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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 QUARTER ENDED SEPTEMBER 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 1-7667
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SANTA FE ENERGY RESOURCES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 36-2722169
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
1616 SOUTH VOSS, SUITE 1000
HOUSTON, TEXAS 77057
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (713) 507-5000
------------------------
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 [ ]
Shares of Common Stock outstanding at October 1, 1996 -- 90,738,682
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PART I - FINANCIAL STATEMENTS
PAGE
----
Consolidated Statement of Operations Three Months and
Nine Months Ended September 30, 1996 and 1995 .......................... 2
Consolidated Balance Sheet September 30, 1996 and
December 31, 1995 ...................................................... 3
Consolidated Statement of Cash Flows Three Months and
Nine Months Ended September 30, 1996 and 1995 .......................... 4
Consolidated Statement of Shareholders' Equity Nine
Months Ended September 30, 1996 and 1995 ............................... 5
Notes to Consolidated Financial Statements ............................... 6
Management's Discussion and Analysis of Financial
Condition and Results of Operations .................................... 11
1
SANTA FE ENERGY RESOURCES, INC.
CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
(IN MILLIONS OF DOLLARS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1996 1995 1996 1995
--------- --------- --------- ---------
Revenues
Sales of crude oil and liquids
produced......................$ 109.4 $ 87.4 $ 309.6 $ 254.5
Sales of crude oil purchased.... 20.4 -- 21.6 --
Sales of natural gas produced... 25.5 19.8 75.3 53.5
Crude oil marketing and
trading....................... 4.6 4.2 13.9 10.3
Other........................... (0.2) (0.3) 0.1 1.1
--------- --------- --------- ---------
159.7 111.1 420.5 319.4
--------- --------- --------- ---------
Costs and Expenses
Production and operating........ 48.3 38.0 136.1 114.2
Cost of crude oil purchased..... 20.2 -- 21.4 --
Exploration, including dry hole
costs......................... 5.4 6.6 16.9 17.7
Depletion, depreciation and
amortization.................. 38.7 34.2 106.1 97.3
Impairment of oil and gas
properties.................... -- -- 10.4 --
General and administrative...... 6.4 7.1 20.3 19.9
Taxes (other than income)....... 6.8 5.1 19.4 15.2
Loss (gain) on disposition of
oil and gas properties........ -- 0.3 0.5 0.3
--------- --------- --------- ---------
125.8 91.3 331.1 264.6
--------- --------- --------- ---------
Income from Operations............... 33.9 19.8 89.4 54.8
Interest income................. 0.5 0.5 1.5 2.0
Interest expense................ (9.6) (8.1) (28.9) (28.0)
Interest capitalized............ 1.2 2.2 3.7 4.3
Other income (expense).......... (0.2) (2.1) (0.7) (0.7)
--------- --------- --------- ---------
Income Before Income Taxes........... 25.8 12.3 65.0 32.4
Income tax expense.............. (9.3) (5.3) (18.5) (14.2)
--------- --------- --------- ---------
Net Income........................... 16.5 7.0 46.5 18.2
Preferred dividend
requirement................... (3.7) (3.7) (11.1) (11.1)
--------- --------- --------- ---------
Earnings (Loss) Attributable to
Common Shares......................$ 12.8 $ 3.3 $ 35.4 $ 7.1
========= ========= ========= =========
Earnings (Loss) Attributable to
Common Shares
Per Share..........................$ 0.14 $ 0.04 $ 0.39 $ 0.08
========= ========= ========= =========
Weighted Average Number of Shares
Outstanding
(in millions)...................... 90.7 90.3 90.6 90.2
========= ========= ========= =========
The accompanying notes are an integral part of these financial statements.
2
SANTA FE ENERGY RESOURCES, INC.
CONSOLIDATED BALANCE SHEET
(IN MILLIONS OF DOLLARS)
SEPTEMBER 30, DECEMBER 31,
1996 1995
-------------- ------------
(UNAUDITED)
ASSETS
Current Assets
Cash and cash equivalents....... $ 35.9 $ 42.6
Accounts receivable............. 92.0 89.0
Inventories..................... 12.9 10.5
Other current assets............ 19.8 17.2
-------------- ------------
160.6 159.3
-------------- ------------
Properties and Equipment, at cost
Oil and gas (on the basis of
successful efforts
accounting)................... 2,496.3 2,336.3
Other........................... 40.0 35.6
-------------- ------------
2,536.3 2,371.9
Accumulated depletion,
depreciation, amortization and
impairment.................... (1,584.1) (1,482.4)
-------------- ------------
952.2 889.5
-------------- ------------
Other Assets
Receivable under gas balancing
arrangements.................. 5.0 5.8
Other........................... 8.9 10.2
-------------- ------------
13.9 16.0
-------------- ------------
$ 1,126.7 $ 1,064.8
============== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable................ $ 79.2 $ 73.1
Interest payable................ 4.3 7.9
Current portion of long-term
debt.......................... 35.0 --
Other current liabilities....... 33.1 28.6
-------------- ------------
151.6 109.6
-------------- ------------
Long-Term Debt....................... 309.4 344.4
-------------- ------------
Deferred Revenues.................... 4.7 4.9
-------------- ------------
Other Long-Term Obligations.......... 27.9 24.2
-------------- ------------
Deferred Income Taxes................ 76.0 64.0
-------------- ------------
Commitments and Contingencies (Note
5)................................. -- --
-------------- ------------
Convertible Preferred Stock, 7%
Series............................. 80.0 80.0
-------------- ------------
Shareholders' Equity
Preferred stock................. -- --
$.732 Series A preferred
stock......................... 91.4 91.4
Common stock.................... 0.9 0.9
Paid-in capital................. 505.4 501.4
Accumulated deficit............. (120.3) (155.7)
Foreign currency translation
adjustment.................... (0.3) (0.3)
-------------- ------------
477.1 437.7
-------------- ------------
$ 1,126.7 $ 1,064.8
============== ============
The accompanying notes are an integral part of these financial statements.
