<PAGE>
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------------
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 JUNE 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. 0-21411
-------------------------
COSTILLA ENERGY, INC.
(Exact name of registrant as specified in its charter)
-------------------------
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)
-------------------------
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 JULY 31, 1997.... 10,378,500
- --------------------------------------------------------------------------------
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COSTILLA ENERGY, INC.
FORM 10-Q
TABLE OF CONTENTS
PAGE
----
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Balance Sheets as of June 30, 1997 (unaudited)
and December 31, 1996 ......................................... 3
Consolidated Statements of Operations for the three and six
months ended June 30, 1997 and 1996 (unaudited) ............... 4
Consolidated Statements of Cash Flows for the three and
six months ended June 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
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COSTILLA ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- -------------
ASSETS (UNAUDITED)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 6,005 $ 12,618
Accounts receivable:
Trade, net 4,975 6,675
Affiliates - 332
Oil and gas sales 9,198 9,031
Prepaid and other current assets 1,368 1,753
----------- -----------
Total current assets 21,546 30,409
----------- -----------
PROPERTY, PLANT AND EQUIPMENT, AT COST:
Oil and gas properties, using the successful efforts
method of accounting:
Proved properties 168,244 140,477
Unproved properties 9,915 4,482
Accumulated depletion, depreciation and amortization (29,829) (20,435)
----------- -----------
148,330 124,524
Other property and equipment, net 3,259 2,420
----------- -----------
Total property, plant and equipment 151,589 126,944
----------- -----------
OTHER ASSETS:
Deferred charges 4,310 4,503
Note receivable - other 250 250
Note receivable - affiliate 476 684
----------- -----------
Total other assets 5,036 5,437
----------- -----------
$ 178,171 $ 162,790
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt $ 98 $ 98
Trade accounts payable 15,395 12,718
Undistributed revenue 4,274 3,517
Other current liabilities 3,946 3,756
----------- -----------
Total current liabilities 23,713 20,089
----------- -----------
LONG-TERM DEBT, LESS CURRENT MATURITIES 114,826 100,262
----------- -----------
OTHER NONCURRENT LIABILITIES 430 1,870
----------- -----------
DEFERRED INCOME TAXES - -
----------- -----------
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;
10,378,500 shares outstanding at June 30, 1997 and
10,475,000 shares outstanding at December 31, 1996) 1,048 1,047
Additional paid-in capital 39,847 41,081
Retained earnings (deficit) (1,693) (1,559)
----------- -----------
Total stockholders' equity 39,202 40,569
----------- -----------
COMMITMENTS AND CONTINGENCIES - -
----------- -----------
$ 178,171 $ 162,790
----------- -----------
----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
COSTILLA ENERGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- ------------------------
1997 1996 1997 1996
---------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
REVENUES:
Oil and gas sales $ 15,279 $ 10,613 $ 34,892 $ 19,446
Other 154 (38) 920 80
---------- ---------- ---------- -----------
15,433 10,575 35,812 19,526
---------- ---------- ---------- -----------
EXPENSES:
Oil and gas production 6,794 4,621 14,163 8,279
General and administrative 1,856 1,449 3,370 2,810
Exploration and abandonments 1,774 78 3,115 308
Depreciation, depletion and amortization 4,806 2,710 9,720 4,619
Interest 2,809 2,375 5,516 4,156
---------- ---------- ---------- -----------
18,039 11,233 35,884 20,172
---------- ---------- ---------- -----------
Income (loss) before federal income taxes (2,606) (658) (72) (646)
PROVISION FOR FEDERAL INCOME TAXES (BENEFIT)
Current - - 62 -
Deferred (191) - - -
---------- ---------- ---------- -----------
Income (loss) before extraordinary item (2,415) (658) (134) (646)
Extraordinary loss resulting from early
extinguishment of debt - (1,640) - (1,640)
---------- ---------- ---------- -----------
NET INCOME (LOSS) $ (2,415) $ (2,298) $ (134) $ (2,286)
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------
INCOME (LOSS) PER SHARE:
Net income (loss) $ (0.23) $ (0.44) $ (0.01) $ (0.44)
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------
WEIGHTED AVERAGE SHARES OUTSTANDING 10,459 5,200 10,468 5,200
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
4
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COSTILLA ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- ------------------------
