UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
Commission File Number 1-10537
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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
-------------- ------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 713/652-0706
------------
Not Applicable Former name, former address and former fiscal year, if changed
since last report
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
As of May 13, 1999, the number of outstanding shares of the Registrant's common
stock was 20,308,462.
NUEVO ENERGY COMPANY
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INDEX
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PAGE
NUMBER
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PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Balance Sheets:
March 31, 1999 (Unaudited) and December 31, 1998............. 3
Condensed Consolidated Statements of Operations (Unaudited):
Three months ended March 31, 1999 and March 31, 1998......... 5
Condensed Consolidated Statements of Cash Flows (Unaudited):
Three months ended March 31, 1999 and March 31, 1998......... 6
Notes to Condensed Consolidated Financial
Statements (Unaudited)....................................... 8
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................. 14
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk....... 26
PART II. OTHER INFORMATION................................................ 27
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NUEVO ENERGY COMPANY
--------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
(AMOUNTS IN THOUSANDS)
ASSETS
------
March 31, 1999 December 31, 1998
--------------- ------------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents............................ $ 118,548 $ 7,403
Accounts receivable.................................. 24,762 25,096
Product inventory.................................... 1,784 5,998
Assets held for sale................................. 10,000 120,055
Prepaid expenses and other........................... 2,488 2,700
---------- ----------
Total current assets............................... 157,582 161,252
---------- ----------
PROPERTY AND EQUIPMENT, at cost:
Land................................................. 51,666 51,038
Oil and gas properties (successful efforts method)... 973,641 959,348
Gas plant facilities................................. 17,606 17,112
Other facilities..................................... 7,125 6,696
---------- ----------
1,050,038 1,034,194
Accumulated depreciation, depletion and
amortization....................................... (440,942) (417,622)
---------- ----------
609,096 616,572
---------- ----------
DEFERRED TAX ASSETS, net.............................. 12,908 27,534
OTHER ASSETS.......................................... 11,890 12,327
---------- ----------
$ 791,476 $ 817,685
========== ==========
See accompanying notes to condensed consolidated financial statements.
3
NUEVO ENERGY COMPANY
--------------------
CONDENSED CONSOLIDATED BALANCE SHEETS - Continued
-------------------------------------------------
(Amounts in Thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
March 31, 1999 December 31, 1998
--------------- -----------------
(Unaudited)
CURRENT LIABILITIES:
Accounts payable............................................................................ $ 15,982 $ 24,393
Accrued interest............................................................................ 8,220 4,161
Accrued liabilities......................................................................... 17,982 17,917
Current maturities of long-term debt........................................................ 2,977 3,152
-------- ---------
Total current liabilities................................................................ 45,161 49,623
-------- ---------
OTHER LONG-TERM LIABILITIES................................................................... 2,595 2,034
LONG-TERM DEBT, net of current maturities..................................................... 365,500 419,150
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 shares issued at
March 31, 1999 and December 31, 1998....................................................... 203 203
Additional paid-in capital................................................................. 355,600 355,600
Treasury stock, at cost, 459,704 and 473,876 shares, at March 31, 1999 and
December 31, 1998, respectively............................................................. (19,236) (19,335)
Stock held by benefit trust, 62,658 and 47,759 shares, at March 31, 1999 and
December 31, 1998, respectively............................................................. (1,831) (1,732)
Accumulated deficit........................................................................ (71,516) (102,858)
-------- ---------
Total stockholders' equity.............................................................. 263,220 231,878
-------- ---------
$791,476 $ 817,685
======== =========
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 March 31,
------------------------------
1999 1998
--------------- ------------
REVENUES:
Oil and gas revenues........................................................... $ 42,880 $ 63,142
Gas plant revenues............................................................. 584 828
Pipeline and other revenues.................................................... 4 1,242
Gain on sale................................................................... 81,699 1,677
Interest and other income...................................................... 1,476 772
--------- --------
126,643 67,661
--------- --------
COSTS AND EXPENSES:
Lease operating expenses....................................................... 28,543 33,036
Gas plant operating expenses................................................... 1,371 738
Pipeline and other operating expenses.......................................... 81 1,266
Exploration costs.............................................................. 2,125 1,415
Depreciation, depletion and amortization....................................... 23,320 24,782
General and administrative expenses............................................ 3,832 4,685
Outsourcing fees............................................................... 3,210 3,759
Interest expense............................................................... 7,999 6,826
Dividends on Guaranteed Preferred
Beneficial Interests in Company's
Convertible Debentures (TECONS)............................................. 1,653 1,653
Other expense.................................................................. 2,441 810
--------- --------
74,575 78,970
--------- --------
Income (loss) before income taxes................................................. 52,068 (11,309)
Provision (benefit) for income taxes.............................................. 20,726 (4,727)
--------- --------
NET INCOME (LOSS)................................................................. $ 31,342 $ (6,582)
========= ========
EARNINGS PER SHARE:
Earnings (loss) per common share - Basic.......................................... $ 1.58 $ (0.33)
========= ========
Weighted average common shares outstanding........................................ 19,840 19,745
========= ========
Earnings (loss) per common share - Diluted........................................ $ 1.58 $ (0.33)
========= ========
Weighted average common and dilutive
potential common shares outstanding.............................................. 19,840 19,745
========= ========
See accompanying notes to condensed consolidated financial statements.
