UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1997
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. 1-12905
ENSERCH EXPLORATION, INC.
(Exact name of Registrant as specified in its charter)
Texas
(State or other jurisdiction of incorporation or organization)
75-2421863
(I.R.S. Employer Identification No.)
2500 CityWest Blvd., Suite 1400, Houston, Texas 77042
(Address of principal executive office) (Zip Code)
(713) 243-3100
(Registrant's telephone number, including Area Code)
Indicate by check mark whether the Registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Act of 1934 during the preceding twelve 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
----- -----
Number of shares of Common Stock of Registrant outstanding
as of November 10, 1997: 126,911,927
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
ENSERCH EXPLORATION, INC.
CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS (UNAUDITED)
Three Months Ended Nine Months Ended
September 30 September 30
--------------------------------------
1997 1996 1997 1996
--------------- ------- --------
(Restated) (Restated)
---------- ---------
(In thousands except per share amounts)
Revenues
Natural gas $ 51,175 $ 51,373 $154,826 $161,772
Oil and condensate 21,866 26,852 71,230 70,583
Natural gas liquids 2,177 2,800 4,968 6,444
Cogeneration operations 2,912 2,771 8,387 8,055
Other 100 743 883 1,626
---------- ------- ------- --------
Total 78,230 84,539 240,294 248,480
---------- ------- ------- --------
Costs and Expenses
Production and operating 12,267 18,412 37,317 55,340
Exploration 25,192 28,481 65,213 68,335
Depreciation and amortization 38,604 43,299 112,353 121,028
Impairment of producing oil
and gas properties 210,202 210,202
Loss (gain) on sales of property,
plant & equipment 1,635 (21,777) 1,635 (24,383)
Unusual charges 24,229 26,412
Cogeneration operations 2,584 2,589 7,742 7,553
General, administrative and other 7,710 7,487 22,181 23,999
Taxes, other than income 4,670 5,245 13,624 16,218
---------- -------- -------- --------
Total 327,093 83,736 496,679 268,090
---------- -------- -------- --------
Operating Income (Loss) (248,863) 803 (256,385) (19,610)
Other Income (Expense) - Net (79) (42) (150) 42
Interest Income 383 469
Interest and Other Financing Costs (8,804) (6,918) (25,502) (21,015)
---------- -------- -------- ---------
Loss Before Income Taxes (257,363) (6,157) (281,568) (40,583)
Income Taxes (Benefit) (75,828) (2,214) (84,303) (14,309)
Minority Interest (73) (73)
---------- -------- -------- ---------
Net Loss $(181,608) $(3,943)$(197,338) $(26,274)
========== ======== ========= =========
Net Loss Per Share $ (1.44) $ (0.03) $ (1.56) $ (0.21)
========== ======== ========= =========
Weighted Average Shares Outstanding 126,666 126,571 126,666 126,565
========= ======== ========= =========
See accompanying Notes.
2
ENSERCH EXPLORATION, Inc.
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS (UNAUDITED)
Nine Months Ended
September 30
---------------------------
1997 1996
-------- ----------
(Restated)
----------
(In Thousands)
OPERATING ACTIVITIES
Net income (loss) $(197,338) $ (26,274)
Impairment of producing oil and gas properties 210,202
Impairment of undeveloped leasehold 40,866 25,500
Dry hole cost 7,409 18,834
Depreciation and amortization 112,353 121,028
Deferred income tax expense (benefit) (79,172) (12,861)
Other 23,709 (10,464)
Changes in current operating
assets and liabilities
Accounts receivable 17,068 16,509
Other current assets (2,477) 64
Accounts payable 17,915 (17,951)
Other current liabilities 355 3,672
--------- ---------
Net cash flows from operating activities 150,890 118,057
--------- ---------
INVESTING ACTIVITIES
Additions to property, plant and equipment (128,522) (150,512)
Retirements of property, plant and equipment 53,237 82,136
Changes in property, plant
and equipment accruals (3,386) (554)
--------- ---------
Net cash flows used in
investing activities (78,671) (68,930)
--------- ---------
FINANCING ACTIVITIES
Borrowings under bank revolving
credit agreement 60,000 125,000
Repayment of borrowings under bank
revolving credit agreement (140,000) (155,000)
Borrowings under short term
financing agreement 130,900
Repayments under short term
financing agreement (127,900)
Repayment of Company-Obligated
Mandatorily Redeemable Preferred
Securities of Subsidiary (150,000)
Issuance of Minority Interests in
Preferred Securities of Subsidiaries 150,000
Change in temporary advances with
affiliated companies 13,328 (19,957)
Change in deferred payable to
affiliated company (1,887)
Change in advances under leasing arrangements (5,457) 5,930
Payments of capital lease obligations (2,899) (3,413)
Issuance of common stock 2 120
--------- ---------
Net cash flows used in financing activities (72,026) (49,207)
--------- ---------
Net Increase in Cash 193 (80)
Cash at Beginning of Period 1,358 1,565
--------- ---------
Cash at End of Period $ 1,551 $ 1,485
========= =========
See accompanying Notes.
