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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
[x] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
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 NO. 0-21411
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COSTILLA ENERGY, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 75-2658940
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
400 WEST ILLINOIS, SUITE 1000
MIDLAND, TEXAS 79701
(Address of principal executive offices) (Zip code)
(915) 683-3092
(Registrant's telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last
report)
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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
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NUMBER OF SHARES OF COMMON STOCK OUTSTANDING
AS OF NOVEMBER 12, 1998 . . . . .. . . . . . . . . . . . . . . . . . 9,610,615
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COSTILLA ENERGY, INC.
FORM 10-Q
TABLE OF CONTENTS
Page
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
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Consolidated Balance Sheets as of September 30, 1998 (unaudited) and
December 31, 1997 . . . . . . . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Operations for the three and nine months
ended September 30, 1998 and 1997 (unaudited) . . . . . . . . . . . 4
Consolidated Statements of Cash Flows for the three and nine months
ended September 30, 1998 and 1997 (unaudited) . . . . . . . . . . . 5
Notes to Consolidated Financial Statements (unaudited) . . . . . . . . 6
Item 2. Management's Discussion and Analysis of Financial
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Condition and Results of Operations . . . . . . . . . . . . . . . . 10
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . 19
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Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COSTILLA ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
ASSETS (UNAUDITED)
CURRENT ASSETS:
Cash and cash equivalents $ 6,361 $ 3,615
Accounts receivable:
Trade, net 4,229 5,241
Oil and gas sales 7,295 9,312
Prepaid and other current assets 1,111 912
--------- ---------
Total current assets 18,996 19,080
--------- ---------
PROPERTY, PLANT AND EQUIPMENT, AT COST:
Oil and gas properties, using the successful efforts
method of accounting:
Proved properties 277,108 199,355
Unproved properties 46,762 35,971
Accumulated depletion, depreciation and amortization (91,961) (71,152)
--------- ---------
231,909 164,174
Other property and equipment, net 3,506 3,766
--------- ---------
Total property, plant and equipment 235,415 167,940
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OTHER ASSETS:
Deferred charges 6,658 4,212
Other 2,162 2,856
--------- ---------
Total other assets 8,820 7,068
--------- ---------
$ 263,231 $ 194,088
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt $ 98 $ 98
Trade accounts payable 22,433 22,490
Undistributed revenue 3,545 4,566
Other current liabilities 10,381 3,437
--------- ---------
Total current liabilities 36,457 30,591
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LONG-TERM DEBT, LESS CURRENT MATURITIES 207,362 163,087
--------- ---------
OTHER NONCURRENT LIABILITIES -- --
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STOCKHOLDERS' EQUITY :
Preferred stock, $.10 par value (3,000,000 shares authorized; 50,000
shares outstanding at September 30, 1998 and
no shares outstanding at December 31, 1997) 5 --
Common stock, $.10 par value (20,000,000 shares authorized;
9,665,115 shares outstanding at September 30, 1998 and
10,150,500 shares outstanding at December 31, 1997) 967 1,015
Additional paid-in capital 80,016 37,425
Retained deficit (61,576) (38,030)
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Total stockholders' equity 19,412 410
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COMMITMENTS AND CONTINGENCIES -- --
--------- ---------
$ 263,231 $ 194,088
========= =========
See accompanying notes to consolidated financial statements.
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COSTILLA ENERGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1998 1997 1998 1997
-------- -------- -------- --------
REVENUES:
Oil and gas sales $ 16,809 $ 19,339 $ 48,824 $ 54,231
Interest and other 150 (38) 510 882
Gain on sale of assets -- -- 337 --
-------- -------- -------- --------
16,959 19,301 49,671 55,113
-------- -------- -------- --------
EXPENSES:
Oil and gas production 6,982 6,875 21,208 21,038
General and administrative 2,786 2,172 7,857 5,543
Exploration and abandonments 2,108 634 7,336 3,748
Depreciation, depletion and amortization 7,533 6,038 21,896 15,758
Interest 4,789 3,340 14,622 8,856
-------- -------- -------- --------
24,198 19,059 72,919 54,943
-------- -------- -------- --------
Income (loss) before federal income taxes
and extraordinary item (7,239) 242 (23,248) 170
PROVISION FOR FEDERAL INCOME TAXES
Current -- -- -- 62
Deferred -- 90 -- 90
-------- -------- -------- --------
Income (loss) before extraordinary item (7,239) 152 (23,248) 18
Extraordinary loss resulting from early
extinguishment of debt -- (219) (299) (219)
-------- -------- -------- --------
NET LOSS $ (7,239) $ (67) $(23,547) $ (201)
======== ======== ======== ========
CUMULATIVE PREFERRED STOCK DIVIDEND $ 1,000 $ -- $ 1,307 $ --
======== ======== ======== ========
LOSS BEFORE EXTRAORDINARY ITEM
APPLICABLE TO COMMON EQUITY $ (8,239) $ 152 $(24,555) $ 18
======== ======== ======== ========
NET LOSS APPLICABLE TO COMMON EQUITY $ (8,239) $ (67) $(24,854) $ (201)
======== ======== ======== ========
LOSS PER SHARE:
Loss before extraordinary item $ (0.83) $ 0.01 $ (2.46) $ 0.00
Extraordinary loss resulting from early
extinguishment of debt -- (0.02) (0.03) (0.02)
-------- -------- -------- --------
NET LOSS $ (0.83) $ (0.01) $ (2.49) $ (0.02)
======== ======== ======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING 9,870 10,340 9,974 10,425
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
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COSTILLA ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
NET LOSS $ (7,239) $ (67) $ (23,547) $ (201)
ADJUSTMENTS TO RECONCILE NET LOSS TO NET
CASH PROVIDED BY OPERATING ACTIVITIES:
Depreciation, depletion and amortization 7,533 6,038 21,896 15,758
Exploration and abandonments 61 78 323 136
Amortization of deferred charges 156 604 637 1,214
Deferred income tax expense -- (39) -- (39)
Allowance for doubtful accounts -- -- -- 208
Gain (loss) on sale of oil and gas properties -- -- (337) 30
Extraordinary loss resulting from early extinguishment of debt -- 348 299 348
Gain (loss) on investment transactions (1) 447 (5) (534)
--------- --------- --------- ---------
510 7,409 (734) 16,920
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable (489) (3,181) 3,028 (1,317)
Decrease (increase) in other assets 359 (3,240) 518 (3,669)
Increase (decrease) in accounts payable 6,367 5,707 (1,286) 9,142
Increase (decrease) in other liabilities 4,701 2,555 6,945 2,747
--------- --------- --------- ---------
Net cash provided by (used in) operating activities 11,448 9,250 8,471 23,823
--------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to oil and gas properties (43,342) (61,854) (91,816) (97,732)
Proceeds from sale of oil and gas properties -- 2,460 3,158 5,169
Additions to other property and equipment (202) (378) (698) (1,663)
--------- --------- --------- ---------
Net cash used in investing activities (43,544) (59,772) (89,356) (94,226)
--------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under long-term debt 25,000 72,704 136,000 87,304
Payments of long-term debt (21) (19,923) (91,562) (19,960)
Proceeds from issuance of preferred stock, net (30) -- 47,927 --
Proceeds from issuance of common stock, net -- -- -- 14
Purchase of common stock (3,539) (1,203) (5,379) (2,451)
Deferred loan and financing costs (42) (481) (3,355) (542)
--------- --------- --------- ---------
Net cash provided by (used in) financing activities 21,368 51,097 83,631 64,365
--------- --------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (10,728) 575 2,746 (6,038)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 17,089 6,005 3,615 12,618
--------- --------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 6,361 $ 6,580 $ 6,361 $ 6,580
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
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COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The interim financial information as of September 30, 1998, and for
the nine months ended September 30, 1998 and 1997, is unaudited. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted in this Form 10-Q pursuant to the rules and regulations of
the Securities and Exchange Commission. However, in the opinion of management,
these interim financial statements include all the necessary adjustments to
fairly present the results of the interim periods and all such adjustments are
of a normal recurring nature. The interim consolidated financial statements
should be read in conjunction with the audited financial statements for the
year ended December 31, 1997.