5
NUEVO ENERGY COMPANY
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------
(Unaudited)
(Amounts in Thousands)
Three Months Ended March 31,
----------------------------
1999 1998
--------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)............................................................... $ 31,342 $ (6,582)
Adjustments to reconcile net income (loss) to net cash (used in)
provided by operating activities:
Depreciation, depletion and amortization................................... 23,320 24,782
Gain on sale............................................................... (81,699) (1,677)
Dry hole costs............................................................. 827 ---
Amortization of other costs................................................ 405 364
Appreciation of deferred compensation plan................................. 152 ---
Deferred revenues.......................................................... --- (703)
Deferred taxes............................................................. 14,626 (4,907)
--------- --------
(11,027) 11,277
Change in assets and liabilities:
Accounts receivable......................................................... 334 9,125
Accounts payable and accrued liabilities.................................... (4,287) 1,235
Other....................................................................... 4,548 2,802
--------- --------
NET CASH (USED IN) PROVIDED BY OPERATING
ACTIVITIES....................................................................... (10,432) 24,439
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to oil and gas properties............................................ (15,630) (48,739)
Additions to gas plant facilities.............................................. (494) (1,008)
Additions to pipeline and other facilities..................................... (1,057) (540)
Proceeds from sales of properties.............................................. 192,583 3,611
--------- --------
NET CASH PROVIDED BY (USED IN) INVESTING
ACTIVITIES....................................................................... 175,402 (46,676)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings....................................................... 86,590 18,000
Payments of long-term debt..................................................... (140,415) (958)
Proceeds from issuance of common stock......................................... --- 132
--------- --------
NET CASH (USED IN) PROVIDED BY FINANCING
ACTIVITIES....................................................................... (53,825) 17,174
--------- --------
Net increase/(decrease) in cash and cash
equivalents................................................................... 111,145 (5,063)
Cash and cash equivalents at beginning of
period...................................................................... 7,403 9,208
--------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD........................................ $ 118,548 $ 4,145
========= ========
See accompanying notes to condensed consolidated financial statements.
6
NUEVO ENERGY COMPANY
--------------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
------------------------------------------------------------
(Unaudited)
(Amounts in Thousands)
Three Months Ended March 31,
----------------------------
1999 1998
------------- ------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest (net of amounts capitalized)......... $2,306 $3,318
Income taxes.................................. $ --- $ 150
See accompanying notes to condensed consolidated financial statements.
7
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 March 31, 1999 and December 31, 1998 and the
results of operations and changes in cash flows for the periods ended March
31, 1999 and 1998. These financial statements should be read in conjunction
with the financial statements and notes to the financial statements in the
1998 Form 10-K of Nuevo Energy Company (the "Company") that was filed with
the Securities and Exchange Commission.
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.
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 prices. Commodity price and
basis swaps are sometimes used to hedge the basis differential between the
derivative financial instrument index price and the commodity 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 March 31, 1999 or December 31, 1998. 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
$0.2 million and $0.1 million in the first quarter of 1999 and 1998,
respectively.
The Company entered into a swap arrangement with a major financial
institution that effectively converts the interest rate on $9.2 million
notional amount of the 9 1/2 % Senior Subordinated Notes due 2006 to a
variable LIBOR-based rate through February 25, 2000. Based on LIBOR rates in
effect at March 31, 1999, this amounted to a net reduction in the carrying
cost of the 9 1/2 % Senior Subordinated Notes due 2006 from 9.5% to 5.56%, or
394 basis points. In addition, the swap arrangement also effectively hedges
the price at which these Notes can be repurchased by the Company at 100.51%
of their face amount. Based on the market price of 102.25% for the Notes at
March 31, 1999, an early termination of this arrangement would result in a
payment of $0.2 million from the institution to Nuevo.
8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
----------------------------------------------------------------
(Unaudited)
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("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 requires all
derivative instruments to be carried on the balance sheet at fair value and
is effective for the Company beginning January 1, 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 drilling, whether or not successful, are
capitalized when incurred. When a proved property is sold, ceases to produce
or is abandoned, a gain or loss is recognized. When an entire interest in an
unproved property is sold for cash or cash equivalent, gain or loss is
recognized, taking into consideration any recorded impairment. When a
partial interest in an unproved property is sold, the amount received is
treated as a reduction of the cost of the interest retained.
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, development 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 dismantlement,
abandonment and 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 the
undiscounted expected future net revenues computed by application of
estimated future oil and gas prices, production and expenses, as determined
by management, to estimated future production of oil and gas reserves over
the economic life of the reserves. If the carrying value exceeds the
undiscounted future net revenues, an impairment is recognized equal to the
difference between the carrying value and the discounted estimated future net
revenues of that depletable unit. The Company considers probable reserves
and escalated commodity pricing in its estimate of future net revenues. A
fair value impairment of $69.8 million was recognized as of December 31,
1998.
Interest costs associated with non-producing leases and exploration and
development projects are capitalized only for the period that activities are
in progress to bring these projects to their intended use. The
capitalization rates are based on the Company's weighted average cost of
funds used to finance expenditures.
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
----------------------------------------------------------------
(Unaudited)
3. INDUSTRY SEGMENT INFORMATION
As of December 31, 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information", which was issued by the
FASB in June 1997. 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 periods.
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 and 1999. 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 by mid-
year 1999, 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.
