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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, 1997
or
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from to
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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
----- -----
NUMBER OF SHARES OF COMMON STOCK OUTSTANDING
AS OF OCTOBER 31, 1997 . . . . . . . . . . . . . . . . . . . 10,268,000
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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
Consolidated Balance Sheets as of September 30, 1997
(unaudited) and December 31, 1996 . . . . . . . . . . . . 3
Consolidated Statements of Operations for the three and
nine months ended September 30, 1997 and
1996 (unaudited). . . . . . . . . . . . . . . . . . . . . 4
Consolidated Statements of Cash Flows for the three and
nine months ended September 30, 1997 and
1996 (unaudited). . . . . . . . . . . . . . . . . . . . . 5
Notes to Consolidated Financial Statements (unaudited). . . 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . 9
PART II - OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . 15
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COSTILLA ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 6,580 $ 12,618
Accounts receivable:
Trade, net 6,597 6,675
Affiliates - 332
Oil and gas sales 10,758 9,031
Prepaid and other current assets 508 1,753
-------- --------
Total current assets 24,443 30,409
-------- --------
PROPERTY, PLANT AND EQUIPMENT, AT COST:
Oil and gas properties, using the successful efforts
method of accounting:
Proved properties 204,125 140,477
Unproved properties 33,021 4,482
Accumulated depletion, depreciation and amortization (35,287) (20,435)
-------- --------
201,859 124,524
Other property and equipment, net 3,386 2,420
-------- --------
Total property, plant and equipment 205,245 126,944
-------- --------
OTHER ASSETS:
Deferred charges 4,318 4,503
Note receivable - other 250 250
Other 3,258 684
-------- --------
Total other assets 7,826 5,437
-------- --------
$237,514 $162,790
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt $ 5,198 $ 98
Trade accounts payable 20,945 12,718
Undistributed revenue 4,431 3,517
Other current liabilities 6,502 3,756
-------- --------
Total current liabilities 37,076 20,089
-------- --------
LONG-TERM DEBT, LESS CURRENT MATURITIES 162,506 100,262
-------- --------
OTHER NONCURRENT LIABILITIES - 1,870
-------- --------
STOCKHOLDERS' EQUITY :
Preferred stock, $.10 par value (3,000,000 shares
authorized; no shares outstanding) - -
Common stock, $.10 par value (20,000,000 shares authorized;
10,268,000 shares outstanding at September 30, 1997 and
10,475,000 shares outstanding at December 31, 1996) 1,027 1,047
Additional paid-in capital 38,665 41,081
Retained earnings (deficit) (1,760) (1,559)
-------- --------
Total stockholders' equity 37,932 40,569
-------- --------
COMMITMENTS AND CONTINGENCIES - -
-------- --------
$237,514 $162,790
-------- --------
-------- --------
See accompanying notes to consolidated financial statements.
3
COSTILLA ENERGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
1997 1996 1997 1996
-------- -------- -------- --------
REVENUES:
Oil and gas sales $19,339 $15,343 $54,231 $34,787
Other (38) 89 882 169
------- ------- ------- -------
19,301 15,432 55,113 34,956
------- ------- ------- -------
EXPENSES:
Oil and gas production 6,875 6,451 21,038 14,729
General and administrative 2,172 1,132 5,543 3,941
Exploration and abandonments 634 698 3,748 1,006
Depreciation, depletion and amortization 6,038 3,454 15,758 8,073
Interest 3,340 4,274 8,856 8,430
------- ------- ------- -------
19,059 16,009 54,943 36,179
------- ------- ------- -------
Income (loss) before federal income taxes 242 (577) 170 (1,223)
PROVISION FOR FEDERAL INCOME TAXES
Current - 17 62 17
Deferred 90 - 90 -
------- ------- ------- -------
Income (loss) before extraordinary item 152 (594) 18 (1,240)
Extraordinary loss resulting from early
extinguishment of debt, net of deferred
tax benefit of $129 (219) - (219) (1,640)
------- ------- ------- -------
NET LOSS $ (67) $ (594) $ (201) $(2,880)
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------- ------- ------- -------
PREFERRED RETURN AND ACCRETION OF
REDEEMABLE MEMBERS' CAPITAL $ - $ (825) $ - $(2,420)
------- ------- ------- -------
------- ------- ------- -------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM
APPLICABLE TO COMMON EQUITY $ 152 $(1,419) $ 18 $(3,660)
------- ------- ------- -------
------- ------- ------- -------
NET LOSS APPLICABLE TO COMMON EQUITY $ (67) $(1,419) $ (201) $(5,300)
------- ------- ------- -------
------- ------- ------- -------
INCOME (LOSS) PER SHARE:
Income (loss) before extraordinary item $ 0.01 $ (0.27) $ 0.00 $ (0.70)
Extraordinary loss resulting from
early extinguishment of debt, net of
deferred tax benefit of $129 (0.02) - (0.02) (0.32)
------- ------- ------- -------
NET LOSS $ (0.01) $ (0.27) $ (0.02) $ (1.02)
------- ------- ------- -------
------- ------- ------- -------
WEIGHTED AVERAGE SHARES OUTSTANDING 10,340 5,200 10,425 5,200
------- ------- ------- -------
------- ------- ------- -------
See accompanying notes to consolidated financial statements.