Costilla Energy, Inc. ("Costilla" or the "Company") was incorporated in
Delaware in June 1996 to consolidate and continue the activities previously
conducted by Costilla Energy, L.L.C., a Texas limited liability company (the
"LLC"), and its wholly owned subsidiaries, to acquire the assets of CSL
Management Corporation (which owned certain office equipment used by the
Company), and to acquire the stock of Valley Gathering Company. Costilla was
formed for the purpose of conducting a $60 million initial public offering of
common stock and a $100 million senior notes offering (the "Offerings"), which
Offerings were completed in early October 1996.
The Company is an oil and gas exploration and production concern with
properties located principally in the Gulf Coast region, the Rocky Mountain
region and the Permian Basin area of Texas and New Mexico.
2. DERIVATIVE FINANCIAL INSTRUMENTS
The Company utilizes derivative financial instruments to manage
well-defined commodity price and interest rate risks. The Company is exposed to
credit losses in the event of nonperformance by the counterparties to its
commodity hedges and its interest rate swap agreements. The Company only deals
with reputable financial institutions as counterparties and anticipates that
such counterparties will be able to fully satisfy their obligations under the
contracts. The Company does not obtain collateral or other security to support
financial instruments subject to credit risk but monitors the credit standing of
the counterparties.
Commodity Hedges. The Company utilizes put option contracts, costless
collars and fixed price swap contracts ("swaps") to hedge the effect of price
changes on a portion of its future oil and gas production. Premiums paid and
amounts receivable under the put option contracts are amortized and accrued to
oil and gas sales, respectively. If market prices of oil and gas exceed the
strike price of put options, the options will expire unexercised, therefore,
reducing the effective price received for oil and gas sales by the cost of the
related option. Conversely, if market prices of oil and gas decline below the
strike price of put options, the options will be exercised, therefore,
increasing the effective price received for oil and gas sales by the proceeds
received from the related option.
A costless collar establishes both a floor price and a ceiling for the
commodity through the simultaneous purchase of a put option contract and the
sale of a call option contract. Since the value of the put option and the call
option offset at the time of their purchase, the collar is costless, therefore
there are no premiums to amortize. If market prices of oil and gas decline
below the strike price of put options, the options will be exercised,
therefore, increasing the effective price received for oil and gas sales by the
proceeds received from the related option. Conversely, if market prices of oil
and gas exceed the strike price of call options, the Company is obligated to
pay
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the counterparty the difference between the market price and the strike price
for the contract volumes, therefore, reducing the effective price received for
oil and gas sales by the amount paid to the counterparty.
Swaps establish a fixed price for the commodity. No premiums are paid
for these swaps and therefore there are no premiums to amortize. If market
prices of oil and gas decline below the swap price, the counterparty pays the
Company the difference between the swap price and the market price for the
contract volumes, therefore, increasing the effective price received for oil
and gas sales by the proceeds received under the swaps. Conversely, if market
prices of oil and gas exceed the swap price, the Company is obligated to pay
the counterparty an amount equal to the difference between the market price and
the swap price for the contract volumes, therefore, reducing the effective
price received for oil and gas sales by the amount paid to the counterparty.
The Company had established a costless collar for oil by purchasing
put options in August 1997 on 6,500 Bbls of oil per day which established a
floor price of $18.50 per Bbl and selling call options on 6,500 Bbls of oil per
day at $22.55 per Bbl. These oil option contracts expired August 31, 1998. In
August 1998, the Company entered into swaps for the remainder of 1998 and for
the calendar year 1999 covering 5,000 Bbls of oil per day. The swaps provide
for a price of $16.25 per Bbl from September 1, 1998 through December 31, 1998
and $16.40 per Bbl from January 1, 1999 through December 31, 1999. The
referenced prices are based upon the price at which WTI trades on the NYMEX.
These contracts do not apply and do not provide a hedge for each trading day
during the periods covered on which the NYMEX price for WTI closes at less than
$13.25 per Bbl for the contract period during 1998 and $13.50 per Bbl during
1999.
The Company has established a costless collar for gas by purchasing
put options on 40,000 Mmbtu of gas per day which establish a floor price of
$2.40 per Mmbtu and selling call options on 40,000 Mmbtu of gas per day at
$2.55 per Mmbtu. These gas option contracts continue through October 1998.
The referenced gas prices are based upon the index price for Houston Ship
Channel gas sales. As of September 30, 1998 the Company had sold a put option
on 40,000 Mmbtu of gas per day at $2.00 per Mmbtu based upon the index price
for Houston Ship Channel gas sales during the months of September and October
1998.
Interest Rate Swap Agreements. The Company had an interest rate swap
agreement in place as of September 30, 1998 with a notional amount of $24
million, a fixed rate of 7.5% and which will expire in January, 1999. As a
result of the Company's borrowings against its line of credit, which bears
interest on a floating rate basis, the interest rate swap agreement again
qualifies as a hedge during the third quarter of 1998.