3
ENSERCH EXPLORATION, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30 December 31
1997 1996
------------ -----------
(Restated)
-----------
(In thousands)
ASSETS
Current Assets
Cash $ 1,551 $ 1,358
Accounts receivable - trade 65,407 65,926
Accounts receivable - affiliated companies 16,549
Temporary advances - affiliated companies 13,328
Other 20,743 18,266
------------ ----------
Total current assets 87,701 115,427
------------ ----------
Property, Plant and Equipment (at cost)
Oil and gas properties
(successful efforts method) 1,969,135 1,984,341
Other 18,617 22,084
------------- ---------
Total 1,987,752 2,006,425
Less accumulated depreciation
and amortization 1,221,234 941,052
-------------- ---------
Net property, plant and equipment 766,518 1,065,373
-------------- ---------
Deferred Income Tax Benefit 30,961
-------------- ---------
Other Assets 10,098 14,654
-------------- --------
Total $ 895,278 $1,195,454
============== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable - trade $ 112,611 $ 91,026
Accounts payable - affiliated companies 8,924
Short term borrowings 3,000
Advances under leasing arrangements 5,457
Current portion of capital lease obligations 8,392 3,250
Other 12,198 11,843
------------- ---------
Total current liabilities 136,201 120,500
------------- ---------
Bank Revolving Credit Agreement 35,000 115,000
------------- ---------
Capital Lease Obligations 233,694 241,735
------------- ---------
Deferred Income Taxes 35,330
------------- ---------
Other Liabilities 47,031 42,483
------------- ---------
Company-Obligated Mandatorily Redeemable
Preferred Securities of Subsidiary 150,000
------------- ---------
Minority Interests in Preferred
Securities of Subsidiaries 150,000
------------ ----------
Common Shareholders' Equity
Common stock (400,000 shares authorized;
126,920 and 126,736 shares outstanding) 1,269 126,736
Paid in capital 569,173 442,246
Accumulated deficit (275,007) (77,669)
Unamortized restricted stock compensation (1,550) (677)
Treasury stock (57 and 25 shares) (533) (230)
------------- ---------
Common shareholders' equity 293,352 490,406
------------- ---------
Total $ 895,278 $1,195,454
============= =========
See accompanying Notes.
4
ENSERCH EXPLORATION, INC.
Notes to Condensed Consolidated Financial Statements
1. BASIS OF PRESENTATION - On August 5, 1997, the merger of
ENSERCH Corporation ("ENSERCH") and Texas Utilities Company and
the related merger of Enserch Exploration, Inc. ("Old EEX") and
Lone Star Energy Plant Operations, Inc. ("LSEPO") were completed.
In the EEX/LSEPO merger, LSEPO changed its name to "Enserch
Exploration, Inc." ("EEX"), shares of Old EEX were automatically
converted into shares of New EEX on a one-for-one basis in a tax-
free transaction, New EEX issued 691,631 shares of common stock
to ENSERCH in exchange for outstanding LSEPO common stock and
ENSERCH distributed to its shareholders, on a pro rata basis, all
of the shares of New EEX common stock it owned. In addition, the
merger fixed LSEPO's working capital at $3.5 million. For
financial reporting purposes, the EEX/LSEPO merger was treated as
a combination of entities under common control. Accordingly, the
operations and assets and liabilities of EEX and LSEPO have been
recorded at their historical amounts in the accompanying
Condensed Statements of Consolidated Operations and Cash Flows
for the three months and nine months ended September 30, 1997 and
1996 and the Condensed Consolidated Balance Sheets as of
September 30, 1997 and December 31, 1996. The number of common
shares outstanding for all periods has been increased to reflect
the 691,631 additional shares issued in the merger. The Restated
Articles of Incorporation of EEX authorized 400 million shares of
common stock with a par value of $.01. This change has been
reflected in the accompanying condensed consolidated financial
statements.
2.In the third quarter 1997, EEX adopted the successful efforts
method of accounting for its oil and gas operations and prior
period financial statements have been restated. Under the
successful efforts method of accounting, lease acquisition
costs are capitalized when incurred. Significant unproved
properties are reviewed periodically on a property-by-property
basis to determine if there has been an impairment in value,
with such impairment charged to expense. All other unproved
properties are aggregated and a portion of the costs estimated
to be non-productive, based on historical experience, is
amortized over the average life of the leases. Geological and
geophysical costs and the costs of carrying and retaining
undeveloped properties are expensed as incurred. Exploratory
drilling costs are initially capitalized but charged to
current expense if the well is commercially unsuccessful.
Leasehold costs of producing properties are depleted using the
unit of production method based on estimated proved oil and
gas reserves quantified on the basis of their equivalent
energy content. Amortization of drilling and equipment costs
is based on the unit of production method using estimated
proved developed oil and gas reserves quantified on the basis
of their equivalent energy content. Depreciation of other
property, plant and equipment is provided principally by the
straight line method over the estimated service lives of the
related assets. The current undiscounted cost of estimated
future site restoration, dismantlement and abandonment, net of
salvage, is included in the cost of productive oil and gas
properties and a corresponding liability recorded. The
recorded cost is amortized on the unit of production method.
Actual costs incurred for these activities are charged to the
recorded liability.
