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UNITED STATES 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 March 31, 1996
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 1-10652
CONVEST ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
TEXAS 76-0312028
(State or jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
2401 FOUNTAIN VIEW DRIVE, SUITE 700
HOUSTON, TEXAS 77057
(Address of principal executive offices) (Zip Code)
(713) 780-1952
Registrant's telephone number, including area code:
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) 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
----- ------
The number of shares of the Registrant's Common Stock, par value $.01 per
share, outstanding at May 10, 1996, was 10,412,722.
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CONVEST ENERGY CORPORATION
Quarterly Report on Form 10-Q
for the Quarter Ended March 31, 1996
INDEX
I. FINANCIAL INFORMATION
Item 1. Financial Statements of Convest Energy Corporation:
Consolidated Balance Sheets.......................................... 3
Consolidated Statements of Operations................................ 4
Consolidated Statements of Stockholders' Equity...................... 5
Consolidated Statements of Cash Flows................................ 6
Notes to Consolidated Financial Statements........................... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................. 15
II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................... 20
Item 6. Exhibits and Reports on Form 8-K..................................... 20
Signature.................................................................... 21
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CONVEST ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(In Thousands)
March 31, December 31,
1996 1995
---------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 619 $ 674
Restricted cash 333 333
Accounts receivable:
Oil and gas production - less allowance
for doubtful accounts of $820 8,389 7,958
Other 504 252
Other current assets 6,093 6,223
-------- --------
Total current assets 15,938 15,440
-------- --------
Property and equipment:
Oil and gas properties, successful efforts method 111,124 114,201
Other 372 364
Less accumulated depreciation and depletion (50,678) (50,225)
-------- --------
60,818 64,340
-------- --------
Other noncurrent assets 2,474 2,177
-------- --------
$ 79,230 $ 81,957
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 1,354 $ 1,625
Accounts payable:
Oil and gas production 9,015 9,609
Affiliates 637 550
Accrued liabilities and other 4,887 3,803
Deferred revenue 2,115 2,010
-------- --------
Total current liabilities 18,008 17,597
-------- --------
Long-term liabilities:
Long-term debt, net of current maturities 12,824 17,553
Deferred revenue 615 691
Other noncurrent liabilities 10,679 11,099
-------- --------
24,118 29,343
-------- --------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $1 par value; authorized 5 million shares;
none issued or outstanding - -
Common stock $.01 par value; 20,000,000 shares
authorized, 10,412,722 issued at March 31, 1996 and
December 31, 1995 104 104
Additional paid-in capital 47,798 47,798
Retained earnings (deficit) (10,798) (12,885)
-------- --------
37,104 35,017
-------- --------
$ 79,230 $ 81,957
======== ========
See accompanying notes to consolidated financial statements.
-3-
CONVEST ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands Except Per Share Data)
Three Months Ended
March 31,
--------------------
1996 1995
--------- ---------
(Unaudited)
Revenues:
Oil and gas sales $11,159 $12,943
Gas plant revenues 361 303
Gain on asset sale 813 -
Other, net 103 40
------- -------
12,436 13,286
------- -------
Expenses:
Production:
Lease operating expense 3,961 4,352
Gas plant operating expense 123 121
Production taxes 310 302
Abandonment and exploration costs 42 365
General and administrative expenses 1,239 1,153
Interest expense 367 566
Depreciation, depletion and amortization 4,138 5,195
------- -------
10,180 12,054
------- -------
Net income before elimination of preacquisition
net loss and income taxes 2,256 1,232
Elimination of preacquisition
net loss of predecessor - (640)
------- -------
Net income before income taxes 2,256 1,872
Income tax provision 169 -
------- -------
Net income $ 2,087 $ 1,872
======= =======
Net income per share (See Note 2) $0.20 $0.30
======= =======
Weighted average common shares outstanding 10,413 6,185
======= =======
See accompanying notes to consolidated financial statements.
-4-
CONVEST ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 1996
(In Thousands)
(Unaudited)
Common Common Additional
Shares Stock, Paid-In Retained
Outstanding $.01 par Capital Earnings Total
----------- -------- ---------- --------- -------
Balance at December 31, 1995 10,412 $104 $47,798 $(12,885) $35,017
Net income - - - 2,087 2,087
----------- -------- ---------- -------- -------
Balance at March 31, 1996 10,412 $104 $47,798 $(10,798) $37,104
=========== ======== ========== ======== =======
See accompanying notes to consolidated financial statements.
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CONVEST ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
Three Months Ended
March 31,
--------------------
1996 1995
--------- ---------
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,087 $ 1,872
Adjustments to reconcile net income to
net cash provided by (used in) operating activities:
Depreciation, depletion and amortization 4,138 3,528
Gain on sale of oil and gas properties (813) -
Abandonment and exploration costs - 346
Increase in accounts receivable (411) (4,450)
Decrease in accounts payable and accrued liabilities (476) (1,853)
Other 180 (23)
------- -------
Net cash flow provided by (used in) operating
activities 4,705 (580)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition, exploration and development of oil and
gas properties (1,756) 85
Proceeds from sales of oil and gas properties 2,207 -
Sale of investment in affiliates - 7,351
(Purchase) sale of short-term investments (203) (1,219)
Increase in other current and noncurrent assets (8) -
------- -------
Net cash provided by investing activities 240 6,217
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term debt (5,000) (7,500)
Distribution of certain assets and
liabilities to affiliate - (431)
------- -------
Net cash used in financing activities (5,000) (7,931)
------- -------
Net decrease in cash and cash equivalents (55) (2,294)
Cash and cash equivalents, beginning of period 1,007 4,956
------- -------
Cash and cash equivalents, end of period $ 952 $ 2,662
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest $ 419 $ 568
======= =======
Cash paid during the period for taxes $ 248 $ -
======= =======
See accompanying notes to consolidated financial statements.