3. LONG TERM DEBT
In August 1997, the Company entered into a credit agreement (the
"Revolving Credit Facility") with Bankers Trust Company, as agent, to refinance
its existing bank indebtedness and to finance a portion of the Ballard
Acquisition purchase price. The Revolving Credit Facility provides for a
maximum availability of $75.0 million, $25.5 million of which was borrowed at
September 30, 1998 against an available borrowing base of $40.0 million at such
date. Borrowings under the Revolving Credit Facility bear interest, at the
Company's option, at a floating rate which is at or above the Lender's prime
rate or above the applicable Eurodollar rate, depending on the percentage of
committed funds which have been borrowed. Interest is payable quarterly as to
base rate loans, and at the end of the applicable interest period as to
Eurodollar loans. The borrowing base of the Revolving Credit Facility is
automatically reduced by 5% each quarter beginning in August 1999, and payments
of principal are required in each quarter in which the outstanding principal
balance is greater than the reduced borrowing base. The remaining balance is
payable on August 28, 2002, the maturity date of the Revolving Credit Facility.
Under the Revolving Credit Facility, the Company is obligated to pay certain
fees to the lender, including a commitment fee based on the unused portion of
the commitment. The Revolving Credit Facility contains customary restrictive
covenants (including restrictions on the payment of dividends and the
incurrence of additional indebtedness) and requires the Company to maintain (i)
a current ratio of not less than 1.0 to 1.0, including amounts available under
the Revolving Credit Facility and excluding current maturities under the
Revolving Credit Facility and the Acquisition Credit Facility, (ii) a ratio of
EBITDA to interest expense, for the last twelve months as of the end of each
quarter, of not less than 1.75 to 1 through December 31, 1998, 2.3 to 1 through
December 31, 1999 and 2.5 to 1 thereafter and (iii) a minimum tangible net
worth. At September 30, 1998, the Company was not in compliance with the
financial ratios. The Company sought and obtained a waiver from the Lenders
under the Revolving Credit Facility permitting the Company's non-compliance at
September 30, 1998. The Company believes that it is probable that the
acquisition described in Note 5 will be consummated and, in that case, the
Company will enter into a new credit facility. The Company anticipates that it
will be in compliance with all covenants required by the new credit facility.
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However, if the Acquisition is not consummated, the Company does not
anticipate that it will be in compliance with any of the financial ratios
currently required by the Revolving Credit Facility at December 31, 1998.
There is no assurance that the Lenders under the Revolving Credit Facility
would grant further waivers of the Company's non-compliance and, as a result,
the Lenders would have the ability to accelerate the maturity of all amounts
due under the Revolving Credit Facility. Borrowings under the Revolving Credit
Facility are secured by substantially all of the assets of the Company.
Contemporaneous with entering into the Revolving Credit Facility, the
Company also entered into a second credit agreement (the "Acquisition Credit
Facility") to provide the remaining financing for the Ballard Acquisition. The
Acquisition Credit Facility was a term loan in the amount of $30.0 million
which was repaid in full in connection with the sale of the 1998 Notes.
In October 1996, the Company issued $100 million aggregate principal
amount of 10.25% Senior Notes due October 1, 2006 (the "Notes"). The Notes
were sold at par and interest is payable April 1 and October 1, commencing
April 1, 1997. The Notes may not be redeemed prior to October 1, 2001, and
thereafter at a premium reducing to par, plus interest, by maturity. There is
no mandatory redemption of the Notes required prior to maturity. The Notes are
general unsecured senior obligations of the Company and rank equally in right
of payment with all other senior indebtedness of the Company and senior in
right of payment of all existing future subordinated indebtedness of the
Company. The Notes are subject to an Indenture between the Company and a
trustee. The Indenture restricts, among other things, the Company's ability to
incur additional indebtedness, pay dividends or make certain other restricted
payments, incur liens, engage in any sale and leaseback transaction, sell stock
of subsidiaries, apply net proceeds from certain assets sales, merge or
consolidate with any other person, sell, assign, transfer, lease, convey or
otherwise dispose of substantially all of the assets of the company, or enter
into certain transactions with affiliates. Net proceeds from the sale of the
Notes of approximately $96.1 million were used to repay existing indebtedness.
In January 1998, the Company issued an additional $80 million
aggregate principal amount of 10.25% Senior Notes due October 1, 2006 (the "
1998 Notes"). The notes were sold at a premium (102.5%) and interest is
payable April 1 and October 1, commencing April 1, 1998. The 1998 Notes may
not be redeemed prior to October 1, 2001, and thereafter at a premium reducing
to par, plus interest, by maturity. The 1998 Notes are subject to the same
terms and conditions as the Notes. Net proceeds from the sale of the 1998
Notes of approximately $78.8 million were used to repay the Acquisition Credit
Facility in full, all but $500,000 of the Revolving Credit Facility and the
remainder was used for general corporate working capital needs.
4. CONVERTIBLE PREFERRED STOCK
On June 3, 1998 the Company closed a private placement of 50,000
shares of its 7% (8% Paid in Kind) Series A Cumulative Convertible Preferred
Stock (the "Preferred Stock") to Enron Capital & Trade Resources Corp. and
Joint Energy Development Investments II Limited Partnership for a purchase
price of $50.0 million (the "Convertible Preferred Stock Offering"). Dividends
accrue and are payable quarterly, commencing September 15, 1998, in cash, or in
certain instances in shares of the Company's Common Stock. The dividend rate
is 7% for dividends paid in cash and 8% for dividends paid in shares of Common
Stock. The holders of the Preferred Stock may, at any time, convert shares of
Preferred Stock into shares of the Company's Common Stock at a conversion price
of $12.39 which, subject to certain adjustments, would result in the issuance
of 4,035,513 shares of Common Stock upon conversion of the Preferred Stock.
The Registrant may, at its option, redeem the shares of Preferred Stock after
June 15, 2001, subject to certain limitations, for a premium reducing to par on
June 15, 2004 and thereafter. Net proceeds from the Convertible Preferred
Stock Offering were $48.0 million, of which $29.0 million was used to repay all
but $0.5 million of the Revolving Credit Facility and the remainder was used
for general corporate purposes.
5. PENDING ACQUISITION
On September 4, 1998 the Company entered into a purchase and sale
agreement with Pioneer Natural Resources U.S.A., Inc. ("Pioneer") for the
purchase of certain oil and gas assets of Pioneer for $410.0 million,
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subject to certain adjustments. The assets to be purchased include producing
oil and gas properties, undeveloped mineral acres, undeveloped leasehold acres,
a license to use certain seismic data and gas plants, pipelines and processing
facilities. The Company paid a $25.0 million performance deposit to Pioneer
which may be subject to forfeiture if the Acquisition is not consummated, due
to a breach by the Company, and the Company may be liable for an additional $16
million in liquidated damages. The Company intends to fund the purchase price,
which is estimated to be approximately $390.0 million after adjustments,
through the sale of common stock, convertible preferred stock and borrowings
under a new bank credit facility. The acquisition is scheduled to close on
December 15, 1998.