1997 1996 1997 1996
---------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME (LOSS) $ (2,415) $ (2,298) $ (134) $ (2,286)
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS)TO
NET CASH PROVIDED BY OPERATING ACTIVITIES:
Depreciation, depletion and amortization 4,806 2,710 9,720 4,620
Exploration and abandonments 11 - 58 -
Amortization of deferred charges 459 92 610 169
Deferred income tax expense (191) - - -
Allowance for doubtful accounts 208 - 208 -
Other noncash - 49 - 79
Gain (loss) on sale of oil and gas properties - (10) 30 (40)
Extraordinary loss resulting from early
extinguishment of debt - 1,640 - 1,640
Gain on investment transactions (224) - (981) -
---------- ---------- ---------- -----------
2,654 2,183 9,511 4,182
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable 2,485 (1,202) 1,864 (1,209)
Increase in other assets (21) (1,829) (429) (2,190)
Increase (decrease) in accounts payable (1,580) (1,603) 3,435 (880)
Increase (decrease) in other liabilities (2,425) 528 191 671
Decrease in deferred revenue - (475) - (696)
---------- ---------- ---------- -----------
Net cash provided by (used in) operating activities 1,113 (2,398) 14,572 (122)
---------- ---------- ---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to oil and gas properties (20,672) (42,977) (35,878) (47,727)
Proceeds from sale of oil and gas properties 1,842 - 2,709 -
Additions to other property and equipment (613) (1,614) (1,284) (1,996)
---------- ---------- ---------- -----------
Net cash used in investing activities (19,443) (44,591) (34,453) (49,723)
---------- ---------- ---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under long-term debt 14,600 122,390 14,600 125,390
Payments of long-term debt (19) (74,519) (37) (74,519)
Proceeds from issuance of common stock, net - - 14 -
Purchase of common stock (1,248) - (1,248) -
Deferred loan and financing costs - (2,728) (61) (2,728)
---------- ---------- ---------- -----------
Net cash provided by financing activities 13,333 45,143 13,268 48,143
---------- ---------- ---------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (4,997) (1,846) (6,613) (1,702)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 11,002 3,010 12,618 2,866
---------- ---------- ---------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 6,005 $ 1,164 $ 6,005 $ 1,164
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The interim financial information as of June 30, 1997, and for the six
months ended June 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, South Texas, and the Rocky
Mountain regions of the United States.
2. 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 option.
The following table sets forth the future volumes hedged by year and the
weighted-average strike price of the option contracts at June 30, 1997:
OIL GAS
VOLUME VOLUME STRIKE PRICE
(Bbls) (Mmbtu) PER Bbl/Mmbtu
------------ ------------ -----------------------
Oil:
1997 . . . . . . 1,052,757 - $16.56 - $20.65(a)
Gas:
1997 . . . . . . - 1,800,000 $1.78(b)
- --------------------
(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.
6
<PAGE>
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. The $60 million interest rate swap expired
agreement in May, 1997. During the three months ended June 30, 1997, the
Company borrowed $14.6 million against its line of credit which bears interest
on a floating rate basis. As a result of this borrowing, a portion of the
interest rate swap agreement is a hedge. 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. The liability for the
non-hedge portion of the remaining interest rate swap agreement was $272,000 at
June 30, 1997. As a result of expiration and marking the agreements to market
during the six and three month periods ended June 30, 1997, the Company recorded
net investment gains of approximately $63,000 for the three month period then
ended and $604,000 for the six 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 June 30, 1997:
NOTIONAL
PRINCIPAL FIXED
TERM AMOUNT INTEREST RATE
- ------------------------------- --------------- ---------------
Jan. 25, 1996 to Jan. 25, 1999 $24 million 7.50%
3. INCOME TAXES
At December 31, 1996, the Company had provided a valuation allowance equal
to its net deferred tax asset of $1,712,000. In light of the Company's net loss
before income taxes for the six month period ended June 30, 1997, it is still
uncertain whether it is more likely than not the Company will be able to utilize
a portion of its available carryforwards to the extent that such utilization
would provide a deferred tax benefit. Thus, the Company has continued to
provide a valuation allowance equal to its net deferred tax asset as of June 30,
1997.