-6-
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND BASIS OF PRESENTATION
Convest Energy Corporation, a Texas corporation ("Convest" or the "Company"),
is an independent oil and gas exploration and production company whose common
stock is traded on the American Stock Exchange.
On June 26, 1995, the Company acquired all of the outstanding capital stock of
Edisto Exploration & Production Company ("Edisto E&P") from Edisto Resources
Corporation ("Edisto") in exchange for 6,185,400 newly issued shares of
Convest's common stock and $10,000 in cash. The newly issued shares of Convest
common stock increased Edisto's interest in Convest from 31% to 72%. Upon
closing of this transaction with Edisto (the "Edisto Transaction"), Convest's
Board was restructured so that affiliates of Edisto constituted a majority of
the directors.
Since Edisto acquired control of Convest in the Edisto Transaction, the
acquisition of Edisto E&P has been accounted for as a reverse acquisition with
Edisto E&P being considered the acquiring entity. Accordingly, all future
references to "Convest" or the "Company" will apply to Edisto E&P, and any
references to "CEC" will apply solely to Convest Energy Corporation prior to the
reverse acquisition. In accordance with the accounting rules for a reverse
acquisition, the following should be noted when reviewing the consolidated
financial statements of the Company presented herein:
(i) The Consolidated Statement of Operations of the Company for the quarter
ended March 31, 1995 sets forth the combined pro forma results of operations
of Edisto E&P and CEC as if the Edisto Transaction had occurred on January 1,
1995, with the preacquisition net loss of CEC for such quarter being
eliminated for purposes of determining net income.
(ii) The Consolidated Statement of Cash Flows of the Company for the three
months ended March 31, 1995 sets forth only the cash flows of Edisto E&P, and
accordingly, is not comparable with the cash flows for the three months ended
March 31, 1996, which includes the cash flows of both Edisto E&P and CEC.
These financial statements should be read in conjunction with the audited
financial statements and the notes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1995. Reference also is
made to the "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in this report.
The information presented in this Form 10-Q is unaudited, but in the opinion
of management reflects all adjustments (all of which were normal and recurring)
necessary to fairly present such information. Interim results are not
necessarily indicative of a full year of operations.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION. All significant intercompany accounts and
activities have been eliminated.
RESTRICTED CASH. Restricted cash consists of $333,000 of certificates of
deposit held by various financial institutions. The certificates of deposit are
held in escrow as collateral for letters of credit issued for (i) lease payments
on certain offshore platforms and (ii) estimated plugging and abandonment costs
expected to be incurred on certain onshore oil and gas properties.
PROPERTY AND EQUIPMENT. The Company follows the successful efforts method of
accounting for its oil and gas properties. Costs of productive wells,
developmental drilling expenditures, including dry holes, and productive leases
are capitalized. Exploratory drilling costs, including stratigraphic test
wells, are initially
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CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
capitalized, but charged to expense if and when the well is determined to be
unsuccessful. The capitalized costs of oil and gas properties are charged to
operations as depreciation, depletion and amortization using the unit-of-
production method based on the ratio of current production to proved recoverable
oil and gas reserves (as defined by the Securities and Exchange Commission) on a
lease by lease basis. Reserve estimates for the Company's properties were
prepared by independent petroleum engineering firms at year end. Gas is
converted to equivalent barrels of oil on an energy content basis of 6 Mcf of
gas to 1 barrel of oil. Depreciation, depletion and amortization per equivalent
barrel of oil production was $5.07 and $4.56 for the three month periods ended
March 31, 1996 and 1995, respectively. Oil and gas leasehold costs are
capitalized when incurred. Unproved properties are assessed periodically on a
property-by-property basis and impairments in value are charged to expense.
Exploratory expenses, including geological and geophysical expenses and annual
delay rentals, are charged to expense as incurred.
In the fourth quarter of 1995, Convest adopted Statement of Financial
Accounting Standards No. 121 ("SFAS 121") regarding accounting for the
impairment of long-lived assets. SFAS 121 requires Convest to recognize an
impairment loss for its proved oil and gas properties if the carrying value of
such properties (i.e., total capitalized costs less accumulated depreciation and
depletion) exceeds the undiscounted expected future cash flows attributable to
such properties. Under SFAS 121, Convest must assess the need for an impairment
of capitalized costs of oil and gas properties on a property-by-property basis.
If an impairment is indicated based on undiscounted expected future cash flows,
then an impairment loss is recognized to the extent that net capitalized costs
exceed discounted expected future cash flows. No such provision was required
for the period ended March 31, 1996.
OTHER PROPERTY, PLANT AND EQUIPMENT. Other fixed assets are recorded at cost
and depreciated over their estimated useful lives using the straight-line method
of depreciation.
ABANDONMENT RESERVE. The Company records its estimate of future abandonment
costs of offshore properties. Such costs are accrued using a unit-of-production
method based upon estimated proved recoverable reserves. Abandonment costs are
estimated under current regulations using current costs and are reviewed
periodically and adjusted as new information becomes available. Abandonment
costs on onshore properties are typically nominal due to the salvage value of
well equipment, and accordingly, the Company does not provide for the
abandonment of its onshore properties.
Upon emerging from bankruptcy in July 1993, Edisto E&P entered into a
settlement with the United States Minerals Management Service relating to
estimated plugging and abandonment costs for 14 Gulf of Mexico OCS leases in
which Edisto E&P owned interests. Pursuant to this settlement, the operator of
the leases, Edisto E&P and other co-lessees were required to provide security
for payment of such costs through quarterly payments to an Abandonment Fund.