6. REPORTING COMPREHENSIVE INCOME
In June 1997, the FASB issued Statement of Accounting Standards No.
130 "Reporting Comprehensive Income" ("FAS 130") which establishes standards
for reporting and display of comprehensive income and its components in a full
set of general-purpose financial statements. Specifically, FAS 130 requires
that an enterprise (i) classify items of other comprehensive income by their
nature in a financial statement and (ii) display the accumulated balance of
other comprehensive income separately from retained earnings and additional
paid-in capital in the equity section of a statement of financial position.
This statement is effective for fiscal years beginning after December 15, 1997.
The Company has adopted the provisions of FAS 130 in its consolidated financial
statements for periods ending after December 31, 1997. The Company had no
financial instruments giving rise to comprehensive income during the three and
nine month periods ended September 30, 1998.
Comprehensive income consists of the change in equity of a business
enterprise during a period from transactions and other events and circumstances
from nonowner sources. Specifically, this includes net income and other
comprehensive income, which is made up of certain changes in assets and
liabilities that are not reported in a statement of operations but are included
in the balances within a separate component of equity in a statement of
financial position. Such changes include, but are not limited to, unrealized
gains for marketable securities and future contracts, foreign currency
translation adjustments and minimum pension liability adjustments.
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COSTILLA ENERGY, INC.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Form 10-Q constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995 (the "Reform Act"). Such forward-looking statements involve known and
unknown risks, uncertainties, and other factors which may cause the actual
results, performance, or achievements of Costilla to be materially different
from any future results, performance, or achievements expressed or implied by
such forward- looking statements. Such factors include, among others, the
following: the volatility of oil and gas prices, the Company's drilling
results and ability to replace oil and gas reserves, the availability of
capital resources, the reliance upon estimates of proved reserves, operating
hazards and uninsured risks, competition, government regulation, and the
ability of the Company to implement its business strategy, and other factors
referenced in the Company's public filings with the Securities and Exchange
Commission.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
Costilla is an independent energy company engaged in the exploration,
acquisition and development of oil and gas properties. From January 1, 1993 to
September 30, 1998, the Company closed nine acquisitions for an aggregate
purchase price of approximately $149.0 million. Two of those transactions
involved acquisitions from Pioneer's predecessor in 1995 and 1996 for a total
purchase price of approximately $85.0 million.
The Company's strategy is to utilize its technical staff and
technological advances to increase its oil and gas reserves, production and
cash flow from operations through an active exploration program and the
acquisition and development of proved reserves. In addition, Costilla
continues to evaluate the acquisition of undeveloped acreage for its
exploration efforts. Costilla has in-house exploration expertise using 3-D
seismic technology to identify new drilling opportunities as well as for the
development of acquired properties.
The Company has grown primarily through acquisitions which impacted
its reported financial results in a number of ways. Properties sold by others
frequently have not received focused attention prior to sale. After
acquisition, certain of these properties are in need of maintenance, workovers,
recompletions and other remedial activity not constituting capital
expenditures, which substantially increase lease operating expenses. The
increased production and revenue resulting from these expenditures is
predominately realized in periods subsequent to the period of expense.
The following table sets forth certain operating data of Costilla for
the periods presented:
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Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
OIL AND GAS PRODUCTION:
Oil (Mbbls) 461 565 1,510 1,601
Gas (Mmcf) 4,814 4,824 12,376 11,545
MMCFE (1) 7,580 8,214 21,436 21,151
AVERAGE SALES PRICES (2):
Oil (per Bbbl) $ 14.96 $ 16.91 $ 15.26 $ 18.08
Gas (per Mcf) 2.06 2.03 2.08 2.19
COSTS PER MCFE (1):
Production cost $ 0.92 $ 0.84 $ 0.99 $ 0.99
Depreciation, depletion and amortization 0.99 0.74 1.02 0.75
General and administrative expenses 0.37 0.26 0.37 0.26
- ----------
(1) MCFE represents equivalent Mcf of gas. In reference to oil, natural gas
equivalents are determined using the ratio of one barrel of crude oil,
condensate or natural gas liquids to six Mcf of natural gas. MMCFE
represents one thousand Mcf of gas equivalent.
(2) Before deduction of production taxes and including hedging results.
Costilla uses the successful efforts method of accounting for its oil
and gas activities. Costs to acquire mineral interests in oil and gas
properties, to drill and equip exploratory wells that result in proved
reserves, and to drill and equip development wells are capitalized. Costs to
drill exploratory wells that do not result in proved reserves, geological,
geophysical and seismic costs, and costs of carrying and retaining unproved
properties are expensed. Capitalized costs of producing oil and gas
properties, after considering estimated dismantlement and abandonment costs and
estimated salvage values, are depreciated and depleted using the
unit-of-production method. Unproved oil and gas properties that are
individually significant are periodically reviewed for impairment of value, and
a loss is recognized at the time of impairment by providing an impairment
allowance. Other unproved properties are amortized based on the Company's
experience of successful drilling and average holding period.
The Company utilizes put option contracts, costless collars and swaps
to hedge the effect of price changes on a portion of its future oil and gas
production. Premiums paid and amounts receivable under the put option
contracts are amortized and accrued to oil and gas sales, respectively. If
market prices of oil and gas exceed the strike price of put options, the
options will expire unexercised, therefore, reducing the effective price
received for oil and gas sales by the cost of the related option. Conversely,
if market prices of oil and gas decline below the strike price of put options,
the options will be exercised, therefore, increasing the effective price
received for oil and gas sales by the proceeds received from the related
option.
A costless collar establishes both a floor price and a ceiling for the
commodity through the simultaneous purchase of a put option contract and the
sale of a call option contract. Since the value of the put option and the call
option offset at the time of their purchase, the collar is costless, therefore
there are no premiums to amortize. If market prices of oil and gas decline
below the strike price of put options, the options will be exercised,
therefore, increasing the effective price received for oil and gas sales by the
proceeds received from the related option. Conversely, if market prices of oil
and gas exceed the strike price of call options, the Company is obligated to
pay the counterparty the difference between the market price and the strike
price for the contract volumes, therefore, reducing the effective price
received for oil and gas sales by the amount paid to the counterparty.
Swaps establish a fixed price for the commodity. No premiums are paid
for these price swap contracts and therefore there are no premiums to amortize.
