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 September 30, 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 77057
HOUSTON, TEXAS (Zip Code)
(Address of principal executive offices)
(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 November 13, 1996, was 10,412,722.
1 of 23
CONVEST ENERGY CORPORATION
Quarterly Report on Form 10-Q
for the Quarter Ended September 30, 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....................... 6
Consolidated Statements of Cash Flows................................. 7
Notes to Consolidated Financial Statements............................ 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................... 15
II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................... 22
Item 6. Exhibits and Reports on Form 8-K...................................... 22
Signature....................................................................... 23
-2-
CONVEST ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(In Thousands)
September 30, December 31,
1996 1995
------------- ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 4,273 $ 674
Restricted cash 333 333
Accounts receivable:
Oil and gas production - less allowance
for doubtful accounts of $816 5,802 7,958
Other 609 252
Other current assets 2,565 6,223
-------- --------
Total current assets 13,582 15,440
-------- --------
Property and equipment:
Oil and gas properties, successful efforts method 116,026 114,201
Other 475 364
Less accumulated depreciation and depletion (60,048) (50,225)
-------- --------
56,453 64,340
-------- --------
Other noncurrent assets 2,959 2,177
-------- --------
$72,994 $ 81,957
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ - $ 1,625
Accounts payable:
Oil and gas production 10,140 9,609
Affiliates 588 550
Accrued liabilities and other 5,476 3,803
Deferred revenue 2,120 2,010
-------- --------
Total current liabilities 18,324 17,597
-------- --------
Long-term liabilities:
Long-term debt, net of current maturities 8,503 17,553
Deferred revenue 573 691
Other noncurrent liabilities 7,979 11,099
-------- --------
17,055 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 September 30, 1996 and
December 31, 1995 104 104
Additional paid-in capital 47,798 47,798
Retained earnings (deficit) (10,287) (12,885)
-------- --------
37,615 35,017
-------- --------
$72,994 $ 81,957
======== ========
-3-
CONVEST ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands Except Per Share Data)
Nine Months Ended
September 30,
-------------------------------------
1996 1995
------------ -----------
(Unaudited)
Revenues:
Oil and gas sales $ 32,574 $ 37,208
Gas plant revenues 1,060 930
Gain (loss) on asset sale 817 (515)
Other, net 44 201
--------- ----------
34,495 37,824
--------- ----------
Expenses:
Production:
Lease operating expense 10,710 13,180
Gas plant operating expense 361 360
Production taxes 992 904
Abandonment and exploration costs 1,724 680
General and administrative expenses 3,506 3,724
Interest expense 896 1,594
Depreciation, depletion and amortization 12,360 16,090
Impairment of oil and gas properties 1,120 -
---------- ----------
31,669 36,532
---------- ----------
Net income before elimination of preacquisition
net loss and income taxes 2,826 1,292
Elimination of preacquisition
net loss of predecessor - 1,664
---------- ----------
Net income before income taxes 2,826 2,956
Income tax provision 228 9
---------- ----------
Net income $ 2,598 $ 2,947
========== ==========
Net income per share (See Note 2) $ 0.25 $ 0.38
========== ==========
Weighted average common shares outstanding 10,413 7,672
========== ==========
See accompanying notes to consolidated financial statements
-4-
CONVEST ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands Except Per Share Data)
Three Months Ended
September 30,
--------------------------
1996 1995
-------- --------
(Unaudited)
Revenues:
Oil and gas sales $ 11,245 $ 11,363
Gas plant revenues 356 307
Gain (loss) on asset sale (1) (218)
Other, net (160) 30
--------- --------
11,440 11,482
--------- --------
Expenses:
Production:
Lease operating expense 3,074 4,139
Gas plant operating expense 128 123
Production taxes 375 293
Abandonment and exploration costs 804 182
General and administrative expenses 1,225 1,118
Interest expense 222 460
Depreciation, depletion and amortization 4,452 5,121
--------- --------
10,280 11,436
--------- --------
Net income (loss) before income taxes 1,160 46
Income tax provision 11 -
--------- --------
Net income (loss) $ 1,149 $ 46
========= ========
Net income (loss) per share (See Note 2) $ 0.11 $ -
========= ========
Weighted average common shares outstanding 10,413 10,413
========= ========
-5-
CONVEST ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
(In Thousands)
(Unaudited)
Common Common Additional Retained
Shares Stock, Paid-In Earnings
Outstanding $.01 par Capital (Deficit) Total
----------- -------- ---------- --------- ---------
Balance at December 31, 1995 10,413 $104 $ 47,798 $ (12,885) $ 35,017
Net income - - - 2,598 2,598
----------- -------- ---------- --------- ---------
Balance at September 30, 1996 10,413 $104 $ 47,798 $ (10,287) $ 37,615
=========== ======== ========== ========= ========
See accompanying notes to consolidated financial statements.