Following the Edisto Transaction, the Company continues to be subject to the
Abandonment Fund payments covering the properties in which the Company owns a
working interest. As of March 31, 1996 and December 31, 1995, the Company was
subject to total Abandonment Fund payments of $4.3 million.
As of March 31, 1996 and December 31, 1995, the Company had made payments
totaling $3.9 million and $3.7 million to the Abandonment Fund, respectively.
These payments were applied to the total long-term abandonment reserve of $10.4
million and $10.2 million, as of March 31, 1996 and December 31, 1995,
respectively, resulting in a net long-term abandonment reserve of $6.5 million
as of those dates. The current portion of the abandonment reserve was $357,000
and $556,000 as of March 31, 1996 and December 31, 1995, respectively. The
current portion of the abandonment reserve is included in "Accrued Liabilities
and Other" and the noncurrent portion is included in "Other Noncurrent
Liabilities" in the consolidated financial statements.
LEASE OPERATING EXPENSES. In connection with a 1992 sale of certain future
production volumes of oil to Enron Reserve Acquisition Corp., the Company
established a reserve for the expenses associated with the volumes sold and
amortizes this reserve as the volumes are delivered. As of March 31, 1996 and
December 31, 1995, the
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CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
current balance of this reserve was $1.8 million and the long-term balance was
$4.2 million and $4.6 million, respectively, and are included in "Accrued
Liabilities and Other" and "Other Noncurrent Liabilities," respectively, in the
consolidated financial statements.
GAS BALANCING. The Company uses the entitlement method of accounting for gas
imbalances. Receivables resulting from undertakes of gas production at March
31, 1996 and December 31, 1995, were $1.6 million and $1.4 million,
respectively, and are included in "Accounts Receivable - Oil and Gas Production"
and "Other Noncurrent Assets" in the consolidated financial statements.
Deferred revenue and payables resulting from overtakes of gas production at
March 31, 1996 and December 31, 1995 were $2.7 million and are included in
"Deferred Revenue" and "Other Noncurrent Liabilities" in the consolidated
financial statements.
ACCOUNTING FOR INCOME TAXES. The Company records income taxes in accordance
with the Financial Accounting Standards Board - Statement of Financial
Accounting Standards No. 109 ("SFAS No. 109"), "Accounting for Income Taxes."
SFAS No. 109 requires the balance sheet approach of income tax accounting
whereby deferred income taxes are provided at the balance sheet date for the
differences existing in the tax basis of assets and liabilities and their
financial statement carrying amounts.
NET INCOME PER SHARE. Net income per share is computed based on the weighted
average number of shares outstanding which were 10,412,722 and 6,185,400 for the
three months ended March 31, 1996 and 1995, respectively. No effect has been
given to options outstanding under the Company's stock option plans because
their effect is antidilutive or immaterial. In accordance with the accounting
rules for a reverse acquisition, the Company's capital structure was restated so
that Edisto E&P assumed CEC's capital structure as of the date of the Edisto
Transaction (June 26, 1995) and prior period equity balances and earnings per
share were retroactively adjusted to reflect this change. The Company considers
net income per share information for periods prior to June 30, 1995 to be of
limited value since Edisto E&P was a wholly-owned subsidiary of Edisto prior to
the Edisto Transaction. See Note 1 above describing the accounting for the
Edisto Transaction.
RISK MANAGEMENT/HEDGING ACTIVITIES. The Company from time to time engages in
commodity hedging activities to minimize the risk of market fluctuations in the
prices of crude oil and natural gas. The hedging objectives include assurance
of stable and known cash flows and fixed favorable prices. The hedges are
effected through the purchase and sale of futures contracts on the New York
Mercantile Exchange ("NYMEX") and price swap agreements with major financial
institutions. Gains or losses on the Company's hedging agreements are deferred
and are recorded as oil and gas sales revenue in the month for which the hedged
transaction is completed.
STATEMENT OF CASH FLOWS. For purposes of the Consolidated Statements of Cash
Flows, the Company considers all highly liquid investments purchased with a
maturity of three months or less to be cash equivalents.
USE OF ESTIMATES. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financials
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. All
significant estimates are discussed herein.
(3) ACQUISITIONS/DISPOSITIONS
EDISTO TRANSACTION
The Edisto Transaction is described in Note 1 herein. As described therein,
the Edisto Transaction has been accounted for as a reverse acquisition since
Edisto acquired control of CEC.
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CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SENSOR PROPERTIES ACQUISITION
In May and June 1995, prior to the closing of the Edisto Transaction, CEC and
Edisto E&P acquired from Sensor Oil & Gas ("Sensor") certain oil and gas
properties located in Kansas, Oklahoma and Nebraska (the "Sensor Properties").
As of January 1, 1996, these properties had proved oil and gas reserves totaling
approximately 1.4 million barrels of oil and 300 Mmcf of gas. The aggregate
purchase price, including transaction costs, was approximately $8.0 million.
The accompanying Consolidated Statements of Operations for the three months
ended March 31, 1996, includes revenues of approximately $1.2 million and direct
operating expenses of $576,000 attributable to the Sensor Properties.
DISPOSITION OF OIL AND GAS PROPERTIES
In January 1996, the Company sold an offshore oil and gas property for
approximately $2.0 million. As a result of the sale, the Company recorded a
gain on the property sale of approximately $620,000 during the first quarter of
1996. In addition, the Company sold several other nonstrategic oil and gas
properties during the first quarter of 1996. Aggregate sale proceeds totaled
approximately $400,000 and resulted in a gain of approximately $195,000 for the
three months ended March 31, 1996.
