<PAGE>
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 1-10652
CONVEST ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
TEXAS 76-0312028
(State or jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
2401 FOUNTAIN VIEW DRIVE, SUITE 700
HOUSTON, TEXAS 77057
(Address of principal executive offices) (Zip Code)
(713) 780-1952
Registrant's telephone number, including area code:
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) 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
----- -----
The number of shares of the Registrant's Common Stock, par value $.01 per
share, outstanding at August 13, 1996, was 10,412,722.
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<PAGE>
CONVEST ENERGY CORPORATION
Quarterly Report on Form 10-Q
for the Quarter Ended June 30, 1996
INDEX
<TABLE>
<CAPTION>
I. FINANCIAL INFORMATION
Item 1. Financial Statements of Convest Energy Corporation:
<S> <C> <C>
Consolidated Balance Sheets.................................. 3
Consolidated Statements of Operations........................ 4
Consolidated Statements of Stockholders' Equity.............. 6
Consolidated Statements of Cash Flows........................ 7
Notes to Consolidated Financial Statements................... 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 15
II. OTHER INFORMATION
Item 1. Legal Proceedings............................................ 22
Item 4. Submission of Matters to a Vote of Security Holders.......... 22
Item 6. Exhibits and Reports on Form 8-K............................. 22
Signature............................................................ 23
</TABLE>
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<PAGE>
CONVEST ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(In Thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1996 1995
----------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,292 $ 674
Restricted cash 333 333
Accounts receivable:
Oil and gas production - less allowance
for doubtful accounts of $820 6,738 7,958
Other 501 252
Other current assets 5,390 6,223
-------- --------
Total current assets 15,254 15,440
-------- --------
Property and equipment:
Oil and gas properties, successful efforts method 111,730 114,201
Other 452 364
Less accumulated depreciation and depletion (55,591) (50,225)
-------- --------
56,591 64,340
-------- --------
Other noncurrent assets 2,830 2,177
-------- --------
$ 74,675 $ 81,957
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ _ $ 1,625
Accounts payable:
Oil and gas production 8,882 9,609
Affiliates 586 550
Accrued liabilities and other 4,333 3,803
Deferred revenue 2,128 2,010
-------- --------
Total current liabilities 15,929 17,597
-------- --------
Long-term liabilities:
Long-term debt, net of current maturities 11,278 17,553
Deferred revenue 743 691
Other noncurrent liabilities 10,259 11,099
-------- --------
22,280 29,343
-------- --------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $1 par value; authorized 5 million shares;
none issued or outstanding - -
Common stock, $.01 par value; 20,000,000 shares
authorized, 10,412,722 issued at June 30, 1996
and December 31, 1995 104 104
Additional paid-in capital 47,798 47,798
Retained earnings (deficit) (11,436) (12,885)
-------- --------
36,466 35,017
-------- --------
$ 74,675 $ 81,957
======== ========
</TABLE>
See accompanying notes to consolidated financial statements
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<PAGE>
CONVEST ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands Except Per Share Data)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------
1996 1995
--------- --------
(Unaudited)
<S> <C> <C>
Revenues:
Oil and gas sales $21,329 $25,845
Gas plant revenues 704 623
Gain (loss) on asset sale 817 (297)
Other, net 205 171
------- -------
23,055 26,342
------- -------
Expenses:
Production:
Lease operating expense 7,636 9,041
Gas plant operating expense 232 237
Production taxes 617 611
Abandonment and exploration costs 921 498
General and administrative expenses 2,281 2,606
Interest expense 674 1,134
Depreciation, depletion and amortization 7,908 10,969
Impairment of oil and gas properties 1,120 -
------- -------
21,389 25,096
------- -------
Net income before elimination of preacquisition
net loss and income taxes 1,666 1,246
Elimination of preacquisition
net loss of predecessor - (1,664)
------- -------
Net income before income taxes 1,666 2,910
Income tax provision 217 9
------- -------
Net income $ 1,449 $ 2,901
======= =======
Net income per share (See Note 2) $0.14 $0.46
======= =======
Weighted average common shares outstanding 10,413 6,279