-6-
CONVEST ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
Nine Months Ended
September 30,
-----------------------------
1996 1995
---------- ----------
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,598 $ 2,947
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation, depletion and amortization 12,360 12,553
Impairment of oil and gas properties 1,120 -
(Gain) loss on sale of oil and gas properties (817) 515
Abandonment and exploration costs 1,568 400
Decrease (increase) in accounts receivable 1,770 (3,125)
Increase (decrease) in accounts payable and accrued liabilities (608) 72
Other, net 17 (107)
---------- ----------
Net cash flow provided by operating activities 18,008 13,255
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash received in reverse acquisition of CEC by Edisto E&P - 716
Acquisition, exploration and development of oil and
gas properties (9,000) (9,273)
Advances to working interest owners (1,088) -
Proceeds from sales of oil and gas properties 2,231 (312)
Sale of investment in affiliates - 7,351
Sale of short-term investments 4,235 464
Increase in other current and noncurrent assets (112) (828)
---------- ----------
Net cash used in investing activities (3,734) (1,882)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on long-term debt 3,100 2,075
Payments on long-term debt (13,775) (10,250)
Payment of note payable - (5,212)
Distribution of certain assets and
liabilities to affiliate - (652)
---------- ----------
Net cash used in financing activities (10,675) (14,039)
---------- ----------
Net increase (decrease) in cash and cash equivalents 3,599 (2,666)
Cash and cash equivalents, beginning of period 1,007 4,956
---------- ----------
Cash and cash equivalents, end of period $ 4,606 $ 2,290
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest $ 1,258 $ 910
========== ==========
Cash paid during the period for taxes $ 306 $ 9
========== ==========
See accompanying notes to consolidated financial statements.
-7-
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. In April 1996, Edisto purchased additional shares of Convest
common stock on the open market which increased Edisto's ownership percentage of
Convest to 73%.
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 Statements of Operations of the Company for the
periods ended September 30, 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 periods being eliminated for purposes of
determining net income.
(ii) The Consolidated Statement of Cash Flows of the Company for the nine
months ended September 30, 1995 sets forth nine months of the cash
flows of Edisto E&P and only the cash flows of CEC for the three
months ended September 30, 1996, and accordingly, is not comparable
with the cash flows for the nine months ended September 30, 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.
-8-
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 capitalized, but charged to expense if 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 $4.98 and $4.79 for the nine month
periods ended September 30, 1996 and 1995, respectively, and $5.28 and $4.87 for
the three month periods ended September 30, 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 regularly 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.
The Company's SFAS 121 evaluation for the second and third quarter of 1996
was prepared using the Company's 1995 year end reserve estimates adjusted for
production and other known changes subsequent to the preparation of the
Company's year end reserve estimates. As a result of this evaluation, the
Company determined that an offshore property had less reserves than as
previously estimated. Accordingly, the Company recorded an impairment loss on
the property of approximately $1.1 million during the second quarter of 1996,
based on production problems encountered during the period. No impairment loss
was recorded during the third quarter of 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 the
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 continued to be subject to the
Abandonment Fund payments covering the properties in which the Company owns a
working interest. As of September 30, 1996 and December 31, 1995, the Company
was subject to total Abandonment Fund payments of $4.3 million.