4. SUBSEQUENT EVENTS
PURCHASE OF OIL AND GAS PROPERTIES
On July 2, 1997, the Company announced an agreement to purchase oil and gas
properties for approximately $42.0 million from Ballard Petroleum, LLC (the
"Ballard Acquisition"). The Company expects to provide funding for the
acquisition through the combination of a new acquisition facility and borrowings
under a new credit facility. The acquisition is scheduled to close in late
August 1997.
NEW BANK COMMITMENT
The Company has received a commitment from Bankers Trust Company (the
"Lender") to provide an acquisition facility for financing $30.0 million of the
Ballard Acquisition (the "Acquisition Facility"). In addition, the commitment
will provide the Company with a new revolving line of credit (the "New Credit
Facility"), which will replace its existing revolving line of credit, with the
availability of funds being subject to a borrowing base determined at least
semi-annually. Closing of the Acquisition Facility and the New Credit Facility
is expected contemporaneously with the closing of the Ballard Acquisition.
The Acquisition 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 Facility will bear interest, at the Company's option, at a
floating rate which is above the Lender's prime rate or the LIBOR rate.
Interest is payable quarterly,
7
<PAGE>
with principal payments, commencing February 1998, of $1.7 million quarterly for
the first year and $1.4 million each quarter thereafter for two years, with a
balloon payment of 40% due at maturity. Borrowings under the Acquisition
Facility will be secured by the assets being acquired from Ballard Petroleum.
The New Credit Facility will provide for a maximum availability of $75.0
million, with an initial borrowing base of $50.0 million. At June 30, 1997, the
Company had $14.7 million borrowed against the existing revolving line of
credit, which will be renewed under the New Credit Facility. In addition, the
Company will utilize funds available under the New Credit Facility to fund the
remaining portion of the Ballard Petroleum Acquisition. Borrowings under the
New Credit Facility will bear interest at the Company's option at a floating
rate which is at or above the Lender's prime rate or the LIBOR rate, depending
on the percentage of committed funds which have been borrowed. Interest is
payable quarterly and principal under the New Credit Facility is to be amortized
in twelve equal quarterly installments of 5% each, commencing, August 1999, with
a balloon payment of 40% due at maturity. Under the New 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 New 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 a current ratio of not less than 1.0 to 1.0, a ratio of
Adjusted EBITDA to interest expense of not less than 2.25 to 1 until October 1,
1997 and thereafter 2.5 to 1 and a minimum tangible net worth. At June 30,
1997, the Company was in compliance with all of the ratios to be required by the
New Credit Facility. Borrowings under the New Credit Facility are secured by
substantially all of the existing assets of the Company.
8
<PAGE>
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"), and 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").
To date, the Company has achieved its high rate of growth primarily through
acquisitions. This has 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 significantly without a corresponding significant
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 exploitation
activities to complement its acquisition efforts.
Costilla's strategy is to increase its oil and gas reserves, production and cash
flow from operations through a two-pronged approach which combines an active
exploration program with the acquisition and exploitation 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.
9
<PAGE>
Costilla has shown a significant increase in its oil and gas reserves and
production, especially due to the 1995 Acquisition and the 1996 Acquisition.