5
The effect of the adoption of the successful efforts method
of accounting on net income (loss) for the quarters ended
September 30, 1997 and 1996 is as follows (in thousands,
except per share amounts):
1997 1996
---------------------
Increase (Decrease)
Net (loss) $ (173,331) $ (6,135)
=========== =========
Net (loss) per share $ (1.37) $ (0.05)
=========== =========
The effect on previously reported net income (loss) for the
first two quarters of 1997 and 1996 is as follows (in
thousands, except per share amounts):
Three Months Ended
===========================
June 30 March 31
========== ===========
1997
Net income (loss) as previously reported $ 6,044 $ (234,595)
Adjustment for effect of change to
successful efforts (19,573) 232,392
---------- -----------
Net (loss) as adjusted $ (13,529) $ (2,201)
=========== ==========
Per share amounts:
Net income (loss) as previously reported $ .05 $ (1.85)
Adjustment for effect of change to
successful efforts (.16) 1.83
---------- -----------
Net (loss) as adjusted $ (.11) $ (.02)
=========== ==========
1996
Net income as previously reported $ 5,334 $ 205
Adjustment for effect of change to
successful efforts (18,473) (9,398)
----------- ----------
Net (loss) as adjusted $ (13,139) $ (9,192)
=========== ==========
Per share amounts:
Net income as previously reported $ .04 $ .00
Adjustment for effect of change to
successful efforts (.14) (.07)
---------- ------------
Net (loss) as adjusted $ (.10) $ (.07)
=========== ==========
The effect on retained earnings (deficit) and paid in capital is
as follows (in thousands):
Retained
Earnings Paid In
(Deficit) Capital
--------- -----------
Balance at December 31, 1996,
as previously reported $ 2,292 $ 819,393
Adjustment for cumulative effect for
restatement to successful efforts
accounting for the following periods:
Through December 31, 1994 (377,147)
Two years ended December 31, 1996 (79,961)
---------- ----------
Balance at December 31, 1996, as restated (77,669) $ 442,246
==========
Restated net (loss) for quarters ended
March 31 and June 30, 1997 (15,730)
----------
Balance at beginning of quarter
ended September 30, 1997, as restated (93,399)
Net (loss) for quarter ended September 30, 1997 (181,608)
----------
Balance September 30, 1997 $ (275,007)
==========
6
3. Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to be Disposed Of", (SFAS 121) provides for the
recognition of losses when events or changes in circumstances
indicate that the carrying value of long-lived assets may not be
realized. When there is evidence that the cost of such assets may
not be realized based upon periodic evaluation, SFAS 121 requires
the carrying values of long-lived assets be written down to fair
values. The Company estimates fair values using the present value
of expected future cash flows for each significant oil and gas
field.
Early in 1997, EEX began a review and evaluation of the
commercial feasibility of its non-producing oil and gas
reserves. The Company has announced, based upon a preliminary
evaluation, that it expects a material downward revision of
its oil and natural gas reserves, primarily in its behind pipe
and proved undeveloped reserves in East Texas and its proved
undeveloped reserves in the deep-water Gulf of Mexico. While
additional analysis is required and is currently in progress,
EEX management believes that the study progressed sufficiently
during the third quarter of 1997 that the amount of the year-
end 1997 downward revision could be reasonably estimated to
approximate 670 billion cubic feet of gas equivalent.
As a result of the estimated downward revision of reserves,
the Company reexamined the carrying value of its properties as
a part of the overall process. In order to determine whether
its assets had been impaired, EEX grouped its producing
properties by fields, which it believes is the lowest level
for which cash flows are reasonably and separately
identifiable, and determined that anticipated future cash
flows based on the revised reserve estimations and development
plans were insufficient to recover the carrying value of
certain fields. Accordingly, the carrying value of such fields
were reduced to fair value, and EEX recorded a $137 million
after-tax, ($210 million pre-tax) charge for impairment at the
end of the third quarter 1997.
4. The deferred tax effect of the difference in financial
accounting basis and the income tax basis of EEX's assets and
liabilities at September 30, 1997, and December 31, 1996, were as
follows:
September 30, December 31,
1997 1996
------------- ------------
(In thousands)
Deferred tax assets (liabilities):
Property, plant and equipment $ 50,896 $ (44,399)
Losses of controlled foreign corporations 8,044 8,079
All other 3,018 2,088
---------- ----------
Total 61,958 (34,232)
Valuation allowance (30,000)
---------- ----------
Net deferred tax asset (liability) $ 31,958 $ (34,232)
========== ==========
Current amount $ 997 $ 1,098
Non-current amount 30,961 (35,330)
---------- ----------
Total $ 31,958 $ (34,232)
========== ==========
7
The Company established a $30 million valuation allowance to
reduce the calculated deferred tax asset to net realizable
value in accordance with Statement of Financial Accounting
Standards No. 109 (SFAS 109). Although the Company has
incurred net taxable losses for book purposes in recent years,
management believes it is more likely than not that the
Company will generate taxable income sufficient to realize a
portion of the tax benefits associated with assets which have
a tax basis in excess of net cost recorded under the
successful efforts method of accounting used for financial
reporting purposes. Such assets are primarily represented by
seismic costs capitalized for tax purposes but expensed under
successful efforts accounting and assets impaired under the
provisions of SFAS 121 for which no tax deduction was
immediately available. This belief is based primarily on
available tax planning strategies which include anticipated
sales of assets with fair market values in excess of book and
tax cost bases within the next year. While management is
optimistic that future earnings will be significantly enhanced
as a result of its ongoing restructuring program, the
anticipated earnings benefit which could be realized from
further realization of the additional tax basis in selected
assets has not been recognized in the valuation of the
Company's deferred tax asset.
5. On September 29, 1997, EEX concluded a transaction in which
all of the outstanding mandatorily redeemable preferred
securities of a subsidiary were redeemed at the stated value of
$150 million. The redemption was funded by a private sale of new
issues of preferred stock of EEX Capital, Inc. (EEXC), wholly
owned by EEX, and Preferred Interests of MIStS Issuer L.L.C.
