million on
December 31, 1999 and $5.5 million on September 30, 2000. Principal payments on
the subordinated loans can only be made with proceeds from the issuance of First
Permian's equity securities; advances under First Permian's revolving credit
facility (if the borrowing base is greater than $74.0 million); proceeds from
the sale of First Permian's assets with the prior consent of Bank One; and any
other source of payment with Bank One's prior consent. Our proportionate share
of the subordinated debt is $3.6 million and is reflected in our September 30,
1999 consolidated balance sheet as subordinated notes payable.
NOTE 7. PREFERRED STOCK
We have outstanding 974,500 shares of 6% Convertible Preferred Stock, $0.10
par value per share. Cumulative annual dividends of $0.60 per share are payable
semi-annually on June 15 and December 15 of each year. Each share of Preferred
Stock may be converted, at the option of the holder, into 2.8571 shares of
common stock at an initial conversion price of $3.50 per share, subject to
adjustment in certain events. The preferred stock has a liquidation preference
of $10 per share and has no voting rights, except as required by law. We may
redeem the preferred stock, in whole or part, for $10 per share plus accrued and
unpaid dividends.
NOTE 8. FULL COST CEILING TEST
We use the full cost method to account for our oil and gas producing
activities. Under the full cost method of accounting, the net book value of oil
and gas properties, less related deferred income taxes, may not exceed a
calculated "ceiling." The ceiling limitation is the discounted estimated
after-tax future net revenues from proved oil and gas properties. In calculating
future net revenues, current prices and costs are generally held constant
indefinitely. The net book value, less related deferred income taxes, is
compared to the ceiling on a quarterly and annual basis. Any excess of the net
book value, less related deferred income taxes, is generally written off as an
expense. Under rules and regulations of the SEC, the excess above the ceiling is
not written off if, subsequent to the end of the quarter or year but prior to
the release of the financial results, prices increased sufficiently such that an
excess above the ceiling would not have existed if the increased prices were
used in the calculations.
During the fourth quarter of 1998, we recognized a non-cash impairment
charge of $15.0 million, or $12.0 million net of tax, related to our oil and gas
reserves and unproved properties. The impairment of oil and gas assets was
primarily the result of the effect of significantly lower oil and natural gas
prices on both proved and unproved oil and gas properties. At September 30,
1999, our net book value of oil and gas, less related deferred income taxes, was
below the calculated ceiling. As a result, we were not required to record a
reduction of our oil and gas properties under the full cost method of
accounting.
NOTE 9. NET INCOME PER COMMON SHARE
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("FAS 128"). FAS
128 replaced the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants and
convertible securities and is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding for the
period. Diluted earnings per share is computed similarly to the previously
reported fully diluted earnings per share and reflects the assumed conversion of
all potentially dilutive securities.
11
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1999 1998 1999
---------- ---------- ---------- ----------
Basic EPS Computation:
Numerator
Net income $ 124,292 $ 575,907 $ 377,730 $ 471,380
Preferred stock dividends (90,000) (146,175) (173,000) (462,887)
---------- ---------- ---------- ----------
Net income available to common Stockholders 34,292 429,732 204,730 8,493
========== ========== ========== ==========
Denominator -
Weighted average common shares outstanding 18,381,967 18,331,858 18,207,852 18,329,759
---------- ---------- ---------- ----------
Basic EPS $ 0.002 $ .023 $ 0.011 $ .0005
========== ========== ========== ==========
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1999 1998 1999
---------- ---------- ---------- -----------
Diluted EPS Computation:
Numerator
Net income $ 124,292 $ 575,907 $ 377,730 $ 471,380
Preferred stock dividends (90,000) (146,175) (173,000) (462,887)
---------- ---------- ---------- ----------
Net income available to common stockholders 34,292 429,732 204,730 8,493
========== ========== ========== ==========
Denominator -
Weighted average common shares outstanding 18,381,967 18,331,858 18,207,852 18,329,759
Employee 370,530 173,789 537,307 138,883
Warrants 3,548 -- 6,341 --
---------- ---------- ---------- ----------
18,756,045 18,505,647 18,751,500 18,468,642
========== ========== ========== ==========
Diluted EPS $ 0.002 $ .023 $ 0.011 $ .0005
========== ========== ========== ==========
Convertible preferred stock equivalents of 974,500 shares for the three-
and nine-month periods ended September 30, 1999, that could potentially dilute
basic earnings per share in the future, was not included in the computation of
diluted earnings per share for the periods presented because to do so would have
been antidilutive.
NOTE 10: RECENTLY ANNOUNCED ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities" which establishes standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. It establishes conditions
under which a derivative may be designated as a hedge, and establishes standards
for reporting changes in the fair value of a derivative. SFAS No. 133 is
required to be implemented for the first quarter of the fiscal year ended 2000.
Early adoption is permitted. Recently, the FASB deferred the implementation
requirements of SFAS No. 133 for one year. We have not evaluated the effects of
implementing SFAS No. 133.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
In addition to historical information contained herein, this Form 10-Q
Report contains forward-looking statements subject to various risks and
uncertainties that could cause our actual results to differ materially from
those in the forward- looking statements. Forward-looking statements can be
identified by the use of forward-looking terminology such as "may," "will,"
"expect," "intend," "anticipate," "estimate," "continue," "present value,"
"future," "reserves" or other variations thereof or comparable terminology.