The following table sets forth certain operating data of Costilla for the
periods presented:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- --------------------------
1997 1996 1997 1996
------------ ------------- ------------- -----------
<S> <C> <C> <C> <C>
OIL AND GAS PRODUCTION:
Oil (Mbbls) 489 371 1,037 709
Gas (Mmcf) 3,437 1,861 6,721 3,504
MBOE (1) 1,062 681 2,157 1,293
AVERAGE SALES PRICES:
Oil (per Bbbl) $ 17.46 $ 18.88 $ 18.71 $ 18.14
Gas (per Mcf) 1.96 1.93 2.30 1.88
COSTS PER BOE (1):
Production cost $ 6.40 $ 6.78 $ 6.57 $ 6.40
Depreciation, depletion and amortization 4.52 3.98 4.51 3.57
General and administrative expenses 1.75 2.13 1.56 2.17
</TABLE>
- --------------------
(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 $236,155 for the three months ended June 30,
1997 and $691,755 for the three months ended June 30, 1996. The net effect of
the Company's commodity hedging activities reduced oil and gas revenues by
$746,330 for the six months ended June 30, 1997 and $691,755 for the six months
ended June 30, 1996.
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 six
months and $328,000 for the three months ended June 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. The $60 million interest
rate swap expired in May, 1997. During the three months ended June 30, 1997,
the Company borrowed $14.6 million against
10
<PAGE>
its line of credit which bears interest on a floating rate basis. As a result
of this borrowing, a portion of the interest rate swap agreement is a hedge. 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.
The liability for the non-hedge portion of the remaining interest rate swap
agreement was $272,000 at June 30, 1997. As a result of expiration and marking
the agreements to market during the six and three month periods ended June 30,
1997, the Company recorded a net investment gains of approximately $63,000 for
the three month period then ended and $604,000 for the six 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 JUNE 30, 1997 COMPARED TO THREE MONTHS ENDED JUNE 30, 1996
The Company's total oil and gas revenues for the three months ended June 30,
1997 were $15,279,000, representing an increase of $4,666,000 (44%) over
revenues of $10,613,000 in 1996. This increase was primarily due to the 1996
Acquisition, which accounted for approximately $4,509,000 of increased revenue.
Lower oil prices partially offset this increased revenue from the 1996
Acquisition. The average oil price per barrel received in 1997 was $17.46
compared to $18.88 in 1996, an 8% decrease, and the average gas price received
in 1997 was $1.96 compared to $1.93 in 1996, a 1% increase.
Oil and gas production was 1,062 MBOE in 1997 compared to 681 MBOE in 1996, a
56% increase. Of the 381 MBOE increase, approximately 295 MBOE was due to the
properties acquired in the 1996 Acquisition. The remainder of the increase was
due to a combination of successful drilling activities and the enhancement of
existing production.
Other income was $154,000 for the three month period ended June 30, 1997
compared to a loss of $38,000 for the comparable 1996 first quarter period,
representing a 505% increase. Interest and other revenues were $106,000 for the
three months ended June 30, 1997 compared to a loss of $48,000 in 1996,
representing an increase of $154,000, virtually all of which was related to
increased interest income due to increased funds earning interest. Gains on
investment transactions of $63,000 were recorded for the three months ended June
30, 1997 related to the interest rate swap contract which was marked-to-market.
No comparable transactions existed in 1996.
Oil and gas production costs for the three month period ended June 30, 1997 were
$6,794,000 ($6.40 per BOE), compared to $4,620,000 in 1996 ($6.78 per BOE),
representing an increase of $2,174,000 (47%), due principally to the 1996
Acquisition. On a per BOE basis, production costs decreased $0.38 (6%) due to a
combination of the sale of a group of high operating cost properties in April,
1997 and lower production costs on newly completed wells.
General and administrative expenses for the three months ended June 30, 1997
were $1,856,000, representing an increase of $407,000 (50%) from 1996 of
$1,449,000. 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 increased activities of the Company. However, as
noted above, production volumes increased 56% and, therefore, general and
administrative expenses per BOE decreased 18% to $1.75 per BOE for the three
months ended June 30, 1997 from the $2.13 per BOE in 1996.