(Issuer), whose common equity interests are wholly owned by EEXC.
On October 27, 1997, EEXC sold an additional $75 million of
preferred stock and used the proceeds to satisfy a $75 million
demand note with Issuer. Issuer used the proceeds from the
demand note to redeem all the preferred interests sold by Issuer
on September 29, 1997. The dividend rate for EEXC's new
securities is based on LIBOR (reset quarterly) plus a spread
beginning at 3.0% for the period ending December 31, 1997, and
increasing by 1.0% quarterly through December 31, 1998. The new
securities are redeemable, in whole or in part, at the option of
EEXC on the quarterly dividend payment dates. Interest payable
on a $150 million demand note from EEX to EEXC will fund the
dividends.
6. In early 1997, EEX management committed to restructure the
Company and undertook a program to refocus the scope of its
future operations and reduce the number of personnel. Costs and
expenses associated with this program include unusual charges
incurred in connection with restructuring and relocating
administrative functions as well as terminating a number of
employees. In the third quarter 1997, as an integral part of its
restructure plan, EEX relocated its Corporate headquarters to
Houston, Texas, committed to the severance of approximately 375
Dallas-based employees and authorized the closure of its Dallas,
Texas administrative offices by year-end 1998. Accordingly, EEX
accrued $19 million for severance of employees not relocating to
Houston under the benefits outlined in its severance program and
$1.6 million for cancellation of office leases during the
quarter. Amounts paid and charged against these accruals during
the quarter were employee severance of $5.8 million (72
employees) and lease cancellation costs of $.4 million. Other
amounts associated with these changes which are expected to
benefit future operations are expensed as incurred; during the
third quarter they included professional services of $1.3
million and office and employee
8
relocation of $1 million. Also during the third quarter 1997,
non oil and gas assets were written down $2.3 million to net
realizable value. Second quarter 1997 charges included
employee severance of $1.6 million (45 employees),
professional services of $.3 million and office and employee
relocation of $.3 million.
7. EEX has filed suit in the 11th District Court of Harris
County, Texas alleging, among other claims, anticipatory breach
of a drilling rig contract which provides EEX with daily rig
rates substantially less than current market rates. EEX is
seeking a declaratory judgment that the contract includes a three
year Option Term. Unfavorable settlement of this matter could
materially impact future offshore deep water drilling costs.
8. Earnings per share applicable to common stock are based on
the weighted average number of common shares outstanding during
the period, including common equivalent shares when dilutive.
9. In the opinion of management, all adjustments (consisting
only of normal recurring accruals) necessary for a fair
presentation of the financial position, results of operations and
cash flows for the interim periods included herein have been
made. Certain items in prior periods have been reclassified to
be consistent with the current presentation.
9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
OVERVIEW
On August 5, 1997, the merger of ENSERCH and Texas Utilities
Company and the related merger of Enserch Exploration, Inc.
("EEX") and Lone Star Energy Plant Operations, Inc. ("LSEPO")
were completed. Under the terms of the EEX/LSEPO merger, LSEPO
changed its name to "Enserch Exploration, Inc." ("New EEX"),
shares of EEX were automatically converted into shares of New
EEX on a one-for-one basis in a tax-free transaction, New EEX
issued 691,631 shares of common stock to ENSERCH in exchange for
outstanding LSEPO common stock and ENSERCH distributed to its
shareholders, on a pro rata basis, all shares of New EEX common
stock it owned. In addition, the merger fixed LSEPO's working
capital at $3.5 million. For financial reporting purposes, the
EEX/LSEPO merger was treated as a combination of entities under
common control. Accordingly, the operations and assets and
liabilities of EEX and LSEPO have been recorded at their
historical amounts in the accompanying financial statements.
The number of common shares outstanding has been increased to
reflect the 691,631 additional shares issued in the merger and
the adjustment of LSEPO's working capital to $3.5 million is
reflected in the accompanying Condensed Consolidated Balance
Sheets.
RESULTS OF OPERATIONS
EEX changed from the full cost method to the successful efforts
method to account for its oil and gas operations in the third
quarter of 1997 and all prior period financial statements have
been restated. See Note 2 of Notes to Condensed Consolidated
Financial Statements for additional information. The following
discussions of operating results are based on those restated
amounts.
EEX reported a third quarter 1997 net loss of $182 million
($1.44 per share), versus a net loss of $3.9 million ($.03 per
share) in 1996. The third quarter 1997 operating loss was $249
million, compared to operating income of $1 million for 1996.
For the first nine months of 1997, EEX had a net loss of $197
million ($1.56 per share) compared to a net loss of $26 million
($.21 per share) for 1996.
Results of operations for the third quarter and year-to-date
1997 were impacted by the following unusual items:
A third quarter $137 million after-tax ($210 million pre-
tax) charge for impairment of producing oil and gas properties
required by Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to Be Disposed Of." This impairment will reduce
future depreciation and amortization expense.
10
An unusual charge, primarily severance, of $16 million after-
tax ($24 million pre-tax) for the third quarter and $17 million
after-tax ($26 million pre-tax) year-to-date related to the
reorganization and restructuring of operations and the relocation
of corporate headquarters to Houston, Texas.
In the following comparisons of results of operations, 1997
results have been adjusted to exclude the unusual items
described above.