For the Three Months Ended March 31,
-------------------------------------
1999 1998
-------- --------
Sales to unaffiliated customers:
Oil and gas - East........................ $ 3,596 $ 12,104
Oil and gas - West........................ 35,623 47,503
Oil and gas - International............... 3,661 3,535
Gas plant, pipelines and other............ 588 2,070
-------- --------
Total sales................................. 43,468 65,212
Other revenues............................ 83,175 2,449
-------- --------
Total revenues.............................. $126,643 $ 67,661
======== ========
Operating profit before income taxes:
Oil and gas - East........................ $ 81,948 $ 7,274
Oil and gas - West........................ (9,019) 648
Oil and gas - International............... (1,963) (1,796)
Gas plant, pipelines and other............ (1,070) (128)
-------- --------
69,896 5,998
Unallocated corporate expenses.............. 8,176 8,828
Interest expense............................ 7,999 6,826
Dividends on TECONS......................... 1,653 1,653
-------- --------
Income (loss) before income taxes......... $ 52,068 $(11,309)
======== ========
Depreciation, depletion and amortization:
Oil and gas - East........................ $ 1,574 $ 3,411
Oil and gas - West........................ 19,573 19,727
Oil and gas - International............... 1,798 1,104
Gas plant, pipelines and other............ 375 540
-------- --------
$ 23,320 $ 24,782
======== ========
10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
----------------------------------------------------------------
(Unaudited)
4. LONG-TERM DEBT
Long-term debt consists of the following (amounts in thousands):
March 31, December 31,
1999 1998
----------------- ----------------
9 1/2% Senior Subordinated Notes due 2006.................................... $160,000 $160,000
8 7/8% Senior Subordinated Notes due 2008 (a)................................. 100,000 100,000
Bank credit facility (b)...................................................... 105,500 158,400
OPIC credit facility.......................................................... 2,977 3,902
-------- --------
Total debt............................................................ 368,477 422,302
Less: current maturities...................................................... (2,977) (3,152)
-------- --------
Long-term debt................................................................ $365,500 $419,150
======== ========
(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 January 6, 1999, the borrowing base on the Company's credit
facility with a bank group led by NationsBank of Texas, N.A., was reduced
from $380.0 million to $200.0 million, reflecting the sale on that date of
the Company's East Texas natural gas reserves, and also reflecting a
significant decline in current and projected oil prices since the previous
determination. Subsequent discussions with the Company's bank group have led
to an amendment to the credit facility granting the Company relief from the
fixed charge coverage covenant through March 31, 2000. The Company is also
discussing with its banks other possible changes to the agreement, including
the provision of mortgages to secure the facility, more frequent borrowing
base determinations, and the further relaxation of the fixed charge coverage
test and a number of other covenant restrictions. The Company is confident
that the outcome of these discussions will include a borrowing base of $200.0
million for the first half of 1999, and improved certainty of the continued
availability of the full commitment under this agreement.
5. EARNINGS (LOSS) 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-
month period ended March 31, 1999 there were no potential dilutive common
shares. In the three months ended March 31, 1998, weighted average potential
dilutive common shares of 506,000 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 March 31,
------------------------------------------------------------
1999 1998
----------------------------- ----------------------------
Income Shares Loss Shares
------------- ------------- ------------- ------------
Earnings (loss) per common share - Basic................. $31,342 19,840 $(6,582) 19,745
Effect of dilutive securities:
Stock options............................................ -- -- -- ---
------- ------ ------- ------
Earnings (loss) per common share - Diluted............... $31,342 19,840 $(6,582) 19,745
======= ====== ======= ======
11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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(Unaudited)
6. CONTINGENCIES
The Company has been named as a defendant in the 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, 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 March 1999, the Company discovered that a non-officer employee had
fraudulently authorized and diverted for personal use Company funds totaling
$5.9 million, $4.3 million in 1998 and the remainder in 1999, that were
intended for international exploration. Accordingly, the Company has
reclassified the amounts lost in 1998 and 1999 to other expense. Based on
its review of the facts, management is confident that only one employee was
involved in the matter and that all misappropriated funds have been
identified. The Board has engaged a Certified Fraud Examiner to conduct an
in-depth review of the fraudulent transactions to determine the scope of the
fraud, the possibility of recovery of amounts lost from insurance, from the
terminated employee and/or from third parties, and to make recommendations
regarding what, if any, new internal control procedures should be
implemented.
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 from 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.
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 ("OPIC"). The Company is currently
investigating its options for political risk insurance in the Republic of
Ghana in West Africa ("Ghana").
The Company and its partners in the Congo are undergoing a tax examination
related to their ownership interests in the Yombo field offshore Republic of
Congo, for the years 1994 through 1997. The Congolese taxing authorities
have issued a preliminary assessment of approximately $3.6 million in taxes
and penalties for all years, in aggregate for all parties who have ownership
in this field. Nuevo's working interest in this field is 43.75% during the
period under examination. The Company, along with the other partners, is in
12
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
----------------------------------------------------------------
(Unaudited)
discussions with the Congolese taxing authorities refuting this assessment as
without merit to the items being disallowed. Management does not believe
that the outcome of this matter will have a material adverse effect upon the
Company.
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.
7. DISPOSITIONS
On January 6, 1999, the Company completed the sale of its East Texas natural
gas assets to an affiliate of Samson Resources Company for an adjusted
purchase price of $192.0 million. Of the proceeds, $100.0 million was set
aside to fund an escrow account to provide "like-kind exchange" tax treatment
in the event the Company acquires domestic producing oil and gas properties
in the first half of 1999. The remainder of the proceeds were used to repay
outstanding senior bank debt. The Company realized an $81.7 million pre-tax
gain on the sale of the East Texas natural gas assets resulting in the
realization of $14.6 million of the Company's deferred tax asset. A $5.2
million gain on settled hedge transactions was realized in connection with
the closing of this sale in 1999. The effective date of the sale is July 1,
1998. The Company reclassified these assets to assets held for sale and
discontinued depleting these assets during the third quarter of 1998.
Estimated net proved reserves associated with these properties totaled
approximately 329.0 billion cubic feet of natural gas equivalent at
January 1, 1999.