Exploration and abandonment expense increased to $1,774,000 for the three months
ended June 30, 1997 compared to $79,000 in 1996. The Company incurred $812,000
of seismic costs for the three months ended June 30, 1997, compared to $4,000 in
the comparable period in 1996. Dry hole and abandonment costs increased to
$737,000 in 1997 from $76,000 in 1996. The Company incurred $225,000 of other
geological and geophysical costs during the three month period ended June 30,
1997. No comparable costs were incurred during the same period in 1996. The
11
<PAGE>
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 June 30, 1997 was $4,806,000 compared to $2,710,000 for 1996, representing
an increase of $2,095,000 (77%). During the 1997 period, depreciation,
depletion and amortization (D D & A) on oil and gas production was provided at
an average rate of $4.52 per BOE compared to $3.98 per BOE for 1996. The
increase was due in part to the 1996 Acquisition and also 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 $2,809,000 for the three months ended June 30, 1997,
compared to $2,375,000 for the comparable period in 1996. The $434,000 (18%)
increase was attributable primarily to increased levels of debt. The average
amounts of applicable interest-bearing debt in 1997 and 1996 were $104,251,000
and $83,369,000, respectively. The effective annualized interest rate in 1997
was 10.8%, as compared to 11.4% in 1996.
SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO SIX MONTHS ENDED JUNE 30, 1996
The Company's total oil and gas revenues for the six months ended June 30, 1997
were $34,892,000, representing an increase of $15,446,000 (79%) over revenues of
$19,446,000 in 1996. This increase was primarily due to the 1996 Acquisition,
which accounted for approximately $10,456,000 of increased revenue. The
remainder of the increase was due to a combination of increased product prices,
primarily gas prices, successful drilling activities and the enhancement of
existing production. The average oil price per barrel received in 1997 was
$18.71 compared to $18.14 in 1996, a 3% increase, and the average gas price
received in 1997 was $2.30 compared to $1.88 in 1996, a 23% increase.
Oil and gas production was 2,157 MBOE in 1997 compared to 1,293 MBOE in 1996, a
67% increase. Of the 864 MBOE increase, approximately 612 MBOE was due to the
properties acquired in the 1996 Acquisition. The remainder of the increase was
due to a combination of successful drilling activities and the enhancement of
existing production.
Other income was $920,000 for the six month period ended June 30, 1997 compared
to $80,000 for the comparable 1996 six month period, representing a 1050%
increase. Interest and other revenues were $361,000 for the six months ended
June 30, 1997 compared to $40,000 in 1996, representing an increase of $321,000,
virtually all of which was related to increased interest income due to increased
funds earning interest. Gains on investment transactions of $604,000 were
recorded for the six months ended June 30, 1997 related to the interest rate
swap contract which was marked-to-market. No comparable transactions existed in
1996.
Oil and gas production costs for the six month period ended June 30, 1997 were
$14,163,000 ($6.57 per BOE), compared to $8,279,000 in 1996 ($6.40 per BOE),
representing an increase of $5,884,000 (71%), due principally to the 1996
Acquisition. On a per BOE basis, production costs increased $0.17 due primarily
to higher productions costs on properties acquired in the 1996 Acquisition.
General and administrative expenses for the six months ended June 30, 1997 were
$3,370,000, representing an increase of $560,000 (22%) from 1996 of $2,810,000.
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 increased activities of the Company. However, as noted above,
production volumes increased 79% and, therefore, general and administrative
expenses per BOE decreased 28% to $1.56 per BOE for the six months ended June
30, 1997 from the $2.17 per BOE in 1996.
Exploration and abandonment expense increased to $3,115,000 for the six months
ended June 30, 1997 compared to $308,000 in 1996. The Company incurred $893,000
of seismic costs for the six months ended June 30, 1997, compared to $4,000 in
the comparable period in 1996. Dry hole and abandonment costs increased to
$1,857,000 in 1997 from $304,000 in 1996. The Company incurred $365,000 of
other geological and geophysical costs during the six month period ended June
30, 1997. No comparable costs were incurred during the same period in 1996.