3
SANTA FE ENERGY RESOURCES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(IN MILLIONS OF DOLLARS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------- -----------------
1996 1995 1996 1995
------ ------ ------ ------
Operating Activities:
Net income .......................... $ 16.5 $ 7.0 $ 46.5 $ 18.2
Adjustments to reconcile net
income (loss) to net cash
provided by operating
activities:
Depletion, depreciation and
amortization ................ 38.7 34.2 106.1 97.3
Impairment of oil and gas
properties .................. -- -- 10.4 --
Deferred income taxes .......... 6.8 4.4 12.0 11.2
Net loss (gain) on
disposition of
properties .................. -- 0.3 0.5 0.3
Exploratory dry hole
costs ....................... 1.1 0.7 2.5 4.9
Other .......................... 0.9 2.4 2.3 1.4
Changes in operating assets and
liabilities:
Decrease (increase) in
accounts receivable ......... (2.7) (2.8) (3.0) 6.6
Decrease (increase) in
inventories ................. (1.2) 2.0 (2.4) (1.2)
Increase (decrease) in
accounts payable ............ (2.1) 1.9 7.4 (1.6)
Increase (decrease) in
interest payable ............ (3.6) 9.2 (3.6) 8.6
Increase (decrease) in
income taxes payable ........ 1.4 0.1 2.8 1.2
Net change in other assets
and liabilities ............. 0.8 1.9 1.6 (6.0)
------ ------ ------ ------
Net Cash Provided by Operating
Activities ............................. 56.6 61.3 183.1 140.9
------ ------ ------ ------
Investing Activities:
Capital expenditures, including
exploratory dry hole costs ........ (58.5) (51.2) (142.9) (157.4)
Acquisitions of producing
properties ........................ (2.5) (5.2) (37.8) (33.0)
Net proceeds from sales of
properties ........................ 0.1 -- 0.5 58.7
------ ------ ------ ------
Net Cash Used in Investing
Activities ............................. (60.9) (56.4) (180.2) (131.7)
------ ------ ------ ------
Financing Activities:
Issuance of common stock ............ 0.6 -- 1.5 --
Principal payments on long-term
borrowings ........................ -- -- -- (10.0)
Cash dividends paid ................. (3.7) (3.7) (11.1) (11.1)
------ ------ ------ ------
Net Cash Used in Financing
Activities ............................. (3.1) (3.7) (9.6) (21.1)
------ ------ ------ ------
Net Cash Provided (Used) in the
Period ................................. (7.4) 1.2 (6.7) (11.9)
Cash and Cash Equivalents at
Beginning of Period .................... 43.3 40.6 42.6 53.7
------ ------ ------ ------
Cash and Cash Equivalents at End of
Period ................................. $ 35.9 $ 41.8 $ 35.9 $ 41.8
====== ====== ====== ======
The accompanying notes are an integral part of these financial statements.
4
SANTA FE ENERGY RESOURCES, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED)
(SHARES AND DOLLARS IN MILLIONS)
$.732
SERIES A
CONVERTIBLE FOREIGN
PREFERRED STOCK COMMON STOCK CURRENCY TOTAL
--------------- --------------- PAID-IN ACCUMULATED TRANSLATION SHAREHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT ADJUSTMENT EQUITY
------ ------ ------ ------ -------- ----------- ----------- --------------
Balance at December 31, 1995......... 10.7 $91.4 90.3 $0.9 $ 501.4 $(155.7) $(0.3) $437.7
Issuance of common stock........... -- -- 0.4 -- 4.0 -- -- 4.0
Net income......................... -- -- -- -- -- 46.5 -- 46.5
Dividends declared................. -- -- -- -- -- (11.1) -- (11.1)
------ ------ ------ ------ -------- ----------- ----------- --------------
Balance at September 30, 1996........ 10.7 $91.4 90.7 $0.9 $ 505.4 $(120.3) $(0.3) $477.1
====== ====== ====== ====== ======== =========== =========== ==============
Balance at December 31, 1994......... 10.7 $91.4 90.0 $0.9 $ 498.9 $(167.5) $(0.4) $423.3
Issuance of common stock........... -- -- 0.3 -- 2.3 -- -- 2.3
Foreign currency translation
adjustment........................ -- -- -- -- -- -- 0.1 0.1
Net income......................... -- -- -- -- -- 18.2 -- 18.2
Dividends declared................. -- -- -- -- -- (11.1) -- (11.1)
------ ------ ------ ------ -------- ----------- ----------- --------------
Balance at September 30, 1995........ 10.7 $91.4 90.3 $0.9 $ 501.2 $(160.4) $(0.3) $432.8
====== ====== ====== ====== ======== =========== =========== ==============
The accompanying notes are an integral part of these financial statements.
5
SANTA FE ENERGY RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) ACCOUNTING POLICIES
The unaudited consolidated financial statements of Santa Fe Energy
Resources, Inc. ("Santa Fe" or the "Company") reflect, in the opinion of
management, all adjustments, consisting only of normal and recurring
adjustments, necessary to present fairly the Company's financial position at
September 30, 1996 and the Company's results of operations and cash flows for
the three-month and nine-month periods ended September 30, 1996 and 1995.
Interim period results are not necessarily indicative of results of operations
or cash flows for a full-year period.
Revenues from sales of crude oil purchased and costs of crude oil purchased
relate to the purchase and sale of light weight (i.e., low viscosity) crude oil
which is blended with certain of the Company's heavy (i.e., low gravity, high
viscosity) crude oil production to facilitate transportation through certain
pipelines.
These financial statements and the notes thereto should be read in
conjunction with the Company's annual report on Form 10-K for the year ended
December 31, 1995.
(2) STATEMENT OF CASH FLOWS
The Company made interest and income tax payments as follows during the
three-month and six-month periods ended September 30, 1996 and 1995 (in millions
of dollars):
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- --------------------
1996 1995 1996 1995
--------- ----------- --------- ---------
Interest payments........... 12.9 -- 31.4 19.2
Income tax payments......... 0.7 0.4 2.8 1.2
In addition, during the three months ended June 30, 1996 the Company received a
$4.6 million income tax refund and during the three months ended March 31, 1995
the Company received a $1.0 million income tax refund.
(3) INITIAL PUBLIC OFFERING AND PROPOSED SPINOFF
On September 18, 1996, the Company announced its intention to separate its
Western Division from its other domestic and international operations. The
initial phase of the separation involves (i) the contribution of substantially
all of the assets and operations of the Western Division, which include the
Company's interest in the Midway-Sunset, South Belridge, Coalinga and Kern River
oil fields, to Monterey Resources, Inc. ("Monterey"), a newly-formed, wholly
owned subsidiary of the Company, and the assumption by Monterey of substantially
all of the liabilities and obligations associated with the Western Division,
including $245 million of indebtedness in respect of the Company's Senior Notes,
and (ii) the initial public offering of approximately 15% (17% if the
underwriters' over-allotment options are exercised in full) of the common stock
of Monterey (the "Monterey IPO"). Net proceeds from the Monterey IPO will be
used to reduce corporate indebtedness. Monterey has filed a registration
statement with the Securities and Exchange Commission relating to the proposed
Monterey IPO. The Monterey IPO is expected to be completed during the fourth
quarter of 1996.
The second phase of the separation would involve a pro rata distribution by
the Company to its common shareholders of its remaining ownership interest in
Monterey by means of a tax-free distribution (the "Proposed Spinoff"). The
Proposed Spinoff is subject to certain conditions including the receipt of a
ruling from the Internal Revenue Service that such a distribution would be
tax-free, the approval of such distribution by the Company's common
shareholders, the absence of any future change in the market or economic
conditions (including developments in the capital markets) or the Company's or
Monterey's
6
SANTA FE ENERGY RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
business or financial condition that causes the Company's board of directors to
conclude that the Proposed Spinoff is not in its shareholders' best interests
and the final declaration of the spinoff by the Company's board of directors.