13
NUEVO ENERGY COMPANY
--------------------
ITEM 2. 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, plans and objectives of
management of the Company for future operations and covenant compliance, are
forward-looking statements. Although the Company believes that the
assumptions upon which such forward-looking statements are based are
reasonable, it can give no assurances that such assumptions 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. 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 its 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 Company's primary source of capital has been
operating cash flows, debt and bank financing, private and public placements
of equity, property divestitures and joint ventures with industry
participants. Net cash (used in) provided by operating activities was
($10.4) million and $24.4 million for the three months ended March 31, 1999
and 1998, respectively. The Company invested $17.2 million and $50.3 million
in oil and gas properties for the three months ended March 31, 1999 and 1998,
respectively. As of March 31, 1999, the Company also had unused commitments
under the revolving credit line of $94.5 million, subject to borrowing base
determination. In addition, the Company had placed $100.0 million in escrow
associated with the sales proceeds from the sale of the East Texas natural
gas properties to provide "like-kind exchange" tax treatment in the event the
Company acquires domestic producing oil and gas properties in the first half
of 1999. Effective January 6, 1999, the borrowing base on the Company's
credit facility with a bank group led by NationsBank of Texas, N.A., was
reduced from $380.0 million to $200.0 million, reflecting the sale on that
date of the Company's East Texas natural gas reserves, and also reflecting a
significant decline in current and projected oil prices since the previous
determination. Subsequent discussions with the Company's bank group have led
to an amendment to the credit facility granting the Company relief from the
fixed charge coverage covenant through March 31, 2000. The Company is also
discussing with its banks other possible changes to the agreement, including
the provision of mortgages to secure the facility, more frequent borrowing
base determinations, and the further relaxation of the fixed charge coverage
test and a number of other covenant restrictions. The Company is confident
that the outcome of these discussions will include a borrowing base of $200.0
million for the first half of 1999, and improved certainty of the continued
availability of the full commitment under this agreement.
The Company believes its cash flow from operations and available financing
sources, including cash on hand will be sufficient to meet its obligations as
they become due and to finance its exploration and development programs.
Capital Expenditures
The Company anticipates spending an additional $27.0 million on development
activities during the remainder of 1999, primarily in California and the
Congo.
The Company also has an active and growing exploration program targeting
high-potential reserve opportunities in the Republic of Ghana in West Africa
("Ghana"), Tunisia in West Africa, California and the
14
NUEVO ENERGY COMPANY
--------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
onshore Gulf Coast region. The Company anticipates spending an additional
$12.0 million during 1999 on exploration projects.
Due to lower average realized oil prices in 1998 which continued into the
first quarter of 1999, the Company's capital spending plans for 1999 have
been reduced significantly from levels in previous years. Management
believes that all of these development projects which have been deferred will
ultimately be undertaken once oil prices return to historic norms. The
Company will be reviewing its capital spending plans in the latter half of
1999 if crude oil prices continue in the current upward trend. In addition,
the Company has undertaken a program to reduce operating costs through
forming alliances with pump manufacturers to reduce workover costs offshore
as well as reworking the steam plan. The Company is currently reviewing
other means of reducing costs.
Exploration and Development Activities
During the first three months of 1999, the Company completed seven wells.
Following is a description of significant exploration and development
activity during the first three months of 1999.
Exploration Activity
Domestic - East
Along the Gulf Coast, the Company is drilling below 9,000 feet toward a
proposed total depth of 14,800 feet at the LL&E 12-14 well at Four Isle Dome
as part of the Company's continuing drilling program in this area. Also, the
Company's 3-D work is continuing in the LeLeux area in South Louisiana. The
Company plugged and abandoned the DeBord #1 well in the Fuller Prospect
during the first quarter of 1999.
Domestic - West
In the first quarter of 1999, much progress was made in the Company's
preparations for additional exploratory drilling in California at the Midway
Peak area and on the Belridge Road (Sosa) 3-D project. As for the Cree Fee
1A well, the deeper intervals were tested during the first quarter and there
does not appear to be commercial development opportunities. The best
potential oil zone in the Cree Fee 1A well should begin testing in the middle
of the second quarter. Also in California, the Company is nearing completion
of the 3-D work at Belridge Road. This 12,000 acre area is adjacent to the
Monument Junction area. The initial project, Sosa, which is currently
scheduled to be drilled in September 1999, is analogous to Monument Junction
and will test multiple objectives on an anticline updip to a well drilled in
the 1970's, which previously tested oil.
International
The Company is nearing completion of its interpretations on both blocks in
Ghana (East Cape Three Points and Accra Keta) and has just completed
technical meetings with its partners in East Cape Three Points. The 2.7
million acre Accra Keta block appears to be a good candidate for a 3-D survey
as the Company has identified several prospects, some with multiple
objectives. Mapping of the East Cape Three Points area has been updated.
Seismic programs in these areas could begin late in the second quarter.
Development Activity
Domestic - East
No significant activity during the first quarter of 1999.
15
NUEVO ENERGY COMPANY
--------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS (Continued)
-----------------------------------------------
Domestic - West
In the Bakersfield area, the Company is currently completing the next phase
of an expansion program relating to the Hopkins thermal property. In the
first quarter of 1999, 16 injectors and associated facilities were added to
the Hopkins area to support some of the horizontal wells drilled in 1998. In
addition, the Company anticipates drilling an additional four horizontals in
the Hopkins area at mid-year 1999. The Hopkins thermal area is being
developed using a combination of horizontal and vertical wells also with a
combination of continuous and cyclic steam injection which will further
expand the continuous injection when the 16 new injectors are brought on line
later in 1999. In the Cymric field, the Company completed four horizontal
wells on the Welport lease. These wells are currently waiting to be hooked
up to production. This activity in Cymric will be followed by drilling six
injector wells later in the second quarter to support the horizontals. A ten
well vertical infill drilling program to the Potter sand in the Midway Sunset
field to produce some undrained areas at the Dome and Tumbador leases is
currently underway. These ten wells will be drilled on 3/4 acre spacing. A
significant facility expansion is underway at the Brea Olinda field.