(4) RELATED PARTY TRANSACTIONS
In the Edisto Transaction, Edisto retained the tax benefits of the net
operating loss carryforwards ("NOLs") of Edisto E&P. The tax benefits include a
$3.3 million NOL usable for regular taxable income and a $3.6 million NOL usable
for alternative minimum taxable income. The Company determined that the use of
these NOLs would reduce its taxes for 1995 by approximately $437,000. In
addition, based on current projections of the Company's future taxable income,
it was determined that the remaining NOLs of Edisto E&P would be a valuable
asset that could be utilized by Convest in the near future. Accordingly, Edisto
allowed Convest to utilize the NOLs of Edisto E&P in consideration for the
payment by Convest of $550,000. At December 31, 1995, the Company recorded a
deferred tax asset of $550,000 and a corresponding accounts payable to Edisto
which is presented in "Other Noncurrent Assets" and "Accounts Payable -
Affiliates," respectively, in the consolidated financial statements.
During January 1995, CEC entered into a gas marketing agreement with Energy
Source, Inc. ("Energy Source"), a wholly-owned subsidiary of Edisto, whereby
Energy Source markets a substantial portion of the Company's gas production and
assumes certain related administrative functions. Effective November 1, 1995,
the Company and Energy Source extended the term of the agreement to December 31,
1996, with the Company having the right to renegotiate the pricing structure at
each six month interval of the extended term. For the three months ended March
31, 1996, Energy Source marketed approximately 65% of the Company's gas
production for the period. In exchange for its services, Energy Source receives
a fee of no more than 2% of the spot market price. Under the agreement, Energy
Source takes title to the gas before reselling it, thereby creating an account
receivable from Energy Source for the sold gas. At March 31, 1996 and December
31, 1995, the account receivable from Energy Source was $5.6 million and $4.7
million, respectively, which is included in "Accounts Receivable - Oil and Gas
Production" on the Consolidated Balance Sheets. Convest sells such gas to
Energy Source on open credit without requiring a letter of credit or other
security. Management believes the terms of the Energy Source gas marketing
agreement are no less favorable to the Company than those available from
unaffiliated third parties.
In July 1995, the Company and Edisto obtained a directors' and officers'
fiduciary insurance policy that covers both companies. The annual insurance
premium was allocated 44% to the Company, for a cost of $156,000, based on the
relative percentage that the assets of the Company bear to the total assets of
both the Company and Edisto.
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CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Effective July 1, 1995, the Company and Edisto agreed to share certain
administrative costs to reduce the overall cost that would otherwise be incurred
by each of them in the absence of such an arrangement. Under the arrangement,
certain costs associated with shareholder communication services, costs of
computer hardware and software systems and certain administrative staff who
perform duties on behalf of both entities are shared by Convest and Edisto based
on their respective utilization. In addition, the base salary of Michael Y.
McGovern, who serves as the Chairman and Chief Executive Officer of Edisto and
Convest, is shared equally by Edisto and Convest. Mr. McGovern's annual base
salary is $275,000, so Convest reimburses Edisto for one-half of this amount
plus one-half of his payroll taxes and benefits (such as health, disability and
life insurance and 401(k) plan contributions).
Energy Source executes trades of futures contracts for natural gas and crude
oil on the NYMEX on behalf of the Company. These trades are made in connection
with the Company's program to hedge against the volatility of natural gas and
crude oil prices. In this regard, Energy Source acts solely in a ministerial
capacity to purchase or sell the futures contracts at price levels directed by
the Company's management. Energy Source charges a commission of $.0025 per Mcf
of gas or barrel of crude oil for each trade executed.
Each of the affiliated party transactions described above was approved by
either a special committee of the Company's Board, which was composed of outside
directors with no affiliation to Edisto, or the unanimous consent of the
Company's Board. Effective July 1, 1995, the Company's Board of Directors
established the Affiliate Transaction Review Committee which must review and
unanimously approve all affiliated party transactions.
In March 1996, the Board of Directors of Edisto authorized the open market
purchase of up to 1,160,000 shares of Common Stock of Convest from time to time.
The timing and amounts of purchases will be governed by applicable SEC rules and
market conditions. The purpose of the stock purchase is to increase Edisto's
ownership percentage of Convest to over 80% to allow Edisto and Convest to
consolidate for federal income tax purposes. Edisto has existing net operating
loss carryforwards that may be beneficial to Convest if the two companies are
consolidated for tax purposes. On a primary basis, Edisto needs to acquire an
additional 875,000 shares to allow it to reach 80.5% of Convest's outstanding
shares. On a fully diluted basis, however, Edisto needs to acquire
approximately 1,160,000 shares to reach 80.5% because of outstanding stock
options. As of May 10, 1996, Edisto had purchased an additional 92,000 shares
of Common Stock of Convest, thereby increasing their ownership interest to
approximately 73%.
(5) HEDGING ACTIVITIES
As previously stated, the Company conducts its hedging activities through
futures contracts traded on the NYMEX and price swap agreements with major
financial institutions. Set forth below is the contract amount and term of all
futures contracts held for price risk management purposes by the Company at
March 31, 1996 and December 31, 1995:
-11-
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1996 December 31, 1995
------------------------ -------------------------------
Oil(1) Gas Oil(1) Gas
------------ ---------- ------------ -----------------
Quantity Sold 311 MBbls 4,220 MMcf 285 MBbls 8,220 MMcf
Maximum Term 8 Months 7 Months 11 Months 10 Months
Average Price $17.94 $1.79 $17.23 $1.86
- - --------------
(1) Excludes certain oil volumes attributable to the 1992 sale of certain
future production to Enron Reserve Acquisition Corp. which volumes are subject
to a contractual price of $17.00 per barrel.