Factors, that could cause or contribute to such differences could include, but
are not limited to, those relating to our growth strategy, outstanding
indebtedness, changes in interest rates, dependence on weather conditions,
seasonality, expansion and other activities of competitors, changes in federal
or state environmental laws and the administration of such laws, and the general
condition of the economy and its effect on the securities market. While we
believe our forward- looking statements are based upon reasonable assumptions,
there are factors that are difficult to predict and that are influenced by
economic and other conditions beyond our control. Investors are directed to
consider such risks and other uncertainties discussed in documents filed by
Parallel with the SEC.
The following discussion and analysis should be read in conjunction with
our Financial Statements and the related notes.
OVERVIEW
Our business strategy is to increase oil and gas reserves, production, cash
flow and earnings through:
. using 3-D seismic and other advanced technologies to conduct our
exploratory activities;
. investing in high-potential exploration prospects;
. acquiring producing properties we believe can add incremental value;
. exploiting our existing producing properties;
. emphasizing cost controls; and
. positioning for opportunity.
As part of this business strategy, we have discovered oil and gas reserves
using 3-D seismic technology in the Horseshoe Atoll Reef Trend of west Texas and
the Yegua/Frio Gas Trend onshore the Gulf Coast of Texas. Additionally, we have
acquired oil and gas producing properties in the Permian Basin of west Texas.
Capital utilized to acquire such reserves has been provided primarily by secured
bank financing, sales of our equity securities and cash flow from operations.
Property Acquisitions. Our most recent property acquisition occurred on
June 30, 1999. As described in Note 3 to Consolidated Financial Statements, we
joined with three privately held oil and gas companies to acquire oil and gas
properties from Fina Oil and Chemical Company. The acquisition was effected
through the formation of First Permian, which entered into a cash merger with a
wholly owned subsidiary of Fina Oil and Chemical Company. The primary assets of
the acquired subsidiary are oil and gas reserves and associated assets in
producing fields located in the Permian Basin of west Texas. After giving effect
to purchase price adjustments, First Permian paid to Fina Oil and Chemical
Company cash in the aggregate amount of approximately $92.0 million. Our pro
rata share of the book value of the assets acquired through the cash merger was
approximately $20.0 million
First Permian is owned by Parallel, Baytech, Inc., Tejon Exploration
Company and Mansefeldt Investment Corporation. Baytech, Tejon and Mansefeldt are
privately held oil and gas companies. Parallel and Baytech are the managers of
First Permian and each owns a 22.5% membership interest. Tejon Exploration and
Mansefeldt Investment each own a 27.5% interest in First Permian. If certain
conditions are met regarding the prepayment of $16.0 million aggregate principal
amount of subordinated unsecured notes made by First Permian and payable to
Tejon and Mansefeldt, the proceeds of which were used to help finance the
acquisition, Parallel's interest in First Permian could increase to 37.5% for a
nominal fee per membership unit.
The purchase was financed, in part, with the proceeds of a $110.0 million
revolving credit facility provided by Bank One, Texas, N.A. to First Permian.
The principal amount of the initial loan was $74.0 million. The terms of First
Permian's revolving credit facility are discussed in Note 5 to Consolidated
Financial Statements. In addition, First Permian also borrowed $8.0 million from
13
Tejon Exploration Company and $8.0 million from Mansefeldt Investment
Corporation to help finance the purchase. The terms of First Permian's
subordinated unsecured loans are discussed in Note 6 to Consolidated Financial
Statements.
Operating Performance. Our operating performance is influenced by several
factors, the most significant of which are the prices we receive for our oil and
gas production volumes. The world price for oil has overall influence on the
prices we receive for our oil production. The prices received for different
grades of oil are based upon the world price for oil, which is then adjusted
based upon the particular grade. Typically, light oil is sold at a premium,
while heavy grades of crude are discounted. Gas prices we receive are primarily
influenced by seasonal demand, weather, hurricane conditions in the Gulf of
Mexico, availability of pipeline transportation to end users and proximity of
our wells to major transportation pipeline infrastructure and, to a lesser
extent, world oil prices. Additional factors influencing our operating
performance include production expenses, overhead requirements, and cost of
capital.
Our oil and gas exploration, development and acquisition activities require
substantial and continuing capital expenditures. Historically, the sources of
financing to fund our capital expenditures have included:
. cash flow from operations,
. sales of our equity securities, and
. bank borrowings.
Because of the sustained deterioration in prices we received for the oil
and gas we produced in 1998 and the first part of 1999, the capital normally
available to us from our cash flow and bank borrowings has been significantly
reduced. In January 1998, we were receiving approximately $17.00 per barrel of
oil and $2.70 per Mcf of gas for the oil and gas we produced. Since then, oil
prices have been as low as $10.00 per barrel. At January 1, 1999, we were
receiving approximately $10.50 per barrel of oil and $2.00 per Mcf of gas.
For the nine months ended September 30, 1999, the average sales price we
received for our crude oil production averaged $15.13 per barrel compared with
$13.25 per barrel at September 30, 1998 and $12.49 per barrel at December 31,
1998. The average sales price for natural gas during this same period was $2.08
per mcf compared with $2.20 per mcf at September 30, 1998 and $2.04 per mcf at
December 31, 1998.
Primarily because of sustained low oil and gas prices, which have adversely
affected the value of our proved oil and gas reserves, our available borrowing
capacity under our revolving credit facility was reduced from $21,000,000 to
$18,815,889. This means we have borrowed all the funds currently available under
our revolving credit agreement. We have reduced our drilling activities during
this period of reduced cash flow and restricted capital availability. If the
prices we receive for oil and gas production continue to improve, increasing
cash flow, or if we are successful in raising additional capital, drilling
activity may be accelerated.