The Proposed Spinoff is not expected to occur prior to June 1997.
On October 22, the Company announced it has entered into a supplement to
the indenture relating to its $100 million principal amount 11% Senior
Subordinated Debentures due 2004 that will permit the Monterey IPO and the
Proposed Spinoff to proceed without the occurrence of a breach or default under
such indenture.
(4) PREFERRED TENDER OFFER
On October 22, 1996 the Company announced that it has commenced an offer to
purchase up to 4.5 million of the 5.0 million outstanding shares of its
Convertible Preferred Stock, 7% Series, for $24.50 per share, net to the seller
in cash. The Company intends to purchase all validly tendered and not withdrawn
shares, upon the terms and subject to the conditions of the offer, including the
provisions relating to proration. The offer, proration period and withdrawal
rights will expire at 12:00 midnight, EST, on Tuesday, November 19, 1996, unless
extended.
(5) COMMITMENTS AND CONTINGENCIES
OIL AND GAS HEDGING
The Company hedges a portion of its oil and gas sales to provide a certain
minimum level of cash flow from its sales of oil and gas. While the hedges are
generally intended to reduce the Company's exposure to declines in market price,
the Company's gain from increases in market price may be limited. The Company
uses various financial instruments whereby monthly settlements are based on
differences between the prices specified in the instruments and the settlement
prices of certain futures contracts quoted on the New York Mercantile Exchange
("NYMEX") or certain other indices. Generally, in instances where the
applicable settlement price is less than the price specified in the contract,
the Company receives a settlement based on the difference; in instances where
the applicable settlement price is higher than the specified price, the Company
pays an amount based on the difference. The instruments utilized by the Company
differ from futures contracts in that there is no contractual obligation which
requires or allows for the future delivery of the product. Gains or losses on
hedging activities are recognized in oil and gas revenues in the period in which
the hedged production is sold.
The Company had no open crude oil hedges at September 30, 1996. During the
first nine months of 1996 crude oil hedges resulted in a $13.4 million decrease
in revenues.
The Company has open natural gas hedges on (i) an average of approximately
40 MMcf per day of its Gulf Coast production for the period October to December
1996 at an approximate break-even price of $1.76 per Mcf and (ii) an average of
approximately 30 MMcf per day of its Permian Basin production for the period
October to December 1996 at an approximate break-even price of $1.55 per Mcf,
based on index prices at certain settlement points. Due to its location, Permian
Basin gas sells at a discount to Gulf Coast gas. Natural gas sales hedges
resulted in a decrease in revenues of $15.0 million in the first nine months of
1996.
In addition to its oil and gas sales hedges, during the first six months of
1996 the Company hedged 20 MMcf per day of the natural gas it purchases for use
in its steam generation operations in the San Joaquin Valley of California. Such
hedges, which terminated at the end of the second quarter, resulted in a $3.2
million increase in production and operating costs in the first six months of
1996.
INDEMNITY AGREEMENT WITH SANTA FE PACIFIC CORPORATION ("SFP")
In December 1990 SFP distributed all of the shares of the Company it held
to its shareholders (the "Spin-Off"). At the time of the Spin-Off, the Company
and SFP entered into an agreement to protect SFP
7
SANTA FE ENERGY RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
from federal and state income taxes, penalties and interest that would be
incurred by SFP if the Spin-off were determined to be a taxable event resulting
primarily from actions taken by the Company during a one-year period that ended
December 4, 1991. If the Company were required to make payments pursuant to the
agreement, such payments could have a material adverse effect on its financial
condition; however, the Company does not believe that it took any actions during
such one-year period that would have such an effect on the Spin-Off.
ENVIRONMENTAL REGULATION
Federal, state and local laws and regulations relating to environmental
quality control affect the Company in all of its oil and gas operations. The
Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"), also known as the "Superfund" law, imposes liability, without
regard to fault or the legality of the original conduct, on certain classes of
persons that contributed to the release of a "hazardous substance" into the
environment. These persons include the owner or operator of a site and companies
that disposed or arranged for the disposal of the hazardous substance found at a
site. CERCLA also authorizes the Environmental Protection Agency (the "EPA")
and, in some cases, third parties to take actions in response to threats to the
public health or the environment and to seek to recover from the responsible
classes of persons the costs they incur. In the course of its operations, the
Company has generated and will generate wastes that may fall within CERCLA's
definition of "hazardous substances". The Company may be responsible under
CERCLA for all or part of the costs to clean up sites at which such wastes have
been disposed. Certain properties owned or used by the Company or its
predecessors have been investigated under state and Federal Superfund statutes,
and the Company has been and could be named a potentially responsible party
("PRP") for the cleanup of some of these sites.
The Company has been identified as one of over 250 PRPs at a Superfund site
in Los Angeles County, California (the "OII Site"). The OII Site was operated
by a third party as a waste disposal facility from 1948 until 1983. The EPA is
requiring the PRPs to undertake remediation of the site in several phases, which
include site monitoring and leachate control, gas control and final remediation.
In November 1988 the EPA and a group of PRPs that includes the Company entered
into a consent decree covering the site monitoring and leachate control phases
of remediation. The Company was a member of the group Coalition Undertaking
Remediation Efforts ("CURE") which was responsible for constructing and
operating the leachate treatment plant. This phase is now complete and the
Company's share of costs with respect to this phase was $0.9 million. Another
consent decree provides for the predesign, design and construction of a gas
plant to harness and market methane gas emissions. The Company is a member of
the New CURE group which is responsible for the gas plant construction and
operation and landfill cover. Currently, New CURE is in the design stage of the
gas plant. The Company's share of costs of this phase is expected to be $1.9
million and such costs have been provided for in the financial statements.
Pursuant to consent decrees settling lawsuits against the municipalities and
transporters involved with the OII site but not named by the EPA as PRPs, such
parties are required to pay approximately $84 million, of which approximately
$76 million will be credited against future remediation expenses. The EPA and
the PRPs are currently negotiating the final closure requirements. After taking
into consideration the credits from the municipalities and transporters, the
Company estimates its share of final costs of closure will be approximately $0.8
million, which amount has been provided for by the Company in its financial
statements. The Company has entered into a Joint Defense Agreement with the
other PRPs to defend against a lawsuit filed in September 1994 by 95 homeowners
alleging, among other things, nuisance, trespass, strict liability and
infliction of emotional distress. A second lawsuit has been filed by 33
additional homeowners and the Company and the other PRPs intend to enter into a
Joint Defense Agreement. At this stage of the lawsuit the Company is not able to
estimate costs or potential liability.
