UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
Commission File Number 1-10537
NUEVO ENERGY COMPANY
(Exact name of registrant as specified in its charter)
DELAWARE 76-0304436
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1331 LAMAR, SUITE 1650
HOUSTON, TEXAS 77010-3039
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (713)652-0706
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
As of November 11, 1998, the number of outstanding shares of the Registrant's
common stock was 19,832,963.
NUEVO ENERGY COMPANY
INDEX
PAGE
NUMBER
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Balance Sheets:
September 30, 1998 (Unaudited) and December 31, 1997 (Restated).................. 3
Condensed Consolidated Statements of Operations (Unaudited):
Three and nine months ended September 30, 1998
and September 30, 1997 (Restated)................................................ 5
Condensed Consolidated Statements of Cash Flows (Unaudited):
Nine months ended September 30, 1998 and September 30, 1997 (Restated)........... 7
Notes to Condensed Consolidated Financial Statements (Unaudited)..................... 8
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................................... 14
PART II. OTHER INFORMATION...................................................................... 25
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NUEVO ENERGY COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands)
ASSETS
------
September 30, 1998 December 31, 1997
------------------- ------------------
(Unaudited) (Restated)
CURRENT ASSETS:
Cash and cash equivalents............................ $ 3,883 $ 9,208
Accounts receivable.................................. 35,638 38,196
Product inventory.................................... 465 1,627
Assets held for sale................................. 113,977 6,950
Prepaid expenses and other........................... 3,301 2,879
---------- ----------
Total current assets............................... 157,264 58,860
---------- ----------
PROPERTY AND EQUIPMENT, AT COST:
Land................................................. 51,038 51,411
Oil and gas properties (successful efforts method)... 947,436 984,273
Gas plant facilities................................. 16,737 15,500
Other facilities..................................... 6,655 7,831
---------- ----------
1,021,866 1,059,015
Accumulated depreciation, depletion and
amortization....................................... (330,500) (324,904)
---------- ----------
691,366 734,111
---------- ----------
DEFERRED TAX ASSETS................................... 12,968 ---
OTHER ASSETS.......................................... 13,141 11,315
---------- ----------
$ 874,739 $ 804,286
========== ==========
See accompanying notes to condensed consolidated financial statements.
3
NUEVO ENERGY COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS - Continued
(Amounts in Thousands, Except Share Data)
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
September 30, 1998 December 31,1997
------------------- -----------------
(Unaudited) (Restated)
CURRENT LIABILITIES:
Accounts payable........................................................................ $ 6,011 $ 8,641
Accrued interest........................................................................ 10,711 4,285
Accrued liabilities..................................................................... 27,881 32,961
Current maturities of long-term debt.................................................... 3,703 3,716
-------- --------
Total current liabilities............................................................ 48,306 49,603
-------- --------
LONG-TERM DEBT, NET OF CURRENT MATURITIES................................................. 408,125 305,940
DEFERRED TAX LIABILITIES.................................................................. --- 4,986
OTHER LONG-TERM LIABILITIES............................................................... 2,597 4,018
CONTINGENCIES
COMPANY-OBLIGATED MANDATORILY
REDEEMABLE CONVERTIBLE PREFERRED
SECURITIES OF NUEVO FINANCING I........................................................... 115,000 115,000
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value, 50,000,000 shares authorized, 20,308,462 and 20,237,537
shares issued at September 30, 1998 and December 31, 1997, respectively................ 203 202
Additional paid-in capital.............................................................. 355,599 354,296
Treasury stock, at cost, 482,761 and 497,372 shares, at
September 30, 1998 and December 31, 1997, respectively.................................. (19,444) (19,929)
Stock held by benefit trust, 43,401 and 45,119 shares, at
September 30, 1998 and December 31, 1997, respectively.................................. (1,612) (1,244)
Accumulated deficit..................................................................... (34,035) (8,586)
-------- --------
Total stockholders' equity.......................................................... 300,711 324,739
-------- --------
$874,739 $804,286
======== ========
See accompanying notes to condensed consolidated financial statements.
4
NUEVO ENERGY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Amounts in Thousands, Except per Share Data)
Three Months Ended September 30,
----------------------------------
1998 1997
--------------- ----------------
(Restated)
REVENUES:
Oil and gas revenues............................ $ 60,770 $81,774
Gas plant revenues.............................. 628 806
Pipeline and other revenues..................... 222 1,191
Gain (loss) on sale of assets................... 4,091 (2,266)
Interest and other income....................... 255 615
-------- -------
65,966 82,120
-------- -------
COSTS AND EXPENSES:
Lease operating expenses........................ 34,022 30,113
Gas plant operating expenses.................... 884 835
Pipeline and other operating expenses........... 116 1,150
Exploration costs............................... 11,891 4,078
Depreciation, depletion and amortization........ 20,261 28,089
General and administrative expenses............. 4,565 6,072
Outsourcing fees................................ 2,388 2,846
Interest expense................................ 8,881 6,585
Dividends on Guaranteed Preferred
Beneficial Interests in Company's
Convertible Debentures (TECONS)............... 1,653 1,689
Other expense................................... 54 87
-------- -------
84,715 81,544
-------- -------
(Loss) income before income taxes and minority
interest........................................ (18,749) 576
(Benefit) provision for income taxes............. (7,504) 227
Minority interest................................ --- (3)
-------- -------
NET (LOSS) INCOME................................ $(11,245) $ 352
======== =======
(LOSS) EARNINGS PER SHARE:
BASIC:
(Loss) earnings per common share - Basic........ $ (0.57) $ 0.02
======== =======
Weighted average common shares outstanding....... 19,820 19,688
======== =======
DILUTED:
(Loss) earnings per common share - Diluted...... $ (0.57) $ 0.02
======== =======
Weighted average common and dilutive
potential common shares outstanding............. 19,820 20,351
======== =======
See accompanying notes to condensed consolidated financial statements.
5
NUEVO ENERGY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Amounts in Thousands, Except per Share Data)
Nine Months Ended September 30,
---------------------------------
1998 1997
--------------- ---------------
(Restated)
REVENUES:
Oil and gas revenues........................... $183,815 $249,045
Gas plant revenues............................. 2,033 13,842
Pipeline and other revenues.................... 2,446 3,928
Gain on sale of assets, net.................... 5,768 2,134
Interest and other income...................... 1,077 1,557
-------- --------
195,139 270,506
-------- --------
COSTS AND EXPENSES:
Lease operating expenses....................... 99,796 88,052
Gas plant operating expenses................... 2,307 12,477
Pipeline and other operating expenses.......... 1,958 3,451
Exploration costs.............................. 15,985 5,705
Depreciation, depletion and amortization....... 66,817 76,288
General and administrative expenses............ 15,478 14,692
Outsourcing fees............................... 7,200 9,033
Interest expense............................... 23,325 20,593
Dividends on Guaranteed Preferred Beneficial
Interests in Company's Convertible
Debentures (TECONS)........................... 4,959 4,959
Other expense.................................. 137 347
-------- --------
237,962 235,597
-------- --------
(Loss) income before income taxes, minority
interest and extraordinary item.................. (42,823) 34,909
(Benefit) provision for income taxes.............. (17,374) 13,968
Minority interest................................. --- (8)
-------- --------
(Loss) income before extraordinary item........... (25,449) 20,949
Extraordinary loss on early extinguishment
of debt, net of income tax benefit.............. --- 3,024
-------- --------
NET (LOSS) INCOME................................. $(25,449) $ 17,925
======== ========
(LOSS) EARNINGS PER SHARE:
BASIC:
(Loss) income before extraordinary item........... $ (1.29) $ 1.05
Extraordinary loss on early extinguishment
of debt, net of income tax benefit.............. --- (0.15)
-------- --------
(Loss) earnings per common share - Basic.......... $ (1.29) $ 0.90
======== ========
Weighted average common shares outstanding........ 19,781 19,822
======== ========
DILUTED:
(Loss) income before extraordinary item........... $ (1.29) $ 1.02
Extraordinary loss on early extinguishment
of debt, net of income tax benefit.............. --- (0.15)
-------- --------
(Loss) earnings per common share - Diluted........ $ (1.29) $ 0.87
======== ========
Weighted average common and dilutive
potential common shares outstanding.............. 19,781 20,499
======== ========
See accompanying notes to condensed consolidated financial statements.