Our oil and gas producing activities are accounted for using the full cost
method of accounting. Under this method, we capitalize all costs incurred in
connection with the acquisition of oil and gas properties and the exploration
for and development of oil and gas reserves. See Note 8 to Consolidated
Financial Statements. These costs include lease acquisition costs, geological
and geophysical expenditures, costs of drilling both productive and
non-productive wells, and overhead expenses directly related to land acquisition
and exploration and development activities. Proceeds from the disposition of oil
and gas properties are accounted for as a reduction in capitalized costs, with
no gain or loss recognized unless such disposition involves a material change in
reserves, in which case the gain or loss is recognized.
Depletion of the capitalized costs of oil and gas properties, including
estimated future development costs, is provided using the equivalent
unit-of-production method based upon estimates of proved oil and gas reserves
and production, which are converted to a common unit of measure based upon their
relative energy content. Unproved oil and gas properties are not amortized, but
are individually assessed for impairment. The cost of any impaired property is
transferred to the balance of oil and gas properties being depleted.
Our production and results of operations vary from quarter to quarter. We
expect our 1999 production volumes to increase significantly compared to our
production volumes in the prior year as a result of our 22.5% interest in First
Permian. Because we consolidate our proportionate share of the production
volumes from our membership interest in First Permian, we anticipate that this
will have a material positive effect on our production volumes for the remainder
of 1999. RESULTS OF OPERATIONS
14
Our business activities are characterized by frequent, and sometimes
significant, changes in our:
. sources of production;
. product mix (oil vs. gas volumes); and
. the prices we receive for our oil and gas production.
Year-to-year or other periodic comparisons of the results of our operations
can be difficult and may not accurately describe our condition. The following
table compares the results of operations on the basis of equivalent barrels of
oil ("EBO") for the period indicated. An EBO means one barrel of oil equivalent
using the ratio of six Mcf of gas to one barrel of oil.
THREE MONTHS ENDED THREE MONTHS ENDED
-------------------------------- ----------------------
3-31-99 6-30-99 9-30-99 9-30-98 9-30-99
--------- --------- --------- --------- ---------
>
Production and prices:
Oil (Bbls) 44,619 45,908 113,946 48,321 113,946
Natural gas (Mcf) 697,593 749,856 791,732 869,215 791,732
Equivalent barrels of oil(EBO) 160,884 170,884 245,902 193,190 245,902
Oil price (per Bbl) $12.18 $13.17 $17.07 $12.15 $17.07
Gas price (per Mcf) $ 2.03 $1.85 $2.33 $2.25 $2.33
Price per EBO $12.20 $11.66 $15.42 $13.15 $15.42
Results of operations per EBO
Oil and gas revenues $ 12.20 $ 11.66 $ 15.42 $ 13.15 $ 15.42
Costs and expenses:
Lease operating expense 3.19 3.23 4.33 3.22 4.33
General and administrative 1.26 1.29 1.23 1.18 1.23
Depreciation and depletion 5.62 5.60 4.34 5.77 4.34
------- ------- ------- ------- -------
Total costs and expenses 10.07 10.12 9.90 10.17 9.90
------- ------- ------- ------- -------
Operating income 2.13 1.54 5.52 2.98 5.52
------- ------- ------- ------- -------
Interest expense, net (2.22) (2.12) (3.55) (2.05) (3.55)
Other income, net .03 .03 .37 .03 .37
------- ------- ------- ------- -------
Pretax income (loss) (.06) (.55) 2.34 .96 2.34
Income tax benefit .00 .00 .00 .32 .00
------- ------- ------- ------- -------
Net income (loss) $ (.06) $ (.55) $ 2.34 $ .64 $ 2.34
------- ------- ------- ------- -------
Income before working
capital adjustments $ 5.56 $ 5.05 $ 6.68 $ 6.73 $ 6.68
======= ======= ======= ======= =======
The following table sets forth for the periods indicated the percentage of
total revenues represented by each item reflected on our statements of
operations.
15
NINE MONTHS ENDING
---------------------------
9-30-97 9-30-98 9-30-99
------- ------- -------
Production and prices:
Oil (Bbls) 133,924 136,180 204,473
Natural gas (Mcf) 2,632,460 2,407,751 2,239,181
Equivalent barrels of oil (EBO) 572,667 537,472 577,670
Oil price (per Bbl) $20.45 $13.25 $15.13
Gas price (per Mcf) $ 2.60 $ 2.20 $2.08
Price per EBO $16.72 $13.22 $13.41
Results of operations per EBO
Oil and gas revenues $16.72 $13.22 $13.41
Costs and expenses:
Lease operating expense 3.93 3.34 3.69
General and administrative .74 1.20 1.25
Depreciation and depletion 4.55 5.78 5.07
------- ------ ------
Total costs and expenses 9.22 10.32 10.01
------- ------ ------
Operating income 7.50 2.90 3.40
------- ------ ------
Interest expense, net (1.03) (1.94) (2.76)
Other expense .03 .09 .17
------ ------ ------
Pretax income 6.50 1.05 .81
Income tax expense deferred 2.15 .35 .00
------ ------ ------
Net income 4.35 .70 .81
====== ====== ======
Net cash flow before working
capital adjustments $11.05 $ 6.83 $ 5.88
====== ====== ======
The following table sets forth for the periods indicated the percentage of total
revenues represented by each item reflected on our statements of operations.