4
COSTILLA ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- -----------------------
1997 1996 1997 1996
-------- -------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
NET LOSS $ (67) $ (594) $ (201) $ (2,880)
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO
NET CASH PROVIDED BY OPERATING ACTIVITIES:
Depreciation, depletion and amortization 6,038 3,454 15,758 8,073
Exploration and abandonments 78 - 136 -
Amortization of deferred charges 604 824 1,214 993
Deferred income tax expense (39) - (39) -
Allowance for doubtful accounts - - 208 -
Other noncash - - - 79
Gain (loss) on sale of oil and gas properties - (33) 30 (73)
Extraordinary loss resulting from early extinguishment of debt 348 - 348 1,640
Gain on investment transactions 447 - (534) -
-------- ------- -------- --------
7,409 3,651 16,920 7,832
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (3,181) (5,444) (1,317) (6,653)
(Increase) decrease in other assets (3,240) 901 (3,669) (1,289)
Increase (decrease) in accounts payable 5,707 5,302 9,142 4,422
Increase (decrease) in other liabilities 2,555 810 2,747 1,482
Decrease in deferred revenue - (536) - (1,232)
-------- ------- -------- --------
Net cash provided by operating activities 9,250 4,684 23,823 4,562
-------- ------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to oil and gas properties (61,854) (5,299) (97,732) (53,026)
Proceeds from sale of oil and gas properties 2,460 - 5,169 -
Additions to other property and equipment (378) (172) (1,663) (2,168)
-------- ------- -------- --------
Net cash used in investing activities (59,772) (5,471) (94,226) (55,194)
-------- ------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under long-term debt 72,704 2,817 87,304 128,207
Payments of long-term debt (19,923) - (19,960) (74,519)
Proceeds from issuance of common stock, net - - 14 -
Purchase of common stock (1,203) - (2,451) -
Deferred loan and financing costs (481) (1,245) (542) (3,973)
-------- ------- -------- --------
Net cash provided by financing activities 51,097 1,572 64,365 49,715
-------- ------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 575 785 (6,038) (917)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 6,005 1,164 12,618 2,866
-------- ------- -------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 6,580 $ 1,949 $ 6,580 $ 1,949
-------- ------- -------- --------
-------- ------- -------- --------
See accompanying notes to consolidated financial statements.
5
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The interim financial information as of September 30, 1997, and for the
nine months ended September 30, 1997 and 1996, 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, 1996.
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 West Texas and Southeast New Mexico, South and
East Texas, and the Rocky Mountain regions of the United States.
2. EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("FAS") No. 128, Earnings per Share. FAS No.
128 establishes standards for computing and presenting earnings per share and is
effective for periods ending after December 15, 1997. The impact of the adoption
of FAS No. 128 on the Company's earnings per share is expected to be immaterial.
3. DERIVATIVE FINANCIAL INSTRUMENTS
The Company utilizes derivative financial instruments to manage well-defined
interest rate and commodity price risks. The Company is exposed to credit
losses in the event of nonperformance by the counterparties to its interest rate
swap agreements and its commodity hedges. The Company anticipates, however,
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 option contracts to hedge the effect
of price changes on future oil and gas production. 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 put option.
6
The following table sets forth the future volumes hedged by year and the
weighted-average strike price of the option contracts at September 30, 1997:
Oil Gas
Volume Volume Strike Price
(Bbls) (Mmbtu) per Bbl/Mmbtu
---------- ---------- --------------------
Oil:
1997. . . . . . . . . . . . 1,028,000 - $17.65 - $22.02(a)
1998. . . . . . . . . . . . 1,579,500 - $18.50 - $22.55(a)
Gas:
1997. . . . . . . . . . . . - 755,000 $1.87(b)
1998. . . . . . . . . . . . - 1,520,000 $2.00(b)
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(a) Represents the weighted-average price of a purchased put option
contract and of a collar established with the purchase of a put option
contract and the sale of a call option contract.