6
NUEVO ENERGY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Amounts in Thousands)
Nine Months Ended September 30,
---------------------------------
1998 1997
--------------- ---------------
(Restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income......................................... $ (25,449) $ 17,925
Adjustments to reconcile net (loss) income to
net cash provided by operating activities:
Depreciation, depletion and amortization............. 66,817 76,288
Gain on sale of assets, net.......................... (5,768) (2,134)
Dry hole costs....................................... 10,204 4,799
Amortization of other costs.......................... 1,214 1,166
Extraordinary loss on early extinguishment of debt... --- 5,061
Deferred revenues.................................... (1,429) (2,465)
Deferred taxes....................................... (17,929) 12,277
Depreciation of deferred compensation plan........... (695) ---
Minority interest.................................... --- (8)
Employee stock awards................................ --- 1,145
--------- ---------
26,965 114,054
Changes in assets and liabilities:
Accounts receivable.................................... 3,049 (7,484)
Accounts payable and accrued liabilities............... (1,270) 23,804
Other.................................................. (1,051) (2,003)
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES................. 27,693 128,371
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to oil and gas properties...................... (142,682) (150,469)
Additions to gas plant facilities........................ (1,238) (704)
Additions to other facilities............................ (1,162) (1,105)
Proceeds from sale of gas plant.......................... --- 24,992
Proceeds from sales of properties........................ 11,830 4,050
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES..................... (133,252) (123,236)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings................................. 225,000 183,500
Deferred financing costs................................. (3,342) ---
Payments of long-term debt............................... (122,828) (179,077)
Premium to retire long-term debt......................... --- (3,440)
Proceeds from sale of put options........................ --- 1,630
Treasury stock sale (purchase)........................... 100 (21,173)
Proceeds from issuance of common stock................... 1,304 6,493
--------- ---------
NET CASH PROVIDED BY/(USED IN) FINANCING
ACTIVITIES.............................................. 100,234 (12,067)
--------- ---------
Net decrease in cash and cash equivalents................ (5,325) (6,932)
Cash and cash equivalents at beginning of
period................................................. 9,208 13,636
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD................ $ 3,883 $ 6,704
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest (net of amounts capitalized)................ $ 16,318 $ 18,238
Income taxes......................................... $ 475 $ 350
See accompanying notes to condensed consolidated financial statements.
7
NUEVO ENERGY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with instructions to Form 10-Q and, therefore, do
not include all disclosures required by generally accepted accounting
principles. However, in the opinion of management, these statements include
all adjustments, which are of a normal recurring nature, necessary to present
fairly the financial position at September 30, 1998 and December 31, 1997 and
the results of operations and changes in cash flows for the periods ended
September 30, 1998 and 1997. These financial statements should be read in
conjunction with the financial statements and notes to financial statements
in the 1997 Form 10-K of Nuevo Energy Company (the "Company") and in the Form
8-K that was filed with the Securities and Exchange Commission on May 20,
1998. The form 8-K was filed in connection with the Company's conversion
from the full cost to the successful efforts method of accounting for its
investments in oil and gas properties (see discussion below) and includes
restated financial statements as of December 31, 1997 and 1996, and for the
years ended December 31, 1997, 1996 and 1995.
USE OF ESTIMATES
In order to prepare these financial statements in conformity with generally
accepted accounting principles, management of the Company has made a number
of estimates and assumptions relating to the reporting of assets and
liabilities, the disclosure of contingent assets and liabilities and reserve
information (which affects the depletion calculation). Actual results could
differ from those estimates.
CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 1998, the Company elected to convert from the full cost
method to the successful efforts method of accounting for its investments in
oil and gas properties. The Company believes that the successful efforts
method of accounting is preferable, as it will provide a fair presentation of
the Company's development activities in its core California business and the
drilling success of its selective exploration activities, and reflect an
impairment in the carrying value of its oil and gas properties only when
there has been a permanent decline in their fair value. Accordingly, the
December 31, 1997 condensed consolidated balance sheet, the condensed
consolidated statements of operations for the three and nine months ended
September 30, 1997, and the condensed consolidated statement of cash flows
for the nine months ended September 30, 1997, have been restated to conform
with successful efforts accounting. The effect of the accounting change,
after tax, was to reduce December 31, 1997 retained earnings by $64.1
million. For the condensed consolidated statement of operations for the three
months ended September 30, 1997, the effect of the accounting change was to
decrease net income by $5.9 million, or $0.30 per common share - basic and
$0.29 per common share - diluted. For the condensed consolidated statement of
operations for the nine months ended September 30, 1997, the effect of the
accounting change was to decrease net income by $8.0 million, or $0.41 per
common share - basic and $0.40 per common share - diluted. Had the Company
not converted to the successful efforts method, the results of operations for
the three months ended March 31, 1998, would have included a pre-tax full
cost ceiling write-down of approximately $250.0 million.
COMPREHENSIVE INCOME
The Company adopted Statement of Financial Accounting Standards ("SFAS") No.
130, "Reporting Comprehensive Income", effective January 1, 1998.
Comprehensive income includes net income and all changes in an enterprise's
other comprehensive income including, among other things, foreign currency
translation adjustments, and unrealized gains and losses on certain
investments in debt and equity securities. The implementation of this
statement had no impact on the Company, as there are no differences between
comprehensive income (loss) and net income (loss) for the periods presented.
8
NUEVO ENERGY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
DERIVATIVE FINANCIAL INSTRUMENTS
The Company utilizes derivative financial instruments to reduce its exposure
to changes in the market price of natural gas and crude oil. Commodity
derivatives utilized as hedges include futures, swap and option contracts,
which are used to hedge natural gas and oil. Natural gas basis swaps are
sometimes used to hedge the basis differential between the derivative
financial instrument index price and the natural gas field price. In order
to qualify as a hedge, price movements in the underlying commodity derivative
must be highly correlated with the hedged commodity. Settlement of gains and
losses on price swap contracts are realized monthly, generally based upon the
difference between the contract price and the average closing New York
Mercantile Exchange ("NYMEX") price and are reported as a component of oil
and gas revenues and operating cash flows in the period realized.
Gains and losses on option and futures contracts that qualify as a hedge of
firmly committed or anticipated purchases and sales of oil and gas
commodities are deferred on the balance sheet and recognized in income and
operating cash flows when the related hedged transaction occurs. Premiums
paid on option contracts are deferred in other assets and amortized into oil
and gas revenues over the terms of the respective option contracts. Gains or
losses attributable to the termination of a derivative financial instrument
are deferred on the balance sheet and recognized in revenue when the hedged
crude oil and natural gas is sold. There were no such deferred gains or
losses at September 30, 1998 or December 31, 1997. Gains or losses on
derivative financial instruments that do not qualify as a hedge are
recognized in income currently.
As a result of hedging transactions, oil and gas revenues were increased by
$0.3 million and reduced by $1.6 million in the third quarter of 1998 and
1997, respectively. During the first nine months of 1998 and 1997, oil and
gas revenues were increased by $0.5 million and reduced by $3.3 million,
respectively, as a result of these transactions.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related
Information". This statement establishes standards for reporting information
about operating segments in annual financial statements and requires that
enterprises report selected information about operating segments in interim
reports. The Company will adopt the provisions of SFAS No. 131 during 1998.
As SFAS No. 131 establishes standards for reporting and display, the Company
does not expect the adoption of this statement to have a material impact on
its financial condition or results of operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This statement establishes standards of
accounting for and disclosures of derivative instruments and hedging
activities. This statement is effective for the Company beginning in the
first quarter of the year 2000, however, early adoption is permitted. The
Company has not yet determined the impact of this statement on its financial
condition or results of operations or whether it will adopt the statement
early.
RECLASSIFICATIONS
Certain reclassifications of prior year amounts have been made to conform to
the current presentation.
2. PROPERTY AND EQUIPMENT
The Company utilizes the successful efforts method of accounting for its
investments in oil and gas properties. Under successful efforts, oil and gas
lease acquisition costs and intangible drilling costs associated with
exploration efforts that result in the discovery of proved reserves and costs
associated with development
9
NUEVO ENERGY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
drilling, whether or not successful, are capitalized when incurred. When a
property is sold, ceases to produce or is abandoned, a gain or loss is
recognized.