12
<PAGE>
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 six month period ended
June 30, 1997 was $9,720,000 compared to $4,619,000 for 1996, representing an
increase of $5,101,000 (110%). During the 1997 period, depreciation, depletion
and amortization (D D & A) on oil and gas production was provided at an average
rate of $4.51 per BOE compared to $3.57 per BOE for 1996. The increase was due
in part to the 1996 Acquisition and also 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 $5,516,000 for the six months ended June 30, 1997, compared
to $4,156,000 for the comparable period in 1996. The $1,360,000 (33%) increase
was attributable primarily to increased levels of debt. The average amounts of
applicable interest-bearing debt in 1997 and 1996 were $102,263,000 and
$77,646,000, respectively. The effective annualized interest rate in 1997 was
10.8%, as compared to 10.7% in 1996.
LIQUIDITY AND CAPITAL RESOURCES
NET CASH PROVIDED BY OPERATING ACTIVITIES
For the six months ended June 30, 1997, net cash provided by operating
activities increased to $14.6 million from $(.1) million for 1996. Cash
provided by operations, before changes in operating assets and liabilities,
increased to $9.5 million from $4.2 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, offset in part by a
decrease in the price of oil.
NET CASH USED IN INVESTING ACTIVITIES
Net cash used in investing activities for the six months ended June 30, 1997 was
$34.5 million. Approximately $35.9 million was used for exploration and
development activities and $1.3 million was used for other property and
equipment, which amounts were partially offset by approximately $2.7 million net
cash provided by sales of oil and gas properties during the period. For the six
months ended June 30, 1996, net cash used in investing activities was $49.7
million. Approximately $42.5 million was used for the 1996 Acquisition, $5.2
million was used for exploration and development activities and $2.0 million
primarily for other property and equipment.
NET CASH PROVIDED BY FINANCING ACTIVITIES
The Company incurred $14.6 million of new debt during the six months ended June
30, 1997, which was used in connection with its exploration and development
activities. In addition, the Company used approximately $1.3 million, primarily
for the purchase of 98,000 shares of its common stock. For the six months ended
June 30, 1996, the Company incurred approximately $125.4 million of debt, of
which $122.0 million was funded under its then-existing $125.0 million credit
agreement. Approximately $74.5 million of such amount was used for the
extension and refinancing of prior debt, $42.5 million was used for the 1996
Acquisition and approximately $8.4 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 Credit Facility, new borrowings for
acquisitions and proceeds from the divestiture of non-core, non-strategic
assets.
In July 1997 the Company announced an agreement to purchase oil and gas
properties for approximately $42.0 million from Ballard Petroleum L.L.C. (the
"Ballard Acquisition"). The Ballard Acquisition is scheduled to close in late
August 1997. While the Company regularly engages in discussions relating to
potential acquisitions, other than
13
<PAGE>
the Ballard Acquisition, 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.
The Company has received a commitment from Bankers Trust Company (the "Lender")
to provide an acquisition facility for financing $30.0 million of the Ballard
Acquisition (the "Acquisition Facility"). In addition, the commitment will
provide the Company with a new revolving line of credit (the "New Credit
Facility"), which will replace its existing revolving line of credit, with the
availability of funds being subject to a borrowing base determined at least
semi-annually. Closing of the Acquisition Facility and the New Credit Facility
is expected contemporaneously with the closing of the Ballard Acquisition.
The Acquisition 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 Facility will bear interest, at the Company's option, at a
floating rate which is above the Lender's prime rate or the LIBOR rate.
Interest is payable quarterly, with principal payments, commencing February
1998, of $1.7 million quarterly for the first year and $1.4 million each quarter
thereafter for two years, with a balloon payment of 40% due at maturity.
Borrowings under the Acquisition Facility will be secured by the assets being
acquired from Ballard Petroleum.