-9-
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of September 30, 1996 and December 31, 1995, the Company had made
payments totaling $4.2 million and $3.7 million to the Abandonment Fund,
respectively. These payments were applied to the Company's total abandonment
reserve of $10.1 million and $10.8 million, as of September 30, 1996 and
December 31, 1995, respectively, resulting in a net abandonment reserve of $5.9
million and $7.1 million as of those dates. The current portion of the
abandonment reserve was $2.2 million and $556,000 as of September 30, 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 September 30, 1996
and December 31, 1995, the current balance of this reserve was $1.3 million and
$1.8 million, respectively, 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" 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
September 30, 1996 and December 31, 1995 were $2.3 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
September 30, 1996 and December 31, 1995 were $2.7 million as of those dates 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
7,671,931 for the nine months ended September 30, 1996 and 1995, respectively,
and 10,412,722 for the three months ended September 30, 1996 and 1995. 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.
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 financial statements and the reported
-10-
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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.
DISPOSITION OF OIL AND GAS PROPERTIES
In January 1996, the Company sold an offshore oil and gas property for
approximately $2.0 million and recorded a gain of approximately $620,000. In
addition, the Company sold several other nonstrategic oil and gas properties
during the first six months of 1996 for aggregate sale proceeds of approximately
$400,000 which resulted in a gain of approximately $200,000.
(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. 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
account 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. In exchange for its services,
Energy Source receives a fee of no more than 2% of the spot market price.
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. The Company and Energy Source are currently reviewing the gas marketing
agreement to determine under what terms and conditions the agreement should be
extended. For the nine months ended September 30, 1996, Energy Source marketed
approximately 54% of the Company's gas production. 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 September 30, 1996 and
December 31, 1995, the account receivable from Energy Source was $2.7 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.
-11-
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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.
In July 1996, the Company and Edisto obtained a directors' and officers'
fiduciary insurance policy that covers both companies. The annual insurance
premium was allocated 32% to the Company, for a cost of $96,000, based on the
relative percentage that the assets of the Company bear to the total assets of
both the Company and Edisto.
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. In April 1996, Edisto purchased an additional
92,000 shares of Common Stock of Convest, thereby increasing its 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
September 30, 1996 and December 31, 1995:
-12-
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1996 December 31, 1995
---------------------- --------------------------------
Oil(1) Gas Oil(1) Gas
----------- --------- ------------ -----------------
Quantity Sold 82 MBbls 550 MMcf 285 MBbls 8,220 MMcf
Maximum Term 2 Months 4 Months 11 Months 10 Months
Average Price $18.36 $2.34 $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 September 30, 1996 and
December 31, 1995, the Company recorded deferred hedging losses of $492,000 and
$421,000, respectively, which is included in "Other Current Assets" in the
accompanying Consolidated Balance Sheets. The cash margin required by the
counterparties to the Company's hedging activities totaled $817,000 and $5.1
million as of September 30, 1996 and December 31, 1995, respectively, which is
included in "Other Current Assets" in the accompanying Consolidated Balance
Sheets.
As a result of the Company's hedging activities, the Company recorded
hedging losses of approximately $6.3 million and $1.8 million for the nine and
three month periods ended September 30, 1996, respectively, and hedging income
of approximately $785,000 and $385,000 for the nine and three months ended
September 30, 1995. Such amounts were recorded as oil and gas sales revenue in
the accompanying Consolidated Statements of Operations. The Company has
substantially decreased its hedged activities for the remainder of 1996 and
1997.
(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 nine months and three months ended September 30, 1996, the Company
recorded current income tax expense of $228,000 and $11,000, respectively. 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, N.A. 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
-13-
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
on borrowings under the Agreement is computed at (i) the agent bank's prime
lending rate plus 3/4% 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 September 30, 1996 and December 31, 1995, the
borrowing base available under the Agreement was $21.5 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 in effect on December 31, 1995, after giving effect to the scheduled
monthly borrowing base reductions, the Company's outstanding borrowings exceeded
the borrowing base by $1.6 million at December 31, 1995, and accordingly, such
amount was classified as current at such date.
As of September 30, 1996 and December 31, 1995, outstanding indebtedness
under the Agreement was $8.5 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
September 30, 1996, substantially all of the Company's outstanding borrowings
were subject to an interest rate of prime plus 3/4% at an effective rate of
approximately 9% 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. A
trial on damages against the other defendants was held in May 1996, wherein a
judgment was rendered in favor of plaintiffs. 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.
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 nine months of 1996 are described
below:
RESULTS OF OPERATIONS. The Company had net income of $1.1 million for the
----------------------
three months ended September 30, 1996 compared to net income of $46,000 for the
same period of 1995, and net income of $2.6 million for the nine months ended
September 30, 1996 compared to net income of $2.9 million for the corresponding
period of 1995.