Currently, the Company flares approximately 2 MMCF of natural gas per day.
The Company is in the process of installing a cogen unit, which will utilize
the flared gas and convert it to electricity to supply all of the field
electrical needs as well as sell excess electricity. In addition, the
Company has just started up a propane extraction facility in the Brea Olinda
field. The implementation of the cogen project and the propane extraction
facility should result in significant cost savings for the Brea Olinda
property.
International
During the first quarter of 1999, the Company added two wells at the Congo
property as part of the continued drilling program on that property. Congo
production is currently at a net 4,800 BOPD, compared to a fourth quarter
1998 net rate of 4,000 BOPD and a first quarter 1999 net rate of 4,300 BOPD.
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 prices. Commodity price and
basis swaps are sometimes used to hedge the basis differential between the
derivative financial instrument index price and the commodity 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 March 31, 1999 or December 31, 1998. 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
$0.2 million and $0.1 million in the first quarter of 1999 and 1998,
respectively.
The Company entered into a swap arrangement with a major financial
institution that effectively converts the interest rate on $9.2 million
notional amount of the 9 1/2% Senior Subordinated Notes due 2006 to a
variable LIBOR-based rate through February 25, 2000. Based on LIBOR rates in
effect at March 31, 1999, this
16
NUEVO ENERGY COMPANY
--------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS (Continued)
-----------------------------------------------
amounted to a net reduction in the carrying cost of the 9 1/2% Senior
Subordinated Notes due 2006 from 9.5% to 5.56%, or 394 basis points. In
addition, the swap arrangement also effectively hedges the price at which
these Notes can be repurchased by the Company at 100.51% of their face
amount. Based on the market price of 102.25% for the Notes at March 31, 1999,
an early termination of this arrangement would result in a payment of $0.2
million from the institution to Nuevo.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("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 requires all
derivative instruments to be carried on the balance sheet at fair value and
is effective for the Company beginning January 1, 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.
CONTINGENCIES
The Company has been named as a defendant in the 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, 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 March 1999, the Company discovered that a non-officer employee had
fraudulently authorized and diverted for personal use Company funds totaling
$5.9 million, $4.3 million in 1998 and the remainder in 1999, that were
intended for international exploration. Accordingly, the Company has
reclassified the amounts lost in 1998 and 1999 to other expense. Based on
its review of the facts, management is confident that only one employee was
involved in the matter and that all misappropriated funds have been
identified. The Board has engaged a Certified Fraud Examiner to conduct an
in-depth review of the fraudulent transactions to determine the scope of the
fraud, the possibility of recovery of amounts lost from insurance, from the
terminated employee and/or from third parties, and to make recommendations
regarding what, if any, new internal control procedures should be
implemented.
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 from
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.
17
NUEVO ENERGY COMPANY
--------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS (Continued)
-----------------------------------------------
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 ("OPIC"). The Company is currently
investigating its options for political risk insurance in the Republic of
Ghana in West Africa ("Ghana").
The Company and its partners in the Congo are undergoing a tax examination
related to their ownership interests in the Yombo field offshore Republic of
Congo, for the years 1994 through 1997. The Congolese taxing authorities
have issued a preliminary assessment of approximately $3.6 million in taxes
and penalties for all years, in aggregate for all parties who have ownership
in this field. Nuevo's working interest in this field is 43.75% during the
period under examination. The Company, along with the other partners, is in
discussions with the Congolese taxing authorities refuting this assessment as
without merit to the items being disallowed. Management does not believe
that the outcome of this matter will have a material adverse effect upon the
Company.
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.
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
embedded 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 United States and host governments abroad.
The risks associated with Y2K fall into three general areas: i) financial and
administrative systems, ii) embedded 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;
18
NUEVO ENERGY COMPANY
--------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS (Continued)
-----------------------------------------------
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 ("CEO") of
the Company, and from the CEO through the Chief Financial Officer (for
financial and administrative systems) and the Vice President of Exploitation
(for embedded systems in field process control units). As a 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 and Torch Energy Advisors, Inc. ("Torch") have jointly developed
a plan to address Nuevo's risks associated with Y2K. Torch provides the
financial and administrative systems for Nuevo and operates a substantial
portion of its properties. (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 May 3, 1999, the Company is in
various stages of implementation of the plan, as summarized below:
Financial and Administrative Systems
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.
Risk Identification. Nuevo's most significant financial and administrative
systems exposure is the Y2K status of the accounting and land administration
software package that Torch uses 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.
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 time period during which the quality of management
information comes under question. At this time, management is confident that
any Y2K disruptions associated with its or Torch's financial and
administrative systems will not have a material effect on the Company.
Remediation. Since April 1998, Torch 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, Torch 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 for
financial and administrative systems are borne by Torch under the terms of
Nuevo's outsourcing agreements.
Contingency Planning. Notwithstanding the previously described efforts,
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.
Embedded Systems
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
19
NUEVO ENERGY COMPANY
--------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS (Continued)
-----------------------------------------------
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.
Risk Identification. Nuevo has completed a comprehensive inventory of
embedded computer components within the process control systems of its
operated oil and natural gas fields and processing plants. Nuevo identified
approximately 1,900 embedded components in these computerized systems. Nuevo
researched 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 embedded components so researched have been deemed either
date insensitive or Y2K compliant. The Y2K compliance status is unknown for
approximately 21% of the embedded components identified, and research is
continuing on these components. However, the complexity of embedded systems
is such that a small minority of non-compliant components, even a single non-
compliant component, can corrupt an entire system.