(b) Represents the strike price on purchased put option contracts.
INTEREST RATE SWAP AGREEMENTS. Prior to the Offerings, the Company
utilized two interest rate swap agreements to reduce the potential impact of
increases in interest rates on floating-rate long-term debt. Concurrent with
the issuance of the $100 million of 10.25% fixed-rate senior notes in early
October 1996, the two interest rate swap agreements ceased to be hedges. These
interest rate swap agreements were marked-to-market and the related liability
recorded. The liability for the two interest rate swap agreements was
$1,712,000 at December 31, 1996. A $60 million interest rate swap agreement
expired in May, 1997. As a result of the Company's borrowings against its line
of credit, which bears interest on a floating rate basis, the remaining interest
rate swap agreement again qualifies as a hedge during the third quarter of 1997.
At each borrowing date, the interest rate swap agreement was marked-to-market
and the hedge portion is being amortized over the remaining life of the
agreement. As a result of expiration and marking the agreements to market
during the three and nine month periods ended September 30, 1997, the Company
recorded a net investment loss of approximately $69,000 for the three month
period then ended and net investment income of $534,000 for the nine month
period then ended. The following table sets forth the term, fixed rate and
notional amounts of the interest rate swap agreement in place as of September
30, 1997:
NOTIONAL
PRINCIPAL FIXED
TERM AMOUNT INTEREST RATE
------------------------------ ----------- -------------
Jan. 25, 1996 to Jan. 25, 1999 $24 million 7.50%
4. ACQUISITIONS
On August 28, 1997, the Company consummated the purchase from Ballard
Petroleum LLC ("Ballard") of certain oil and gas properties for an estimated
adjusted purchase price of approximately $41.2 million (the "Ballard
Acquisition"). The properties are located primarily in the Rocky Mountain
region of the United States. The transaction was accounted for using the
purchase method. The results of operations of the acquired properties are
included in the Consolidated Statements of Operations as of the acquisition
closing date, August 28, 1997. In addition, the Company and Ballard have
entered into an Acquisition and Exploration Agreement that establishes an
area of mutual interest in the Rocky Mountain Region in which the parties
will jointly own, acquire, explore and develop properties.
On June 14, 1996, the Company consummated the purchase from Parker and
Parsley Petroleum Company of certain oil and gas properties for an estimated
adjusted purchase price of approximately $38.7 million (the "1996 Acquisition").
The properties are located primarily in south and west Texas. The transaction
was accounted for using the purchase method. The results of operations of the
acquired properties are included in the Consolidated Statements of Operations
beginning on the acquisition closing date, June 14, 1996.
7
PRO FORMA RESULTS OF OPERATIONS
The following table reflects the pro forma results of operations for the
nine months ended September 30, 1997 and 1996, as though the 1996
Acquisition, the Offerings and the Ballard Acquisition had each occurred as
of January 1, 1996. The pro forma amounts are not necessarily indicative of
results that may be reported in the future.
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
1997 1996
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(IN THOUSANDS)
Revenues $60,801 $52,665
Net loss before extraordinary items (1,125) (1,104)
Net loss per share before extraordinary items $ (0.11) $ (0.11)
5. GAS IMBALANCES
The Company uses the entitlements method of accounting for natural gas
revenues. Under this method, revenues are recognized based upon actual
production of natural gas. As of September 30, 1997, the Company had recorded a
net gas imbalance receivable for gas previously produced of approximately
$2,743,000, comprised of approximately 1,647,000 mcf at a net price of $1.67 per
mcf.
6. 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, with an initial borrowing base of $50.0 million,
$37.5 million of which was borrowed at September 30, 1997. 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 of not less than 2.50 to 1
and (iii) a minimum tangible net worth. Borrowings under the Revolving Credit
Facility are secured by substantially all of the assets of the Company.
In August 1997, the Company also entered into a second credit agreement (the
"Acquisition Credit Facility") with Bankers Trust company, as agent, to provide
funds for a substantial portion of the Ballard Acquisition purchase price. The
Acquisition Credit Facility is a term loan in the amount of $30.0 million and is
subject to a borrowing base to be determined at least semi-annually. Borrowings
under the Acquisition Credit Facility bear interest, at the Company's option, at
a floating rate which is above the Lender's prime rate or the applicable
Eurodollar rate. Interest is payable quarterly as to base rate loans, and at
the end of the applicable interest period as to Eurodollar loans. Principal
payments commence in February 1998, and are $1.7 million quarterly for the first
year and $1.4 million each quarter thereafter for two years, with all remaining
amounts due at maturity, February 28, 2001. Borrowings under the Acquisition
Credit Facility are secured by the assets acquired in the Ballard Acquisition.