The net income of $2.6 million for the nine months ended September 30, 1996
includes (i) a $1.1 million writedown during the second quarter of the Company's
oil and gas properties due to SFAS No. 121, and (ii) exploration costs and
leasehold writeoffs of approximately $1.5 million due to two unsuccessful
exploratory wells in the South Timbalier prospect.
MANAGEMENT CHANGES. In September 1996, Richard T. Howell resigned from his
-------------------
positions as the President and Chief Operating Officer of the Company, and as a
director. Effective November 15, 1996, Gary L. Pittman is resigning from his
position as an Executive Vice President and Chief Financial Officer of the
Company. Michael Y. McGovern, the Chairman and Chief Executive Officer of the
Company and Edisto, will assume the responsibilities of Mr. Howell and Mr.
Pittman for the near future.
SFAS NO. 121 IMPAIRMENT LOSS. As a result of the Company's SFAS No. 121
-----------------------------
evaluation of its proved oil and gas properties for the second quarter of 1996,
the Company determined that an offshore property had less reserves than as
previously estimated. Accordingly, the Company recorded an impairment loss on
the property of approximately $1.1 million in the second quarter of 1996 based
on production problems encountered during the period. This impairment loss is
described in more detail in Note 2 to the Consolidated Financial Statements and
"Results of Operations - Impairment of Oil and Gas Properties Under SFAS No.
121" below. The Company recorded no impairment loss during the third quarter of
1996.
SIGNIFICANT DRILLING OPERATIONS. During 1996, the Company has invested a
--------------------------------
substantial portion of its cash flow in drilling operations on its offshore
properties. As described below under "Liquidity and Capital Resources -Capital
Expenditures," the Company's capital expenditure budget for 1996 has increased
from approximately $8.0 million to $15.0 million. This drilling activity will
continue in the fourth quarter of 1996 with three wells to be drilled and three
workovers scheduled to be completed during the period. The most significant
drilling operations during 1996 are described below.
EUGENE ISLAND 281. During early 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 1,276 barrels of
oil and 1,699 Mcf of gas. The well was connected to existing production
facilities on the platform and as of September 30, 1996, the well was flowing at
approximately 600 barrels of oil per day and 300 Mcf of gas per day, but
subsequently the production rates have declined.
SOUTH TIMBALIER. During April 1996, the Company participated in the
drilling of a development well on Block 221 of the South Timbalier area of the
Gulf of Mexico. The well was drilled from an existing well bore to
approximately 12,000 feet. The well encountered productive sands and was tested
at a rate of approximately 7,000 Mcf of gas per day. The cost of drilling this
well was approximately $1.4 million, net to the Company's 40% working interest.
This well is producing at approximately 6,500 Mcf of gas per day and 115 barrels
of oil per day.
During June 1996, the Company participated in the drilling of an 8,000 foot
exploratory test well on a prospect located across Block 144 and Block 109 of
the South Timbalier area. At the completion of drilling in early
-15-
July 1996, the well encountered no commercial production and was subsequently
abandoned. The cost of the well was approximately $600,000, net to the
Company's 50% working interest. The Company also has written off the
approximate $350,000 leasehold cost of this property.
During early July 1996, the Company participated in a second exploratory
well in the South Timbalier area. The 5,700 foot well was drilled on a prospect
situated across Block 109 and Block 102 and encountered no commercial
production. This well cost approximately $550,000, net to the Company's 50%
interest.
GRAND ISLE. During June 1996, the Company participated in the drilling of
an 8,000 foot development well on Block 82 of the Grand Isle area of the Gulf of
Mexico. The well encountered productive sands and is producing at approximately
4,200 Mcf of gas per day. Total cost of the well was approximately $1.0
million, net to the Company's 39% working interest.
HIGH ISLAND. During September 1996, the Company participated in the
drilling of a 12,000 foot development well on Block 195 of the High Island area
of the Gulf of Mexico. The well encountered the objective formation and tested
in excess of 5,000 mcf of gas per day. The Company is currently laying the
flowline to the existing facilities and expects to be on production by mid
November. Total cost of the well was approximately $1.0 million, net to the
Company's 24% interest. The Company plans to drill a second well in this area
late in the fourth quarter of 1996 or early in the first quarter of 1997.