Unproved leasehold costs are capitalized pending the results of exploration
efforts. Significant unproved leasehold costs are reviewed periodically and
a loss is recognized to the extent, if any, that the cost of the property has
been impaired. Exploration costs, including geological and geophysical
expenses, exploratory dry holes and delay rentals, are charged to expense as
incurred.
Costs of productive wells, developmental dry holes and productive leases are
capitalized and depleted on a unit-of-production basis over the life of the
remaining proved reserves. Capitalized drilling costs are depleted on a
unit-of-production basis over the life of the remaining proved developed
reserves. Estimated costs (net of salvage value) of site remediation are
computed by the Company's independent reserve engineers and are included when
calculating depreciation and depletion using the unit-of-production method.
The Company reviews proved oil and gas properties on a depletable unit basis
whenever events or circumstances indicate that the carrying value of those
assets may not be recoverable. For each depletable unit determined to be
impaired, an impairment loss equal to the difference between the carrying
value and the fair value of the depletable unit is recognized. Fair value, on
a depletable unit basis, is estimated to be the present value of expected
future net revenues computed by application of estimated future oil and gas
prices, production, and expenses, as determined by management, over the
economic life of the reserves. The Company recorded an impairment loss of
$30.0 million in the fourth quarter of 1997, however, no such impairment was
recognized during the three month or nine-month periods ended September 30,
1998 or 1997.
Interest costs related to exploration and development activities on unproved
properties are capitalized until the related properties are evaluated and are
subject to depletion. The capitalization rates are based on the Company's
weighted average cost of funds used to finance expenditures.
Environmental expenditures that relate to current or future revenues are
expensed or capitalized, as appropriate. Expenditures that relate to an
existing condition caused by past operations, and do not contribute to
current or future revenue generation, are expensed. Liabilities are recorded
when environmental assessments and/or clean-ups are probable, and the costs
can be reasonably estimated. Generally, the timing of these accruals
coincides with the Company's commitment to a formal plan of action.
3. DEFERRED TAX ASSETS
As a result of the net loss generated during the first nine months of 1998,
the Company has deferred tax assets of $13.0 million as of September 30,
1998. The Company believes that sufficient future taxable income will be
generated and has concluded that these deferred tax assets will more likely
than not be realized.
4. INDUSTRY SEGMENT INFORMATION
Historically, the Company's operations were concentrated primarily in two
segments: the exploration and production of oil and natural gas and gas
plant, pipeline and gas storage operations. The Company's non-core gas
gathering, pipeline and gas storage assets were reclassified to assets held
for sale as of December 31, 1997, consistent with the Company's intention to
dispose of these assets during 1998. The Company completed the sale of its
Bright Star gas gathering system in July 1998 and the Richfield gas storage
assets in February 1998, at their approximate carrying values, and has signed
a letter of intent with a third party to sell the remaining asset, the Illini
pipeline. Closing of the Illini pipeline sale is expected prior to year-end,
pending finalization of a purchase and sale agreement and certain regulatory
approvals. The Company's policy is to record revenues and expenses
associated with these assets, which are no longer being depreciated, until
they are sold.
10
NUEVO ENERGY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
For the Nine Months Ended
-------------------------------
September 30, September 30,
1998 1997
-------------- --------------
(Restated)
SALES TO UNAFFILIATED CUSTOMERS:
Oil and gas.............................................. $183,815 $249,045
Gas plant, pipelines and other(1)........................ 4,479 17,770
-------- --------
Total sales........................................... 188,294 266,815
Gain on sale of assets, net.............................. 5,768 2,134
Other revenues........................................... 1,077 1,557
-------- --------
Total revenues........................................ $195,139 $270,506
======== ========
OPERATING (LOSS) PROFIT BEFORE INCOME TAXES:
Oil and gas.............................................. $ 8,119 $ 81,591
Gas plant, pipelines and other(1)........................ (392) 1,897
-------- --------
7,727 83,488
Unallocated corporate expenses........................... 22,266 23,027
Interest expense......................................... 23,325 20,593
Dividends on Guaranteed Preferred Beneficial Interests
in Company's Convertible Debentures (TECONS)........... 4,959 4,959
-------- --------
(Loss) income before income taxes, minority
interest, and extraordinary item....................... $(42,823) $ 34,909
======== ========
DEPRECIATION, DEPLETION AND AMORTIZATION:
Oil and gas.............................................. $ 65,683 $ 73,544
Gas plant, pipelines and other(1)........................ 606 2,232
-------- --------
$ 66,289 $ 75,776
======== ========
(1) The Company sold its interests in the Benedum Plant System in May 1997,
the Richfield gas storage assets in February 1998, and the Bright Star gas
gathering system in July 1998.
5. LONG-TERM DEBT
Long-term debt consists of the following (amounts in thousands):
September 30, December 31,
1998 1997
-------------- ------------------
9 1/2% Senior Subordinated Notes due 2006..................................... $ 160,000 $ 160,000
8 7/8% Senior Subordinated Notes due 2008 (a)................................. 100,000 ---
Bank credit facility (b)...................................................... 147,000 142,000
OPIC credit facility.......................................................... 4,828 7,605
Other......................................................................... --- 51
------------ ----------
Total debt............................................................ 411,828 309,656
Less: current maturities...................................................... (3,703) (3,716)
------------ ----------
Long-term debt................................................................ $ 408,125 $ 305,940
============ ==========
(a) On June 8, 1998, the Company issued $100.0 million of 8 7/8% Senior
Subordinated Notes due 2008. Net proceeds from this offering of $97.6
million were used to repay borrowings under the Company's credit facility.
(b) Effective May 5, 1998, the borrowing base on the Company's credit
facility with a bank group led by NationsBank of Texas, N.A., was increased
from $330.0 million to $380.0 million.
11
NUEVO ENERGY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULT OF OPERATIONS
6. (LOSS) EARNINGS PER SHARE COMPUTATION
SFAS No. 128 requires a reconciliation of the numerator (income) and
denominator (shares) of the basic earnings per share ("EPS") computation to
the numerator and denominator of the diluted EPS computation. In the three
and nine-month periods ended September 30, 1998, weighted average potential
dilutive common shares of 71,000 and 394,000, respectively, are not included
in the calculation of diluted loss per share due to their anti-dilutive
effect. The Company's reconciliation is as follows:
For the Three Months Ended September 30,
------------------------------------------------------------
1998 1997
------------------------------ ---------------------------
Loss Shares Income Shares
-------------- ------------- ------------ ------------
(Loss) earnings per Common share - Basic................. $(11,245) 19,820 $352 19,688
Effect of dilutive securities:
Stock options............................................ -- -- -- 663
-------- ------ ---- ------
(Loss) earnings per Common share - Diluted............... $(11,245) 19,820 $352 20,351
======== ====== ==== ======
For the Nine Months Ended September 30,
------------------------------------------------------------
1998 1997
------------------------------ ---------------------------
Loss Shares Income Shares
-------------- ------------- ------------ ------------
(Loss) earnings per Common share - Basic................. $(25,449) 19,781 $17,925 19,822
Effect of dilutive securities:
Stock options............................................ -- -- -- 677
-------- ------ ------- ------
(Loss) earnings per Common share - Diluted............... $(25,449) 19,781 $17,925 20,499
======== ====== ======= ======
7. EMPLOYEE STOCK PURCHASE PLAN
Effective March 1, 1998, the Company adopted an Employee Stock Purchase Plan
("ESPP"). The ESPP is a benefit plan that allows Nuevo employees to purchase
Nuevo common stock through payroll deductions at a purchase price equal to
85% of the fair market value of the common stock on the last day of the month
in which contributions are withheld. Fair market value is defined as the
closing price on the last day of the month in which shares were traded. The
Company's obligation under the ESPP is the remaining 15% of the purchase
price of shares purchased by employees. Participating employees may elect to
withdraw or sell shares of stock after the expiration of one year from the
purchase date.