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
-4-
<PAGE>
CONVEST ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands Except Per Share Data)
<TABLE>
<CAPTION>
Three Months Ended
June 30,
------------------
1996 1995
-------- --------
(Unaudited)
<S> <C> <C>
Revenues:
Oil and gas sales $10,170 $12,902
Gas plant revenues 343 320
Gain (loss) on asset sale 5 (297)
Other, net 101 131
------- -------
10,619 13,056
------- -------
Expenses:
Production:
Lease operating expense 3,675 4,689
Gas plant operating expense 110 116
Production taxes 307 309
Abandonment and exploration costs 878 133
General and administrative expenses 1,042 1,453
Interest expense 307 568
Depreciation, depletion and amortization 3,770 5,774
Impairment of oil and gas properties 1,120 -
------- -------
11,209 13,042
------- -------
Net income (loss) before elimination of preacquisition
net loss and income taxes (590) 14
Elimination of preacquisition
net loss of predecessor - (1,024)
------- -------
Net income (loss) before income taxes (590) 1,038
Income tax provision 48 9
------- -------
Net income (loss) $ (638) $ 1,029
======= =======
Net income (loss) per share (See Note 2) $ (0.06) $ 0.16
======= =======
Weighted average common shares outstanding 10,413 6,371
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
-5-
<PAGE>
CONVEST ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 1996
(In Thousands)
(Unaudited)
<TABLE>
<CAPTION>
Common Common Additional Retained
Shares Stock, Paid-In Earnings
Outstanding $.01 par Capital (Deficit) Total
----------- -------- ---------- --------- -------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 10,412 $104 $47,798 $(12,885) $35,017
Net income - - - 1,449 1,449
----------- -------- ---------- -------- -------
Balance at June 30, 1996 10,412 $104 $47,798 $(11,436) $36,466
=========== ======== ========== ======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
-6-
<PAGE>
CONVEST ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------
1996 1995
--------- ---------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,449 $ 2,901
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation, depletion and amortization 7,908 7,433
Impairment of oil and gas properties 1,120 0
(Gain) loss on sale of oil and gas properties (797) 286
Abandonment and exploration costs 781 400
Decrease (increase) in accounts receivable 560 (5,470)
Decrease in accounts payable and accrued liabilities (345) (668)
Other 184 427
------- --------
Net cash flow provided by operating activities 10,860 5,309
------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash received in reverse acquisition of CEC by Edisto E&P - 716
Acquisition, exploration and development of oil and
gas properties (4,120) (4,776)
Advances to working interest owners (601) -
Proceeds from sales of oil and gas properties 2,210 (12)
Sale of investment in affiliates - 7,351
(Purchase) sale of short-term investments 1,257 712
Increase in other current and noncurrent assets (88) (657)
------- --------
Net cash provided by (used in) investing activities (1,342) 3,334
------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on long-term debt - 2,041
Payments on long-term debt (7,900) (8,250)
Payment of note payable - (5,212)
Distribution of certain assets and
liabilities to affiliate - (652)
------- --------
Net cash used in financing activities (7,900) (12,073)
------- --------
Net decrease in cash and cash equivalents 1,618 (3,430)
Cash and cash equivalents, beginning of period 1,007 4,623
------- --------
Cash and cash equivalents, end of period $ 2,625 $ 1,193
======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest $ 844 $ 588
======= ========
Cash paid during the period for taxes $ 296 $ 9
======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
-7-
<PAGE>
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND BASIS OF PRESENTATION
Convest Energy Corporation, a Texas corporation ("Convest" or the "Company"), is
an independent oil and gas exploration and production company whose common stock
is traded on the American Stock Exchange.
On June 26, 1995, the Company acquired all of the outstanding capital stock of
Edisto Exploration & Production Company ("Edisto E&P") from Edisto Resources
Corporation ("Edisto") in exchange for 6,185,400 newly issued shares of
Convest's common stock and $10,000 in cash. The newly issued shares of Convest
common stock increased Edisto's interest in Convest from 31% to 72%. Upon
closing of this transaction with Edisto (the "Edisto Transaction"), Convest's
Board was restructured so that affiliates of Edisto constituted a majority of
the directors.