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------------- ------------------------
3-31-99 6-30-99 9-30-99 9-30-98 9-30-99
-------- -------- --------- --------- --------
Oil and gas revenues 100.0% 100.0% 100.0% 100.0% 100.0%
Costs and expenses:
Production costs 26.1 27.7 28.1 25.3 27.5
General and administrative 10.3 11.1 8.0 9.1 9.3
Depreciation, depletion and
amortization 46.0 48.0 28.1 43.7 37.8
------ ------ ------ ------ ------
Total costs and expenses 82.4 86.8 64.2 78.1 74.6
------ ------ ------ ------ ------
Operating income 17.6 13.2 35.8 21.9 25.4
------ ------ ------ ------ ------
Interest expense, net (18.2) (18.2) (23.0) (14.7) (20.6)
Other income, net .2 .2 2.4 .7 1.3
------ ------ ------ ------ ------
Pretax income (loss) (.4) (4.8) 15.2 7.9 6.1
Income tax (expense) benefit .0 .0 .0 2.6 .0
------ ------ ------ ------ ------
Net income (loss) (.4)% (4.8)% 15.2% 5.3% 6.1%
====== ====== ====== ====== ======
16
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1999:
The results of operations for the three-month period ended September 30,
1999 include three months of operations of First Permian. We own a 22.5%
interest in First Permian. The current year third quarter reflects the
consolidation of our proportionate share of the results of operations of First
Permian. The corresponding period in 1998 did not include any results of
operations of First Permian. Unless otherwise stated, the increases for the
three-month period ended September 30, 1999 are substantially the result of our
interest in First Permian.
Oil and Gas Revenues. Oil and gas revenues increased $1,251,947, or 49%, to
$3,792,756 for the three months ended September 30, 1999, from $2,540,809 for
the same period of 1998. The increase in revenues is primarily attributable to a
26% increase in production volumes. Contributing to the increase in revenues was
a 19% increase in the average sales price per EBO. We received $15.42 per EBO in
the three months ended September 30, 1999 compared with $13.15 per EBO for the
same period of 1998. Approximately 60% of the increase in revenues was
attributable to an increase in oil production volumes and approximately 40% of
the increase was attributable to higher oil and gas prices.
The oil and gas prices we report are based on the market price received for
the commodity adjusted by the results of hedging activities. From time to time,
through our interest in First Permian, we enter into commodity derivative
contracts to reduce the effects of price volatility. Approximately 72% of our
oil volumes for the three months ended September 30, 1999 were hedged at a net
price of $15.19 per barrel and 28% of our oil volumes were unhedged with an
effective price of $21.89 per barrel. The effect of hedging activities decreased
the average price we received for oil production by approximately $1.67 per
barrel, or approximately $90,000.
Production Costs. Production costs increased $442,954, or 71%, to
$1,065,159 during the third three months of 1999 compared with $622,205 for the
same period of 1998. Average production costs per EBO increased 34%, to $4.33,
for the third three months in 1999 compared with $3.22 for the same period in
1998.
General and Administrative Expenses. General and administrative expenses
increased by $73,896 or 32%, to $301,761 for the third three months of 1999,
from $227,865 for the same period of 1998. General and administrative expenses
were $1.23 per EBO in the third three months of 1999 compared with $1.18 per EBO
in the third three months of 1998.
Depreciation, Depletion and Amortization Expense. Depreciation, depletion
and amortization expense ("DD&A") decreased by $46,738, or 4%, to $1,067,700 for
the third three months of 1999 compared with $1,114,438 for the same period of
1998. As a percentage of revenues, the DD&A rate decreased by 24% when compared
with the prior year three months, a result of a non-cash impairment charge
incurred in the fourth quarter of 1998 that reduced our full cost pool and the
addition of our proportionate share of the production and reserves of First
Permian at June 30, 1999. The DD&A rate per EBO decreased to $4.34 for the three
months ended September 30, 1999 compared with $5.77 per EBO for the third three
months of 1998.
Historically, we have reviewed our estimates of proven reserve quantities
on an annual basis. However, due to the current uncertainty of oil and gas
prices, we conduct internal reviews of our estimated proven reserves on a more
frequent basis and make necessary adjustment to our DD&A rate accordingly. We
believe periodic reviews and adjustments, if necessary, will result in a more
accurate reflection of its DD&A rate during the year and minimize possible
year-end adjustments.
Net Interest Expense. Net interest expense increased $476,281, or 120%, to
$872,560 for the three months ended September 30, 1999, compared with $396,279
for the same period of 1998, due principally to borrowings against our revolving
line of credit during 1998 and the consolidation of our proportionate share of
the net interest expense of First Permian in 1999.
Net Income and Operating Cash Flow. Net income increased $451,615, or 363%,
to $575,907 for the three months ended September 30, 1999, compared with
$124,292 for the three months ended September 30, 1998. Operating cash flow
increased $343,608, or 26%, to $1,643,607 for the three months ended September
30, 1999 compared with $1,299,999 for the three months ended September 30, 1998.
17
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1999:
The results of operations for the nine-month period ended September 30,
1999 include three months of operations of First Permian. We own a 22.5%
interest in First Permian. The current nine-month period reflects the
consolidation of our proportionate share of the results of operations of First
Permian for the three months ended September 30, 1999. The corresponding
nine-month period in 1998 does not include any results of operations of First
Permian. Unless otherwise stated, the increases for the nine-month period ended
September 30, 1999 are substantially the result of this acquisition.
Oil and Gas Revenues. Oil and gas revenues increased $641,060, or 9%, to
$7,747,572 for the nine months ended September 30, 1999, from $7,106,512 for the
same period of 1998. The revenues increase is primarily attributable to a 7%
increase in production volumes and a 2% increase in the average sales price we
received per EBO. We received $13.41 per EBO in the nine months ended September
30, 1999 compared with $13.22 per EBO for the same period of 1998.