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, to environmental or safety
incidents. Now that the component-level evaluation is substantially complete,
a broader evaluation at the system-level has commenced. Nuevo anticipates
that the system-level evaluation will be completed by the end of the second
quarter of 1999. 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. The target date for
completing risk assessment of all mission critical systems for all properties
the Company currently owns is June 30, 1999, and as of this writing, Nuevo is
on track to complete the risk assessment by the target date. Costs incurred
through December 31, 1998, were not material to Nuevo's results of
operations, and the cost of the assessment is not expected to be material to
Nuevo's future 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.
Remediation. The Company has prioritized the remediation of embedded
components and systems that are either known to be Y2K non-compliant or that
have higher risk of Y2K failures. Nuevo intends to give first priority to the
remediation of any situation with potential impacts to human health and
safety or the environment, and will further prioritize remediation targets by
the anticipated financial impact of any such situations on the Company. Nuevo
intends to test, upgrade and re-test those embedded components and systems in
field process control units deemed to pose the greatest risk. It is
important to note that in some circumstances, the procedures that are used to
test embedded components for Y2K compliance themselves pose a risk of
damaging the component or corrupting the system, thereby accelerating the
consequences of Y2K failures. Accordingly, in some situations, it may be
deemed the most prudent decision not to test certain embedded components and
systems. The amount of capital that Nuevo budgeted for these anticipated
costs to remediate or replace embedded components and systems that pose the
greatest risk of Y2K non-compliance, is approximately $1.6 million and is not
considered to be material to the liquidity or financial condition of the
Company. However, it is expected that some additional risks may be
identified during 1999, so there can be no assurances that actual capital
spending on Y2K remediation will not significantly exceed any amounts
originally budgeted.
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
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
20
NUEVO ENERGY COMPANY
--------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS (Continued)
-----------------------------------------------
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.
Risk Identification. Nuevo's most significant third-party Y2K exposure is to
the refinery customers who purchase its oil production, on the customer side,
and from electricity and other utility companies supplying field operations,
on the supplier side. 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 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.
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.
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, Nuevo
may pursue joint testing during 1999. Joint testing would occur following
upgrades and other remediation to hardware, software and communication links,
as applicable, with the intent of determining that the remediated system
being tested will perform as expected on December 31, 1999.
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.
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 March 31, 1999 and 1998)
The following table sets forth certain operating information of the Company
(inclusive of the effect of crude oil and natural gas price swaps) for the
periods presented:
Three Months
Ended March 31, %
--------------- Increase/
1999 1998 (Decrease)
------ ------ -----------
Production:
Oil and condensate - East (MBBLS)......................... 171 203 (16)%
Oil and condensate - West (MBBLS)......................... 3,814 4,000 (5)%
Oil and condensate - International (MBBLS)................ 389 325 20%
------ ------
Oil and condensate - Total (MBBLS)........................ 4,374 4,528 (3)%
Natural gas - East (MMCF)................................ 979 4,823 (80)%
Natural gas - West (MMCF)................................. 3,113 3,796 (18)%
------ ------
Natural gas - Total (MMCF)................................ 4,092 8,619 (53)%
Natural gas liquids - East (MBBLS)....................... 13 16 (19)%
Natural gas liquids - West (MBBLS)........................ 30 29 3%
------ ------
Natural gas liquids - Total (MBBLS)....................... 43 45 (4)%
Equivalent barrels of production - East (MBOE)............ 347 1,023 (66)%
Equivalent barrels of production - West (MBOE)............ 4,363 4,662 (6)%
Equivalent barrels of production - International (MBOE)... 389 325 20%
------ ------
Equivalent barrels of production - Total (MBOE)........... 5,099 6,010 (15)%
Average Sales Price:
Oil and condensate - East................................. $11.45 $14.43 (21)%
Oil and condensate - West................................. $ 7.68 $ 9.73 (21)%
Oil and condensate - International........................ $ 9.46 $10.88 (13)%
Oil and condensate - Total................................ $ 7.99 $10.02 (20)%
Natural gas - East........................................ $ 1.62 $ 1.84 (12)%
Natural gas - West........................................ $ 1.90 $ 2.14 (11)%
Natural gas - Total....................................... $ 1.83 $ 1.99 (8)%
Lease Operating Expense:
Average unit production cost/(1)/ per BOE - East.......... $ 1.95 $ 2.97 (34)%
Average unit production cost/(1)/ per BOE - West.......... $ 5.71 $ 5.81 (2)%
Average unit production cost/(1)/ per BOE - International. $ 7.64 $ 8.90 (14)%
Average unit production cost/(1)/ per BOE - Total......... $ 5.60 $ 5.50 2%
Depletion, Depreciation and Amortization:
Average depletion per BOE - East.......................... $ 4.52 $ 3.33 36%
Average depletion per BOE - West.......................... $ 4.49 $ 4.23 6%
Average depletion per BOE - International................. $ 4.62 $ 3.40 36%
Average depletion per BOE - Total......................... $ 4.50 $ 4.03 12%
Average DD&A per BOE - Total.............................. $ 4.57 $ 4.12 11%
/(1)/ Costs incurred to operate and maintain wells and related equipment and
facilities, including ad valorem and severance taxes.
22
NUEVO ENERGY COMPANY
--------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS (Continued)
-----------------------------------------------
Revenues
Oil and Gas Revenues:
Oil and gas revenues for the three months ended March 31, 1999 were $42.9
million, or 32% lower than oil and gas revenues of $63.1 million for the same
period in 1998. This decrease is primarily due to lower realized oil prices in
the first quarter of 1999 as well as reduced gas volumes as a result of the sale
of the East Texas natural gas properties on January 6, 1999.
East: Oil and gas revenues in the Eastern division for the three months ended
March 31, 1999 were $3.6 million, or 70% lower than oil and gas revenues of
$12.1 million for the same period in 1998. The decrease results primarily from
lower natural gas production due to the sale of the East Texas natural gas
properties as well as lower realized natural gas prices.