8
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
recent prospectus for its initial public offering of common stock.
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. The Company's
predecessor began operating in 1988 and through mid-1995 had grown primarily
through a series of small acquisitions of oil and gas properties and the
exploitation of those properties. In June 1995, Costilla consummated the
acquisition of certain oil and gas properties for a purchase price of
approximately $46.6 million (the "1995 Acquisition"), in June 1996, Costilla
consummated the acquisition of certain oil and gas properties for a purchase
price of approximately $38.7 million (the "1996 Acquisition") and in August
1997, Costilla consummated the purchase of certain oil and gas properties for
a purchase price of approximately $41.2 million (the "Ballard Acquisition").
Costilla'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 with 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 exploitation of acquired properties.
To date, the Company has achieved its high rate of growth 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. In addition, the rapid growth of the Company has required it to
develop operating, accounting and administrative personnel compatible with its
increased size. The Company believes it has now achieved a sufficient size to
expand its reserve base without a corresponding increase in its general and
administrative expense. The Company also believes it now has a sufficient
inventory of prospects and the professional staff necessary to follow a more
balanced program of exploration and development activities to complement its
acquisition efforts.
9
Costilla has shown a significant increase in its oil and gas reserves and
production, especially due to its acquisitions from 1995 through 1997. The
following table sets forth certain operating data of Costilla for the periods
presented:
Three Months Ended Six Months Ended
September 30, September 30,
----------------------- ----------------------
1997 1996 1997 1996
-------- -------- -------- --------
OIL AND GAS PRODUCTION:
Oil (Mbbls) 565 502 1,601 1,211
Gas (Mmcf) 4,824 2,698 11,545 6,202
MBOE (1) 1,369 951 3,525 2,245
AVERAGE SALES PRICES:
Oil (per Bbbl) $ 16.91 $ 20.02 $ 18.08 $ 18.92
Gas (per Mcf) 2.03 1.96 2.19 1.92
COSTS PER BOE (1):
Production cost $ 5.02 $ 6.78 $ 5.97 $ 6.56
Depreciation, depletion and amortization 4.40 3.63 4.47 3.60
General and administrative expenses 1.59 1.19 1.57 1.76
(1) BOE represents equivalent barrels of oil. In reference to natural gas,
natural gas equivalents are determined using the ratio of six Mcf of
natural gas to one barrel of crude oil, condensate or natural gas liquids.
MBOE represents one thousand barrels of oil equivalent.
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 units-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 option contracts to hedge the effect of price changes
on a portion of its future oil and gas production. Premiums paid and amounts
receivable under the 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 sale by the proceeds received from the
related option. The net effect of the Company's commodity hedging activities
reduced oil and gas revenues by $338,950 for the three months ended September
30, 1997, by $563,074 for the three months ended September 30, 1996, by
$1,085,280 for the nine months ended September 30, 1997 and by $1,254,829 for
the nine months ended September 30, 1996. As of October 31, 1997, the Company
had purchased put options on 6,500 barrels of oil per day which establish a
floor price of $18.50 per barrel and sold call options on 6,500 barrels of oil
per day at $22.55 per barrel. These option contracts continue through August
1998. Additionally, the Company had purchased put options on 5,000 Mmbtu of gas
per day which provide for a floor of $2.00 per Mmbtu through October 1998.
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 the Credit Agreement. The net effect of the Company's interest
rate hedging activities increased interest expense by $359,000 for the nine
months and $328,000 for the
10
three months ended September 30, 1996. Concurrent with the payment of all of
the Company's floating rate debt from proceeds of the Offerings in the fourth
quarter of 1996, the interest rate swap agreements ceased to qualify as hedges.
These interest rate swap agreements were marked-to-market and the related
liability recorded. A $60 million interest rate swap expired in May, 1997. As
a result of the Company's borrowings against its line of credit, which bears
interest on a floating rate basis, the remaining interest rate swap agreement
again qualifies as a hedge during the third quarter of 1997. At each borrowing
date, the interest rate swap agreement was marked-to-market and the hedge
portion is being amortized over the remaining life of the agreement. As a
result of expiration and marking the agreements to market during the three and
month periods ended September 30, 1997, the Company recorded a net investment
loss of approximately $69,000 for the three month period then ended and net
investment income of $534,000 for the nine month period then ended.