The oil and gas prices we report are based on the market price received for
the commodity adjusted by the results of hedging activities. From time to time,
through our interest in First Permian, we enter into commodity derivative
contracts to reduce the effects of price volatility. Approximately 40% of our
oil volumes for the nine months ended September 30, 1999 were hedged at a net
price of $15.19 per barrel and 60% of our oil volumes were unhedged with an
effective price of $15.09 per barrel. The effect of hedging activities increased
the average price we received for oil production by approximately $0.10 per
barrel, or approximately $20,000.
Production Costs. Production costs increased $337,227, or 19%, to
$2,130,122 during the first nine months of 1999, compared with $1,792,895 for
the same period of 1998. Average production costs per EBO increased 10%, to
$3.69 for the first nine months in 1999 compared with $3.34 for the same period
in 1998.
General and Administrative Expenses. General and administrative expenses
increased by $78,537, or 12%, to $725,908 for the first nine months of 1999,
from $647,371 for the same period of 1998. General and administrative expenses
were $1.25 per EBO in the first nine months of 1999 compared with $1.20 per EBO
in the first nine months of 1998.
Depreciation, Depletion and Amortization Expense. Depreciation, depletion
and amortization expense ("DD&A") decreased by $180,227, or 6%, to $2,928,494
for the first nine months of 1999 compared with $3,108,721 for the same period
of 1998. As a percentage of revenues, the DD&A rate decreased by 13% when
compared with the prior year nine months, a result of a non-cash impairment
charge incurred in the fourth quarter of 1998 that reduced our full cost pool
and the addition of our proportionate share of the production and reserves of
First Permian at June 30, 1999. The DD&A rate per EBO decreased to $5.07 for the
nine months ended September 30, 1999 compared with $5.78 per EBO for the first
nine months of 1998.
Historically, we have reviewed our estimates of proven reserve quantities
on an annual basis. However, due to the current uncertainty of oil and gas
prices, we conduct internal reviews of our estimated proven reserves on a more
frequent basis and make necessary adjustment to our DD&A rate accordingly. We
believe periodic reviews and adjustments, if necessary, will result in a more
accurate reflection of its DD&A rate during the year and minimize possible
year-end adjustments.
Net Interest Expense. Net interest expense increased $550,813 or 53%, to
$1,592,717 for the nine months ended September 30, 1999 compared with $1,041,904
for the same period of 1998, due principally to borrowings against our revolving
line of credit during 1998 and the consolidation of our proportionate share of
the net interest expense of First Permian in 1999.
Net Income and Operating Cash Flow. Net income increased $93,650 or 25%, to
$471,380 for the nine months ended September 30, 1999, compared with $377,730
for the nine months ended September 30, 1998. Operating cash flow decreased
$272,541, or 7%, to $3,399,874 for the nine months ended September 30, 1999
compared with $3,672,415 for the nine months ended September 30, 1998. The
increase in net income resulted from a 9% increase in oil and gas revenues, a 2%
increase in the average price we received per EBO and a 6% decrease in DD&A
expense. These increases were offset by a 56% increase in interest expense, a
19% increase in lease operating expenses and a 12% increase in general and
administrative expenses. Operating cash flow decreased primarily because of
lower DD&A expenses and the absence of deferred income taxes.
18
LIQUIDITY AND CAPITAL RESOURCES
Our cash flow is highly dependent on oil and gas prices. Decreases in the
market price of oil and gas in the prior 12 months have reduced cash flow and
also resulted in the reduction of our borrowing base under our bank credit
facility. These factors have decreased the funds available to us for capital
expenditures.
As described in Note 3 to Consolidated Financial Statements, we acquired a
22.5% membership interest in First Permian, LLC. On June 30, 1999, First Permian
acquired by cash merger a subsidiary of Fina Oil and Chemical Company. The
primary assets of the acquired subsidiary consist of oil and gas properties and
related assets in the Permian Basin of west Texas. We have elected to report our
interest in this entity using the proportional consolidated method of
accounting. As a result, our working capital increased as of September 30, 1999
compared with December 31, 1998. Current assets exceeded current liabilities by
$806,767 at September 30, 1999 compared with working capital of $128,813 at
December 31, 1998.
Current assets increased primarily because we classified $3,825,000 of the
book value of our oil and gas assets as assets held for sale. A part of our
longer term business strategy is to sell certain non-core assets, which may
include producing oil and gas properties, undeveloped leasehold acreage and
other assets, to raise additional capital and reduce debt. Current liabilities
increased primarily because of the consolidation of our proportionate share of
the liabilities of First Permian, which reflects the current portion of First
Permian's long term debt of $675,000 and subordinated notes payable of
$3,600,000.
In the normal course of business, we review opportunities for the possible
sale of certain non-core oil and gas properties. If the bids or offers submitted
are acceptable and consistent with our growth strategy, we may elect to sell the
property to raise additional capital. Likewise, we review opportunities for the
possible acquisition of oil and gas reserves. When possible acquisition
opportunities are consistent with our growth strategy, we may submit bids or
offers in amounts and with terms consistent with our growth strategy. Such
acquisitions would require additional financing.
We incurred net property costs of $22,569,384 for the nine months ended
September 30, 1999. Of this amount, $19,933,537 was associated with our
proportionate interest in First Permian. Funding of such amount was provided by
borrowings discussed in Notes 5 and 6 to Consolidated Financial Statements. The
remaining amount, $2,635,847, was expended on Parallel's 3-D seismic
interpretation, leasehold costs and drilling and completion activities. These
activities were financed by the utilization of our cash flow provided by
operations, sales of equity securities, proceeds from the sale of certain
properties and cash provided by credit lines.