EXPENSE FOR UNSUCCESSFUL WELLS. Since the Company follows the successful
-------------------------------
efforts method of accounting, the drilling costs and the leasehold writeoffs of
approximately $1.5 million for the two unsuccessful South Timbalier exploratory
wells were expensed based on the costs incurred during the second and third
quarters of 1996. Although the two wells were completed in July 1996, the
leasehold writeoffs and a portion of the exploration costs were incurred prior
to that time. Therefore, $750,000 of this cost was expensed during the second
quarter of 1996 while approximately $790,000 of additional costs were expensed
during the third quarter of 1996.
PROPERTY SALES. During January 1996, the Company sold its interest in
---------------
Vermilion Block 284 for approximately $2.0 million. The Company also sold other
nonstrategic oil and gas properties during 1996 for aggregate sales proceeds of
approximately $400,000. As a result of these sales, the Company recorded a gain
of approximately $820,000 during 1996.
REPAYMENT OF OUTSTANDING DEBT. During 1996, the Company has repaid a net
------------------------------
$10.7 million of outstanding debt under its long-term credit facility. The
Company used the $2.0 million proceeds received from the Vermilion 284 property
sale and approximately $8.7 million of cash flow from operations to make this
debt repayment.
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 May
1, 1996, the new borrowing base under the credit facility was $25.5 million,
based on the lending banks' semi-annual redetermination, which began reducing by
$1.0 million per month beginning June 1, 1996. As of September 30, 1996,
outstanding indebtedness under the agreement was $8.5 million with an additional
$200,000 of letters of credit outstanding.
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
-16-
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 borrowing base redetermination received in May 1996 coupled with the
repayment of outstanding borrowings during 1996, the Company was not required to
classify any of its outstanding long-term borrowings as current at September 30,
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 September 30, 1996, the Company had a working capital deficit of
approximately $4.7 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 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.
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 during
the remainder of 1996 and beyond due to the 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 and meeting operating needs arising in the ordinary course of
business.
CAPITAL EXPENDITURES
As previously stated, the Company has devoted a substantial portion of its
available cash flow to drilling opportunities on its offshore properties and the
reduction of its outstanding borrowings under its long-term credit facility. In
addition to the drilling activity discussed, 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. Therefore, the Company has increased its original capital
expenditure budget for 1996 from approximately $8.0 million to approximately
$15.0 million.
If the Company does not participate in a drilling 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. 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. However, significant changes in oil and gas prices or significant
revisions in the reserve volumes securing the Company's long-term credit
facility could require management to dedicate all or a substantial portion of
the Company's cash flow to meet working capital needs and debt maturities,
thereby precluding the Company from participating in proposed drilling
opportunities.
-17-
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 nine month and three month periods ended September 30, 1996 and
1995.
For the Nine Months For the Three Months
Ending September 30, Ending September 30,
---------------------------------------- ---------------------------------------
Percentage Percentage
1996 1995 Change 1996 1995 Change
---------- ---------- --------------- --------- -------- ----------------
PRODUCTION VOLUMES:
Oil (Mbbls) 715 903 (21%) 255 309 (17%)
Gas (including NGL's)(Mmcf) 10,494 14,562 (28%) 3,488 4,416 (21%)
BOE (Mbbls)/(1)/ 2,464 3,330 (26%) 837 1,045 (20%)
PRICES:
Oil ($/Bbl) $ 17.83 $ 17.16 4% $ 19.22 $ 17.74 8%
Gas ($/Mcf) $ 1.89 $ 1.49 27% $ 1.82 $ 1.33 37%
GROSS OIL AND GAS REVENUE (IN THOUSANDS):
Oil $12,746 $15,492 (18%) $ 4,901 $ 5,481 (11%)
Gas (including NGL's) 19,828 21,716 (9%) 6,344 5,882 8%