8. CONTINGENCIES
The Company has been named as a defendant in Gloria Garcia Lopez and Husband,
Hector S. Lopez, Individually, and as successors to Galo Land & Cattle
Company v. Mobil Producing Texas & New Mexico, et al. in the 79th Judicial
District Court of Brooks County, Texas. The plaintiffs allege: i)
underpayment of royalties and claim damages, on a gross basis to all working
interest owners, of $27.7 million plus $26.2 million in interest for the
period from 1985 to date; ii) that their production was improperly commingled
with gas produced from an adjoining lease, resulting in damages, including
interest of $40.8 million (gross); and iii) numerous other claims that may
result in unspecified damages. Nuevo's working interest in these properties
is 20%. The Company, along with the other defendants in this case, denies
these allegations and is vigorously contesting these claims. Management does
not believe that the final outcome of this matter will have a material
adverse impact on the Company's operating results, financial condition or
liquidity.
The Company has been named as a defendant in certain other lawsuits
incidental to its business. Management does not believe that the outcome of
such litigation will have a material adverse impact on the Company's
operating results or financial condition. However, these actions and claims
in the aggregate seek substantial damages against the Company and are subject
to the inherent uncertainties in any litigation. The Company is defending
itself vigorously in all such matters.
12
NUEVO ENERGY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
In September 1997, there was a spill of crude oil into the Santa Barbara
Channel from a pipeline that connects the Company's Point Pedernales field
with shore-based processing facilities. The volume of the spill was
estimated to be 163 barrels of oil. The costs of the clean up and the cost to
repair the pipeline either have been or are expected to be covered by
insurance, less the Company's deductibles, which in total are $120,000.
Repairs were completed by the end of 1997, and production recommenced in
December 1997. The Company also has exposure to certain costs that may not be
recoverable by insurance, including fines, penalties, and damages. Such costs
are not quantifiable at this time, but are not expected to be material to the
Company's operating results, financial condition or liquidity.
In connection with their respective acquisitions of two subsidiaries owning
interests in the Yombo field offshore West Africa (each a "Congo
subsidiary"), the Company and a wholly-owned subsidiary of CMS NOMECO Oil &
Gas Co. ("CMS") agreed with the seller not to claim certain tax losses
incurred by such subsidiaries prior to the acquisitions. Pursuant to the
agreement, the Company and CMS may be liable to the seller for the recapture
of these tax losses utilized by the seller in years prior to the acquisitions
if certain triggering events occur. A triggering event will not occur,
however, if a subsequent purchaser enters into certain agreements specified
in the consolidated return regulations intended to ensure that such losses
will not be claimed. The Company's potential direct liability could be as
much as $50.0 million if a triggering event with respect to the Company
occurs, and the Company believes that CMS's liability (for which the Company
would be jointly liable with an indemnification right against CMS) could be
as much as $67.0 million. The Company does not expect a triggering event to
occur with respect to it or CMS and does not believe the agreement will have
a material adverse effect upon the Company.
The Company's international investments involve risks typically associated
with investments in emerging markets such as an uncertain political,
economic, legal and tax environment and expropriation and nationalization of
assets. In addition, if a dispute arises in its foreign operations, the
Company may be subject to the exclusive jurisdiction of foreign courts or may
not be successful in subjecting foreign persons to the jurisdiction of the
United States. The Company attempts to conduct its business and financial
affairs so as to protect against political and economic risks applicable to
operations in the various countries where it operates, but there can be no
assurance that the Company will be successful in so protecting itself. A
portion of the Company's investment in the Republic of Congo in West Africa
("Congo") is insured through political risk insurance provided by the
Overseas Private Investment Corporation. The Company is currently
investigating its options for political risk insurance in the Republic of
Ghana in West Africa ("Ghana").
During 1997, a new government was established in the Congo. Political unrest
continues to exist in West Africa, with insurgents challenging the government
of the neighboring Democratic Republic of Congo (formerly Zaire). Although
the political situation in the Congo has not to date had a material adverse
effect on the Company's operations in the Congo, no assurances can be made
that continued political unrest in West Africa will not have a material
adverse effect on the Company and its operations in the Congo.
9. ACQUISITIONS
In April 1998, the Company acquired a third party's interest in the Yombo
field in the Congo for $7.8 million. Such acquisition added 3.4 million
barrels of oil equivalent to the Company's December 31, 1997 reserve base and
increased the Company's net working interest in the Congo from 43.75% to
50.0%.
10. SUBSEQUENT EVENT
On October 19, 1998, the Company announced that it signed a purchase and sale
agreement with a third party for the sale of its East Texas natural gas
assets for $190.6 million. The effective date of the sale is July 1, 1998.
Accordingly, the Company reclassified these assets to assets held for sale
and discontinued depleting these assets during the third quarter of 1998.
Closing is expected in either December 1998 or January 1999. The purchase
price is subject to typical purchase price adjustments effective upon
closing. The Company plans to use the net proceeds from the sale to eliminate
its senior bank debt. Estimated net proved reserves associated with these
properties totaled approximately 275.0 billion cubic feet of natural gas
equivalent at January 1, 1998.
13
NUEVO ENERGY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
This document includes "forward looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act"),
and Section 21E of the Securities Exchange Act of 1934 ("Exchange Act"). All
statements other than statements of historical facts included in this
document, including without limitation, statements under "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
regarding the Company's financial position, estimated quantities and net
present values of reserves, business strategy, the effect of political
contingencies in foreign countries, plans and objectives of management of the
Company for future operations and covenant compliance, are forward-looking
statements. The Company can give no assurances that the assumptions upon
which such forward looking statements were based will prove to have been
correct. Important factors that could cause actual results to differ
materially from the Company's expectations ("Cautionary Statements") are
disclosed below and elsewhere in this document. Additional Cautionary
Statements are set forth in the Company's Form 10-K for the year ended
December 31, 1997 under the caption "Risk Factors" and elsewhere, and are
incorporated herein by reference. Such Cautionary Statements include a
description of risks associated with the volatility of oil and gas prices,
uncertainties in estimating oil and gas reserves, the need to replace
reserves, the substantial capital requirements associated with oil and gas
operations, risks of foreign investment, operating risks, risks associated
with competition and markets for production, as well as the effect of
environmental and other regulations on the Company's business. All
subsequent written and oral forward-looking statements attributable to the
Company or persons acting on its behalf are expressly qualified by the
Cautionary Statements.
Capital Resources and Liquidity
Since inception, the Company has grown and diversified its operations through
a series of opportunistic acquisitions of oil and gas properties and the
subsequent exploitation of these properties. The Company has complemented
these efforts with an active exploration program, which provides exposure to
prospects that have the potential to add substantially to the growth of the
Company. The funding of these activities has historically been provided by
operating cash flows, debt and bank financing, private and public placements
of debt and equity securities, property divestitures and joint ventures with
industry participants. Net cash provided by operating activities was $27.7
million and $128.4 million for the nine months ended September 30, 1998 and
1997, respectively. The reduction in cash flows was primarily attributable
to lower oil prices in the first nine months of 1998, compared with the first
nine months of 1997, which is described under "Results of Operations (Nine
months ended September 30, 1998 and 1997)". As of September 30, 1998, the
Company had $109.0 million of working capital. Effective May 5, 1998, the
borrowing base on the Company's credit facility was increased from $330.0
million to $380.0 million. The Company had unused commitments under the
revolving credit line of $233.0 million as of September 30, 1998, subject to
borrowing base determination.
On October 19, 1998, the Company announced that it signed a purchase and sale
agreement with a third party for the sale of its East Texas natural gas
assets for $190.6 million. The effective date of the sale is July 1, 1998.
Accordingly, the Company reclassified these assets to assets held for sale
and discontinued depleting these assets during the third quarter of 1998.
Closing is expected in either December 1998 or January 1999. The purchase
price is subject to typical purchase price adjustments effective upon
closing. The Company plans to use the net proceeds from the sale to eliminate
its senior bank debt. Estimated net proved reserves associated with these
properties totaled approximately 275.0 billion cubic feet of natural gas
equivalent at January 1, 1998.