Gains and losses realized upon settlement of the Company's hedge positions are
deferred and recognized as oil and gas sales revenue in the month of the
underlying physical production being hedged. As of March 31, 1996 and December
31, 1995, the Company recorded deferred hedging expense of $1.3 million and
$421,000, respectively, and are presented in "Other Current Assets" in the
accompanying Consolidated Balance Sheets. The cash margin required by the
counterparts to the Company's hedging activities totaled $4.5 million and $5.1
million as of March 31, 1996 and December 31, 1995, respectively, and are
included in "Other Current Assets" in the accompanying Consolidated Balance
Sheets.
As a result of the Company's hedging activities, the Company recorded hedging
expense of approximately $2.2 million for the three month period ended March 31,
1996, and hedging income of approximately $638,000 for the corresponding period
of 1995. Such amounts were recorded as oil and gas sales revenue in the
accompanying Consolidated Statements of Operations.
(6) INCOME TAXES
The Company records current income taxes based on its estimated actual tax
liability for the year. The Company provides for deferred income taxes under
SFAS No. 109 based upon differences between the tax basis of the Company's
assets and liabilities and their financial statement carrying amounts multiplied
by the Company's expected future effective tax rate.
For the three months ended March 31, 1996, the Company recorded current income
tax expense of $169,000. The Company has provided a valuation allowance against
substantially all of its net deferred tax assets as the "more-likely-than-not"
criteria for recognition under SFAS No. 109 was not met. At December 31, 1995,
the Company purchased approximately $3.3 million of NOL tax benefits from Edisto
for $550,000 which is included in "Other Noncurrent Assets" in the accompanying
balance sheets. See Note 4 above regarding related party transactions. No
valuation allowance was taken against such amount under SFAS No. 109 since the
Company anticipates that the purchased NOLs will be utilized against the
Company's current income tax.
(7) LONG-TERM DEBT
On June 26, 1995, simultaneous with the closing of the Edisto Transaction, the
Company entered into an Amended and Restated Secured Revolving Credit Agreement
(the "Agreement") with Bank One, Texas, N.A. ("Bank One"), and Compass Bank-
Houston. This facility, which terminates January 1, 1998, combined the existing
credit facilities of CEC and Edisto E&P. Bank One serves as agent bank of the
Agreement. The facility is secured by a first lien on all of the Company's
assets, including its oil and gas properties and gas plant. Interest on
borrowings under the Agreement is computed at (i) the agent bank's prime lending
rate (the "Base Rate") plus 3/4%
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CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
or (ii) the London Inter Bank Offering Rate ("LIBOR") plus 2-3/4%. In addition,
the Company pays a commitment fee equal to 1/2% on any commitment amount in
excess of outstanding borrowings.
The borrowing base is redetermined semi-annually on or before May 31 and
November 30 of each year by the lending banks based on engineering criteria
established by the banks. As of March 31, 1996 and December 31, 1995, the
borrowing base available under the Agreement was $25.0 and $29.8 million,
respectively, and reduces by $1.0 million per month. During January 1996, the
Company sold its interest in an offshore oil and gas property, and accordingly,
the Company's borrowing base was reduced by approximately $1.8 million
simultaneous with the sale of the property. Based on the Company's borrowing
base on March 31, 1996, after giving effect to the scheduled monthly borrowing
base reductions, the Company's outstanding borrowings would have exceeded the
borrowing base by $1.4 million at March 31, 1997, and accordingly, such amount
was classified as current at March 31, 1996. During May 1996, the Company was
notified by the lending banks that based on the lending banks' semi-annual
redetermination, the new borrowing base under the facility was $25.5 million
effective May 1, 1996, which will reduce by $1.0 million per month beginning
June 1, 1996. Based on the borrowing base redetermination received in May 1996,
the Company would not have been required to classify any of its outstanding
long-term borrowings as current at March 31, 1996.
As of March 31, 1996 and December 31, 1995, outstanding indebtedness under the
Agreement was $14.2 million and $19.2 million, respectively, with an additional
$200,000 of letters of credit outstanding as of those dates, primarily related
to performance bonds issued for oil and gas operations. At March 31, 1996,
substantially all of the Company's outstanding borrowings were subject to LIBOR
interest at an effective rate of approximately 8-1/4% per annum.
(8) COMMITMENTS AND CONTINGENCIES
Elizabeth Holt, et al. v. Sun E & P Company, et al., No. 3,217 in the 84th
--------------------------------------------------
District Court, Hansford County, Texas. This suit was originally filed in
August 1984, seeking to cancel a 13-section lease because there was no gas
production for a period of approximately 120 days in 1983 when the gas
purchaser's pipeline was shutdown for repairs. The plaintiff sought to
terminate the lease by reason of non-production as of September 23, 1983. If
successful, the Company would be liable for damages on past production in the
range of $300,000 to $350,000, plus pre-judgment interest and attorneys fees,
which would total approximately $400,000 to $450,000. At the trial held in
August 1995, the trial judge ruled by interlocutory judgment in the Company's
favor that the lease had been preserved by a timely shut-in payment. The
Company expects this judgment to be appealed, but such appeal may not be made
until after the case has been concluded against the other defendants. A trial
on damages against the other defendants is scheduled for May 1996. The
predecessor in interest to Convest has indemnified the Company to a maximum of
$357,000 in value for the well provided that total damages exceed $250,000.
John S. Turner v. Convest, et al., in the 56th Judicial District Court of
---------------------------------
Galveston County, Texas. This lawsuit relates to two title claims involving
interests in an oil and gas property in Galveston County, Texas in which the
Company has a working interest. In the first claim, the plaintiff alleges that
a lease acquired by the working interest owners through a court appointed
receiver is void due to the failure to give proper legal notice of the
receivership proceedings to the owner of the interest. In the second claim, the
plaintiff claims that he is the true owner of another interest in this property
because he acquired it from the Company's predecessor-in-interest. In both
claims, the plaintiff claims that he is the present owner of the interests and
that he is entitled to his proportionate share of past and future production
from the property, plus punitive damages and attorney's fees. The Company has a
46% working interest in this property. Discovery is proceeding, but no trial
date has been set. The Company is unable to determine a range of possible loss
at this time.