QUARTERS ENDED SEPTEMBER 30, 1997 AND 1996 - Revenues for 1997
were $78 million, $6 million (7%) lower than 1996. Natural gas
revenues, unchanged from 1996, were impacted by a 16% increase
in average prices, offset by a 14% decrease in production due to
sales of the Rocky Mountain properties in late 1996. The average
natural gas sales price per thousand cubic feet (Mcf) was $2.32
in 1997 compared with $2.01 in 1996. Natural gas production for
1997 was 22 billion cubic feet (Bcf), compared with 25.6 Bcf in
1996. Oil revenues decreased $5 million (19%) due to sales of
the Rocky Mountain properties in late 1996 and a decrease in the
average crude oil sales price per barrel to $17.88 in 1997 from
$19.86 in 1996. Crude oil production was 1,223 thousand barrels
(MBbls),compared with 1,352 MBbls in 1996.
Costs and expenses, excluding loss (gain) on sales of property,
plant and equipment, were down 14% in the third quarter of 1997
compared to 1996. Production and operating expenses decreased
33% from 1996 as a result of properties sold in late 1996 and
capitalization of the Cooper Project operating lease in December
1996. Exploration expenses decreased 12% due primarily to a
change in focus to offshore and international and the
curtailment of the onshore exploration program during the first
nine months of 1997. Exploration expenses are expected to be at
lower levels in the future due to reduction of exploration staff
levels, major curtailment of onshore exploration and reduction
of exposure to deep water Gulf of Mexico dry hole cost resulting
from the offshore exploration joint venture (See Offshore
Exploration Joint Venture). Taxes, other than income decreased
11% from 1996 primarily due to the 1996 property sales.
Properties sold in the third quarter of 1997 resulted in a loss
of $1.6 million compared to a gain of $22 million for third
quarter 1996. EEX is divesting non-core properties and
anticipates closing several major sales in the fourth quarter of
1997.
Interest and other financing costs for 1997 were $8.8 million, a
$.5 million (6%) reduction from 1996 after an adjustment of $2.4
million for the impact of capitalization of the Cooper Project
operating lease. The decrease in 1997 is due primarily to the
reduction in debt from proceeds from property sales.
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 - Revenues for
1997 were $240 million, $8 million (3%) decreased from 1996.
Natural gas revenues decreased $7 million (4%), resulting from a
16% decrease in production volumes partially offset by a 14%
increase in the average sales price. The average natural gas
sales price per Mcf was $2.41 in 1997 compared with $2.11 in
1996. Natural gas production for 1997 was 64.2 Bcf, down from
76.5 Bcf in
11
1996 due primarily to the aforementioned property sales. Higher
oil revenues in 1997 reflect a 3% improvement in the average sales
price to $19.50 per barrel in 1997 from $18.94 in 1996, offset by
a 2% decline in production volumes. Crude oil production was 3,652
MBbls in 1997 compared to 3,726 MBbls in 1996. Overall, oil and
gas production in the first nine months of 1997 was reduced
somewhat because the Cooper facility was shut-in for several
weeks to allow for maintenance, repair and completion
activities.
Costs and expenses, excluding loss (gain) on sales of property,
plant and equipment, were down 12% in 1997 compared to 1996.
Production and operating expenses decreased 33% from 1996 for
the reasons described above. Exploration expenses were down 5%
due to the refocusing of the exploration programs described
above and are expected to be at lower levels in the future.
General and administrative expenses were $22 million, 8% less
than 1996 due to restructuring and ongoing cost reduction
initiatives. Taxes, other than income were $14 million, down
16% from 1996 primarily due to lower ad valorem tax accruals and
1996 property sales. Property sales in the first nine months of
1997 resulted in a loss of $1.6 million compared to a gain of
$24 million for 1996.
Interest and other financing costs for 1997 were $26 million, a
$3 million (10%) reduction from 1996 after an adjustment of $7.2
million for the impact of capitalization of the Cooper Project
operating lease. The decrease in 1997 is due to the reduction in
debt from proceeds from property sales.
HEDGING ACTIVITIES
A portion of the risk associated with fluctuations in the price
of oil and natural gas is managed through the use of hedging
techniques such as oil and gas swaps, collars and futures
agreements. EEX fixed the price on third quarter 1997
production volumes of 19 Bcf of natural gas (82% of production)
at an average price of $2.33 per Mcf and 828 MBbls of oil (68%
of production) at an average price of $20.38 per Bbl. For the
first nine months of 1997, EEX fixed the price on 48 Bcf of
natural gas (71% of production) at an average price of $2.60 per
Mcf and 1,759 MBbls of oil (48% of production) at an average
price of $21.24 per Bbl. In total oil and gas price hedging
activities decreased third quarter 1997 revenues by $.8 million,
compared to a decrease of $3.3 million for the third quarter of
1996. For the first nine months of 1997, oil and gas hedging
activities increased revenues by $.8
million, but decreased revenues for the first nine months of
1996 by $11
million. At September 30, 1997, EEX had outstanding swaps,
collars and futures agreements that were entered into as hedges
extending through December 31, 1998, to exchange payments on 39
Bcf of natural gas and 1,548 MBbls of oil. At September 30,
1997, there were $7.5 million of net unrealized and unrecognized
hedging losses based on the difference between the strike price
and the New York Mercantile Exchange futures price for the
applicable trading months of 1997 and 1998. In addition, there
were $6.4 million of realized losses on hedging activities which
were deferred and will be applied as a decrease in revenues in
October 1997, the applicable month of physical sale of
production.