West: Oil and gas revenues for the three months ended March 31, 1999 were $35.6
million, or 25% lower than oil and gas revenues of $47.5 million for the same
period in 1998. This decrease is primarily due to a 21% lower realized oil
price in the first quarter of 1999.
International: Oil revenues for the three months ended March 31, 1999 were $3.7
million as compared to $3.5 million for the same period in 1998. The 6%
increase results from a 20% increase in oil production offset by a 13% decrease
in oil price realizations to $9.46 per barrel.
Gain on Sale:
Gain on sale for the three months ended March 31, 1999 was $81.7 million. Such
gain was recognized in connection with the sale of the Company's East Texas
natural gas properties for proceeds of $192.6 million. Gain on sale for the
three months ended March 31, 1998 was $1.7 million, which relates to the sale of
the Company's interest the Coke field in Chapel Hill, Texas.
Interest and Other Income:
Interest and other income for the three months ended March 31, 1999 includes
$1.3 million associated with interest earned on the $100.0 million in proceeds
from the sale of the East Texas natural gas properties funded into an escrow
account to provide "like-kind exchange" tax treatment in the event the Company
acquires domestic producing oil and gas properties in the first half of 1999.
Expenses
Lease Operating Expenses:
Lease operating expenses for the three months ended March 31, 1999 totaled $28.5
million, or 14% lower than $33.0 million for the three months ended March 31,
1998. Lease operating expenses per barrel of oil equivalent were $5.60 in the
first quarter of 1999, compared to $5.50 in the same period in 1998.
East: Lease operating expenses for the three months ended March 31, 1999
totaled $.7 million, or 77% lower than $3.0 million for the three months ended
March 31, 1998. The decrease is primarily attributable to the sale of the East
Texas natural gas properties in January of 1999. Lease operating expenses per
barrel of oil equivalent were $1.95 in the first quarter of 1999, compared to
$2.97 in the same period in 1998.
West: Lease operating expenses for the three months ended March 31, 1999
totaled $24.8 million, or 8% lower than $27.1 million for the three months ended
March 31, 1998. Lease operating expenses per barrel of oil equivalent were
$5.71 in the first quarter of 1999, compared to $5.81 in the same period in 1998
which is attributable to lower costs and offset by a 6% reduction in production
year over year. In 1999, the average cost for gas used to generate steam
23
NUEVO ENERGY COMPANY
--------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS (Continued)
-----------------------------------------------
in the production of crude oil decreased from $2.18 per MCF in the first quarter
of 1998 to $1.82 per MCF in the first quarter of 1999. In addition, some low
volume wells were shut-in during the first quarter of 1999. The Company chose to
shut-in low volume producers that would not harm the respective reservoirs or
their long-term potential due to lower realized oil prices. The steam cycle was
lengthened on some wells during the first quarter of 1999, which decreased fuel
volumes during the quarter. Offshore, the Company experienced very good run
rates with its electric submergible pumps and hence experienced lower workovers
compared to the first quarter of 1998. In the first quarter of 1998, poor
weather conditions in California caused landslides and power outages, which
resulted in $2.3 million of incremental, unusual costs. The Company also
benefited from reduced service costs in the first quarter of 1999 such as
chemicals and reduced boat transportation costs for the offshore properties.
Reduced workover costs onshore also contributed to the lower lease operating
expenses year over year.
International: Lease operating expenses for the three months ended March 31,
1999 totaled $3.0 million, or 3% higher than $2.9 million for the three months
ended March 31, 1998. Lease operating expenses per barrel of oil equivalent
were $7.64 in the first quarter of 1999, compared to $8.90 in the same period in
1998.
Gas Plant Operating Expenses:
Gas plant operating expenses were $1.4 million for the three months ended March
31, 1999 as compared to $.7 million for the three months ended March 31, 1998.
The 100% increase in gas plant expenses in 1999 compared to 1998 is due to
increased ad valorem taxes.
Exploration Costs
Exploration costs, including geological and geophysical ("G&G") costs, dry hole
costs, delay rentals and expensed project costs, were $2.1 million and $1.4
million for the three months ended March 31, 1999 and 1998, respectively. For
the three months ended March 31, 1999, exploration costs are comprised of $0.8
million in dry hole costs, $0.8 million in G&G, $0.2 million in delay rentals
and $0.3 million in expensed project costs. The entire amount of $1.4 million
in exploration costs in the first quarter of 1998 relates to G&G in Ghana.
East: During the first quarter of 1999, the Company decided to plug and abandon
the DeBord #1 well in the Fuller prospect area. The dry hole costs associated
with this well were $0.6 million. The first quarter of 1999 also includes $0.1
million of G&G costs associated with the LeLeux prospect in South Louisiana.
There were no dry hole expenses in the first quarter of 1998.
West: There were no exploration costs in the first quarter of 1999 or 1998 in
the Western region.
International: During the first quarter of 1999, $0.6 million in G&G costs were
expensed associated with the Accra Keta and the East Cape Three Points prospects
in Ghana. The entire amount of $1.4 million in exploration costs in the first
quarter of 1998 relates to G&G in Ghana.
Depreciation, Depletion and Amortization:
Depreciation, depletion and amortization of $23.3 million for the three months
ended March 31, 1999 reflects a 6% decrease from $24.8 million in the same
period in 1998, due primarily to decreased production volumes offset by a higher
depletion rate per barrel of oil equivalent on the Company's oil and gas
properties. The weighted average depletion rate per barrel of oil equivalent in
the first quarter of 1999 was $4.50 versus $4.03 in the first quarter of 1998.