If market prices of oil and gas decline below the swap price, the counterparty
pays the Company the difference between the swap price and the market price for
the contract volumes, therefore, increasing the effective price received for
oil and gas sales by the proceeds received under the
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swaps. Conversely, if market prices of oil and gas exceed the swap price, the
Company is obligated to pay the counterparty an amount equal to the difference
between the market price and the swap price for the contract volumes,
therefore, reducing the effective price received for oil and gas sales by the
amount paid to the counterparty.
The net effect of the Company's commodity hedging activities increased
oil and gas revenues by $3,163,000 and $7,299,923 for the three and nine month
periods ended September 30, 1998 and reduced oil and gas revenues by $338,950
and $1,085,280 for the comparable periods in 1997. The Company had established
a costless collar for oil by purchasing put options on 6,500 Bbls of oil per
day which establish a floor price of $18.50 per Bbl and selling call options on
6,500 Bbls of oil per day at $22.55 per Bbl. These oil option contracts
expired August 1998. In August 1998, the Company entered into price swap
contracts for the remainder of 1998 and for the calendar year 1999 covering
5,000 Bbls of oil per day. The contracts provide for a price of $16.25 per Bbl
from September 1, 1998 through December 31, 1998 and $16.40 per Bbl from
January 1, 1999 through December 31, 1999. The referenced prices are based
upon the price at which WTI trades on the NYMEX. These contracts do not apply
and do not provide a hedge for each trading day during the period covered on
which the NYMEX price for WTI closes at less than $13.25 per Bbl for the
contract period during 1998 and $13.50 per Bbl during 1999. For the three
months and nine months ended September 30, 1998, the Company has received a
gross wellhead sales price for oil of approximately 74 % and 75 %,
respectively, of the NYMEX price.
The Company has established a costless collar for gas by purchasing
put options on 40,000 Mmbtu of gas per day which establish a floor price of
$2.40 per Mmbtu and selling call options on 40,000 Mmbtu of gas per day at
$2.55 per Mmbtu. These gas option contracts continue through October 1998.
The referenced gas prices are based upon the index price for Houston Ship
Channel gas sales, which is approximately 100% of NYMEX. For the three months
and nine months ended September 30, 1998, the Company has received a gross
wellhead sales price for gas of approximately 93% of NYMEX. As of September
30, 1998 the Company had sold a put option on 40,000 Mmbtu of gas per day at
$2.00 per Mmbtu based upon the index price for Houston Ship Channel gas sales
during the months of September and October 1998. In November 1998, the Company
entered into fixed price swap contracts for a period of three years, beginning
January 1, 1999, covering 25,000 Mmbtu of gas at prices of $2.60 per Mmbtu for
the months of November through March and $2.25 per Mmbtu for the months of
April through October, resulting in a blended price of $2.40 per Mmbtu. The
referenced gas prices are based upon the price at which gas trades on the
NYMEX. The counterparty has certain rights to extend the contracts for up to
25,000 Mmbtu per day for up to two years through December 2003 at the above
noted prices.
The Company utilizes interest rate swap agreements to reduce the
potential impact of increases in interest rates on floating-rate, long term
debt. If market rates of interest experienced during the applicable swap term
are below the rate of interest effectively fixed by the swap agreement, the
rate of interest incurred by the Company will exceed the rate that would have
been experienced under its then outstanding floating-rate indebtedness. The
net effect of the Company's interest rate hedging activities decreased interest
expense by $17,000 for the three months and by $25,000 for the nine months
ended September 30, 1998. The Company had an interest rate swap agreement in
place as of September 30, 1998 with a notional amount of $24 million, a fixed
rate of 7.5% and which will expire in January, 1999. As a result of the
Company's borrowings against its line of credit, which bears interest on a
floating rate basis, the interest rate swap agreement again qualifies as a
hedge during the third quarter of 1998.
RESULTS OF OPERATIONS
Three Months Ended September 30, 1998 Compared to Three Months Ended September
30, 1997
The Company's oil and gas revenues for the three months ended
September 30, 1998 were $16,809,000, representing an decrease of $2,530,000
(13%) from revenues of $19,339,000 in 1997. Revenues increased approximately
$5,510,000 due to successful new drilling activities and the net effect of
revenues related to properties purchased exceeded revenues from properties
sold. Lower oil prices offset in part by higher gas prices combined to account
for $1,580,000 of the decrease in revenues. Revenues attributable to gas
imbalances accounted for $2,743,000 of revenue in 1997, for which there were no
comparable amounts in 1998. The average net oil price per barrel received in
1998 was $14.96 compared to $16.91 in 1997, a 12% decrease, and the average net
gas price received in 1998 was $2.06 per Mcf compared to $2.03 in 1997, a 1%
increase. Revenues received from oil and gas hedges accounted for $4.58 per
barrel and $0.22 per Mcf for the three months ended September 30, 1998. Oil
and gas hedges cost $0.37 per barrel and $0.03 per Mcf for the comparable
period in 1997.
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Oil and gas production was 7,580 MMCFE in 1998 compared to 8,214 MMCFE
in 1997, an 8% decrease. Volumes related to gas imbalances were responsible
for 1,644 MMCFE in 1997. Excluding the volumes from gas imbalances in 1997,
1998 production increased 15% due to additional production from a combination
of successful drilling activities and acquired properties, partially offset by
production related to properties sold.
Oil and gas production costs for the three month period ended
September 30, 1998 were $6,982,000 ($0.92 per MCFE), compared to $6,875,000 in
1997 ($0.84 per MCFE), representing an increase of $107,000 (2%). Excluding
the effect of gas imbalance volumes on 1997 production costs per MCFE,
production costs in 1998 were $0.92 compared to $1.05 in 1997, or $0.13 (12%)
lower on a per MCFE basis due to a combination of lower production costs on
both newly completed wells and acquired properties and the sale of certain oil
and gas properties.
General and administrative expenses for the three months ended
September 30, 1998 were $2,786,000, representing an increase of $614,000 (28%)
from 1997 of $2,172,000. The increase is primarily due to an increase in
personnel and related costs necessary to accommodate the increase in the
Company's oil and gas activities, including the Acquisition and Exploration
Agreement with Ballard Petroleum, and an increase from 50% to 100% in its
Moldova operations.
Exploration and abandonment expense increased to $2,108,000 for the
three months ended September 30, 1998 compared to $634,000 in 1997. Dry hole
and abandonment costs increased to $1,468,000 in 1998 from $343,000 in 1997.
The Company incurred $177,000 of seismic costs for the three months ended
September 30, 1998, compared to $91,000 in the comparable period in 1997. The
Company incurred $463,000 of other geological and geophysical costs during the
three month period ended September 30, 1998 compared to $200,000 for the same
period in 1997.