12
RESERVE REVISION AND IMPAIRMENT OF PRODUCING OIL AND GAS
PROPERTIES
Statement of Financial Accounting Standards No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of", (SFAS 121) provides for the recognition of
losses when events or changes in circumstances indicate that the
carrying value of long-lived assets may not be realized. When
there is evidence that the cost of such assets may not be
realized based upon periodic evaluation, SFAS 121 requires the
carrying values of long-lived assets be written down to fair
values. The Company estimates fair values using the present value
of expected future cash flows for each significant oil and gas
field.
Early in 1997, EEX began a review and evaluation of the
commercial feasibility of its non-producing oil and gas
reserves. The Company has announced, based upon a preliminary
evaluation, that it expects a material downward revision of its
oil and natural gas reserves, primarily in its behind pipe and
proved undeveloped reserves in East Texas and its proved
undeveloped reserves in the deep-water Gulf of Mexico. While
additional analysis is required and is currently in progress, EEX
management believes that the study progressed sufficiently during
the third quarter of 1997 that the amount of the year-end 1997
downward revision could be reasonably estimated to approximate
670 billion cubic feet of gas equivalent.
As a result of the estimated downward revision of reserves, the
Company reexamined the carrying value of its properties as a part
of the overall process. In order to determine whether its assets
had been impaired, EEX grouped its producing properties by
fields, which it believes is the lowest level for which cash
flows are reasonably and separately identifiable, and determined
that anticipated future cash flows based on the revised reserve
estimations and development plans were insufficient to recover
the carrying value of certain fields. Accordingly, the carrying
value of such fields were reduced to fair value, and EEX recorded
a $137 million after-tax, ($210 million pre-tax) charge for
impairment at the end of the third quarter 1997.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
EEX generated sufficient cash flows from operations and property
sales to fund its capital requirements and reduce financings by
$80 million. Net cash flows from operating activities were
$151 million, an increase of $33 million over 1996 largely due
to higher commodity prices during the first quarter of 1997 and
changes in current operating assets and liabilities. Net cash
flows used for investing activities in 1997 were $79 million, a
$10 million increase from 1996.
EEX intends to utilize substantially all of its internally
generated cash flows for growth of the business and expects to
have sufficient cash flow from operations and the continuous
monetization of non-core assets to fund its business plans.
Borrowings under EEX's credit facilities may be used to
supplement temporary cash flow needs. EEX does not anticipate
paying cash dividends in the foreseeable future.
13
Capital Structure
In the third quarter 1997, EEX redeemed, at the stated value of
$150 million, all the outstanding mandatorily redeemable
preferred securities of a subsidiary. The redemption was funded
by private sales of new issues of preferred securities by EEX
subsidiaries. The new preferred securities are redeemable at the
option of the subsidiaries and are reflected on the condensed
consolidated balance sheet as "Minority Interests in Preferred
Securities of Subsidiaries". After the redemption, debt at
September 30, 1997 represented 49% of total capitalization of
$573 million, compared to 51%, including the mandatorily
redeemable preferred securities of a subsidiary, of total
capitalization of $1 billion at December 31, 1996. The
reduction in total capitalization at September 30, 1997 was due
to the reduction in shareholders' equity from the third quarter
1997 non-cash impairment of producing oil and gas properties and
the reduction in debt resulting from redemption of the
mandatorily redeemable preferred securities.
OFFSHORE EXPLORATION JOINT VENTURE
On July 1, 1997 EEX announced agreement with Enterprise Oil Plc
("Enterprise") to participate in an exploration venture to
evaluate EEX's portfolio of offshore blocks in the deep water of
the Gulf of Mexico.
The agreement, covering approximately 78 blocks primarily in the
areas of Garden Banks, Green Canyon and Mississippi Canyon, was
closed on September 15, 1997 and all required governmental
approvals have been obtained. Excluded from the agreement are
reserves at Green Canyon 254 (Allegheny Project) and reserves
and production facilities at Mississippi Canyon and Garden Banks
388 (Cooper Project).
Under the agreement, approved by the Boards of each company,
Enterprise will pay $65 million, which will be used to fund
EEX's exploration drilling costs and in return receive an
immediate assignment of 50% of EEX's deep water portfolio.
A further $35 million to be funded by Enterprise is contingent
on drilling successes and the announcement of at least two
commercial developments. Enterprise will immediately become a
full partner in the relevant Joint Operating Agreements.
The companies intend to conduct a 10 to 12 well drilling program
over the next two and one-half years utilizing two rigs capable
of drilling in 3,300 feet of water. The rigs are under long-term
contract to EEX at below market day rates. EEX has filed suit in
the 11th District Court of Harris County, Texas alleging, among
other claims, anticipatory breach of one of the rig contracts
which provides EEX with daily rig rates substantially less than
current market rates. EEX is seeking a declaratory judgment that
the contract includes a three year Option Term. Unfavorable
settlement of this matter could materially impact future offshore
deep water drilling costs. The first well has been spudded on
the Llano prospect in Garden Banks 386 and is currently drilling
below 18,000 feet towards a proposed depth of 25,000 feet.
Results are expected to be known by the end of the fourth
quarter. The second well in this program is expected to be
spudded in the fourth quarter.