On July 2, 1998, the Company announced that it anticipates receiving
approximately $14.0 million from three separate transactions for its
remaining non-core gas gathering, pipeline and storage assets. The Company
completed the sale of its Bright Star gas gathering system in July 1998 and
Richfield Gas Storage facility ("Richfield") in February 1998, at their
approximate carrying values, and has signed a letter of intent with a
14
NUEVO ENERGY COMPANY
ITEM. 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
third party to sell the remaining asset, the Illini Pipeline. Closing of the
Illini Pipeline sale is expected prior to year-end, pending finalization of a
purchase and sale agreement and certain regulatory approvals.
On June 8, 1998, the Company issued $100.0 million of 8 7/8% Senior
Subordinated Notes due 2008. Net proceeds from this offering of $97.6
million were used to repay borrowings under the Company's credit facility.
The Company believes its working capital, cash flow from operations, and
available financing sources are sufficient to meet its obligations as they
become due and to finance its exploration and development programs.
CAPITAL EXPENDITURES
Due to lower average realized oil prices in the first quarter of 1998, the
Company revised its capital spending plans for 1998. Originally, the Company
planned to spend $150.0 million on development projects in 1998. The
development budget was reduced to $112.0 million, affecting those projects
with projected rates of return expected to fall below acceptable threshold
levels assuming the continuation of current low oil prices. Management
believes that all of these delayed development projects will ultimately be
undertaken once oil prices return to historic norms. In addition, the
exploration budget was reduced from $47.0 million to $39.0 million,
representing plans to drill fewer exploratory wells than originally planned.
Drilling of the remaining exploration projects has been deferred until 1999.
Exploration and development expenditures for the first nine months of 1998
and 1997 are as follows (amounts in thousands):
For the Nine Months Ended
September 30,
----------------------------
1998 1997
---------- ----------
United States $118,495 $138,443
Africa 29,968 12,932
---------- ----------
Total $148,463 $151,375
=========== ===========
In the United States, Nuevo completed 154 producing wells out of 160 wells
drilled during the first nine months of 1998, while internationally the
Company discovered 7 new producers out of 13 wells drilled. As of September
30,1998, the Company was participating in the drilling or completing of an
additional 12 wells.
Significant exploration and development activity during the first nine months
of 1998 included: development drilling of the Antelope Shale formation at the
Monument Junction area in California and an offset to the B-14 Lower Sendji
completion at the Yombo field offshore Congo, and exploratory drilling at
Midway Peak in California, offshore the Republic of Ghana in West Africa
("Ghana") and in Tunisia, Africa. The Company drilled 21 wells (20 of which
were productive) in the Monument Junction area during the first nine months
of 1998, bringing current volumes to approximately 3,100 net barrels of oil
equivalent per day from 36 producing wells. The Company is still in the
progress of drilling the wells at Midway Peak and Tunisia. Testing of these
wells will begin when the drilling is complete. In September 1998, the
Company plugged and abandoned its first well in the East Cape Three Points
prospect offshore Ghana due to the lack of commercial quantities of reserves.
Dry hole costs for this well were $7.0 million net to the Company.
Other significant development activities include a new steamflood project in
the South Belridge field in California and the implementation of waterflood
projects in the Sendji and Tchala formations at the Yombo field offshore
Congo, and the Brea Olinda and Huntington Beach fields in California.
Production responses have already been noted in each of these projects, which
should result in production gains in 1999 and reserve bookings at January 1,
1999 and beyond.
15
NUEVO ENERGY COMPANY
ITEM. 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
In addition to its exploration and development activity, the Company acquired
a third party's interest in the Yombo field in the Congo for $7.8 million in
April 1998. Such acquisition added 3.4 million barrels of oil equivalent to
the Company's December 31, 1997 reserve base and increased the Company's net
working interest in the Congo from 43.75% to 50.0%.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company utilizes derivative financial instruments to reduce its exposure
to changes in the market price of natural gas and crude oil. Commodity
derivatives utilized as hedges include futures, swap and option contracts,
which are used to hedge natural gas and oil. Natural gas basis swaps are
sometimes used to hedge the basis differential between the derivative
financial instrument index price and the natural gas field price. In order
to qualify as a hedge, price movements in the underlying commodity derivative
must be highly correlated with the hedged commodity. Settlement of gains and
losses on price swap contracts are realized monthly, generally based upon the
difference between the contract price and the average closing New York
Mercantile Exchange ("NYMEX") price and are reported as a component of oil
and gas revenues and operating cash flows in the period realized.
Gains and losses on option and futures contracts that qualify as a hedge of
firmly committed or anticipated purchases and sales of oil and gas
commodities are deferred on the balance sheet and recognized in income and
operating cash flows when the related hedged transaction occurs. Premiums
paid on option contracts are deferred in other assets and amortized into oil
and gas revenues over the terms of the respective option contracts. Gains or
losses attributable to the termination of a derivative financial instrument
are deferred on the balance sheet and recognized in revenue when the hedged
crude oil and natural gas is sold. There were no such deferred gains or
losses at September 30, 1998 or December 31, 1997. Gains or losses on
derivative financial instruments that do not qualify as a hedge are
recognized in income currently.
As a result of hedging transactions, oil and gas revenues were increased by
$0.3 million and reduced by $1.6 million in the third quarter of 1998 and
1997, respectively. During the first nine months of 1998 and 1997, oil and
gas revenues were increased by $0.5 million and reduced by $3.3 million,
respectively, as a result of these transactions.
CONTINGENCIES
The Company has been named as a defendant in Gloria Garcia Lopez and Husband,
Hector S. Lopez, Individually, and as successors to Galo Land & Cattle
Company v. Mobil Producing Texas & New Mexico, et al. in the 79th Judicial
District Court of Brooks County, Texas. The plaintiffs allege: i)
underpayment of royalties and claim damages, on a gross basis to all working
interest owners, of $27.7 million plus $26.2 million in interest for the
period from 1985 to date; ii) that their production was improperly commingled
with gas produced from an adjoining lease, resulting in damages, including
interest of $40.8 million (gross); and iii) numerous other claims that may
result in unspecified damages. Nuevo's working interest in these properties
is 20%. The Company, along with the other defendants in this case, denies
these allegations and is vigorously contesting these claims. Management does
not believe that the final outcome of this matter will have a material
adverse impact on the Company's operating results, financial condition or
liquidity.
The Company has been named as a defendant in certain other lawsuits
incidental to its business. Management does not believe that the outcome of
such litigation will have a material adverse impact on the Company's
operating results or financial condition. However, these actions and claims
in the aggregate seek substantial damages against the Company and are subject
to the inherent uncertainties in any litigation. The Company is defending
itself vigorously in all such matters.
In September 1997, there was a spill of crude oil into the Santa Barbara
Channel from a pipeline that connects the Company's Point Pedernales field
with shore-based processing facilities. The volume of the spill was
estimated to be 163 barrels of oil. The costs of the clean up and the cost
to repair the pipeline either have been
16
NUEVO ENERGY COMPANY
ITEM. 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
or are expected to be covered by insurance, less the Company's deductibles,
which in total are $120,000. Repairs were completed by the end of 1997, and
production recommenced in December 1997. The Company also has exposure to
certain costs that may not be recoverable by insurance, including fines,
penalties, and damages. Such costs are not quantifiable at this time, but are
not expected to be material to the Company's operating results, financial
condition or liquidity.
In connection with their respective acquisitions of two subsidiaries owning
interests in the Yombo field offshore West Africa (each a "Congo
subsidiary"), the Company and a wholly-owned subsidiary of CMS NOMECO Oil &
Gas Co. ("CMS") agreed with the seller not to claim certain tax losses
incurred by such subsidiaries prior to the acquisitions. Pursuant to the
agreement, the Company and CMS may be liable to the seller for the recapture
of these tax losses utilized by the seller in years prior to the acquisitions
if certain triggering events occur. A triggering event will not occur,
however, if a subsequent purchaser enters into certain agreements specified
in the consolidated return regulations intended to ensure that such losses
will not be claimed. The Company's potential direct liability could be as
much as $50.0 million if a triggering event with respect to the Company
occurs, and the Company believes that CMS's liability (for which the Company
would be jointly liable with an indemnification right against CMS) could be
as much as $67.0 million. The Company does not expect a triggering event to
occur with respect to it or CMS and does not believe the agreement will have
a material adverse effect upon the Company.