------- ------- ------- -------
Total Oil and Gas Revenue $32,574 $37,208 (12%) $11,245 $11,363 (1%)
======= ======= ======= =======
PRODUCTION EXPENSES (IN THOUSANDS):
Lease Operating Expenses $10,710 $13,180 (19%) $ 3,074 $ 4,139 (26%)
Production Taxes 992 904 10% 375 293 28%
------- ------- ------- -------
Total Production Expenses 11,702 $14,084 (17%) $ 3,449 $ 4,432 (22%)
======= ======= ======= =======
ABANDONMENT AND EXPLORATION COSTS $ 1,724 $ 680 154% $ 804 $ 182 342%
======= ======= ======= =======
GENERAL AND ADMINISTRATIVE EXPENSE $ 3,506 $ 3,724 (6%) $ 1,225 $ 1,118 10%
======= ======= ======= =======
INTEREST EXPENSE $ 896 $ 1,594 (44%) $ 222 $ 460 (52%)
======= ======= ======= =======
DEPRECIATION, DEPLETION & AMORTIZATION
OF OIL AND GAS PROPERTIES $12,279 $15,966 (23%) $ 4,422 $ 5,094 (13%)
======= ======= ======= =======
PRODUCTION COSTS PER BOE $ 4.75 $ 4.22 13% $ 4.12 $ 4.24 (3%)
======= ======= ======= =======
DEPRECIATION, DEPLETION & AMORTIZATION
PER BOE $ 4.98 $ 4.79 4% $ 5.28 $ 4.87 8%
======= ======= ======= =======
/(1)/ Natural gas is converted into oil equivalents at a rate of six Mcf per
each barrel of oil.
The following comparison of results of operations of the Company for
the nine and three month periods ended September 30, 1996 and 1995 was prepared
from 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 respective periods 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.
-18-
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995.
Revenues. Oil and gas revenue decreased by approximately $4.6 million or
12% between the nine month periods ended September 30, 1996 and 1995. The
average price the Company received for its oil and gas sales increased by 4% and
27%, respectively, between the corresponding periods. Oil and gas production
decreased by 21% and 28%, 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
completed in late 1995 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 losses of approximately $6.3 million for the nine month
period ended September 30, 1996, and hedging income of approximately $785,000
for the corresponding period of 1995. Such amounts were recorded as oil and gas
sales revenue in the accompanying statements of operations, and accordingly,
such amounts are reflected in the per unit price the Company received for its
oil and gas sales.
The hedges affecting 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 and these high prices have continued
during most of 1996 which caused the hedging losses in 1996. The Company has
substantially decreased its hedging activities for the remainder of 1996 and
1997.
Production Expenses. Production expenses decreased by approximately $2.4
million or 17% between the corresponding periods. The decrease in production
expenses is primarily due to a decrease in workover activity during the nine
months ended September 30, 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 $4.75
and $4.22 for the nine months ended September 30, 1996 and 1995, respectively.
The increase in production expense per BOE is caused by the decreased offshore
production without a corresponding decrease in production expense.
Abandonment and Exploration Costs. Abandonment and exploration costs
increased by approximately $1.0 million between the corresponding periods. The
increase in abandonment and exploration costs is primarily due to two
unsuccessful South Timbalier exploratory wells of costs of approximately
$1,540,000. Also, 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 the Company had substantially provided for its future
abandonment liability, and accordingly, no additional accrual was provided for
1996.
Impairment of Oil and Gas Properties Under SFAS No. 121. Prior to 1995, the
Company provided an impairment reserve for proved oil and gas properties to the
extent that total capitalized costs less accumulated depreciation and depletion,
exceed undiscounted future net revenues attributable to proved oil and gas
reserves on an overall basis. During March 1995, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standard No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of" ("SFAS No. 121"). SFAS No. 121 requires the Company to provide
an impairment reserve for proved oil and gas properties to the extent that total
capitalized costs, less accumulated depreciation and depletion, exceed
undiscounted expected future cash flows attributable to proved oil and gas
reserves on a property-by-property basis. The Company adopted the provisions of
SFAS No. 121 during the fourth quarter of 1995.