At the present time, our cash flow from operations is adequate to meet
normal operating expenses, the interest expense under our credit facility and
preferred stock dividends. However, during a period of sustained price
downturns, we reduced exploration activities to match internally generated cash
flows. Therefore, without additional capital or an increase in our credit
facility borrowing base, our capital expenditure budget for the remainder of
1999 remains highly dependent on future oil and gas prices. If the prices we
receive for oil and gas production continue to improve, increasing cash flow, or
if we are successful in obtaining additional capital, drilling activity may be
accelerated.
TRENDS AND PRICES
During 1998, we experienced a significant erosion in prices for oil and
natural gas. Industry conditions deteriorated significantly during 1998 and the
first three months of 1999 as a result. While prices recovered significantly in
the third quarter of 1999, prices for the first nine months of 1999, on an EBO
basis, were only slightly improved versus the comparable period in 1998. There
is substantial uncertainty regarding future oil and gas prices and there can be
no assurances that oil and gas prices will not decline in the future.
Our revenues, cash flows and borrowing capacity are affected by changes in
oil and gas prices. The markets for oil and gas have historically been, and will
continue to be, volatile. Prices for oil and gas typically fluctuate in response
to relatively minor changes in supply and demand, market uncertainty, and
seasonal, political and other factors beyond our control. We are unable to
accurately predict domestic or worldwide political events or the effects of such
other factors on the prices we receive for oil and gas.
Historically, we have not entered into transactions to hedge against
changes in oil and gas prices. However, effective July 1, 1999, a portion of the
future crude oil production associated with our membership interest in First
19
Permian was hedged against price risks through the use of swap contracts. The
gains and losses on these instruments will be included as an adjustment to oil
and gas revenues. See "Item 3 Quantitative and Qualitative Disclosures about
Market Risk" for a description of our hedging activities.
OTHER MATTERS
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities" which establishes standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. It establishes conditions
under which a derivative may be designated as a hedge, and establishes standards
for reporting changes in the fair value of a derivative. SFAS No. 133 is
required to be implemented for the first quarter of the fiscal year ended 2000.
Early adoption is permitted. Recently, the FASB deferred the implementation
requirements of SFAS No. 133 for one year. We have not evaluated the effects of
implementing SFAS No. 133.
INFORMATION SYSTEMS FOR THE YEAR 2000
We place a high priority on resolving the computer or embedded chip
problems related to the Year 2000 that might cause operational disruptions. Our
Year 2000 project addresses the inability of computer software; hardware or
equipment with embedded microprocessors that are time sensitive to process
correctly dates data beginning on January 1, 2000. This problem results from
computer programs using two digits rather than four to define an applicable
year.
In planning and developing the project, we considered both our information
technology, or IT, systems and non-IT systems. IT systems generally include
computer equipment and software. Alarm systems, fax machines, monitors for field
operations and other miscellaneous systems, which may contain embedded
technology, are considered non-IT systems. These types of systems are more
difficult to assess and repair than IT systems.
The scope of the project includes:
. conducting an inventory of software, hardware and embedded systems
equipment;
. assessing the potential for failure and the associated risk;
. prioritizing the need for remediation, repairing or replacing significant
non-compliant items; and
. testing any modifications to ensure Year 2000 compliance.
Additionally, the project assesses the risks associated with the Year 2000
compliance of material business partners.
The assessment phase of our Year 2000 project is at varying stages of
completion as it pertains to IT and non-IT systems and applications. We have
begun a comprehensive analysis of the operational problems and costs that would
be reasonably likely to result from the failure by us and significant third
parties to complete efforts necessary to achieve Year 2000 compliance on a
timely basis.
We believe our most significant risks will be in two areas:
. measuring the quantities of oil and natural gas produced; and
. receiving timely payment from the purchasers of its gas and oil.
We also depend upon third parties for most of our non-information
technology systems such as:
. telephones;
. facsimile machines;
. air conditioning;
. heating;
. elevators in the office building; and
. other equipment which may have embedded technology such as
microprocessors.
20
Many systems owned or controlled by third parties that we are dependent
upon, including non-information technology systems, may or may not be Year 2000
compliant. Written inquiries have been sent to these third parties, but most of
this technology is outside of our control and it is difficult to assess or
remedy any non-compliance that could adversely affect our ability to conduct
business.
In December 1998, letters were mailed to significant vendors, service
providers and business partners to determine the extent to which interfaces with
such entities are vulnerable to Year 2000 issues and whether the products and
services purchased from or provided by such entities are Year 2000 compliant.
Written assurances have been obtained from our bank lender, our major purchasers
of production, with the exception of one, and our accounting software provider
indicating that they anticipate they are or will be Y2K compliant by the end of
the year. Efforts are being made to locate the Y2K coordinator of the one
purchaser to determine their Y2K compliance. We are mindful that our own level
of readiness is partially dependent on the ability of these and other third
parties to be fully compliant. The failure of third parties to be Y2K compliant
creates likelihood that we will also experience Y2K interruptions through a
"ripple effect" stemming from external forces. However, we currently believe we
have resolved any significant Year 2000 issues.
The remedial phase of the project is substantially complete. The remedial
phase includes the upgrade and/or replacement of software applications and
hardware systems. Most of the software providers for Parallel's personal
computers have confirmed their readiness for the Year 2000 or have provided
updates to correct most identified Year 2000 problems. Testing of our local area
network and a check for embedded systems have been completed. Minor corrections
to the local computers have been identified and corrected.