In 1994 the Company received a request from the EPA for information
pursuant to Section 104(e) of CERCLA and a letter ordering the Company and other
PRPs to negotiate with the EPA regarding
8
SANTA FE ENERGY RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
implementation of a remedial plan for a site located in Santa Fe Springs,
California (the "Santa Fe Springs Site"). The Company owned the property on
which the Santa Fe Springs Site is located from 1921 to 1932. During that time
the property was leased to another company and in 1932 the property was sold to
that company. During the time the other company leased or owned the property,
hazardous wastes were allegedly disposed at the Santa Fe Springs Site. The EPA
estimates total past and future costs for remediation to be approximately $8.0
million. The Company filed its response to the Section 104(e) order setting
forth its position and defenses based on the fact that the other company was the
lessee and operator of the site during the time the Company was the owner of the
property. However, the Company has also given its Notice of Intent to comply
with the EPA's order to prepare a remediation design plan. The PRPs estimate
total costs to final remediation to be $3.0 million and the Company has provided
$250,000 for such costs in the financial statements.
In 1995 the Company and twelve other companies received notice that they
have been identified as PRPs by the California Department of Toxic Substances
Control (the "DTSC") as having generated and/or transported hazardous waste to
the Environmental Protection Corporation ("EPC") Eastside Landfill during its
fourteen-year operation from 1971 to 1985. EPC has since liquidated all assets
and placed the proceeds in trust (the "EPC Trust") for closure and
post-closure activities. However, these monies may not be sufficient to close
the site. The PRPs have entered into an enforceable agreement with the DTSC to
characterize the contamination at the site and prepare a focused remedial
investigation and feasibility study. The DTSC has agreed to implement reasonable
measures to bring new PRPs into the agreement. The DTSC will address subsequent
phases of the cleanup, including remedial design and implementation in a
separate order agreement. The cost of the remedial investigation and feasibility
study is estimated to be $0.8 million, the cost of which will be shared by the
PRPs and the EPC Trust. The ultimate costs of subsequent phases will not be
known until the remedial investigation and feasibility study is completed and a
remediation plan is accepted by the DTSC. The Company currently estimates final
remediation could cost $2 million to $6 million and believes the monies in the
EPC Trust will be sufficient to fund the lower end of this range of costs. The
Company has provided $80,000 in its financial statements for its share of costs
related to this site.
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with eight key
employees. The initial term of seven of the agreements expired on December 31,
1990 and, on January 1, 1991 and beginning on each January 1 thereafter, is
automatically extended for one-year periods, unless by September 30 of any year
the Company gives notice that the agreement will not be extended. The term of
the agreements is automatically extended for a minimum of 24 months following a
change of control. The consummation of the Company's merger with Adobe in 1992
constituted a change of control as defined in the agreements. The initial term
of the other agreement will expire December 31, 1996 and beginning on each
January 1 thereafter, is automatically extended for one-year periods, unless by
September 30 of any year the Company gives notice that the agreement will not be
extended. The agreement is automatically extended for a minimum of 24 months
following a change of control.
In the event that following a change of control employment is terminated
for reasons specified in the agreements, the employee would receive: (i) a lump
sum payment equal to two years' base salary; (ii) the maximum possible bonus
under the terms of the Company's incentive compensation plan; (iii) a lapse of
restrictions on any outstanding restricted stock grants and full payout of any
outstanding Phantom Units; (iv) cash payment for each outstanding stock option
equal to the amount by which the fair market value of the common stock exceeds
the exercise price of the option; and, (v) life, disability and health benefits
for a period of up to two years. In addition, payments and benefits under
certain employment agreements are subject to further limitations based on
certain provisions of the Internal Revenue Code.
9
SANTA FE ENERGY RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
OTHER MATTERS
The Company has certain long-term contracts ranging up to twelve years for
the supply and transportation of approximately 20 million cubic feet per day of
natural gas to the Company's operations in Kern County, California. In the
aggregate, these contracts involve a minimum commitment on the part of the
Company of approximately $10.9 million per year (based on prices equal to 102%
of the applicable index and transportation charges in effect for September
1996). In connection with the development of a gas field in Argentina in which
the Company has a 19.9% working interest, a gas contract for 106 million cubic
feet of gas per day with "take-or-pay" and "delivery-or-pay" obligations was
executed in 1994 with a gas distribution company.
There are other claims and actions, including certain other environmental
matters, pending against the Company. In the opinion of management, the amounts,
if any, which may be awarded in connection with any of these claims and actions
could be significant to the results of operations of any period but would not be
material to the Company's consolidated financial position.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The Company reported earnings to common shares for the third quarter of
1996 of $12.8 million, or $0.14 per share, compared to earnings of $3.3 million,
or $0.04 per share, in the third quarter of 1995. The increased earnings
resulted from increased production and higher prices. Crude oil and liquids
production of 75,900 barrels per day in the third quarter of 1996 represents the
highest quarterly average in the Company's history. Natural gas production
averaged 178.9 MMcf per day in the third quarter of 1996, the highest quarterly
average in the Company's history, compared to 160.4 MMcf per day in the third
quarter of 1995. The Company's average hedged sales price for crude oil and
liquids of $15.72 per barrel in the third quarter of 1996 was $1.40 per barrel
higher than the third quarter of 1995. Similarly, the Company's average hedged
sales price for natural gas increased $0.27 per Mcf from the prior year to $1.62
in the third quarter of 1996.
Earnings to common shares for the first nine months of 1996 totalled $35.4
million or $0.39 per share, compared to $7.1 million, or $0.08 per share, in the
first nine months of 1995. Crude oil and liquids production averaged 73,500
barrels per day in the first nine months of 1996 compared to 65,600 barrels per
day in the first nine months of 1995 and natural gas production averaged 165.8
MMcf per day in the first nine months of 1996 compared to 146.6 Mmcf per day in
the first nine months of 1995. The Company's average hedged sales price for
crude oil and liquids averaged $15.50 per barrel in the first nine months of
1996 compared to $14.41 per barrel in the first nine months of 1995. The
Company's average hedged sales price for natural gas averaged $1.73 per Mcf in
the first nine months of 1996 compared to $1.36 per Mcf in the first nine months
of 1995.
The Company has announced its intention to separate its Western Division
from its other domestic and international operations, see "-- Initial Public
Offering and Proposed Spinoff".
GENERAL
As an independent oil and gas producer, the Company's results of operations
are dependent upon the difference between the prices received for oil and gas
and the costs of finding and producing such resources. A material portion of the
Company's crude oil production is from long-lived fields in the San Joaquin
Valley of California where EOR methods are being utilized. The market price of
the heavy (i.e., low gravity, high viscosity) and sour (i.e., high sulfur
content) crude oils produced in these fields is lower than sweeter, light (i.e.,
low sulfur and low viscosity) crude oils, reflecting higher transportation and
refining costs. In addition, the lifting costs of heavy crude oils are generally
higher than the lifting costs of light crude oils. As a result of these narrower
margins, even relatively modest changes in crude oil prices may significantly
affect the Company's revenues, results of operations, cash flows and proved
reserves. In addition, prolonged periods of high or low oil prices may have a
material effect on the Company's financial position.