14
FORWARD LOOKING STATEMENTS - UNCERTAINTIES AND RISKS
Written statements throughout this report on Form 10-Q relating
to EEX management's intentions, hopes, beliefs, expectations or
predictions of the future are forward-looking statements. It is
important to note that EEX's actual results could differ
materially from those projected in such forward-looking
statements. Information concerning some of the factors that could
cause actual results to differ materially from those in the
forward-looking statements are described below.
Estimating Reserves and Future Net Cash Flows. Uncertainties are
inherent in estimating quantities and values of reserves and in
projecting rates of production, net revenues and the timing of
development expenditures. The reserve data represent estimates
only of the recovery of hydrocarbons from underground
accumulations and are often different from the quantities
ultimately recovered. Any downward adjustment in reserve
estimates could adversely affect EEX.
Operational Risks and Hazards. EEX's operations are subject to
the risks and uncertainties associated with finding, acquiring
and developing gas and oil properties, and producing,
transporting and selling gas and oil. Operations may be
materially curtailed, delayed or canceled as a result of numerous
factors, such as accidents, weather conditions, compliance with
governmental requirements and shortages or delays in the delivery
of equipment. Drilling may involve unprofitable efforts, not
only with respect to dry wells, but also with respect to wells
that are productive but do not produce sufficient net revenues to
return a profit after drilling, operating and other costs.
Various field operating hazards such as fires, explosions,
blow-outs, equipment failures, abnormally pressured formations
and environmental accidents may adversely affect production from
successful wells. EEX's ability to sell its gas and oil
production is dependent on the availability and capacity of
gathering systems, pipelines and other forms of transportation.
Offshore Risks. EEX's offshore Gulf of Mexico gas and oil
reserves include properties located in water depths of 20 to
3,400 feet where operations are by their nature more difficult
than drilling operations conducted on land. Deep water drilling
and operations require the application of more advanced
technologies, involving a higher risk of mechanical failure and
inevitably resulting in significantly higher drilling and
operating costs. Furthermore, offshore operations require a
significant amount of time between the time of discovery and the
time the gas or oil is actually marketed, increasing the market
risk involved with such operations.
Volatility of Gas and Oil Markets. EEX's operations are highly
dependent upon the prices of, and demand for, gas and oil. These
prices have been, and are likely to continue to be, volatile.
Prices are subject to fluctuations in response to a variety of
factors that are beyond the control of EEX, such as worldwide
economic and political conditions as they affect actions of OPEC
and Middle East and other producing countries, and the price and
availability of alternative fuels. EEX's hedging activities
with respect to some of its
15
projected oil and gas production, which are designed to protect
against price declines, may prevent EEX from realizing the
benefits of price increases above the levels of the hedges and
protect it from incurring the detriments of price decreases below
the level of hedges. Because EEX's reserve base is approximately
80% natural gas on an energy equivalent basis, it is more
sensitive to fluctuations in the price of natural gas.
Government Regulation. EEX's business is subject to certain
federal, state and local laws and regulations relating to the
drilling for the production of gas and oil, as well as
environmental and safety matters.
16
ENSERCH EXPLORATION, INC.
SUMMARY OF SELECTED OPERATING DATA (UNAUDITED)
Three Months Ended Nine Months Ended
September 30 September 30
------------------- -----------------
1997 1996 1997 1996
------ ------ ------ ------
Sales Volumes
Natural gas (MMcf) 22,022 25,561 64,173 76,501
Oil and condensate (MBbls) 1,223 1,352 3,652 3,726
Natural gas liquids (MBbls) 179 209 365 572
Total volumes (MMcfe) (a) 30,434 34,957 88,275 102,289
Average Sales Price
Natural gas (per Mcf) $ 2.32 $ 2.01 $ 2.41 $ 2.11
Oil and condensate (per Bbl) 17.88 19.86 19.50 18.94
Natural gas liquids (per Bbl) 12.16 13.39 13.61 11.26
Total product revenue
(per Mcfe) (a) 2.47 2.32 2.62 2.33
Cost and Expenses (per Mcfe) (a) (b)
Production and operating (c) $ .40 $ .53 $ .42 $ .54
Exploration .83 .81 .74 .67
Depreciation and amortization 1.27 1.24 1.27 1.18
General, administration and other .25 .21 .25 .23
Taxes, other than income .15 .15 .15 .16
Net Wells
Drilled 16 30 45 84
Productive 9 22 33 64
(a) Oil and natural gas liquids have been converted to Mcf
equivalents (Mcfe) on the basis of one barrel equals 6.0 Mcfe.
(b) Excludes unusual and non-recurring expenses.
(c) Excludes related production, severance and ad valorem taxes.
17
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a)
EXHIBIT
NNUMBER
3.1 Restated Articles of
Incorporation of the Registrant (included as
Annex C to the Joint Proxy Statement/Prospectus
filed as Exhibit 3.1 to the Company's
Registration Statement on Form S-4 (No. 333-
13241).(1)
3.2 Bylaws of the Registrant.(2)
4.1 Form of Common Stock Certificate included as
Exhibit 4.1 to the Registration Statement of
Old EEX on Form S-4 (No. 33-56792).(1)
4.2 Rights Agreement dated as of September 10,
1996, between the Company (formerly Lone Star
Gas Company) and Harris Trust Company of New
York as Rights Agent, filed as Exhibit 10.21 to
the Company's Registration Statement on Form S-
4 (No. 333-13241).(1)
4.3 Subscription Agreement among EEX Capital Inc.
and UBS Securities LLC, as Placement Agent for
the Holders from time to time of the Preferred
Stock and Enserch Exploration, Inc. (not an
issuer), effective as of September 29, 1997.(2)
4.4 Amended and Restated Certificate of
Designations, Preferences and Relative,
Participating, Optional and Other Special
Rights -- Class A Cumulative Perpetual
Increasing Dividend Preferred Stock of EEX
Capital Inc.(2)
4.5 $150,000,000 Subordinated Note made by Enserch
Exploration, Inc. in favor of EEX Capital,
Inc.(2)
10.1 Lease Agreement for Garden Banks 388-1 between
Old EEX and Enserch Exploration Holdings, Inc.