The New Credit Facility will provide for a maximum availability of $75.0
million, with an initial borrowing base of $50.0 million. At June 30, 1997, the
Company had $14.7 million borrowed against the existing revolving line of
credit, which will be renewed under the New Credit Facility. In addition, the
Company will utilize funds available under the New Credit Facility to fund the
remaining portion of the Ballard Petroleum Acquisition. Borrowings under the
New Credit Facility will bear interest at the Company's option at a floating
rate which is at or above the Lender's prime rate or the LIBOR rate, depending
on the percentage of committed funds which have been borrowed. Interest is
payable quarterly and principal under the New Credit Facility is to be amortized
in twelve equal quarterly installments of 5% each, commencing, August 1999, with
a balloon payment of 40% due at maturity. Under the New 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 New 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 a current ratio of not less than 1.0 to 1.0, a ratio of
Adjusted EBITDA to interest expense of not less than 2.25 to 1 until October 1,
1997 and thereafter 2.5 to 1 and a minimum tangible net worth. At June 30,
1997, the Company was in compliance with all of the ratios to be required by the
New Credit Facility. Borrowings under the New Credit Facility are secured by
substantially all of the existing assets of the Company.
The Company believes that cash flow from operations, supplemented by borrowings
from the 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 six months ended June 30, 1997, the Company
expended approximately $35.9 million in oil and gas activities 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 half of 1997.
14
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
Exhibit
Number Description of Exhibit
------- ----------------------
*10.1 First and Second Amendments to 1996 Stock Option
Plan of Costilla Energy, Inc.
*10.2 First Amendment to Outside Directors Stock Option
Plan of Costilla Energy, Inc.
*10.3 First, Second and Third Amendments to Bonus
Incentive Plan of Costilla Energy, Inc.
*27.1 Financial Data Schedule
* Filed herewith
REPORTS ON FORM 8-K
The Company did not file a report on Form 8-K for the quarter for
which this report is filed.
15
<PAGE>
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: August 13, 1997 By: /s/ Bobby W. Page
------------------------------
Bobby W. Page
Senior Vice President
and Chief Financial Officer
16
<PAGE>
EXHIBIT 10.1, PAGE 1 OF 2
FIRST AMENDMENT TO 1996 STOCK OPTION PLAN OF
COSTILLA ENERGY, INC.
ADOPTED BY THE BOARD OF DIRECTORS OF COSTILLA ENERGY, INC.
AS OF APRIL 14, 1997
AND
ADOPTED BY THE SHAREHOLDERS OF COSTILLA ENERGY, INC.
AS OF JUNE 16, 1997
Section 4.1 of the 1996 Stock Option Plan of Costilla Energy, Inc. (the "Stock
Option Plan") is amended to provide that the Stock Option Plan shall be
administered by the Compensation Committee of the Board of Directors of Costilla
Energy, Inc. and that each reference to the Board of Directors of Costilla
Energy, Inc. in the Stock Option Plan shall mean the Compensation Committee of
the Board of Directors of Costilla Energy, Inc.
<PAGE>
EXHIBIT 10.1, PAGE 2 OF 2
SECOND AMENDMENT TO 1996 STOCK OPTION PLAN OF
COSTILLA ENERGY, INC.
ADOPTED BY THE BOARD OF DIRECTORS OF COSTILLA ENERGY, INC.
AS OF APRIL 14, 1997
AND
ADOPTED BY THE SHAREHOLDERS OF COSTILLA ENERGY, INC.
AS OF JUNE 16, 1997
Section 6.1 of the 1996 Stock Option Plan of Costilla Energy, Inc. (the "Stock
Option Plan") is amended to provide that an aggregate of one million two hundred
and fifty thousand (1,250,000) shares of Common Stock, $.10 par value, of
Costilla Energy, Inc. are authorized and reserved for issuance upon exercise of
the stock options granted under the Stock Option Plan.
<PAGE>
EXHIBIT 10.2
FIRST AMENDMENT TO OUTSIDE DIRECTORS STOCK OPTION PLAN OF
COSTILLA ENERGY, INC.
ADOPTED BY THE BOARD OF DIRECTORS OF COSTILLA ENERGY, INC.
AS OF APRIL 14, 1997
AND
ADOPTED BY THE SHAREHOLDERS OF COSTILLA ENERGY, INC.