Depreciation, depletion and amortization ("D D & A") expense for the
three month period ended September 30, 1998 was $7,533,000 compared to
$6,038,000 for 1997, representing an increase of $1,495,000 (25%). During the
1998 period, D D & A on oil and gas production was provided at an average rate
of $0.99 per MCFE compared to $0.74 per MCFE for 1997. Of the $1,495,000
increase, $1,642,000 was due to the $0.25 per MCFE increase in D D & A rate
necessitated by lower oil prices at September 30, 1998 than those experienced
at September 30, 1997.
Interest expense was $4,789,000 for the three months ended September
30, 1998, compared to $3,340,000 for the comparable period in 1997. The
$1,449,000 (43%) increase was attributable to a combination of higher levels of
average outstanding indebtedness and the issuance in January 1998 of an
additional $80 million of 10.25% senior notes due in 2006. The average amounts
of applicable interest-bearing debt in 1998 and 1997 were $187,837,000 and
$134,352,000, respectively. The effective annualized interest rate in 1998 was
10.2%, as compared to 9.9% in 1997.
Nine months ended September 30, 1998 Compared to Nine months ended September
30, 1997
The Company's oil and gas revenues for the nine months ended September
30, 1998 were $48,824,000, representing a decrease of $5,407,000 (10%) from
revenues of $54,231,000 in 1997. Lower commodity prices accounted for a
decrease in revenues of $4,818,000 which was partially offset by a combination
of successful drilling activities and revenues related to properties purchased
or sold. The average net oil price per barrel received in 1998 was $15.26
compared to $18.08 in 1997, an 16% decrease, and the average net gas price
received in 1998 was $2.08 compared to $2.19 in 1997, a 5% decrease. Revenues
received from oil and gas hedges accounted for $3.88 per barrel and $0.12 per
Mcf for the nine months ended September 30, 1998. Oil and gas hedges cost
$0.50 per barrel and $0.02 per Mcf for the comparable period in 1997.
Oil and gas production was 21,436 MMCFE in 1998 compared to 21,151
MMCFE in 1997, a 1% decrease. Volumes related to gas imbalances were
responsible for 1,644 MMCFE in 1997. Additional production from a combination
of successful drilling activities and acquired properties was largely offset by
production related to properties sold.
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Gain on sale of assets was $337,000 for the nine months ended
September 30, 1998. There were no similar transactions in 1997.
Oil and gas production costs for the nine month period ended September
30, 1998 were $21,208,000 ($0.99 per MCFE), compared to $21,038,000 in 1997
($0.99 per MCFE), representing an increase of $170,000. Oil and gas production
costs in 1997 would have been $1.08 without the volumes related to gas
imbalances. Production costs in 1998 were $0.09 lower on a per MCFE basis due
to a combination of lower production costs on both newly completed wells and
acquired properties and the sale of certain oil and gas properties.
General and administrative expenses for the nine months ended
September 30, 1998 were $7,857,000, representing an increase of $2,314,000
(42%) from 1997 of $5,543,000. The increase is primarily due to an increase in
personnel and related costs necessary to accommodate the increase in the
Company's oil and gas activities, including the Acquisition and Exploration
Agreement with Ballard Petroleum.
Exploration and abandonment expense increased to $7,336,000 for the
nine months ended September 30, 1998 compared to $3,748,000 in 1997. Dry hole
and abandonment costs increased to $5,461,000 in 1998 from $2,256,000 in 1997.
The Company incurred $801,000 of seismic costs for the nine months ended
September 30, 1998, compared to $983,000 in the comparable period in 1997. The
Company incurred $1,073,000 of other geological and geophysical costs during
the nine month period ended September 30, 1998 compared to $509,000 for the
same period in 1997.
Depreciation, depletion and amortization ("D D & A") expense for the
nine month period ended September 30, 1998 was $21,896,000 compared to
$15,758,000 for 1997, representing an increase of $6,138,000 (39%). During the
1998 period, D D & A on oil and gas production was provided at an average rate
of $1.02 per MCFE compared to $0.75 per MCFE for 1997. Of the $6,138,000
increase, $5,711,000 was due to the $0.27 per MCFE increase in D D & A rate
necessitated by lower oil and gas prices at September 30, 1998 than those
experienced at September 30, 1997.
Interest expense was $14,622,000 for the nine months ended September
30, 1998, compared to $8,856,000 for the comparable period in 1997. The
$5,766,000 (65%) increase was attributable to a combination of higher levels of
average outstanding indebtedness and the issuance in January 1998 of an
additional $80 million of 10.25% senior notes due in 2006. The average amounts
of applicable interest-bearing debt in 1998 and 1997 were $188,995,000 and
$113,077,000, respectively. The effective annualized interest rate in 1998 was
10.3%, as compared to 10.4% in 1997.
Results of operations for the nine months ended September 30, 1998 and
1997 include extraordinary charges of $299,000 and $219,000, respectively.
These extraordinary charges related to the early extinguishment of the
Acquisition Credit Facility and consisted of previously capitalized debt
issuance costs. A portion of the proceeds from the 1998 Notes was used to
repay the Acquisition Credit Facility.
LIQUIDITY AND CAPITAL RESOURCES
Net Cash Provided By Operating Activities
For the nine months ended September 30, 1998, net cash provided by
operating activities decreased to $8.5 million from $23.8 million for 1997.
Cash provided by operations, before changes in operating assets and
liabilities, decreased to a negative $0.7 million from $16.9 million for the
comparable period in 1997 due to a combination of lower oil and gas prices and
increased general and administrative expense, exploration and abandonments and
interest expense. Oil and gas revenues decreased by $5.4 million for the nine
months ended September 30, 1998 as compared to the same period in 1997 because
of lower oil and gas prices. Oil and gas revenues attributable to commodity
hedges amounted to $7.3 million for the nine months ended September 30, 1998.
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Net Cash Used in Investing Activities
Net cash used in investing activities for the nine months ended
September 30, 1998 was $89.4 million. Approximately $12.1 million was used for
the acquisition of oil and gas properties, with $10.4 million going to Manti
Resources ("Manti Acquisition"), $25.0 million was used for the performance
deposit to Pioneer Natural Resources U.S.A. Inc. ("Pioneer") with respect to
the transaction described under "Capital Resources", $52.5 million was used for
exploration and development activities, $2.2 was used to acquire the remaining
membership interest in the limited liability company through which the
Company's Moldovan oil and gas operations are conducted and $0.7 million for
other property and equipment. Proceeds from the sale of various oil and gas
assets resulted in net cash provided from investing activities of approximately
$3.2 million. For the nine months ended September 30, 1997, net cash used in
investing activities was $94.2 million. Approximately $41.2 million was used
for the Ballard Acquisition, $56.5 million was used for exploration and
development activities and $1.7 million was used for other property and
equipment and $5.2 million was provided by sales of oil and gas properties.