The Company's international investments involve risks typically associated
with investments in emerging markets such as an uncertain political,
economic, legal and tax environment and expropriation and nationalization of
assets. In addition, if a dispute arises in its foreign operations, the
Company may be subject to the exclusive jurisdiction of foreign courts or may
not be successful in subjecting foreign persons to the jurisdiction of the
United States. The Company attempts to conduct its business and financial
affairs so as to protect against political and economic risks applicable to
operations in the various countries where it operates, but there can be no
assurance that the Company will be successful in so protecting itself. A
portion of the Company's investment in the Congo is insured through political
risk insurance provided by the Overseas Private Investment Corporation. The
Company is currently investigating its options for political risk insurance
in Ghana.
During 1997, a new government was established in the Congo. Political unrest
continues to exist in West Africa, with insurgents challenging the government
of the neighboring Democratic Republic of Congo (formerly Zaire). Although
the political situation in the Congo has not to date had a material adverse
effect on the Company's operations in the Congo, no assurances can be made
that continued political unrest in West Africa will not have a material
adverse effect on the Company and its operations in the Congo.
CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 1998, the Company elected to convert from the full cost
method to the successful efforts method of accounting for its investments in
oil and gas properties. The Company believes that the successful efforts
method of accounting is preferable, as it will provide a fair presentation of
the Company's development activities in its core California business and the
drilling success of its selective exploration activities, and reflect an
impairment in the carrying value of its oil and gas properties only when
there has been a permanent decline in their fair value. Accordingly, the
December 31, 1997 condensed consolidated balance sheet, the condensed
consolidated statements of operations for the three and nine months ended
September 30, 1997, and the condensed consolidated statement of cash flows
for the nine months ended September 30, 1997, have been restated to conform
with successful efforts accounting. The effect of the accounting change,
after tax, was to reduce December 31, 1997 retained earnings by $64.1
million. For the condensed consolidated statement of operations for the three
months ended September 30, 1997, the effect of the accounting change was to
decrease net income by $5.9 million, or $0.30 per common share - basic and
$0.29 per common share - diluted. For the condensed consolidated statement of
operations for the nine months ended September 30, 1997, the effect of the
accounting change was to decrease net income by $8.0 million, or $0.41 per
common share - basic and $0.40 per common share - diluted. Had the Company
not converted to the successful efforts
17
NUEVO ENERGY COMPANY
ITEM. 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
method, the results of operations for the three months ended March 31, 1998,
would have included a pre-tax full cost ceiling write-down of approximately
$250.0 million.
RECENT ACCOUNTING PRONOUNCEMENTS
The Company adopted Statement of Financial Accounting Standards ("SFAS") No.
130, "Reporting Comprehensive Income", effective January 1, 1998.
Comprehensive income includes net income and all changes in an enterprise's
other comprehensive income including, among other things, foreign currency
translation adjustments, and unrealized gains and losses on certain
investments in debt and equity securities. The implementation of this
statement had no impact on the Company as there are no differences between
comprehensive income (loss) and net income (loss) for the periods presented.
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related
Information". This statement establishes standards for reporting information
about operating segments in annual financial statements and requires that
enterprises report selected information about operating segments in interim
reports. The Company will adopt the provisions of SFAS No. 131 during 1998.
As SFAS No. 131 establishes standards for reporting and display, the Company
does not expect the adoption of this statement to have a material impact on
its financial condition or results of operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This statement establishes standards of
accounting for and disclosures of derivative instruments and hedging
activities. This statement is effective for the Company beginning in the
first quarter of the year 2000, however, early adoption is permitted. The
Company has not yet determined the impact of this statement on its financial
condition or results of operations or whether it will adopt the statement
early.
YEAR 2000
Nuevo, like all other enterprises that utilize computer technology, faces a
threat of business disruption from the Year 2000 Issue. The Year 2000 Issue
("Y2k") refers to the inability of computer and other information technology
systems to properly process date and time information, stemming from the
outdated programming practice of using two digits rather than four to
represent the year in a date. The consequence of Y2k is that computer and
imbedded processing systems are at risk of malfunctioning, particularly
during the transition from 1999 to 2000.
The effects of Y2k are exacerbated by the interdependence of computer and
telecommunication systems throughout the world. This interdependence also
exists among Nuevo and its vendors, customers and business partners, as well
as with regulators in the U.S. and host governments abroad.
The risks associated with Y2k fall into three general areas: i) financial and
administrative systems, ii) imbedded systems in field process control units,
and iii) third party exposures. Nuevo intends to address each of these three
areas through a readiness process that seeks to
a) increase the awareness of the issue among all employees;
b) identify areas of potential risk;
c) assess the relative impact of these risks and the Company's ability to
manage them;
d) remediate high priority risks wherever possible, and
e) engage in contingency planning for identifiable risks that cannot be
remediated.
The Company's Board of Directors has assigned the oversight of Y2k to the
Audit Committee of the Board. From the Audit Committee, all responsibility
for the readiness effort runs through the Chief Executive Officer of the
Company, and from him through the Chief Financial Officer (for financial and
administrative systems) and the Vice President of Exploitation (for imbedded
systems in field process control units). As a
18
NUEVO ENERGY COMPANY
ITEM. 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
matter of routine, management of the Company updates the Audit Committee, and
the entire Board, of its efforts to increase Nuevo's readiness for Y2k.
The Company outsources the majority of its information technology
administration to Novistar Inc., a subsidiary of Torch Energy Advisors Inc.
("Torch"), and outsources the management of its field operations to Torch
Operating Company, another subsidiary of Torch. As such, both Torch entities
are intimately involved in Nuevo's efforts to increase its readiness for Y2k.
Novistar has been planning for the impact of Y2k on its information
technology systems since late 1997, and Torch Operating Company has been
assessing the impact of Y2k on the assets it operates since early 1998.
The Company and Torch have jointly developed a plan to address Nuevo's risks
associated with Y2k. (As used in the remainder of this Y2k discussion,
references to the Company may include the Torch employees assisting the
Company in its Y2k readiness program). As of November 1, 1998, the Company
is in various stages of implementation of the plan, as summarized below:
Financial and Administrative Systems
1. Awareness. Nuevo has conducted numerous Y2k informational programs with
its employees and the employees of Torch who provide input to or utilize the
output of the financial and administrative systems of the Company. Employees
at all levels of the organization have been asked to participate in the
identification of potential Y2k risks which might otherwise go unnoticed by
higher level employees and officers of Nuevo, and as a result, awareness of
the issue is considered high.
2. Risk Identification. Nuevo's most significant financial and administrative
systems exposure is the Y2k status of the accounting and land administration
software package used by Novistar to collect and manage data for internal
management decision making and for external financial reporting purposes.
Other concerns include network hardware and software, desktop computing
hardware and software, telecommunications and office space readiness.
3. Risk Assessment. The failure to identify and correct a material Y2k
problem could result in inaccurate or untimely financial information for
management decision-making or financial reporting purposes. The severity of
any such problems will impact the duration during which the quality of
management information comes under question. At this time, management is
confident that any Y2k disruptions associated with its financial and
administrative systems will not have a material effect on the Company.
4. Remediation. Since April of 1998, Novistar has been working on an upgrade
to its accounting software, which is expected to achieve full Y2k compliance
in the first half of 1999. In addition, Novistar has inventoried all network
and desktop software applications used by Nuevo and believes them to be
generally Y2k compliant. The costs of all such risk assessments and
remediation are borne by Novistar under the terms of Nuevo's outsourcing
agreements.
5. Contingency Planning. Notwithstanding the foregoing, should there be
significant unanticipated disruptions in Nuevo's financial and administrative
systems, a number of accounting processes that are currently automated will
need to be performed manually. Nuevo is currently considering its options
with respect to contingency arrangements for temporary staffing to
accommodate such situations.
Imbedded Systems
1. Awareness. The Company's Y2k program has involved all levels of management
of field assets from production foremen and higher. Employees at all levels
of the organization have been asked to participate in the identification of
potential Y2k risks, which might otherwise go unnoticed by higher level
employees and officers of Nuevo, and as a result, awareness of the issue is
considered high.