It is impossible to accurately predict all potential Y2K problems and the
magnitude of any adverse effects on Parallel. Because of these uncertainties, we
have developed a contingency plan to minimize potential business interruptions.
In preparing contingency plans, we have assumed that many third parties will not
be Y2K compliant. Our remediation efforts are expected to reduce significantly
our level of uncertainty about Year 2000 compliance and the possibility of
interruptions of normal business operations. After completion of the Year 2000
review and testing, which is currently expected to be completed by September 30,
1999, we will further develop a contingency plan as required. This plan is
expected to be completed by September 30, 1999.
The following table summarizes the current overall status of our project
and lists anticipated completion dates for each phase of the project.
Phase
- --------------------------------------------------------------------------------
Component Inventory Assessment Remediation
- --------------------------------------------------------------------------------
Business Partners January 31, 1999 August 31, 1999 Completed
Software April 30, 1999 May 31, 1999 Completed
Hardware April 30, 1999 September 15,1999 November 30, 1999
Embedded Systems April 30, 1999 May 31, 1999 Completed
To date, only minor costs have been incurred for project planning.
Substantially all of the personnel working on the project to identify, assess,
remediate and test Year 2000 issues are existing employees. Therefore, labor
costs incurred in connection with the project are expected to be minimal. Based
on current information, we do not anticipate that the costs associated with any
necessary in-house modifications will be material to its operations or financial
condition. The total cost of the project is expected to range from $10,000 to
$20,000.
The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations that could materially and adversely affect Parallel's operations,
liquidity and financial condition. Because of the uncertainty surrounding Year
2000 issues, primarily those associated with third party suppliers and material
business partners, we are unable to determine at this time whether Year 2000
failures will have a material impact on our operations. However, the project is
expected to reduce the risk of Year 2000 issues significantly, particularly
regarding the compliance and readiness of our material vendors, suppliers and
business partners. We believe that the timely completion of this project will
reduce the possibility of significant interruptions of normal business
operations.
21
This is a flexible plan that will change to address additional Y2K issues
as new problems are identified. As a result, any time and cost estimates and the
assessment of risks associated with Y2K issues are subject to revision as needed
to meet our goal to be Y2K compliant.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our major market risk exposure is in the pricing applicable to our oil and
natural gas production. Realized pricing is primarily driven by the prevailing
domestic price for crude oil and spot prices applicable to the region in which
we produce natural gas. Historically, prices received for oil and gas production
have been volatile and unpredictable. Although Parallel has not entered into
hedging arrangements, First Permian uses swap agreements and other financial
instruments in an attempt to reduce the risk of fluctuating oil and gas prices
and interest rates.
Commodity Price Risk. Effective July 1, 1999, approximately 82% of the
future crude oil production associated with our proportionate interest in First
Permian was hedged against price risks through the use of swap contracts.
Settlements on price swap contracts are realized monthly, generally based upon
the difference between the contract price and the average closing NYMEX price
and are reported as a component of oil and gas revenues and operating cash flows
in the period realized.
While the use of these price risk management arrangements limits the
downside risk of adverse price movements, it may also limit future revenues from
favorable price movements. These hedging activities will be conducted with major
financial or commodities trading institutions that management believes entail
acceptable levels of market and credit risks.
The following table sets forth our proportionate share of First Permian's
outstanding oil hedge contracts, which were effective at July 1, 1999. At
September 30, 1999, Parallel did not have any hedging contracts in place.
Type Volume/Month Term Price Commodity
- ---- ------------ ---- ----- ---------
Swap 22,500 barrels 7/1/99 - 12/31/99 $19.02 WTI NYMEX
Swap 21,600 barrels 1/1/00 - 12/31/00 $18.07 WTI NYMEX
Swap 20,475 barrels 1/1/01 - 6/30/01 $17.70 WTI NYMEX
Commodity Swap 11,250 barrels 8/1/99 - 12/31/99 $1.28 Differential between
Platts WTI/Platts WTS
Commodity Swap 11,250 barrels 8/1/99 12/31/99 $1.24 Differential between
Platts WTI /Platts WTS
Interest Rate Risk. Parallel's only financial instrument sensitive to
changes in interest rates is bank debt. Our annual interest costs in 1999 will
fluctuate based on short-term interest rates. Since the interest rate is
variable and reflects current market conditions, the carrying value approximates
the fair value. The following table shows principal cash flows and related
weighted average interest rates by expected maturity dates.
Instrument 1999 2000 2001 2002 Total Fair Value
- ------------------------------------------------------------------------------------
(in 000's, except interest rates)
Variable rate debt
Revolving Facility (secured) $.2 $.7 $19.5 $15.1 $35.5 $35.5
Average interest rate 9.75% 9.75% 8.55% 9.75%
Effective August 6, 1999, approximately 54% of the long debt associated
with our proportionate share in First Permian was hedged against the impact of
interest rate changes through an interest rate swap agreement. The principal
amount of the swap agreement is $40 million, or $9 million net to our interest.
The agreement terminates on July 1, 2002. The terms of the agreement provide for
quarterly payments either to or from First Permian, determined by whether the
quarterly London Interbank Offered Rate (LIBOR) in effect at the beginning of
each quarterly calculation period is greater or less than 6.52%. The calculation
periods begin on the first day of each January, April, July and October of each
22
year during the term of the agreement, commencing on October 1, 1999. If, on the
date of the beginning of the calculation period, the monthly LIBOR exceeds
6.52%, Bank One, Texas, N.A. (the Lendor) will owe First Permian the quarterly
amount of the excess rate applied to $40 million. Alternatively, if the monthly
LIBOR rate on the applicable monthly date is less than 6.52%, First Permian will
owe the Lender.