The lower price received for the Company's domestic heavy and sour crude
oil is reflected in the average sales price of the Company's domestic crude oil
and liquids (excluding the effect of hedging transactions) for the third quarter
of 1996 of $15.98 per barrel, compared to $20.77 per barrel for West Texas
Intermediate ("WTI") crude oil (an industry posted price generally indicative
of prices for sweeter light crude oil). In the third quarter of 1996 the
Company's average sales price for California heavy crude oil was $14.75 per
barrel, approximately 71% of the average posted price for WTI.
Crude oil prices are subject to significant changes in response to
fluctuations in the domestic and world supply and demand and other market
conditions as well as the world political situation as it affects OPEC, the
Middle East and other producing countries. During 1995 and 1996 the actual
average sales price (unhedged) received by the Company ranged from a high of
$16.62 per barrel in the second quarter of 1996 to a low of $13.53 per barrel
for the fourth quarter of 1995. Based on operating results for the first nine
months of 1996, the Company estimates that, on an annualized basis, a $1.00 per
barrel increase or decrease in its average domestic crude oil sales prices would
result in a corresponding $23.6 million change in income from operations and a
$17.7 million change in cash flow from operating activities. The foregoing
11
estimates do not give effect to changes in any other factors, such as the effect
of the Company's hedging program or depreciation and depletion, that would
result from a change in oil prices.
The price of natural gas fluctuates due to weather conditions, the level of
natural gas in storage, the relative balance between supply and demand and other
economic factors. The actual average sales price (unhedged) received by the
Company in 1995 and 1996 for its natural gas ranged from a high of $2.23 per Mcf
in the first quarter of 1996 to a low of $1.31 per Mcf in the first quarter of
1995. Based on operating results for the first nine months of 1996, the Company
estimates that, on an annualized basis, a $0.10 per Mcf increase or decrease in
its average domestic natural gas sales price would result in a corresponding
$3.4 million change in income from operations and a $2.5 million change in cash
flow from operating activities. The foregoing estimates do not give effect to
changes in any other factors, such as the effect of the Company's hedging
program or depletion and depreciation, that would result from a change in
natural gas prices.
From time to time the Company hedges a portion of its oil and gas sales to
provide a certain minimum level of cash flow from its sales of oil and gas.
While the hedges are generally intended to reduce the Company's exposure to
declines in market price, the Company's gain from increases in market price may
be limited. The Company uses various financial instruments whereby monthly
settlements are based on differences between the prices specified in the
instruments and the settlement prices of certain futures contracts quoted on the
New York Mercantile Exchange ("NYMEX") or certain other indices. Generally, in
instances where the applicable settlement price is less than the price specified
in the contract, the Company receives a settlement based on the difference; in
instances where the applicable settlement price is higher than the specified
price, the Company pays an amount based on the difference. The instruments
utilized by the Company differ from futures contracts in that there is no
contractual obligation which requires or allows for the future delivery of the
product. Gains or losses on hedging activities are recognized in oil and gas
revenues in the period in which the hedged production is sold.
The Company currently has no open crude oil hedges. During the first nine
months of 1996 crude oil hedges resulted in a $13.4 million decrease in
revenues.
The Company has open natural gas hedges on (i) an average of approximately
40 MMcf per day of its Gulf Coast production for the period October through
December 1996 at an approximate break-even price of $1.76 per Mcf and (ii) an
average of approximately 30 MMcf per day of its Permian Basin production for the
period October through December 1996 at an approximate break-even price of $1.55
per Mcf, based on index prices at certain settlement points. Due to its
location, Permian Basin gas sells at a discount to Gulf Coast gas. Natural gas
sales hedges resulted in a decrease in revenues of $15.0 million in the first
nine months of 1996.
With respect to the Gulf Coast production hedges, a $0.10 per Mcf decrease
or increase in the average settlement price for a month results in a $122,000
increase or decrease in revenues, respectively. With respect to the Permian
Basin production hedges, a $0.10 per Mcf decrease or increase in the average
settlement price for a month results in a $92,000 increase or decrease in
revenues, respectively.
In addition to its oil and gas sales hedges, during the first six months of
1996 the Company hedged 20.0 MMcf per day of the natural gas it purchases for
use in its steam generation operations in the San Joaquin Valley of California.
Such hedges, which terminated at the end of the second quarter, resulted in a
$3.2 million increase in production and operating costs in the first six months
of 1996.
In February 1996 the Bureau of Land Management ("BLM") of the United
States Department of the Interior (which oversees the Company's leases of
Federal lands) agreed, effective as of June 1, 1996, to reduce the royalties
payable on any Federal lease that produces crude oil with a weighted average
gravity of less than 20 degrees API ("heavy oil"). The reduced royalty rates
are based upon the weighted average API gravity of the heavy oil produced from
the subject Federal leases and are as low as 3.9%, compared to 12.5% before the
reduction. The reduced royalty rates continue in effect for 12-month periods,
after which the operator can establish a new reduced rate for continued heavy
oil production by submitting an application. As a result of this program, the
Company's royalty rate on its Federal leases has been reduced
12
from 12.5% to an average of 4.8%, resulting in a net increase in the production
attributable to the Company's net revenue interests in such leases of
approximately 1,600 per day. During the period that such royalty reduction is in
effect, the Company (and other working interests owners, if any) will bear all
of the thermal EOR costs to produce the heavy oil from such properties. The
royalty reduction will be terminated upon the first to occur of (i) the
determination by the BLM that the WTI average oil price (as adjusted for
inflation) has remained above $24 per barrel for six consecutive months and (ii)
such time after September 10, 1999, as the Secretary of the Interior determines
that the heavy oil royalty rate reduction has not produced the intended results
(i.e., to reduce the loss of otherwise recoverable reserves).