19
NUEVO ENERGY COMPANY
ITEM. 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
2. Risk Identification. Nuevo is conducting an extensive inventory of all
imbedded computer systems within the process control units of its field
operations. This inventory process is estimated to be approximately 75-80%
complete as of this date. It is estimated that there are thousands of
imbedded components residing in the hundreds of computerized systems within
Nuevo's dozens of operated oil and natural gas fields and processing plants.
Once inventoried, the readiness plan entails researching the manufacturer
and/or installer of each component to determine the anticipated compliance or
non-compliance of the component. To date, the vast majority of imbedded
components so researched have been deemed either date-insensitive, or if they
are date-sensitive, Y2k compliant. However, the complexity of imbedded
systems is such that a small minority of non-compliant components, even a
single non-compliant component, can corrupt an entire system. Therefore, once
the component level evaluation is completed, a broader evaluation at the
system level will commence.
3. Risk Assessment. The failure to identify and correct a material Y2k
problem could result in outcomes ranging from errors in data reporting to
curtailments or shutdowns in production. Nuevo is actively engaged in a
program to prioritize the remediation of imbedded components and systems
which are either known to be Y2k non-compliant or which have higher risk of
Y2k failures, and to further prioritize remediation targets by the
anticipated financial impact of any such failures on the Company. To assist
in this effort, Nuevo and Torch Operating Company have retained consultants
who are knowledgeable and experienced in the assessment of Y2k issues
impacting field operations. Nuevo intends to give extremely high priority to
the remediation of any situation that impacts employee health and safety or
environmental security. However, the effort to assess the situation is
dynamic and will likely not be fully completed by December 31, 1999. The cost
of the assessment is not expected to be material to Nuevo's financial
results. However, at this time management is unable to express any degree of
confidence that there will not be material production disruptions associated
with Y2k non-compliance. Depending on the magnitude of any such disruptions
and the time required to correct them, such failures could materially and
adversely impact the Company's results of operations, liquidity and financial
condition.
4. Remediation. Once identified, assessed and prioritized, Nuevo intends to
test, upgrade and certify those imbedded components and systems in field
process control units deemed to pose the greatest risk of significant non-
compliance. It is important to note that in some circumstances, the
procedures used to test imbedded components for Y2k compliance themselves
pose a risk of damaging the component or corrupting the system, thereby
accelerating the consequences of Y2k failures. Accordingly, there may be
situations in which a decision not to test may be deemed the most prudent. As
of November 12, 1998, Nuevo is in the process of formulating and approving a
capital budget for its fiscal year ended December 31, 1999, and consideration
is being given to the anticipated costs to remediate or replace imbedded
components and systems that pose the greatest risk of significant Y2k non-
compliance. The amount anticipated to be budgeted for these costs is not
expected to be material to the liquidity and financial condition of the
Company; however, as the assessment work is at an early stage and is expected
to identify risks during 1999, there can be no assurances that actual capital
spending on Y2k remediation will not be significantly in excess of any
amounts originally budgeted.
5. Contingency Planning. Should material production disruptions occur as a
result of Y2k failures in field operations, Nuevo's operating cash flow will
be impacted. This contingency is being factored into deliberations on capital
budgeting, liquidity and capital adequacy. It is management's intention to
maintain adequate financial flexibility to sustain the Company during any
such period of cash flow disruption.
Third Party Exposures
1. Awareness. Nuevo has conducted numerous Y2k informational programs with
its employees and the employees of Torch who have significant interaction
with outside vendors, customers, and business partners of the Company. All
such employees have been asked to participate in the identification of
potential third party Y2k risks, which might otherwise go unnoticed by higher
level employees and officers of Nuevo, and as a result awareness of the issue
is considered high.
20
NUEVO ENERGY COMPANY
ITEM. 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
2. Risk Identification. Nuevo's most significant third party Y2k exposure is
to the refinery customers who purchase its oil production. Other significant
concerns include the readiness of third party crude oil and natural gas
pipeline facilities involved in the transportation of Nuevo's products, the
availability of electric power to Nuevo's field operations, the integrity of
global telecommunication systems, the readiness of commercial banks to
execute electronic fund transfers, and of the ability of the financial
community to maintain an orderly market in Nuevo's securities.
3. Risk Assessment. Refineries are extremely complex operations containing
hundreds or thousands of computerized processes. The failure on the part of a
Nuevo refining customer to identify and correct a material Y2k problem could
result in material disruptions in the sale of Nuevo's production to that
refinery. In many cases, affected Nuevo production may not be easily shifted
to other markets, and the result can range from reduced realizations on crude
oil produced, curtailed production or even shut-in production. Failures of
pipelines that connect Nuevo's production to markets may have similar
effects. Although the Company has made inquiries to key third parties on the
subject of Y2k readiness and will continue to do so, it has no ability to
require responses to such inquiries or to independently verify their
accuracy. Accordingly, management is unable to express any degree of
confidence that there will not be material production disruptions associated
with third party Y2k non-compliance. Depending on the magnitude of any such
disruptions and the time required to correct them, such failures could
materially and adversely impact the Company's results of operations,
liquidity and financial condition.
4. Remediation. Where Nuevo perceives significant risk of Y2k non-compliance
that may have a material impact on the Company, and where the relationship
between the Company and a vendor, customer or business partner permits, joint
testing may be undertaken during 1999 to further identify these risks.
5. Contingency Planning. Should material production disruptions occur as a
result of Y2k failures of third parties, Nuevo's operating cash flow will be
impacted. This contingency is being factored into deliberations on capital
budgeting, liquidity and capital adequacy. It is management's intention to
maintain adequate financial flexibility to sustain the Company during any
such period of cash flow disruption.
OIL AND GAS PRICES
The Company's revenues, cash flows, results of operations and liquidity are
dependent on oil and gas prices, as is its ability to acquire financing for
its operations. Approximately 77% of the Company' production for the first
nine months of 1998 was oil. Oil prices during 1998 have been very low
compared to historical prices. As a result, the Company's revenues, earnings
and cash flows have been materially reduced compared to 1997, even though
production levels have increased during 1998. In response to low oil prices,
the Company reduced its capital expenditure budget, postponing projects which
are not expected to generate an acceptable rate of return at current low oil
prices. Although the Company believes that its cash flows from operations
and borrowing capacity will be sufficient to meet the Company's needs for the
foreseeable future, continued low oil prices will continue to adversely
affect the Company.
21
NUEVO ENERGY COMPANY
ITEM. 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS (THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997)
The following table sets forth certain operating information of the Company
(inclusive of the effect of crude oil and natural gas hedging) for the periods
presented:
Three Months
Ended September 30,
------------------- %
Increase/
1998 1997 (Decrease)
-------- -------- -----------
Production:
Oil and condensate (MBBLS)........... 4,732 4,564 3.7%
Natural gas (MMCF)................... 7,892 9,052 (12.8%)
Natural gas liquids (MBBLS).......... 59 77 (23.4%)
Average Sales Price:
Oil and condensate ($ per barrel).... $ 9.41 $13.93 (32.4%)
Natural gas ($ per mcf).............. $ 1.97 $ 1.89 4.2%
Average unit production cost(1) per BOE... $ 5.57 $ 4.90 13.7%
(1) Costs incurred to operate and maintain wells and related equipment and
facilities, including ad valorem and severance taxes.
Revenues
Oil and gas revenues for the three months ended September 30, 1998 were $60.8
million, or 26% lower than oil and gas revenues of $81.8 million for the same
period in 1997. This decrease is due to lower realized oil prices in the third
quarter of 1998.
Gain on sale of assets for the three months ended September 30, 1998 was $4.1
million, compared to a loss on sale of assets of $2.3 million for the three
months ended September 30, 1997. The gain on sale of assets in the third
quarter of 1998 relates to the sale of the Company's interest in the Sansinena
field in California. The loss on sale of assets in the third quarter of 1997
is comprised of a $1.6 million loss on the sale of the Company's interest in the
South Timbalier field and a $0.7 million final accounting adjustment to the
second quarter 1997 gain on sale of the Benedum Plant System.
Expenses
Lease operating expenses for the three months ended September 30, 1998 totaled
$34.0 million, or 13% higher than $30.1 million for the three months ended
September 30, 1997, primarily due to an increase in workovers and steam costs,
primarily in California, as compared to the third quarter of 1997. These
increases resulted in lease operating expenses per barrel of oil equivalent of
$5.57 in the third quarter of 1998, compared to $4.90 in the same period in
1997.