-13-
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In addition, the Company is named as defendant in several lawsuits arising in
the ordinary course of business. While the outcome of lawsuits and other
proceedings against the Company cannot be predicted with certainty, management
does not expect these matters to have a material adverse effect on the Company's
financial position or results of operations.
-14-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Company's consolidated financial statements and the notes thereto.
OVERVIEW AND SIGNIFICANT DEVELOPMENTS
The significant events during the first quarter of 1996 are described below:
RESULTS OF OPERATIONS. The Company had net income of $2.1 million for the
----------------------
quarter ended March 31, 1996 compared to $1.9 million for the corresponding
quarter of 1995.
EUGENE ISLAND 281 DRILLING. During the first quarter of 1996, the Company
---------------------------
participated in the drilling of a development well in Block 281 of the Eugene
Island area in the Gulf of Mexico. The well was drilled from an existing
platform structure at an estimated completed well cost of approximately $1.0
million, net to the Company's 37% working interest, and tested at a daily rate
of 1,020 barrels of oil and 1.6 Mcf of gas. The well was connected to existing
production facilities on the platform and is presently flowing at approximately
950 barrels of oil per day.
PROPERTY SALES. During January 1996, the Company sold its interest in
---------------
Vermillion Block 284 for approximately $2.0 million. The Company also sold
other nonstrategic oil and gas properties during the first quarter for aggregate
sales proceeds of approximately $400,000. As a result of these sales, the
Company recorded a gain of approximately $815,000 during the first quarter of
1996.
REPAYMENT OF OUTSTANDING DEBT. During the first quarter of 1996, the Company
------------------------------
repaid $5.0 million of outstanding debt under its long-term credit facility.
The Company used the proceeds received from the Vermilion 284 property sale and
approximately $3.0 million of cash flow from operations to make this debt
repayment.
SOUTH TIMBALIER 109/144 DRILLING PROSPECT. During May 1996, the Company and
------------------------------------------
the operator of the Company's South Timbalier 144 property interest executed an
agreement to jointly develop an exploratory prospect located across Block 144
and Block 109 of the South Timbalier area of the Gulf of Mexico. The Company
presently owns a 50% working interest in Block 144 and will receive a 50%
working interest in Block 109 under the joint development agreement in exchange
for a payment of approximately $355,000.
The operator of Blocks 109 and 144 plans to drill an 8,000' exploratory test
well in the prospect area for an aggregate cost of between $800,000 and $1.1
million, net to the Company's 50% working interest. Depending upon the success
of the first well, it is anticipated that two additional wells will be drilled
and a platform installed. If all of the proposed wells are successful, Convest's
total cost in the prospect would aggregate approximately $6.0 million, net to
the Company's working interest.
-15-
RESULTS OF OPERATIONS
The following table highlights the production volumes, average oil and gas
prices and revenues received by the Company and production and operating
expenses for the three month periods ended March 31, 1996 and 1995.
For the Three Months
Ending March 31,
-------------------- Percentage
1996 1995 Change
-------- ---------- --------
PRODUCTION VOLUMES:
Oil (Mbbls) 217 289 (25%)
Gas (including NGL's)(Mmcf) 3,572 5,005 (29%)
BOE (Mbbls)/(1)/ 812 1,123 (28%)
PRICES:
Oil ($/Bbl) $ 17.37 $ 16.77 4%
Gas ($/Mcf) 2.07 1.62 28%
GROSS OIL AND GAS REVENUE (IN THOUSANDS):
Oil $ 3,760 $ 4,843 (22%)
Gas (including NGL's) 7,399 8,100 (9%)
------- -------
Total Oil and Gas Revenue $11,159 $12,943 (14%)
======= =======
PRODUCTION EXPENSES (IN THOUSANDS):
Lease Operating Expenses $ 3,961 $ 4,352 (9%)
Production Taxes 310 302 2%
------- -------
Total Production Expenses $ 4,271 $ 4,654 (9%)
======= =======
ABANDONMENT AND EXPLORATION COSTS $ 42 $ 365 (88%)
======= =======
GENERAL AND ADMINISTRATIVE EXPENSE $ 1,239 $ 1,153 7%
======= =======
INTEREST EXPENSE $ 367 $ 566 (35%)
======= =======
DEPRECIATION, DEPLETION AND AMORTIZATION
OF OIL AND GAS PROPERTIES $ 4,112 $ 5,121 (20%)
======= =======
PRODUCTION COSTS PER BOE $ 5.26 $ 4.15 27%
======= =======
DEPRECIATION, DEPLETION AND AMORTIZATION
PER BOE $ 5.07 $ 4.56 11%
======= =======
- - -------------
/(1)/ Natural gas is converted into oil equivalents at a rate of six thousand
cubic feet per each barrel of oil.
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 1996 AND 1995.
Overview. The Consolidated Statements of Operations of the Company
for the three month periods ended March 31, 1996 and 1995 set forth the combined
results of operations of CEC and Edisto E&P as if the Edisto Transaction had
occurred on January 1, 1995, with the preacquisition net loss of CEC for the
three months ended March 31, 1995 being eliminated for purposes of determining
net income. See Note 1 under "Notes to Consolidated Financial Statements" for
additional information regarding the reverse acquisition method of accounting
used for the Edisto Transaction.