The Company's predecessors were classified as partnerships for federal
income tax purposes. Therefore, no income taxes were paid or provided for by
the Company prior to the Offerings. Future tax amounts, if any, will be
dependent upon several factors, including but not limited to the Company's
results of operations.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1996
The Company's total oil and gas revenues for the three months ended
September 30, 1997 were $19,339,000, representing an increase of $3,996,000
(26%) over revenues of $15,343,000 in 1996. Gas imbalances accounted for
approximately $2,743,000 (69%) of the increase, with an average price of $1.67
per mcf. Approximately 50% of the gas imbalance relates to production in prior
periods against which a valuation allowance had been recorded due to uncertainty
of ultimate collection. During the quarter ended September 30, 1997,
uncertainties related to these imbalances were substantially reduced and the
related valuation allowance reversed. Management does not expect similar
effects from gas imbalances in future periods. In addition, the Ballard
Acquisition accounted for approximately $935,000 of the increase. The remainder
of the increase was due to a combination of successful drilling activities and
the enhancement of existing production offset by lower oil prices. The average
oil price per barrel received in 1997 was $16.91 compared to $20.02 in 1996, a
16% decrease, and the average gas price received in 1997 was $2.03 compared to
$1.96 in 1996, a 3% increase.
Oil and gas reported production was 1,369 MBOE in 1997 compared to 951
MBOE in 1996, a 44% increase. Of the 418 MBOE increase, gas imbalances
accounted for approximately 274 MBOE of the increase, offset partially by 122
MBOE attributable to a change in prior production estimates. The Ballard
Acquisition properties accounted for approximately 66 MBOE of the increase.
The remainder of the increase was due to a combination of successful drilling
activities and the enhancement of existing production.
Other loss was $38,000 for the three month period ended September 30, 1997
compared to income of $89,000 for the comparable 1996 third quarter period,
representing a 143% decrease. Interest and other revenues were $101,000 for the
three months ended September 30, 1997 compared to $48,000 in 1996, representing
an increase of $53,000, virtually all of which was related to increased interest
income due to increased funds earning interest. Losses on investment
transactions of $139,000 were recorded for the three months ended September 30,
1997 as a result of marking to market certain option contracts. No comparable
transactions existed in 1996.
Oil and gas production costs for the three month period ended September 30,
1997 were $6,875,000 ($5.02 per BOE), compared to $6,451,000 in 1996 ($6.78 per
BOE), representing an increase of $423,000 (7%), due principally to the Ballard
Acquisition. On a per BOE basis, production costs decreased $1.76 (26%) due to
a combination of the sale of certain high operating cost properties in April,
1997, the gas imbalance volumes and lower production costs on newly completed
wells. Of the $1.76 per BOE decrease in production costs, the net reduction
due to the gas imbalance volumes and the change in previous production
estimates was approximately $0.63 per BOE.
General and administrative expenses for the three months ended September 30,
1997 were $2,172,000, representing an increase of $1,101,000 (103%) from 1996 of
$1,132,000. The increase is primarily due to an increase in personnel and
related costs necessary to accommodate the acceleration of the Company's oil and
gas activities, the Ballard Acquisition, increased insurance costs and costs
related to becoming a public company in October, 1996.
11
Exploration and abandonment expense decreased to $634,000 for the three
months ended September 30, 1997 compared to $698,000 in 1996. The Company
incurred $90,000 of seismic costs for the three months ended September 30, 1997,
compared to $601,000 in the comparable period in 1996. Dry hole and abandonment
costs increased to $343,000 in 1997 from $97,000 in 1996. The Company incurred
$201,000 of other geological and geophysical costs during the three month period
ended September 30, 1997. No comparable costs were incurred during the same
period in 1996. The increase in exploration and abandonments expense was
primarily related to the Company's increased drilling activities in 1997
compared to a very low level of activity in 1996.
Depreciation, depletion and amortization expense for the three month
period ended September 30, 1997 was $6,038,000 compared to $3,454,000 for
1996, representing an increase of $2,584,000 (75%). During the 1997 period,
depreciation, depletion and amortization ("D D & A") on oil and gas
production was provided at an average rate of $4.41 per BOE compared to $3.63
per BOE for 1996. Approximately $1,232,000 of the increase was due to to the
recording of gas imbalances. The remainder of the increase was due primarily
to the Company's decision to increase the D D & A rate based upon the
expectation of lower oil and gas prices during 1997 than those experienced at
December 31, 1996.
Interest expense was $3,340,000 for the three months ended September 30,
1997, compared to $4,274,000 for the comparable period in 1996. The $939,000
(22%) decrease was attributable primarily to higher interest rates experienced
during the comparable period in 1996 and the amortization of certain financing
costs. The average amounts of applicable interest-bearing debt in 1997 and 1996
were $134,352,000 and $124,651,000, respectively. The effective annualized
interest rate in 1997 was 9.9%, as compared to 13.7% in 1996.
NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1996
The Company's total oil and gas revenues for the nine months ended September
30, 1997 were $54,231,000, representing an increase of $19,444,000 (56%) over
revenues of $34,787,000 in 1996. This increase was primarily due to the 1996
Acquisition, which accounted for approximately $10,456,000 of increased revenue.
Gas imbalances accounted for approximately $2,743,000 (14%) of the increase,
with an average price of $1.67 per mcf. Approximately 50% of the gas imbalance
relates to production in prior periods against which a valuation allowance had
been recorded due to uncertainty of ultimate collection. During the quarter
ended September 30, 1997, uncertainties related to these imbalances were
substantially reduced and the related valuation allowance reversed. Management
does not expect similar effects from gas imbalances in future periods. The
Ballard Acquisition accounted for approximately $935,000 of the increase with
the remainder of the increase due to a combination of increased gas prices,
successful drilling activities and the enhancement of existing production,
offset by the sale of certain properties in April, 1997 and December 31, 1996
and lower oil prices. The average oil price per barrel received in 1997 was
$18.08 compared to $18.92 in 1996, a 4% decrease, and the average gas price
received in 1997 was $2.19 compared to $1.92 in 1996, a 14% increase.
Oil and gas production was 3,525 MBOE in 1997 compared to 2,245 MBOE in
1996, a 57% increase. Of the 1,280 MBOE increase, approximately 612 MBOE was
due to the properties acquired in the 1996 Acquisition. Gas imbalances
accounted for approximately 274 MBOE of the increase, offset partially by 122
MBOE attributable to a change in prior production estimates. The Ballard
Acquisition properties accounted for approximately 66 MBOE of the increase.
The remainder of the increase was due to a combination of successful drilling
activities and the enhancement of existing production. The sale of certain
properties in April, 1997 and December, 1996 partially offset the increased
production volumes.
Other income was $882,000 for the nine month period ended September 30, 1997
compared to $169,000 for the comparable 1996 nine month period, representing a
421% increase. Interest and other revenues were $462,000 for the nine months
ended September 30, 1997 compared to $96,000 in 1996, representing an increase
of $366,000, virtually all of which was related to increased interest income due
to increased funds earning interest. Gains on investment transactions of
$534,000 were recorded for the nine months ended September 30, 1997 related to
the interest rate swap contract which was marked-to-market. No comparable
transactions existed in 1996. Losses of $70,000 related to the oil collar which
was marked-to-market. No comparable transactions existed in 1996.
12
Oil and gas production costs for the nine month period ended September 30,
1997 were $21,038,000 ($5.97 per BOE), compared to $14,729,000 in 1996 ($6.56
per BOE), representing an increase of $6,308,000 (43%), with approximately
$4,479,000 of the increase relating to the 1996 Acquisition. The remainder of
the increase was due primarily to successful drilling activities and, to a
lesser extent, the Ballard Acquisition, offset by the sale of certain high
operating cost properties in April 1997. On a per BOE basis, production
costs decreased $0.59 (9%) due to a combination of the sale of certain high
operating cost properties in April 1997, the gas imbalance volumes and lower
production costs on newly completed wells. Of the $0.59 per BOE decrease in
production costs, the net reduction due to the gas imbalance volumes and the
change in previous production estimates is approximately $0.27 per BOE.
General and administrative expenses for the nine months ended September 30,
1997 were $5,543,000, representing an increase of $1,602,000 (41%) from 1996 of
$3,941,000. Included in the 1997 amount is a non-cash item for $208,000 related
to a provision for doubtful accounts on a note receivable. The remaining
increase is primarily due to an increase in personnel and related costs
necessary to accommodate the acceleration of the Company's oil and gas
activities, the Ballard Acquisition, increased insurance costs and costs related
to becoming a public company in October, 1996.
Exploration and abandonment expense increased to $3,748,000 for the nine
months ended September 30, 1997 compared to $1,006,000 in 1996. The Company
incurred $983,000 of seismic costs for the nine months ended September 30, 1997,
compared to $605,000 in the comparable period in 1996. Dry hole and abandonment
costs increased to $2,200,000 in 1997 from $401,000 in 1996. The Company
incurred $566,000 of other geological and geophysical costs during the nine
month period ended September 30, 1997. No comparable costs were incurred during
the same period in 1996. The increase in exploration and abandonments expense
was primarily related to the Company's increased drilling activities in 1997
compared to a very low level of activity in 1996.