Exploration costs, including geological and geophysical ("G&G") costs, dry hole
costs and delay rentals, were $11.9 million and $4.1 million for the three
months ended September 30, 1998 and 1997, respectively. Exploration costs for
the three months ended September 30, 1998 included: $10.1 million of dry hole
costs ($7.0 million of which was attributable to exploration activity in Ghana),
$1.0 million of G&G costs, $0.5 million of delay rentals and $0.3 million of
other exploration costs. Exploration costs for the three months ended September
30, 1997 included $3.3 million of dry hole costs, $0.6 million of G&G costs and
$0.2 million of delay rentals and other exploration costs.
22
NUEVO ENERGY COMPANY
ITEM. 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Depreciation, depletion and amortization of $20.3 million for the three months
ended September 30, 1998 reflects a 28% decrease from $28.1 million in the same
period in 1997, due primarily to the year-end 1997 impairment of $30.0 million
related to the excess of capitalized costs over future net revenues, as well as
the reclassification of the East Texas oil and gas properties to assets held for
sale as of July 1, 1998.
General and administrative expenses, along with outsourcing fees, decreased 22%
to $7.0 million for the three months ended September 30, 1998, from $8.9 million
for the same period in 1997. This decrease is primarily due to the $1.7 million
severance expense incurred in the third quarter of 1997 associated with the
resignation of the Company's president and chief executive officer.
Interest expense increased to $8.9 million for the three months ended September
30, 1998 from $6.6 million in the same period of 1997. This 35% increase is
primarily the result of additional borrowings under the Company's credit
facility and the issuance in June 1998 of $100.0 million of 8 7/8% Senior
Subordinated Notes due 2008.
Net (Loss) Income
A net loss of $11.2 million, ($0.57) per common share basic and diluted,
resulted for the three months ended September 30, 1998, as compared to net
income of $0.4 million, $0.02 per common share basic and diluted, in the same
period in 1997.
RESULTS OF OPERATIONS (NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997)
The following table sets forth certain operating information of the Company
(inclusive of the effect of crude oil and natural gas hedging) for the periods
presented:
Nine Months
Ended September 30,
------------------- %
Increase/
1998 1997 (Decrease)
-------- -------- -----------
Production:
Oil and condensate (MBBLS)........... 13,981 13,021 7.4%
Natural gas (MMCF)................... 24,628 26,812 (8.1%)
Natural gas liquids (MBBLS).......... 175 207 (15.5%)
Average Sales Price:
Oil and condensate ($ per barrel).... $ 9.45 $ 14.90 (36.6%)
Natural gas ($ per mcf).............. $ 2.00 $ 1.94 3.1%
Average unit production cost(1) per BOE... $ 5.47 $ 4.98 9.8%
(1) Costs incurred to operate and maintain wells and related equipment and
facilities, including ad valorem and severance taxes.
Revenues
Oil and gas revenues for the nine months ended September 30, 1998 were $183.8
million, or 26% lower than oil and gas revenues of $249.0 million for the same
period in 1997. This decrease is primarily due to lower realized oil prices in
1998, which were partially offset by increased production and higher gas prices
during the period.
Gas plant revenues of $2.0 million and $13.8 million are reflected in the nine
months ended September 30, 1998 and 1997, respectively. The 85% decrease in
revenues is due to the sale of the Company's interest in the Benedum Plant
System during the second quarter of 1997.
Gain on sale of assets for the nine months ended September 30, 1998 was $5.8
million. This gain on sale of assets includes a $4.1 million gain on the sale of
the Company's interest in the Sansinena field in California in the third quarter
and a $1.7 million gain on the sale of the Company's interest in the Coke field
in Chapel Hill, Texas in the
23
NUEVO ENERGY COMPANY
ITEM. 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
first quarter. Gain on sale of assets (net) for the nine months ended September
30, 1997 was $2.1 million. This net gain includes: a gain of $1.4 million on the
sale of the Company's interest in Second Bayou, Weeks Island, Louisiana, a $2.3
million gain on the sale of the Company's interest in the Benedum Plant System,
and a $1.6 million loss on the sale of the Company's interest in the South
Timbalier field.
Expenses
Lease operating expenses for the nine months ended September 30, 1998 totaled
$99.8 million, compared to $88.1 million for the same period in 1997. This 13%
increase is primarily due to an increase in workovers of $8.3 million in the
first nine months of 1998 as compared to the same period in 1997, as well as
poor weather conditions in the first quarter of 1998 in California that caused
landslides and power outages, which resulted in $2.3 million of incremental,
unusual costs and contributed to decreased production. Lease operating expenses
per BOE were $5.47 in the first nine months of 1998, compared to $4.98 in the
same period in 1997.
Plant operating expenses of $2.3 million are reflected in the nine months ended
September 30, 1998 as compared to $12.5 million for the nine months ended
September 30, 1997. The 82% decrease in gas plant expenses is due to the sale
of the Company's interest in the Benedum Plant System during the second quarter
of 1997.
Exploration costs, including G&G costs, dry hole costs and delay rentals, were
$16.0 million and $5.7 million for the nine months ended September 30, 1998 and
1997, respectively. Exploration costs for the nine months ended September 30,
1998 included: $10.2 million of dry hole costs ($7.0 of which relates to
exploration activity in Ghana), $4.6 million of G&G costs, $0.6 million of
delay rentals and $0.6 million of other exploration costs. Exploration costs for
the nine months ended September 30, 1997 included $4.8 million of dry hole
costs, $0.6 million of G&G costs and $0.3 million of delay rentals and screening
costs.
Depreciation, depletion and amortization of $66.8 million for the nine months
ended September 30, 1998 reflects a decrease of 12% from $76.3 million in the
same period in 1997, due primarily to the year-end 1997 impairment of $30.0
million related to the excess of capitalized costs over future net revenues, as
well as the reclassification of the East Texas oil and gas properties to assets
held for sale as of July 1, 1998.
General and administrative expenses, along with outsourcing fees, decreased 4%
to $22.7 million for the nine months ended September 30, 1998, from $23.7
million for the same period in 1997. This decrease is primarily due to the $1.7
million severance expense incurred in the third quarter of 1997 associated with
the resignation of the Company's president and chief executive officer, offset
in part by non-recurring costs incurred in the first nine months of 1998
associated with outside engineering costs and third-party consulting studies
associated with the re-negotiation of the Company's outsourcing agreements.
Interest expense increased to $23.3 million for the nine months ended September
30, 1998 from $20.6 million in the same period of 1997. This 13% increase is
primarily the result of additional borrowings under the Company's credit
facility and the issuance in June 1998 of $100.0 million of 8 7/8% Senior
Subordinated Notes due 2008.
Extraordinary Item
In June 1997, the Company redeemed its 12 1/2% Senior Subordinated Notes at a
total cost of $78.0 million, representing $75.0 million face value of the debt
plus a 4% premium of $3.0 million. The redemption resulted in an extraordinary
loss on early extinguishment of debt, net of the related tax benefit, of $3.0
million. The Company used proceeds from its bank facility to fund the
redemption.
Net (Loss) Income
A net loss of $25.4 million, ($1.29) per common share - basic and diluted,
resulted for the nine months ended September 30, 1998, as compared to net income
of $17.9 million, $0.90 per common share - basic and $0.87 per common share -
diluted, in the same period in 1997.
24
NUEVO ENERGY COMPANY
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
10. Material Contracts
10.1 Employment agreement with Michael P. Darden.
27. Financial Data Schedule
Reports on Form 8-K.
1. None.
25
NUEVO ENERGY COMPANY
PART II. OTHER INFORMATION (CONTINUED)
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.
NUEVO ENERGY COMPANY
(Registrant)
Date: November 13, 1998 By: /s/ Douglas L. Foshee
----------------- ----------------------------
Douglas L. Foshee
Chairman, President and Chief Executive
Officer
Date: November 13, 1998 By: /s/ Robert M. King
----------------- ---------------------------
Robert M. King
Senior Vice President and Chief Financial
Officer
26