-16-
Revenues. Oil and gas revenue decreased by approximately $1.8 million
or 14% between the three month periods ended March 31, 1996 and 1995. The
average price the Company received for its oil and gas sales increased by 4% and
28%, respectively, between the corresponding periods. Oil and gas production
decreased by 25% and 29%, respectively. The decrease in production volumes was
due primarily to the sale of producing oil and gas properties coupled with the
steep production decline associated with the Company's offshore Gulf of Mexico
properties. The effects of these production declines was partially offset by
the additional drilling on the Company's South Timbalier Block 144 property and
the addition of the Sensor properties purchased in mid 1995. As previously
stated, the Company's offshore properties are subject to inherent steep
production declines. In order to minimize the future effects of such declines,
the Company must replace its reserves through its exploratory and development
drilling and acquisition activities.
Price Risk Management/Hedging. The Company uses a combination of
futures contracts traded on the NYMEX and price swaps with major financial
institutions to hedge against the volatility of natural gas and oil prices.
Gains and losses recognized upon settlement of the Company's hedge positions are
deferred and recognized as oil and gas sales revenue in the month of the
underlying physical production being hedged. As a result of the Company's
hedging activities, the Company recorded hedging expense of approximately $2.2
million for the three month period ended March 31, 1996, and hedging income of
approximately $638,000 for the corresponding period of 1995. Such amounts were
recorded as oil and gas sales revenue in the accompanying statements of
operations.
The hedges affecting the first quarter of 1996 were implemented early
in the fourth quarter of 1995 when oil and gas prices were substantially lower.
These hedges were made as a defensive measure to assure stable cash flows in
1996. The past harsh winter, however, drove prices up substantially which
caused the hedging losses in the first quarter of 1996.
Production Expenses. Production expenses decreased by approximately
$385,000 or 9% between the corresponding periods. The decrease in production
expenses is primarily due to a decrease in workover activity during the three
months ended March 31, 1996, and the sale of producing oil and gas properties
during 1995 and early 1996. The decline in production expenses was offset by
the incremental operating expenses associated with the Sensor properties.
Production expenses per barrel of oil equivalent ("BOE") was $5.26 and $4.15 for
the three months ended March 31, 1996 and 1995, respectively.
Abandonment and Exploration Costs. Abandonment and exploration costs
decreased by $323,000 between the corresponding periods. The Company accrues
its estimated cost of abandonment of its offshore properties. Based upon a
review of the reserve for abandonment, it was determined that no additional
accrual was required for the three months ended March 31, 1996.
General and Administrative Expenses. General and administrative
expenses increased by approximately $86,000 between the corresponding periods.
The primary contributor to the increase in general and administrative expense
was increased personnel costs associated with the larger asset base following
the addition of the Sensor properties and the Edisto Transaction, which were
completed during the second quarter of 1995. This increase was offset by lower
office rent expense after Edisto E&P terminated its existing office lease in
early 1995.
Interest Expense. Interest expense decreased by approximately 35% due
to the repayment of a short-term promissory note issued upon the Company's
purchase of the oil and gas assets of a former affiliate. The short-term
promissory note was repaid simultaneously with the closing of the Edisto
Transaction. In addition, the Company repaid a substantial portion of its
outstanding borrowings under its long-term credit facility during the first
quarter of 1996.
Depreciation, Depletion and Amortization ("DD&A"). DD&A on oil and
gas properties decreased by approximately 20% between the corresponding periods.
The decrease in DD&A was due primarily to the production declines discussed
above. DD&A per BOE, however, was $5.07 for the three month period ended March
31, 1996, compared to $4.56 for the corresponding period of 1995.
Gain on Asset Sales. In mid-January 1996, the Company completed the
sale of an offshore oil and gas property for sale proceeds of approximately $2.0
million. As a result of the sale, the Company recorded a gain on the property
sale of approximately $620,000 during the first quarter of 1996. In addition,
the Company sold
-17-
several other nonstrategic oil and gas properties during the first quarter of
1996. Aggregate sale proceeds totaled approximately $400,000 and resulted in a
gain of approximately $195,000 for the three months ended March 31, 1996.
LIQUIDITY AND CAPITAL RESOURCES
CREDIT FACILITY AND LONG-TERM DEBT
On June 26, 1995, simultaneous with the closing of the Edisto
Transaction, the Company entered into a new joint credit agreement covering both
the Edisto E&P and CEC properties. This facility, which terminates January 1,
1998, combined the existing credit facilities of CEC and Edisto E&P. This
facility is secured by a first lien on substantially all of the Company's
assets, including its oil and gas properties and gas plant.
The borrowing base under the facility is subject to redetermination
semi-annually (on or before May 31 and November 30) using engineering
determinations and pricing and other assumptions designated by the bank group.
Effective December 1, 1995, the new borrowing base under the credit facility was
$29.8 million, based on the lending banks' semi-annual redetermination, and
began reducing by $1.0 million per month beginning January 1, 1996.
Additionally, during January 1996, the Company sold its interest in an offshore
property which reduced the borrowing base to $27.0 million after giving effect
to the sale and the scheduled January 1996 borrowing base reduction. During May
1996, the Company was notified by the lending banks that based on the lending
banks' semi-annual redetermination, the new borrowing base under the facility
was $25.5 million effective May 1, 1996, which will reduce by $1.0 million per
month beginning June 1, 1996.