(formerly Enserch Exploration, Inc.") included
as Exhibit 10.3 to the Registration Statement
of Old EEX on Form S-4 (No. 33-56792).(1)
10.2 Lease Agreement for Garden Banks 388-2 between
Old EEX and Enserch Exploration Holdings, Inc.
(formerly "Enserch Exploration, Inc.") included
as Exhibit 10.4 to the Registration Statement
of Old EEX on Form S-4 (No. 33-56792).(1)
18
10.3 Lease Agreement for Mississippi Canyon 441
between Old EEX and Enserch Exploration
Holdings, Inc. (formerly "Enserch Exploration,
Inc.") included as Exhibit 10.5 to the
Registration Statement of Old EEX on Form S-4
(No. 33-56792).(1)
10.4 Participation Agreement between EP Operating
Limited Partnership and Mobil Producing Texas
and New Mexico Inc. included as Exhibit 10.6
to the Registration Statement of Old EEX on
Form S-4 (No. 33-56792).(1)
10.5 Stock Purchase Agreement dated as of April 12,
1995, By and Between PG&E Enterprises, as
Seller and Old EEX, as Buyer, filed as Exhibit
10.7 to the Registration Statement of Old EEX
on Form S-2 (No. 33-60461) .(1)
10.6 Credit Agreement among Enserch Exploration,
Inc. as Borrower, Texas Commerce Bank National
Association, as Administrative Agent, The Chase
Manhattan Bank, N.A., as Syndication Agent,
Chemical Bank, as Auction Agent and The Lenders
now or hereafter Parties hereto dated as of May
1, 1995, and First Amendment dated September
16, 1996, Second Amendment dated June 27, 1997
and Third Amendment, dated September 25,
1997.(2)
10.7 Tax Sharing Agreement between ENSERCH
Corporation and Old EEX, filed as Exhibit 10.21
to the Registration Statement of Old EEX on
Form S-2 (No. 33-60461) .(1)
10.8 Form of Tax Allocation Agreement among ENSERCH,
the Company and Texas Utilities Company and
attached Tax Sharing Agreement dated as of
January 1, 1995 between ENSERCH and EEX
(included as Annex A-3 to the Agreement and
Plan of Merger filed as Exhibit 2 to the
Company's Registration Statement on Form S-4
(No. 333-13241).(1)
10.9 Form of Tax Assurance Agreement between ENSERCH
and the Company (included as Annex A-4 to the
Agreement and Plan of Merger filed as Exhibit 2
to the Company's Registration Statement on Form
S-4 (No. 333-13241).(1)
Executive Compensation Plan and Arrangements
(Exhibits 10.10 through 10.15):
10.10 Enserch Exploration, Inc. Revised and Amended
1996 Stock Incentive Plan, included as Annex A-
2 to the Agreement and Plan of Merger filed as
Exhibit 2 to the Company's Registration
Statement on Form S-4 (No. 333-13241).(1)
10.11 Performance Incentive Plan - Calendar Year 1997
filed as Exhibit 10.15 to the Form 10-K for the
year ended December 31, 1996, of Old EEX.(1)
10.12 The Company's Deferred Compensation Plan
effective as of July 1, 1997.(2)
10.13 Deferred Compensation Trust effective as of
July 1, 1997.(2)
19
10.14 Form of Change of Control Agreement executed by
certain executive officers of the Company,
filed as Exhibit 10.20 to the Annual Report on
Form 10-K for the year ended December 31, 1996
of Old EEX.(1)
10.15 Form of Employment Agreement executed by
certain executive officers of the Company,
filed as Exhibit 10.20 to the Annual Report on
Form 10-K for the year ended December 31, 1996
of Old EEX.(1)
27 Financial Data Schedule(2)
(1) Incorporated by reference.
(2) Filed herewith.
(b) Reports on Form 8-K
Current Report on Form 8-K dated August 4, 1997.
(News Release dated August 4, 1997: Enserch
Exploration announced it expects a material downward
revision of its oil and gas reserves.)
Current Report on Form 8-K dated August 5, 1997.
1. Item 2 -- Merger with Enserch Exploration, Inc.
2. Item 5 -- Pro Forma Financial Information.
Current Report on Form 8-K dated August 6, 1997.
(Consummation of merger of Enserch Exploration, Inc.
and Lone Star Energy Plant Operations.)
Current Report on Form 8-K dated September 25, 1997.
(Change in EEX's certifying accountant.)
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
ENSERCH EXPLORATION, INC.
(Registrant)
Dated November 12, 1997 By /s/R. S. Langdon
-------------------------------
R. S. Langdon
Executive Vice President,
Finance and Administration,
and Chief Financial Officer
Dated November 12, 1997 By /s/R. E. Schmitz
-------------------------------
R. E. Schmitz
Vice President
and Controller
21