13
RESULTS OF OPERATIONS
REVENUES
The following table reflects the components of the Company's crude oil and
liquids and natural gas revenues:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1996 1995 1996 1995
--------- --------- --------- ---------
CRUDE OIL AND LIQUIDS PRODUCED
REVENUES ($MILLIONS)
Sales
Domestic
California Heavy......... 60.5 48.9 177.5 142.3
Other.................... 39.1 26.2 108.3 77.9
--------- --------- --------- ---------
99.6 75.1 285.8 220.2
Argentina................ 7.5 3.1 18.0 10.2
Indonesia................ 7.0 7.6 21.8 24.3
Hedging..................... (4.4) 2.7 (13.4) 3.1
Net Profits Payments........ (0.3) (1.1) (2.6) (3.3)
--------- --------- --------- ---------
109.4 87.4 309.6 254.5
========= ========= ========= =========
VOLUMES (MBBLS/DAY)
Domestic
California Heavy............ 44.6 39.1 42.9 38.4
Other....................... 23.1 20.1 22.6 19.2
--------- --------- --------- ---------
67.7 59.2 65.5 57.6
Argentina..................... 4.2 2.5 3.6 2.5
Indonesia..................... 4.0 5.5 4.4 5.5
--------- --------- --------- ---------
75.9 67.2 73.5 65.6
========= ========= ========= =========
SALES PRICES ($/BBL)
Unhedged
Domestic
California Heavy......... 14.75 13.60 15.09 13.59
Other.................... 18.36 14.18 17.47 14.90
Total.................... 15.98 13.80 15.91 14.03
Argentina................... 19.54 13.69 18.24 14.86
Indonesia................... 19.03 15.06 18.15 16.14
Total....................... 16.34 13.90 16.16 14.24
Hedged........................ 15.72 14.32 15.50 14.41
NATURAL GAS PRODUCED
REVENUES ($MILLIONS)
Sales
Domestic.................... 27.7 17.7 86.3 50.8
Foreign..................... 3.3 2.3 7.4 3.6
--------- --------- --------- ---------
31.0 20.0 93.7 54.4
Hedging....................... (4.2) -- (15.0) --
Net Profits Payments.......... (1.3) (0.2) (3.4) (0.9)
--------- --------- --------- ---------
25.5 19.8 75.3 53.5
========= ========= ========= =========
SALES VOLUMES (MMCF/DAY)
Domestic 152.6 140.7 144.8 136.1
Foreign....................... 26.3 19.7 21.0 10.5
--------- --------- --------- ---------
178.9 160.4 165.8 146.6
========= ========= ========= =========
SALES PRICES ($/MCF)
Unhedged
Domestic 1.97 1.36 2.17 1.37
Foreign..................... 1.34 1.25 1.28 1.25
Total....................... 1.88 1.35 2.06 1.36
Hedged........................ 1.62 1.35 1.73 1.36
Total revenues increased 44% from $111.1 million in the third quarter of
1995 to $159.7 million in the third quarter of 1996. Crude oil and liquids
revenues increased from $87.4 million in the third quarter of
14
1995 to $109.4 million in the third quarter of 1996 reflecting an increase in
oil and liquids production from 67,200 barrels per day in the third quarter of
1995 to 75,900 barrels per day in the third quarter of 1996 and improved market
conditions which resulted in an increase in the Company's unhedged average sales
price from $13.90 per barrel in 1995 to $16.34 per barrel in 1996. The royalty
reduction program with respect to heavy oil (see "-- General") resulted in a
$2.2 million increase in revenues and a 1,600 barrel per day increase in crude
oil volumes in the third quarter of 1996. Crude oil and liquids revenues for the
third quarter of 1996 include a $4.4 million loss on hedging transactions.
Revenues for the third quarter of 1996 also include $20.4 million related to the
sales of purchased crude oil which was blended with a portion of the Company's
heavy oil to facilitate pipeline transportation. Natural gas revenues increased
from $19.8 million in the third quarter of 1995 to $25.5 million in the third
quarter of 1996 as the Company's average sales price (unhedged) increased from
$1.35 per Mcf in 1995 to $1.88 per Mcf in 1996 and sales volumes increased from
160.4 MMcf per day in 1995 to 178.9 MMcf per day in 1996. The increase in
natural gas sales volumes includes a 6.0 MMcf per day increase in production
from the Company's Sierra Chata field in Argentina which began production in the
second quarter of 1995. Natural gas revenues for the third quarter of 1996
include a $4.2 million loss on hedging transactions.
Total revenues increased 32% from $319.4 million in the first nine months
of 1995 to $420.5 million in the first nine months of 1996. Crude oil and
liquids revenues increased from $254.5 million in the first nine months of 1995
to $309.6 million in the first nine months of 1996 reflecting an increase in oil
and liquids production from 65,600 barrels per day in 1995 to 73,500 barrels per
day in 1996 and improved market conditions which resulted in an increase in the
Company's unhedged average sales price from $14.24 per barrel in 1995 to $16.16
per barrel in 1996. The royalty reduction program with respect to heavy oil (see
"-- General") resulted in a $2.8 million increase in revenues and a 700 barrel
per day increase in crude oil volumes in the first nine months of 1996. Crude
oil and liquids revenues for the first nine months of 1996 included a $13.4
million loss on hedging transactions. Revenues for the first nine months of 1996
also include $21.6 million related to the sales of purchased crude oil which was
blended with a portion of the Company's heavy oil to facilitate pipeline
transportation. Natural gas revenues increased from $53.5 million in the first
nine months of 1995 to $75.3 million in the first nine months of 1996 as the
Company's unhedged average sales price increased from $1.36 per Mcf in 1995 to
$2.06 per Mcf in 1996 and sales volumes increased from 146.6 MMcf per day in
1995 to 165.8 MMcf per day in 1996. The increase in natural gas volumes included
a 10.0 MMcf per day increase in production from the Company's Sierra Chata field
in Argentina which began production in the second quarter of 1995. Natural gas
revenues for the first nine months of 1996 included a $15.0 million loss on
hedging transactions.
15
COSTS AND EXPENSES
The following table sets forth certain of the Company's costs and expenses,
expressed in dollars per barrel of oil equivalent ("BOE") produced by the
Company during the period:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- -------------------
1996(A) 1995 1996(A) 1995
-------- --------- -------- --------
Production and operating costs (b).. 4.88 4.40(f) 4.88(f) 4.65
Exploration, including dry hole..... 0.55 0.77 0.61 0.72
Depletion, depreciation and
amortization...................... 3.99 3.96 3.83 3.96
General and administrative costs
(c)............................... 0.66 0.82 0.67 0.81
Taxes other than income (d)......... 0.69 0.59 0.70 0.62
Interest, net (e)................... 0.82 0.62 0.85 0.89
- ------------
(a) Excludes $10.4 million impairment of oil and gas properties.
(b) Excluding related production, severance and ad valorem taxes.
(c) Excludes effect of $1.6 million charge related to the abandonment of an
office lease of $0.06 per BOE for the six months ended June 30, 1996.
(d) Includes production, severance and ad valorem taxes.
(e) Reflects interest expense less amounts capitalized and interest income.
(f) Excludes effect of $0.9 million change for environmental clean-up costs
of $0.09 per BOE for the three months ended September 30, 1996 and $0.03
per BOE for the nine months ended September 30, 1996.
Costs and expenses for the third quarter of 1996 totalled $125.8 million
compared to $91.3 million in the third quarter of 1995. Production and operating
costs were up $10.3 million primarily reflecting higher production volumes and
increases in the volume and price of natural gas purchased in connection with
steam generation operations in California. Costs and expenses for the third
quarter of 1996 also include $20.2 million related to the cost of crude oil
purchased for blending as discussed in "-- REVENUES". Depletion, depreciation
and amortization increased principally due to higher production volumes. Taxes
other than income in the third quarter of 1995 includes the benefit of $1.0
million in adjustments to ad valorem taxes recorded in prior periods.