The Company's borrowing capacity will be substantially reduced over
the next year (by at least $12.0 million) unless there is substantial
improvement in oil and gas prices or the Company is successful in proving up
additional reserve quantities. On the other hand, should prices fall below
those currently experienced and/or should the Company's reserve base be subject
to downward revision, the amount of the credit reduction could increase and such
increase could be substantial. Based on the December 1, 1995 borrowing base
redetermination and giving effect to the aforementioned property sale and
scheduled monthly borrowing base reductions, the Company's outstanding
borrowings would have exceeded the borrowing base by approximately $1.4 million
at March 31, 1997, and accordingly, such amount has been classified as current
at March 31, 1996. Based on the borrowing base redetermination received in May
1996, the Company would not have been required to classify any of its
outstanding long-term borrowings as current at March 31, 1996. The Company
feels that sufficient cash flow will be derived from its oil and gas sales to
meet its scheduled future debt repayments. As stated above, however, the
borrowing base and the amount of current maturities of debt is subject to
change.
WORKING CAPITAL
At March 31, 1996, the Company had a working capital deficit of
approximately $2.1 million. The primary cause of the working capital deficit is
the classification as current liabilities of the accrued liabilities for
abandonment costs, operating expenses attributable to the sale of a production
payment on two properties, and gas imbalance liabilities (deferred revenues),
all of which are expected to be paid during the next 12 months. There is no
offsetting current asset for any of these liabilities; rather, they will to be
repaid using cash flow from operations of the Company's oil and gas properties,
which are reflected as a long-term asset on the Consolidated Balance Sheets in
accordance with generally accepted accounting principles.
As discussed above under "Credit Facility and Long-Term Debt," $1.4
million of the working capital deficit was caused when $1.4 million of long-term
debt was classified as current. This reclassification was made because the
outstanding borrowings under the Company's credit facility would exceed the
borrowing base by approximately $1.4 million at March 31, 1997 using the
borrowing base in effect at March 31, 1996. Based on the borrowing base
redetermination received in May 1996, however, the Company would not have been
required to classify any of the outstanding long-term borrowings as current at
March 31, 1996.
The Company's ability to reduce the existing working capital deficit
while maintaining an active drilling program and normal operations will depend
upon the net cash flows generated from its oil and gas properties. In this
regard, the Company's future net revenues are expected to decline significantly
in 1996 and beyond due to the
-18-
rapid depletion of the Company's offshore oil and gas properties. This will
result in reduced discretionary cash flow available for expansion of existing
operations, new acquisitions and general corporate purposes. However, based on
current conditions, management believes that the Company has the financial
capability to satisfy its working capital deficit and debt service requirements,
while sustaining capital expenditures (although at a reduced level), and meeting
operating needs arising in the ordinary course of business.
CAPITAL EXPENDITURES
As stated above, changes in product prices or revisions of reserve
volumes could require management to dedicate a substantial portion or all of the
Company's cash flow from operations to meet working capital needs and debt
maturities.
The Company's capital expenditures budget for 1996 totalled
approximately $8.0 million primarily related to development and workover
activities. Due to the recent increase in drilling activity in the Gulf of
Mexico, the Company has been notified by the operators of several of its
offshore properties of their intentions to propose additional exploratory and
development drilling activity during the remainder of 1996.
During May 1996, the Company and the operator of the Company's South
Timbalier 144 property interest executed an agreement to jointly develop an
exploratory prospect located across Block 144 and Block 109 of the South
Timbalier area of the Gulf of Mexico. The Company presently owns a 50% working
interest in Block 144 and will receive a 50% working interest in Block 109 under
the joint development agreement in exchange for a payment of approximately
$355,000. The operator of Blocks 109 and 144 plans to drill an 8,000'
exploratory test well in the prospect area for an aggregate cost of between
$800,000 and $1.1 million, net to the Company's 50% working interest. Depending
upon the success of the first well, it is anticipated that two additional wells
will be drilled and a platform installed. If all of the proposed wells are
successful, Convest's total cost in the prospect would aggregate approximately
$6.0 million, net to the Company's working interest.
If the Company were to elect not to participate in an operation
proposed on one of its properties, under the terms of the pertinent Joint
Operating Agreement, the Company could be subject to a substantial penalty being
imposed on its interest in a specific well or in some cases, may result in loss
of the Company's ownership interest in the affected well. Accordingly,
management plans to carefully evaluate all proposed projects which represent a
substantial draw on corporate resources or which reduce near term liquidity. In
addition, the Company continues to evaluate possible acquisition and divestiture
opportunities in an effort to upgrade the Company's reserve base, primarily in
geographic areas where the Company possesses operating expertise and where the
property profiles have a longer reserve life. It is anticipated that the
Company's 1996 exploratory and development drilling operations will be funded
with cash flow from the Company's oil and gas properties.
INFLATION AND CHANGING PRICES
While the costs of operations have been, and will continue to be,
affected by inflation and the success of acquisition, drilling and workover
activities, oil and gas prices have fluctuated in recent years and generally
have not followed the same pattern as inflation. As a result, the Company from
time to time engages in commodity hedging activities to minimize the risk of
market fluctuations associated with the price of crude oil and natural gas
production. The hedging objectives include assurance of stable and known
minimum cash flows and fixing favorable prices. See Notes 2 and 5 of the "Notes
to Consolidated Financial Statements" included herein.
The Company will continue to monitor energy prices and may enter into
subsequent hedging transactions in the ordinary course of business as management
deems appropriate. Management cannot predict at what level oil prices will be
sustained due to factors beyond the Company's control, such as worldwide oil
supplies and regional world politics.
-19-
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Note 8 of the "Notes to the Consolidated Financial Statements" is
incorporated herein by reference.
ITEM 6. (A) EXHIBITS.
None.
(B) REPORTS ON FORM 8-K
None.
-20-
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.
CONVEST ENERGY CORPORATION
(Registrant)
By: /s/ Gary L. Pittman
-------------------------------
Gary L. Pittman
Executive Vice President and Chief
Financial Officer
(Principal Accounting Officer)
Date: May 14, 1996
----------------------------
-21-