D D & A expense for the nine month period ended September 30, 1997 was
$15,758,000 compared to $8,073,000 for 1996, representing an increase of
$7,685,000 (95%). During the 1997 period, D D & A on oil and gas production
was provided at an average rate of $4.47 per BOE compared to $3.60 per BOE
for 1996. Approximately $2,735,000 of this increase was due to the 1996
Acquisition and an additional $1,232,000 of the increase was due to to the
recording of gas imbalances. The remainder of the increase was due primarily
to the Company's decision to increase the D D & A rate based upon the
expectation of lower oil and gas prices during 1997 than those experienced at
December 31, 1996.
Interest expense was $8,856,000 for the nine months ended September 30,
1997, compared to $8,430,000 for the comparable period in 1996. The $426,000
(5%) increase was attributable primarily to increased levels of debt offset in
part by a decrease in the effective interest rate. The average amounts of
applicable interest-bearing debt in 1997 and 1996 were $113,077,000 and
$93,429,000, respectively. The effective annualized interest rate in 1997 was
10.4%, as compared to 11.5% in 1996.
Results of operations for the nine months ended September 30, 1997 include
an extraordinary charge of $348,000 compared to $1,640,000 for the comparable
period in 1996. These extraordinary charges related to the early extinguishment
of the Company's prior bank credit facilities and consisted of previously
capitalized debt issuance costs. In August, 1997, the Company entered into the
Revolving Credit Facility and the Acquisition Credit Facility with Bankers Trust
Company. The facilities replaced a credit facility with NationsBank entered
into in 1996. In 1996, a credit facility with NationsBank originating in 1995
was replaced with a bridge loan facility outstanding at September 30, 1996.
LIQUIDITY AND CAPITAL RESOURCES
NET CASH PROVIDED BY OPERATING ACTIVITIES
For the nine months ended September 30, 1997, net cash provided by operating
activities increased to $23.8 million from $4.6 million for 1996. Cash provided
by operations, before changes in operating assets and liabilities, increased to
$16.9 million from $7.8 million for 1996, due primarily to the 1996 Acquisition
and the increase in results of operations therefrom, and also due to increases
in production from new drilling activities.
NET CASH USED IN INVESTING ACTIVITIES
Net cash used in investing activities for the nine months ended
September 30, 1997 was $94.2 million. Approximately $41.2 million was used for
the Ballard Acquisition, $56.5 million was used for exploration and
13
development activities and $1.7 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 $5.2 million. For the nine
months ended September 30, 1996, net cash used in investing activities was $55.2
million. Approximately $38.7 million was used for the 1996 Acquisition, $14.3
million was used for exploration and development activities and $2.2 million
primarily for other property and equipment.
NET CASH PROVIDED BY FINANCING ACTIVITIES
For the nine months ended September 30, 1997, the Company incurred $87.3
million of debt, of which approximately $20.0 million was used to repay certain
prior bank debt, $41.2 million was used for the Ballard acquisition and the
remainder was used in connection with its exploration and development
activities. In addition, the Company used approximately $2.5 million for the
purchase of 213,000 shares of its common stock. For the nine months ended
September 30, 1996, the Company incurred approximately $125.0 million of debt.
Approximately $74.5 million of such amount was used for the extension and
refinancing of prior debt, $38.7 million was used for the 1996 Acquisition and
approximately $11.8 million was used for general corporate purposes.
CAPITAL RESOURCES
Funding for the Company's business activities has historically been provided
by bank financings, cash flow from operations, private equity sales, property
divestitures and joint ventures with industry participants. The Company plans
to finance its continuing operations and execute its business strategy with cash
flow from operations, borrowings under the Revolving Credit Facility, new
borrowings for acquisitions, the possible sale of additional equity and proceeds
from the divestiture of non-core, non-strategic assets.
On August 28, 1997, the Company closed the Ballard Acquisition for
approximately $41.2 million. While the Company regularly engages in discussions
relating to potential acquisitions, the Company has no present agreement,
commitment or understanding with respect to any such acquisition, other than the
acquisition of undeveloped acreage and various mineral interests in its normal
course of business. Any future acquisition may require additional financing and
will be dependent upon financing arrangements available at the time.
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, with an initial borrowing base of $50.0 million,
$37.5 million of which was borrowed at September 30, 1997. 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 of not less than 2.50 to 1
and (iii) a minimum tangible net worth. Borrowings under the Revolving Credit
Facility are secured by substantially all of the assets of the Company.