Costs and expenses for the first nine months of 1996 totalled $331.1
million compared to $264.6 million in the first nine months of 1995. Production
and operating costs for the first nine months of 1996 are $21.9 million higher
than the first nine months of 1995 primarily reflecting higher production
volumes, $3.2 million in expenses related to hedges of natural gas purchased in
connection with steam generation operations in California (see -- General) and
higher volumes and prices for natural gas purchased in connection with such
steam generation operations. Costs and expenses for the first nine months of
1996 also include $21.4 million related to the cost of crude oil purchased for
blending as discussed in "-- REVENUES". Taxes other than income in the first
nine months of 1995 includes the benefit of $2.0 million in adjustments to ad
valorem taxes recorded in prior periods and $0.7 million related to the
settlement of certain disputed sales and use taxes.
Other income (expense) for the first nine months of 1995 includes a first
quarter $2.3 million gain on the sale of the Company's interest in Cherokee
Resources Incorporated, a privately-held oil and gas company, and a third
quarter $1.8 million loss on the sale of the Company's investment in Hadson
Corporation.
Income taxes for the first nine months of 1996 include a $6.8 million
deferred tax benefit related to certain foreign expenditures incurred in prior
periods.
In October 1995 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 "Accounting for Stock-Based
Compensation" ("FAS 123"), which established financial accounting and
reporting standards for stock-based employee compensation plans. FAS 123
encourages
16
companies to adopt a fair value based method of accounting for such plans but
continues to allow the use of the intrinsic value based method prescribed by
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees" ("Opinion 25"). Companies electing to continue accounting in
accordance with Opinion 25 must make pro forma disclosures of net income and
earnings per share as if the fair value based method defined in FAS 123 had been
applied. The Company will continue to account for stock-based compensation in
accordance with Opinion 25 and will make pro forma disclosures in accordance
with the provisions of FAS 123 beginning in its 1996 annual financial
statements.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash flow from operating activities is a function of the
volumes of oil and gas produced from the Company's properties and the sales
prices received therefor. Since crude oil and natural gas are depleting assets,
unless the Company replaces the oil and gas produced from its properties, the
Company's assets will be depleted over time and its ability to incur debt at
constant or declining prices will be reduced. The Company increased its proved
reserves (net of production and sales) by approximately 26% over the five years
ended December 31, 1995; however, no assurances can be given that such increase
will occur in the future. Historically, the Company has generally funded
development and exploration expenditures and working capital requirements from
cash provided by operating activities. Depending upon the future levels of
operating cash flows, which are significantly affected by oil and gas prices,
the restrictions on additional borrowings included in certain of the Company's
debt agreements, together with debt service requirements and dividends, may
limit the cash available for future exploration, development and acquisition
activities. Net cash provided by operating activities and net proceeds from
sales of properties totalled $183.6 million in the first nine months of 1996;
net cash used for capital expenditures and producing property acquisitions in
such period totalled $180.7 million.
The Company's 1995 capital program totalled approximately $204.6 million, a
level which allowed the Company to more than replace its 1995 production. The
Company expects to spend approximately $226.3 million on its 1996 program.
However, the actual amount expended by the Company in 1996 will be based upon
numerous factors, the majority of which are outside its control, including,
without limitation, prevailing oil and natural gas prices and the outlook
therefor and the availability of funds. Through September 30, 1996 the Company
had expended $171.9 million (including $37.8 million on acquisitions of
producing properties) on its 1996 program.
Effective April 1, 1995 the Company entered into the Second Amended and
Restated Revolving Credit Agreement (the "Credit Agreement"), an unsecured
revolving credit agreement which matures December 31, 1998. The maximum
borrowing limits under the Credit Agreement are currently $105.0 million, $65.0
million beginning February 28, 1997 and $30.0 million beginning February 28,
1998. Interest rates under the Credit Agreement are tied to LIBOR or the bank's
prime rate with the actual interest rate based upon certain ratios and the value
and projected timing of production of the Company's oil and gas reserves. At
September 30, 1996, $4.2 million in letters of credit were outstanding under the
terms of the Credit Agreement. The Company expects to terminate the Credit
Agreement, see "-- Initial Public Offering and Proposed Spinoff."
The Company has three short-term uncommitted lines of credit totalling
$60.0 million which are used to meet short-term cash needs. Interest rates on
borrowings under these lines of credit are typically lower than rates paid under
the Bank Facility. At September 30, 1996 no amounts were outstanding under these
lines of credit.
Certain of the Company's credit agreements and the indenture for the
Debentures include covenants that restrict the Company's ability to take certain
actions, including the ability to incur additional indebtedness and to pay
dividends on capital stock. Under the most restrictive of these covenants, at
September 30, 1996 the Company could incur up to $217.7 million of additional
indebtedness and pay dividends of up to $144.3 million on its aggregate capital
stock (including its common stock, 7% Convertible Preferred Stock and Series A
Preferred) with the amount payable on its common stock limited to $58.6 million.
17
In October 1996 the Company entered into an agreement to purchase the
working interests of certain producing properties located in the Levelland Field
in the Permian Basin of West Texas from Louis Dreyfus Natural Gas Corp. for
approximately $27 million. The transaction is currently scheduled to close in
January 1997. The properties to be acquired have long-lived proved reserves and
provide additional development potential.
INITIAL PUBLIC OFFERING AND PROPOSED SPINOFF
On September 18, 1996 the Company announced its intention to separate its
Western Division from its other domestic and international operations. The
initial phase of the separation involves (i) the contribution of substantially
all of the assets and operations of the Western Division, which include the
Company's interest in the Midway-Sunset, South Belridge, Coalinga and Kern River
oil fields, to Monterey Resources, Inc. ("Monterey"), a newly-formed, wholly
owned subsidiary of the Company, and the assumption by Monterey of substantially
all of the liabilities and obligations associated with the Western Division,
including $245 million of indebtedness in respect of the Company's Senior Notes,
and (ii) the initial public offering of approximately 15% (17% if the
underwriters' over-allotment options are exercised in full) of the common stock
of Monterey (the "Monterey IPO"). Net proceeds from the Monterey IPO will be
used to reduce corporate indebtedness. Monterey has filed a registration
statement with the Securities and Exchange Commission relating to the proposed
Monterey IPO. The Monterey IPO is expected to be completed during the fourth
quarter of 1996.
The second phase of the separation would involve a pro rata distribution by
the Company to its common shareholders of its remaining ownership interest in
Monterey by means of a tax-free distribution (the "Proposed Spinoff"). The
Proposed Spinoff is subject to certain conditions including, the receipt of a
ruling from the Internal Revenue Service that such a distribution would be
tax-free, the approval of such distribution by the Company's common
shareholders, the absence of any future change in the market or economic
conditions (including developments in the capital markets) or the Company's or
Monterey's business or financial condition that causes the Company's board of
directors to conclude that the Proposed Spinoff is not in its shareholders' best
interests and the final declaration of the spinoff by the Company's board of
directors. The Proposed Spinoff is not expected to occur prior to June 1997.