Financing Activities
For the nine months ended September 30, 1998, the Company incurred
$136.0 million of bank debt and issued $50.0 million of its 7% Series A
Cumulative Convertible Preferred Stock which resulted in net proceeds therefrom
of approximately $48.0 million, bringing total combined proceeds to $184.0
million. Approximately $91.5 million was used to repay certain prior bank
debt, $25.0 million was used for the performance deposit to Pioneer, $14.3
million was used for the acquisition of oil and gas properties, approximately
$5.4 million was for the purchase of shares of its common stock, approximately
$3.4 was used for financing costs and the remainder was used in connection with
its exploration and development activities. During the nine months ended
September 30, 1997, the Company incurred $87.3 million of new debt of which
approximately $20.0 million was used to repay certain prior bank debt, $41.2
million was used for the Ballard Acquisition, approximately $2.5 million, was
used for the purchase of shares of its common stock and the balance was used in
connection with its exploration and development activities.
The Company entered into the Revolving Credit Facility in August 1997.
Approximately $19.9 million of the funds initially borrowed were used for the
extension and refinancing of a prior senior credit facility and $11.2 million
was used as a portion of the purchase price in the Ballard Acquisition. The
Revolving Credit Facility provides for a maximum availability of $75.0 million,
with an current borrowing base of $40.0 million, $25.5 million of which was
borrowed at September 30, 1998. Borrowings under the Revolving Credit Facility
bear interest, at the Company's option, at a floating rate which is at or above
the lender's prime rate or above the applicable Eurodollar rate, depending on
the percentage of committed funds which have been borrowed. Interest is
payable quarterly as to base rate loans, and at the end of the applicable
interest period as to Eurodollar rate loans. The borrowing base of the
Revolving Credit Facility is automatically reduced by 5% each quarter beginning
in August 1999, and payments of principal are required in each such quarter in
which the outstanding principal balance is greater than the reduced borrowing
base. The remaining balance is payable on August 31, 2002, the maturity date
of the Revolving Credit Facility.
Contemporaneous with entering into the Revolving Credit Facility, the
Company also entered into the Acquisition Credit Facility to provide the
remaining financing for the Ballard Acquisition. The Acquisition Credit
Facility was a term loan in the amount of $30.0 million which was repaid in
full in connection with the sale of notes by the Company described in the
following paragraph.
In January 1998 the Company issued $80 million of 10.25% Senior Notes
due 2006 (the "Supplemental Notes Offering"). The net proceeds of the
Supplemental Notes Offering were approximately $78.8 million. The Company used
$30.0 million to repay the Acquisition Credit Facility and $32.5 million to
repay all but $0.5 million of the Revolving Credit Facility. In mid-January
1998 approximately $10.0 million of the remaining proceeds were used to fund
the Manti Acquisition.
On June 3, 1998 the Company closed a private placement of 50,000
shares of its 7% (8% Paid in Kind) Series A Cumulative Convertible Preferred
Stock (the "Preferred Stock") to Enron Capital & Trade Resources Corp. and
Joint Energy Development Investments II Limited Partnership for a purchase
price of $50.0 million (the "Convertible Preferred Stock Offering"). Dividends
accrue and are payable quarterly, commencing September 15,
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1998, in cash, or in certain instances in shares of the Company's Common Stock.
The dividend rate is 7% for dividends paid in cash and 8% for dividends paid in
shares of Common Stock. The holders of the Preferred Stock may, at any time,
convert shares of Preferred Stock into shares of the Company's Common Stock at
a conversion price of $12.39 which , subject to certain adjustments, would
result in the issuance of 4,035,513 shares of Common Stock upon conversion of
the Preferred Stock. The Registrant may, at its option, redeem the shares of
Preferred Stock after June 15, 2001, subject to certain limitations, for a
premium reducing to par on June 15, 2004 and thereafter. Net proceeds from the
Convertible Preferred Stock Offering were $48.0 million, of which $29.0 million
was used to repay all but $0.5 million of the Revolving Credit Facility and the
remainder for general corporate purposes.
Capital Resources
Funding for the Company's business activities has historically been
provided by bank financings, cash flow from operations, equity sales, property
divestitures and joint ventures with industry participants. The 1995
Acquisition, 1996 Acquisition and Ballard Acquisition were substantially funded
by bank financings.
On September 4, 1998 the Company entered into a purchase and sale
agreement with Pioneer for the purchase of certain oil and gas assets of
Pioneer for $410.0 million, subject to certain adjustments (the "Acquisition").
The assets to be purchased include producing oil and gas properties,
undeveloped mineral acres, undeveloped leasehold acres, a license to use
certain seismic data and gas plants, pipelines and processing facilities. The
Company paid a $25.0 million performance deposit to Pioneer which may be
subject to forfeiture if the Acquisition is not consummated. The Company
intends to fund the purchase price, which is estimated to be approximately
$390.0 million after adjustments (the "Estimated Purchase Price"), through the
sale of common stock and convertible preferred stock (the "Stock Issuance") and
borrowings under a new bank credit facility ("New Credit Facility"). The
Company believes that it is probable that it will obtain sufficient funds from
the Stock Issuance which, when combined with the expected proceeds from the New
Credit Facility, will allow the Company to complete the Acquisition.
Funds available under the Revolving Credit Facility were significantly
reduced to fund the $25 million performance deposit made upon execution of the
Acquisition Agreement. In the event the Acquisition is not consummated due to
a breach by Costilla, the Company would forfeit the $25 million deposit and be
liable for an additional $16 million in liquidated damages. The Company does
not currently have available, and has not made arrangements to obtain
financing, to pay the additional $16 million payment, which may make it
necessary to sell assets to fund the payment. The Company's ability to
generate or obtain capital resources necessary to fund its operating plans
could be significantly and adversely affected as a result of a failure to
consummate the Acquisition. If the Acquisition is consummated, the Company
anticipates that cash flow from operations will be sufficient for its 1999
capital expenditures, excluding acquisitions. However, because the Company's
ultimate 1999 capital expenditures, future cash flows and the availability of
financing are subject to a number of variables, there can be no assurance that
the Company's capital resources will be sufficient to maintain its capital
expenditures. In addition, if the Company is unable to generate sufficient
cash flow from operations to service its debt, it may be required to refinance
all or a portion of its debt or to obtain additional financing. There can be
no assurance that any such refinancing would be possible or that any additional
financing could be obtained.