AS OF JUNE 16, 1997
1. Section 2 of the Outside Directors Stock Option Plan of Costilla Energy,
Inc. (the "Outside Directors Plan") is amended to provide that an aggregate of
one hundred thousand (100,000) shares of common stock, $.10 par value of
Costilla Energy, Inc. are authorized and reserved for issuance upon exercise of
the stock options granted under the Outside Directors Plan.
2. Section 4(b) of the Outside Directors Plan is amended to provide that each
person who qualifies as an Outside Director, as that term is defined in the
Outside Directors Plan, shall receive, each year such person so qualifies, an
option for five thousand (5,000) shares of Common Stock, $.10 par value of
Costilla Energy, Inc. under the Outside Directors Plan.
<PAGE>
EXHIBIT 10.3, PAGE 1 OF 3
FIRST AMENDMENT TO BONUS INCENTIVE PLAN OF
COSTILLA ENERGY, INC.
ADOPTED BY THE BOARD OF DIRECTORS OF COSTILLA ENERGY, INC.
AS OF APRIL 14, 1997
AND
ADOPTED BY THE SHAREHOLDERS OF COSTILLA ENERGY, INC.
AS OF JUNE 16, 1997
Section 3 of the Bonus Incentive Plan of Costilla Energy, Inc. (the "Bonus
Plan") is amended to provide that the Bonus Plan shall be administered by the
Compensation Committee of the Board of Directors of Costilla Energy, Inc. and
that each reference to the Board of Directors of Costilla Energy, Inc. in the
Bonus Plan shall mean the Compensation Committee of the Board of Directors of
Costilla Energy, Inc.
<PAGE>
EXHIBIT 10.3, PAGE 2 OF 3
SECOND AMENDMENT TO BONUS INCENTIVE PLAN OF
COSTILLA ENERGY, INC.
ADOPTED BY THE BOARD OF DIRECTORS OF COSTILLA ENERGY, INC.
AS OF APRIL 14, 1997
Section 7 of the Bonus Incentive Plan of Costilla Energy, Inc. (the "Bonus
Plan") is amended to provide that awards of incentive compensation under the
Bonus Plan will be made within one hundred and twenty (120) days after the
expiration of each Fiscal Year, as that term is defined in the Bonus Plan.
<PAGE>
EXHIBIT 10.3, PAGE 3 OF 3
THIRD AMENDMENT TO BONUS INCENTIVE PLAN OF
COSTILLA ENERGY, INC.
ADOPTED BY THE BOARD OF DIRECTORS OF COSTILLA ENERGY, INC.
AS OF APRIL 14, 1997
AND
ADOPTED BY THE SHAREHOLDERS OF COSTILLA ENERGY, INC.
AS OF JUNE 16, 1997
The definition of "Participant" in Section 2 of the Bonus Incentive Plan of
Costilla Energy, Inc. (the "Bonus Plan") is amended to delete the proviso that
excludes any person who owns ten percent (10%) or more of the outstanding shares
of common stock, $.10 par value, of Costilla Energy, Inc. at any time during a
Fiscal Year, as that term is defined in the Bonus Plan, from participating under
the Bonus Plan for that Fiscal Year.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED FINANCIAL STATEMENTS OF COSTILLA ENERGY, INC. FOR THE SIX MONTH PERIOD
ENDED JUNE 30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 6,005
<SECURITIES> 0
<RECEIVABLES> 14,173
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 21,546
<PP&E> 182,142
<DEPRECIATION> (30,553)
<TOTAL-ASSETS> 178,171
<CURRENT-LIABILITIES> 23,713
<BONDS> 114,826
0
0
<COMMON> 1,048
<OTHER-SE> 38,154
<TOTAL-LIABILITY-AND-EQUITY> 178,171
<SALES> 34,892
<TOTAL-REVENUES> 35,812
<CGS> 14,163
<TOTAL-COSTS> 17,278
<OTHER-EXPENSES> 9,720
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 5,516
<INCOME-PRETAX> (72)
<INCOME-TAX> 62
<INCOME-CONTINUING> (134)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
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<NET-INCOME> (134)
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