The Company regularly assesses the need for an impairment of its oil and
gas properties. The Company's SFAS No. 121 evaluation for the second and third
quarter of 1996 was prepared using the Company's 1995 year
-19-
end reserve estimates adjusted for production and other known changes subsequent
to the preparation of the Company's year end reserve estimates. As a result of
this evaluation, the Company determined that an offshore property had less
reserves than as previously estimated. Accordingly, the Company recorded an
impairment loss on the property of approximately $1.1 million during the second
quarter of 1996 based on production problems encountered during the period of
1996. No impairment loss was recorded during the third quarter of 1996.
General and Administrative Expenses. General and administrative expenses
decreased by approximately $218,000 between the corresponding periods. The
primary contributor to the decrease in general and administrative expense was
the inclusion of employee severance cost in 1995 subsequent to the Company's
reorganization upon closing of the Edisto Transaction. In addition, the Company
incurred lower office rent expense after Edisto E&P terminated its existing
office lease in mid 1995.
Interest Expense. Interest expense decreased by approximately 44% due to
the repayment of a short-term promissory note issued in connection with 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 1996.
Depreciation, Depletion and Amortization ("DD&A"). DD&A on oil and gas
properties decreased by approximately $3.7 million or 23% between the
corresponding periods. The decrease in DD&A was due primarily to the production
declines discussed above. DD&A per BOE was $4.98 for the nine month period ended
September 30, 1996, compared to $4.79 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, which resulted in a gain of approximately $620,000. In addition, the
Company sold several other nonstrategic oil and gas properties during 1996 for
aggregate sale proceeds of approximately $400,000, which resulted in a gain of
approximately $200,000.
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995.
Revenues. Oil and gas revenue decreased by approximately $118,000 or 1%
between the three month periods ended September 30, 1996 and 1995. The average
price the Company received for its oil sales increased by 8% while the price
received for natural gas sales increased by 37%. Oil and gas production
decreased by 17% and 21%, respectively. As previously discussed, the primary
reason for the decrease in oil and gas sales volumes was due to the sale of
several properties during 1995 and 1996 coupled with the steep production
declines on the Company's offshore properties.
Price Risk Management/Hedging. As previously stated, the Company uses
futures contracts and swap agreements to hedge its oil and gas production
thereby assuring stable cash flow. As a result of the sharp increase in oil and
gas prices during the past winter, the Company has experienced losses associated
with the contracts. For the three months ended September 30, 1996, the Company
has recorded hedging losses of approximately $1.8 million compared to hedging
income of $385,000 for the corresponding period of 1995. As previously stated,
the Company records gains and losses realized on its hedging activities as oil
and gas sales revenue, accordingly, such amounts are reflected in the per unit
price the Company received for its oil and gas sales.
Production Expenses. Production expenses decreased by approximately
$980,000 or 22% between the three months ended September 30, 1996 and 1995. The
decrease in production expenses was primarily due to the aforementioned decrease
in workover expense. Production expenses per BOE were $4.12 and $4.24 for the
corresponding periods.
Abandonment and Exploration Costs. Abandonment and exploration costs
increased by $622,000 between the corresponding periods. The Company accrues its
estimated cost of abandonment of its offshore properties. The increase in
abandonment and exploration costs is primarily due to two unsuccessful South
Timbalier exploratory wells of costs of approximately $790,000. Based upon a
review of the reserve for abandonment, it was determined that the Company had
substantially provided for its future abandonment liability, and accordingly, no
additional accrual was provided for 1996.
-20-
General and Administrative Expenses. As previously stated, the Company
recorded employee severance expense during early 1995 in conjunction with its
reorganization following the Edisto Transaction. As a result, general and
administrative expense increased in 1996 by approximately 10%.
Interest Expense. Interest expense decreased by approximately 52% between
the corresponding periods. As previously stated, the Company repaid a short-term
note payable to an affiliate in 1995 and repaid a substantial portion of its
outstanding long-term borrowings in 1996.
Depreciation, Depletion and Amortization ("DD&A"). DD&A on oil and gas
properties decreased by approximately $672,000 or 13% between the corresponding
periods. As previously stated, the decrease in DD&A was directly related to the
previously mentioned production declines.
Impairment of Oil and Gas Properties Under SFAS No. 121. The Company's SFAS
No. 121 evaluation for the third quarter of 1996 was prepared using the
Company's 1995 year end reserve estimates adjusted for production and other
known changes subsequent to the preparation of the Company's year end reserve
estimates. As a result of this evaluation, the Company determined that no
impairment loss was required.
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 product prices will
be sustained due to factors beyond the Company's control, such as worldwide oil
supplies and regional world politics.
-21-
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.
-22-
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: November 13, 1996
-----------------------
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