On October 22, the Company announced it has entered into a supplement to
the indenture relating to its $100 million principal amount 11% Senior
Subordinated Debentures due 2004 that will permit the Monterey IPO and the
Proposed Spinoff to proceed without the occurrence of a breach or default under
such indenture.
The Company is taking these actions because of its belief that its oil and
gas operations have developed over time into separate businesses that operate
independently and have diverging capital requirements and risk profiles. In
addition, the board of directors believes that dividing the Company's operations
into two independent companies will allow each to more efficiently develop its
distinct resource base and pursue separate business opportunities while
providing each with improved access to capital markets. The board of directors
also believes that the Monterey IPO and the Proposed Spinoff will allow
investors to better evaluate each business, enhancing the likelihood that each
would achieve appropriate market recognition for its performance.
Also on October 22, the Company announced that it has commenced an offer to
purchase up to 4.5 million of the 5.0 million outstanding shares of its
Convertible Preferred Stock, 7% Series, for $24.50 per share, net to the seller
in cash. The Company intends to purchase all validly tendered and not withdrawn
shares, upon the terms and subject to the conditions of the offer, including the
provisions relating to proration. The offer, proration period and withdrawal
rights will expire at 12:00 midnight, EST, on Tuesday, November 19, 1996, unless
extended. The Company is making the offer because it believes that the goals of
the Proposed Spinoff can be better achieved by reducing the number of preferred
shares outstanding and simplying the Company's capital structure.
The Company and Monterey will enter into a contribution and conveyance
agreement pursuant to which, among other things, (i) the Company will contribute
to Monterey substantially all of the assets and
18
operations of its Western Division, subject to the retention by the Company of a
production payment in an aggregate amount of $30 million with respect to certain
properties in the Midway-Sunset field, which Monterey intends to prepay promptly
following the Monterey IPO; (ii) Monterey will assume all obligations and
liabilities of the Company associated with the assets and properties of the
Western Division, including the Company's outstanding $245 million of Senior
Notes and (iii) the Company and Monterey will agree that under certain
circumstances Monterey will purchase from the Company the surface rights to
approximately 116 surface acres in Orange County, California, to be retained by
the Company, which surface rights are currently held by the Company under a
contract for sale to a third party. Monterey will (i) use a portion of the net
proceeds from the Monterey IPO to repay $70 million of Senior Notes and accrued
and unpaid interest thereon and to pay a prepayment premium of approximately
$2.5 million thereon and (ii) issue $175 million of its Senior Notes due 2005 to
holders of $175 million of the Company's Senior Notes in exchange for
cancellation and surrender of such notes, and pay a $1.3 million consent fee in
connection therewith. In addition, the Company and Monterey will enter into a
new $75 million revolving credit facility with a group of banks and the Company
is expected to borrow approximately $16 million thereunder. Upon consummation of
the Monterey IPO, Monterey will repay all such indebtedness outstanding under
such credit facility with a portion of the net proceeds from the Monterey IPO
and the Company will cease to be an obligor under such credit facility. The
Company will terminate the Credit Agreement discussed under " -- Liquidity and
Capital Resources" and enter into a new $150 million credit facility and use
cash on hand together with funds borrowed under the Company's new credit
facility to purchase the shares of the Company's Convertible Preferred Stock, 7%
Series, tendered under the terms of the offer previously discussed.
ENVIRONMENTAL MATTERS
Almost all phases of the Company's oil and gas operations are subject to
stringent environmental regulation by governmental authorities. Such regulation
has increased the costs of planning, designing, drilling, installing, operating
and abandoning oil and gas wells and other facilities. The Company has expended
significant financial and managerial resources to comply with such regulations.
Although the Company believes its operations and facilities are in general
compliance with applicable environmental regulations, risks of substantial costs
and liabilities are inherent in oil and gas operations. It is possible that
other developments, such as increasingly strict environmental laws, regulations
and enforcement policies or claims for damages to property, employees, other
persons and the environment resulting from the Company's operations, could
result in significant costs and liabilities in the future. As it has done in the
past, the Company intends to fund its cost of environmental compliance from
operating cash flows.
DIVIDENDS
Dividends on the Company's Convertible Preferred Stock, 7% Series, and
Series A Preferred Stock are cumulative at an annual rate of $1.40 per share and
$0.732 per share, respectively. No dividends may be declared or paid with
respect to the Company's common stock if any dividends with respect to the 7%
Convertible Preferred Stock or Series A Preferred Stock are in arrears. None of
the dividends with respect to the Company's 7% Convertible Preferred Stock and
Series A Preferred Stock are in arrears. The determination of the amount of
future cash dividends, if any, to be declared and paid on the Company's common
stock is at the sole discretion of the Company's Board of Directors and will
depend on dividend requirements with respect to the preferred stock, the
Company's financial condition, earnings and funds from operations, the level of
capital and exploration expenditures, dividend restrictions in financing
agreements, future business prospects and other matters the Board of Directors
deems relevant.
The Company has announced a tender offer with respect to its Convertible
Preferred Stock, 7% Series. See " -- Initial Public Offering and Proposed
Spinoff".
FORWARD LOOKING STATEMENTS
In its discussion and analysis of financial condition and results of
operations, the Company has included certain statements (other than statements
of historical fact) that constitute forward-looking
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statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. When used herein, the words
"budget," "budgeted," "anticipate," "expects," "believes," "seeks,"
"goals," "intends" or "projects" and similar expressions are intended to
identify forward-looking statements. It is important to note that the Company's
actual results could differ materially from those projected by such
forward-looking statements. Although the Company believes that the expectations
reflected in such forward-looking statements are reasonable and such
forward-looking statements are based upon the best data available at the time
this report is filed with the Securities and Exchange Commission, no assurance
can be given that such expectations will prove correct. Factors that could cause
the Company's results to differ materially from the results discussed in such
forward-looking statements include, but are not limited to, the following:
production variances from expectations, volatility of oil and gas prices, the
need to develop and replace its reserves, the substantial capital expenditures
required to fund its operations, exploration uses, environmental risks,
uncertainties about estimates of reserves, competition, government regulation
and political sides, and the ability of the Company to implement its business
strategy. All such forward-looking statements in this document are expressly
qualified in their entirety by the cautionary statements in this paragraph.
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PART II
OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 First Supplemental Indenture, dated as of October 21, 1996,
between the Company and State Street Bank and Trust Company,
as Trustee, relating to the Company's 11% Senior Subordinated
Debentures due 2004.
(b) Reports on Form 8-K
Date Item
- -------------------- ------
September 18, 1996 5
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SANTA FE ENERGY RESOURCES, INC.
(Registrant)
By /s/ R. Graham Whaling
R. Graham Whaling
Senior Vice President and Chief
Financial Officer (Principal
Financial and Accounting Officer)
Houston, Texas
November 12, 1996
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