If the Company is unable to obtain the financing necessary to
consummate the Acquisition, the Company may be required to seek alternative
financing or risk termination of the Acquisition Agreement and the consequences
resulting therefrom. The Company does not currently have any arrangements or
commitments for alternative sources of financing, and there can be no assurance
that such sources will be available.
At September 30, 1998, the Company was not in compliance with the
financial ratios required by the Revolving Credit Facility. The Company sought
and obtained a waiver from the Lenders under the Revolving Credit Facility
permitting the Company's non-compliance at September 30, 1998. If the Stock
Issuance is consummated, the Company will enter into the New Credit Facility,
close the Acquisition and anticipates that it will be in compliance with all
required financial ratios. However, if the Acquisition is not consummated, the
Company does not anticipate that it will be in compliance with any of the
financial ratios currently required by the Revolving Credit Facility at
December 31, 1998. There is no assurance that the Lenders under the Revolving
Credit Facility would grant further waivers of the Company's non-compliance
and, as a result, the Lenders would have the ability to accelerate the maturity
of all amounts due under the Revolving Credit Facility.
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Although certain of the Company's costs and expenses may be affected
by inflation, inflationary costs have not had a significant effect on the
Company's results of operations.
Capital Expenditures
During the nine months ended September 30, 1998 the Company had oil
and gas expenditures of approximately $52.5 million, exclusive of the $25.0
million performance deposit on the Acquisition and the $14.3 million spent on
the acquisition of existing oil and gas properties. The $52.5 million of oil
and gas expenditures consisted of $13.5 million of exploration costs, $29.7
million of development costs, $3.6 million of undeveloped acreage and $5.7
million on wells in progress at September 30, 1998. The Company anticipates
that its capital expenditures for the fourth quarter of 1998 will be
approximately $8.0 million, excluding the Acquisition. If the Acquisition is
consummated, the Company expects that cash flow from operations will be
adequate to fund 1999 oil and gas capital expenditures, exclusive of any
acquisitions.
Recent Accounting Pronouncements
YEAR 2000 - The Company will be required to modify its information
systems in order to accurately process data referencing the Year 2000. Because
of the importance of occurrence dates in the oil and gas industry, the
consequences of not pursuing these modifications could be very significant to
the Company's ability to manage and report operating activities. The Company's
third-party software vendor for its integrated oil and gas information system
is currently modifying the system to accurately handle the Year 2000 issue.
All necessary programming modifications are scheduled to be completed by
December 31, 1998. These modifications are part of the routine updates the
Company receives from its third-party software vendor as part of its systems
support contract, and the Company believes it will not incur any material costs
in addition to the ordinary software maintenance costs in preparing its
information systems for the Year 2000 issue.
In addition to its information systems, the Company is conducting an
assessment of the Year 2000 issues with respect to the production and other
field equipment associated with its current properties and the Acquisition
Properties. A significant failure of such equipment may cause delays in
production and product transportation which could have a material adverse
effect on the Company. Following this assessment, the Company intends to
establish a plan to make such equipment Year 2000 compliant or develop a
contingency plan for a possible failure of such equipment.
The Year 2000 issues also affect service companies, purchasers of
production, utility providers and other persons with whom the Company
contracts. The Company has submitted Year 2000 compliance questionnaires to
many of such persons, but is currently not aware of the preparations undertaken
by such person. A material and widespread failure of the utility service,
transportation of oil or gas, or similar service the Company utilizes could
have a material effect on the Company's production, cash flow and overall
financial condition. Therefore, failure of such third parties to adequately
prepare for Year 2000 issues may have a material adverse effect on the Company,
notwithstanding the Company's actions to prepare its own information systems.
The Company does not currently have a contingency plan in the event such third
parties are unable to provide services or products to the Company.
SEGMENT REPORTING - In June 1997, the FASB issued Statement of
Accounting Standards No. 131 "Disclosures about Segments of an Enterprise and
Related Information" ("FAS 131") which establishes standards for public
business enterprises for reporting information about operating segments in
annual financial statements and requires that such enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. This statement also established standards for related
disclosures about products and services, geographic areas, and major customers.
FAS 131 is effective for financial statements for years beginning after
December 15, 1997.
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The Company operates in the one product line of oil and gas production
in limited geographic areas. This information and information about major
customers historically has been disclosed in the Company's annual financial
statements.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - In June 1998, The
FASB issued Statement of Financial Accounting Standards No. 133 "Accounting for
Derivative Instruments and Hedging Activities" which establishes accounting
and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, (collectively referred to
as derivatives) and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. If certain
conditions are met, a derivative may be specifically designated as (a) a hedge
of the exposure to changes in the fair value of a recognized asset or liability
or an unrecognized firm commitment, (b) a hedge of the exposure to variable
cash flows of a forecasted transaction, or (c) a hedge of the foreign currency
exposure of a net investment in a foreign operation, an unrecognized firm
commitment, an available-for-sale security, or a foreign-currency-denominated
forecasted transaction.
Under this Statement, an entity that elects to apply hedge accounting is
required to establish at the inception of the hedge the method it will use for
assessing the effectiveness of the hedging derivative and the measurement
approach for determining the ineffective aspect of the hedge. Those methods
must be consistent with the entity's approach to managing risk.
This Statement applies to all entities and is effective for all fiscal quarters
of fiscal years beginning after June 15, 1999. Initial application of this
Statement should be as of the beginning of an entity's fiscal quarter; on that
date, hedging relationships must be designated anew and documented pursuant to
the provisions of this Statement. Earlier application of all of the provisions
of this Statement is encouraged, but it is permitted only as of the beginning
of any fiscal quarter that begins after issuance of this Statement. This
Statement should not be applied retroactively to financial statements of prior
periods.
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PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
Exhibit
Number Description of Exhibit
------ ----------------------
*10.1 Purchase and Sale Agreement dated
September 4, 1998 by and between Costilla
Energy, Inc. and Pioneer Natural
Resources USA, Inc.
*27.1 Financial Data Schedule
* Filed herewith
REPORTS ON FORM 8-K
None.
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S I G N A T U R E S
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.
COSTILLA ENERGY, INC.
Date: November 13, 1998 By: /S/ BOBBY W. PAGE
-------------------------------
Bobby W. Page
Senior Vice President
and Chief Financial Officer
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Index to Exhibits
Exhibit
Number Description of Exhibit
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*10.1 Purchase and Sale Agreement dated
September 4, 1998 by and between Costilla
Energy, Inc. and Pioneer Natural
Resources USA, Inc.
*27.1 Financial Data Schedule
* Filed herewith