In August 1997, the Company also entered into a second credit agreement (the
"Acquisition Credit Facility") with Bankers Trust company, as agent, to provide
funds for a substantial portion of the Ballard Acquisition purchase price. The
Acquisition Credit Facility is a term loan in the amount of $30.0 million and is
subject to a borrowing base to be determined at least semi-annually. Borrowings
under the Acquisition Credit Facility bear interest, at the Company's option, at
a floating rate which is above the Lender's prime rate or the applicable
Eurodollar rate. Interest is payable quarterly as to base rate loans, and at
the end of the applicable interest period as to Eurodollar loans. Principal
payments commence in February 1998, and are $1.7 million quarterly for the first
year and $1.4
14
million each quarter thereafter for two years, with all remianing amounts due at
maturity, February 28, 2001. Borrowings under the Acquisition Credit Facility
are secured by the assets acquired in the Ballard Acquisition.
The Company believes that cash flow from operations, supplemented by
borrowings from the Revolving Credit Facility, will be sufficient for its
budgeted 1997 capital expenditures. However, because the Company's ultimate
1997 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, including the Notes, 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.
CAPITAL EXPENDITURES
The Company requires capital primarily for the exploration, development and
acquisition of oil and gas properties, the repayment of indebtedness and general
working capital needs. During the nine months ended September 30, 1997, the
Company expended approximately $56.5 million in oil and gas activities,
excluding the Ballard Acquisition, as a result of the Company's acceleration of
such expenditures during the period. The Company has currently reduced the pace
of its oil and gas exploration and development activities when compared to the
first nine months of 1997 and has approximately $6.2 million budgeted for the
fourth quarter of 1997.
RECENT ACCOUNTING PRONOUNCEMENTS
EARNINGS PER SHARE - In February 1997, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards ("FAS") No. 128,
Earnings per Share. FAS No. 128 establishes standards for computing and
presenting earnings per share and is effective for periods ending after December
15, 1997. The impact of the adoption of FAS No. 128 on the Company's earnings
per share is expected to be immaterial.
REPORTING COMPREHENSIVE INCOME - In June 1997, the FASB issued Statement of
Accounting Standards No. 130 "Reporting Comprehensive Income" ("SFAS 130") which
establishes standards for reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements. Specifically,
SFAS 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 anticipates that it will adopt the provisions of SFAS 130
in its year ended December 31, 1998 consolidated financial statements.
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.
SEGMENT REPORTING - In June 1997, the FASB issued Statement of Accounting
Standards No. 131 "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 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 establishes standards for related disclosures
about products and services, geographic areas, and major customers. SFAS 131 is
effective for financial statements for periods beginning after December 15,
1997.
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.
The Company plans to implement SFAS 131 in its year ended December 31, 1998
financial statements.
15
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
Exhibit
Number Description of Exhibit
------ ----------------------
*10.1 Amended and Restated Credit Agreement dated as of
August 28, 1997 between Bankers Trust Company, as
Agent and Union Bank of California, N.A., as Co-
Agent and the Company
*10.2 Acquisition Credit Agreement dated as of August
28, 1997 between Bankers Trust Company, as Agent
and Union Bank of California, N.A., as Co-Agent
and the Company
*10.3 Purchase and Sale Agreement dated July 2, 1997
between Ballard Petroleum LLC, as seller and the
Company, as buyer
*10.4 Acquisition and Exploration Agreement effective as
of July 1, 1997 by and between Ballard Petroleum
LLC and the Company
*27.1 Financial Data Schedule
* Filed herewith
REPORTS ON FORM 8-K
The Company filed a report on Form 8-K on September 12, 1997
reporting the acquisition of oil and gas properties from Ballard
Petroleum LLC.
16
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.
COSTILLA ENERGY, INC.
Date: November 12, 1997 By: /s/ BOBBY W. PAGE
------------------------------
Bobby W. Page
Senior Vice President
and Chief Financial Officer
17
INDEX TO EXHIBITS
Exhibit
Number Description of Exhibit
------ ----------------------
*10.1 Amended and Restated Credit Agreement dated as of
August 28, 1997 between Bankers Trust Company, as
Agent and Union Bank of California, N.A., as Co-
Agent and the Company
*10.2 Acquisition Credit Agreement dated as of August
28, 1997 between Bankers Trust Company, as Agent
and Union Bank of California, N.A., as Co-Agent
and the Company
*10.3 Purchase and Sale Agreement dated July 2, 1997
between Ballard Petroleum LLC, as seller and the
Company, as buyer
*10.4 Acquisition and Exploration Agreement effective as
of July 1, 1997 by and between Ballard Petroleum
LLC and the Company
*27.1 Financial Data Schedule
* Filed herewith
18