Several factors contributed to the change in the average depletion rate per
barrel of oil equivalent. First, the property mix changed as the lower cost
East Texas natural gas properties were sold in January. Second, the Company's
year end reserves decreased by approximately 12% from the previous year
primarily as a result of lower crude oil prices utilized in computing proved
reserves at year end 1998. Finally, the impairment of $68.9 million recognized
in the fourth quarter of 1998 reduced the capitalized costs to be depleted and
partially offset the increase in the depletion rate per barrel of oil
equivalent.
24
NUEVO ENERGY COMPANY
--------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS (Continued)
-----------------------------------------------
East: Depreciation, depletion and amortization of $1.6 million for the three
months ended March 31, 1999 reflects a 53% decrease from $3.4 million in the
same period in 1998, due primarily to decreased production volumes as a result
of the sale of the East Texas natural gas properties in January 1999.
West: Depreciation, depletion and amortization of $19.6 million for the three
months ended March 31, 1999 reflects a 1% decrease from $19.7 million in the
same period in 1998, due primarily to an increased average depletion rate per
barrel of oil equivalent offset by decreased production volumes.
International: Depreciation, depletion and amortization of $1.8 million for the
three months ended March 31, 1999 reflects a 64% increase from $1.1 million in
the same period in 1998, due primarily to an increased average depletion rate
per barrel of oil equivalent as well as increased production volumes.
General and Administrative Expenses:
General and administrative expenses, together with outsourcing fees, totaled
$7.0 million and $8.4 million in the three months ended March 31, 1999 and 1998,
respectively. The 17% decrease is due primarily to a reduction in outsourcing
fees.
Interest Expense:
Interest expense of $8.0 million incurred in the three months ended March 31,
1999 reflects an increase of 18% as compared to interest expense of $6.8 million
in the three months ended March 31, 1998. The increase is attributable to two
factors. First, the Company issued $100.0 million 8 7/8% Senior Subordinated
Notes due 2008 in June of 1998. Second, $100.0 million of the proceeds
associated with the sale of the East Texas natural gas properties was funded
into an escrow account to provide "like-kind exchange" tax treatment in the
event the Company acquires domestic producing oil and gas properties in the
first half of 1999. In the event that the Company does not acquire a domestic
producing oil and gas property under the "like-kind exchange" provisions, the
$100.0 million in escrow will be utilized to reduce the outstandings under the
Company's credit facility.
Other Expense:
In March 1999, the Company discovered that a non-officer employee had
fraudulently authorized and diverted for personal use Company funds totaling
$5.9 million, $4.3 million in 1998 and the remainder in the first quarter of
1999, that were intended for international exploration. Accordingly, the
Company has reclassified the amounts lost in 1998 and 1999 from exploration
costs to other expense. Based on its review of the facts, management is
confident that only one employee was involved in the matter and that all
misappropriated funds have been identified. The Board has engaged a Certified
Fraud Examiner to conduct an in-depth review of the fraudulent transactions to
determine the scope of the fraud, the possibility of recovery of amounts lost
from insurance, from the terminated employee and/or from third parties, and to
make recommendations regarding what, if any, new internal control procedures
should be implemented.
Net (Loss) Income
Net income of $31.3 million, $1.58 per common share - basic and diluted, was
generated for the three months ended March 31, 1999, as compared to a net loss
of $6.6 million, ($0.33) per common share - basic and diluted, in the same
period in 1998.
25
NUEVO ENERGY COMPANY
--------------------
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------- ----------------------------------------------------------
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk, including adverse changes in commodity
prices and interest rates.
Commodity Price Risk - The Company produces and sells crude oil, natural gas and
natural gas liquids. As a result, the Company's operating results can be
significantly affected by fluctuations in commodity prices caused by changing
market forces. The Company periodically seeks to reduce its exposure to price
volatility by hedging its production through swaps, options and other commodity
derivative instruments. The Company uses hedge accounting for these
instruments, and settlements of gains or losses on these contracts are reported
as a component of oil and gas revenues and operating cash flows in the period
realized. These agreements expose the Company to counterparty credit risk to
the extent that the counterparty is unable to meet its settlement commitments to
the Company. At March 31, 1999, the fair value of derivative instruments
outstanding was a loss of $6.7 million. A 10% increase in the underlying
commodity price would increase this loss by $10.9 million.
Interest Rate Risk - The Company may enter into financial instruments such as
interest rate swaps to manage the impact of changes in interest rates. For
1999, the Company has entered into a swap agreement which hedges the price at
which the Company may repurchase a portion of its fixed rate debt and
effectively converts such debt to a floating rate exposure for a period of one
year. This agreement is not held for trading purposes. As the swap provider is
a major financial institution, the Company does not anticipate non-performance
by the provider. Termination of this swap would not be material.
The Company's exposure to changes in interest rates primarily results from its
short-term and long-term debt with both fixed and floating interest rates. The
following table presents principal amounts (stated in thousands) and the related
average interest rates by year of maturity for the Company's debt obligations at
March 31, 1999:
Fair
Value
1999 2000 2001 2002 2003 Thereafter Total Liability
---- ---- ---- ---- ---- ---------- ----- ---------
Long-term debt, including
current maturities:
Variable rate $2,977 -- -- -- $105,500 -- $108,477 $108,477
Average interest rate 5.7% -- -- -- 6.2% -- 6.2%
Fixed rate -- -- -- -- -- $260,000 $260,000 $263,280
Average interest rate -- -- -- -- -- 9.3% 9.3%
26
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
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
Exhibit 27 - Financial Data Schedule
b. Reports on Form 8-K.
None.
27
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: May 17, 1999 By: /s/ Douglas L. Foshee
------------ -----------------------
Douglas L. Foshee
President and Chief Executive
Officer
Date: May 17, 1999 By: /s/ Robert M. King
------------ -----------------------
Robert M. King
Senior Vice President and
Chief Financial Officer
28