The swap agreement is accounted for as a hedge, with the amount which is
either due to or from First Permian recorded as a reduction or increase in
interest expense. Since the quarterly calculation period began in October, we
recognized no increase or reduction to interest expense in the three months
ended September 30, 1999.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
2.1 Certificate of Incorporation of Registrant. (Incorporated by
reference to Exhibit 3.1 to Form 10-K of the Registrant for the
fiscal year ended December 31, 1998)
2.2 Bylaws of Registrant (Incorporated by reference to Exhibit 3.2 to
Form 10-K of the Registrant for the fiscal year ended December
31, 1995)
3.1 Certificate of Designations, Preferences and Rights of Serial
Preferred Stock 6% Convertible Preferred Stock (Incorporated by
reference to Exhibit 4.1 to Form 10-Q of the Registrant for the
fiscal quarter ended September 30, 1998)
9.1 Certificate of Formation of First Permian, L.L.C., dated
September 24, 1999 (Incorporated by reference to Exhibit 10.1 to
Form 8-K of the Registrant dated July 14, 1999 and filed with the
Securities and Exchange Commission on July 15, 1999)
9.2 Limited Liability Company Agreement of First Permian, L.L.C.,
dated September 25, 1999 (Incorporated by reference to Exhibit
10.2 to Form 8-K of the Registrant dated July 14, 1999 and filed
with the Securities and Exchange Commission on July 15, 1999)
9.3 Merger Agreement, dated September 25, 1999 (Incorporated by
reference to Exhibit 10.3 to Form 8-K of the Registrant dated
July 14, 1999 and filed with the Securities and Exchange
Commission on July 15, 1999)
9.4 Agreement and Plan of merger, dated September 30, 1999, of First
Permian, L.L.C. and Nash Oil Company, L.L.C. (Incorporated by
reference to Exhibit 10.4 to Form 8-K of the Registrant dated
July 14, 1999 and filed with the Securities and Exchange
Commission on July 15, 1999)
9.1 Certificate of Merger of First Permian L.L.C. and Nash Oil
Company, dated September 30, 1999 (Incorporated by reference to
Exhibit 10.5 to Form 8-K of the Registrant dated July 14, 1999
and filed with the Securities and Exchange Commission on July 15,
1999)
10.6 Credit Agreement, dated September 30, 1999, among First Permian,
L.L.C., as Borrower, and Parallel Petroleum Corporation and
Baytech, Inc. as Guarantors and Bank One, Texas, N.A. and the
Institutions named Herein as Banks and Bank One, Texas, N.A., as
Agent (Incorporated by reference to Exhibit 10.6 to Form 8-K of
the Registrant dated July 14, 1999 and filed with the Securities
and Exchange Commission on July 15, 1999)
9.7 Limited Guaranty, dated September 30, 1999, by and among First
Permian, L.L.C., Parallel Petroleum Corporation and Bank One,
Texas N.A. (Incorporated by reference to Exhibit 10.7 to Form 8-K
of the Registrant dated July 14, 1999 and filed with the
Securities and Exchange Commission on July 15, 1999)
10.8 Intercreditor Agreement, dated as of September 30, 1999, among
First Permian, L.L.C., Bank One, Texas, N.A., Tejon Exploration
Company and Mansefeldt Investment Corporation. (Incorporated by
reference to Exhibit 10.8 to Form 8-K of the Registrant dated
July 14, 1999 and filed with the Securities and Exchange
Commission on July 15, 1999)
23
9.9 Subordinated Promissory Note, dated September 30, 1999, among
First Permian, L.L.C. and Tejon Exploration Company (Incorporated
by reference to Exhibit 10.9 to Form 8-K of the Registrant dated
July 14, 1999 and filed with the Securities and Exchange
Commission on July 15, 1999)
9.10 Subordinated Promissory Note, dated September 30, 1999, among
First Permian, L.L.C. and Mansefeldt Investment Company
(Incorporated by reference to Exhibit 10.10 to Form 8-K of the
Registrant dated July 14, 1999 and filed with the Securities and
Exchange Commission on July 15, 1999)
*27 Financial Data Schedule
(b) Reports on Form 8-K
On September 14, 1999, we filed a report on Form 8-K/A, dated
September 13, 1999, to amend the Form 8-K Report filed on July
15, 1999 that reported First Permian's acquisition of oil and gas
properties from Fina Oil and Chemical Company. The Form 8-K/A
Report included the following financial statements:
. Statements of Revenues and Direct Operating Expenses for the
Years Ended December 31, 1997 and 1998 and for the Six
Months Ended June 30, 1998 and 1999.
. Unaudited Pro Forma Combined Statement of Operations for the
Year Ended December 31, 1998.
. Unaudited Pro Forma Combined Statement of Operations for the
Six Months Ended June 30, 1999.
-----------------------
* Filed herewith.
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PARALLEL PETROLEUM CORPORATION
BY: /s/ THOMAS R. CAMBRIDGE
Date: November 15, 1999 ---------------------------------
Thomas R. Cambridge
Chairman of the Board of Directors
and Chief Executive Officer
Date: November 15, 1999 BY: /s/ LARRY C. OLDHAM
----------------------------------
Larry C. Oldham,
President ( Principal Financial Officer)