Since Edisto acquired control of Convest in the Edisto Transaction, the
acquisition of Edisto E&P has been accounted for as a reverse acquisition with
Edisto E&P being considered the acquiring entity. Accordingly, all future
references to "Convest" or the "Company" will apply to Edisto E&P, and any
references to "CEC" will apply solely to Convest Energy Corporation prior to
the reverse acquisition. In accordance with the accounting rules for a reverse
acquisition, the following should be noted when reviewing the consolidated
financial statements of the Company presented herein:
(i) The Consolidated Statements of Operations of the Company for the
periods ended June 30, 1995 sets forth the combined pro forma results
of operations of Edisto E&P and CEC as if the Edisto Transaction had
occurred on January 1, 1995, with the preacquisition net loss of CEC
for such periods being eliminated for purposes of determining net
income.
(ii) The Consolidated Statement of Cash Flows of the Company for the six
months ended June 30, 1995 sets forth only the cash flows of Edisto
E&P, and accordingly, is not comparable with the cash flows for the
six months ended June 30, 1996, which includes the cash flows of both
Edisto E&P and CEC.
These financial statements should be read in conjunction with the audited
financial statements and the notes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1995. Reference also is
made to the "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in this report.
The information presented in this Form 10-Q is unaudited, but in the opinion of
management reflects all adjustments (all of which were normal and recurring)
necessary to fairly present such information. Interim results are not
necessarily indicative of a full year of operations.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION. All significant intercompany accounts and
activities have been eliminated.
RESTRICTED CASH. Restricted cash consists of $333,000 of certificates of
deposit held by various financial institutions. The certificates of deposit are
held in escrow as collateral for letters of credit issued for (i) lease payments
on certain offshore platforms and (ii) estimated plugging and abandonment costs
expected to be incurred on certain onshore oil and gas properties.
PROPERTY AND EQUIPMENT. The Company follows the successful efforts method of
accounting for its oil and gas properties. Costs of productive wells,
developmental drilling expenditures, including dry holes, and productive leases
are capitalized. Exploratory drilling costs, including stratigraphic test
wells, are initially
-8-
<PAGE>
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
capitalized, but charged to expense if the well is determined to be
unsuccessful. The capitalized costs of oil and gas properties are charged to
operations as depreciation, depletion and amortization using the unit-of-
production method based on the ratio of current production to proved recoverable
oil and gas reserves (as defined by the Securities and Exchange Commission) on a
lease by lease basis. Reserve estimates for the Company's properties were
prepared by independent petroleum engineering firms at year end. Gas is
converted to equivalent barrels of oil on an energy content basis of 6 Mcf of
gas to 1 barrel of oil. Depreciation, depletion and amortization per equivalent
barrel of oil production was $4.83 and $4.76 for the six month periods ended
June 30, 1996 and 1995, respectively, and $4.60 and $4.95 for the three month
periods ended June 30, 1996 and 1995, respectively. Oil and gas leasehold costs
are capitalized when incurred. Unproved properties are assessed periodically on
a property-by-property basis and impairments in value are charged to expense.
Exploratory expenses, including geological and geophysical expenses and annual
delay rentals, are charged to expense as incurred.
In the fourth quarter of 1995, Convest adopted Statement of Financial Accounting
Standards No. 121 ("SFAS 121") regarding accounting for the impairment of long-
lived assets. SFAS 121 requires Convest to recognize an impairment loss for its
proved oil and gas properties if the carrying value of such properties (i.e.,
total capitalized costs less accumulated depreciation and depletion) exceeds the
undiscounted expected future cash flows attributable to such properties. Under
SFAS 121, Convest must regularly assess the need for an impairment of
capitalized costs of oil and gas properties on a property-by-property basis. If
an impairment is indicated based on undiscounted expected future cash flows,
then an impairment loss is recognized to the extent that net capitalized costs
exceed discounted expected future cash flows.
The Company's SFAS 121 evaluation for the second quarter of 1996 was prepared
using the Company's 1995 year end reserve estimates adjusted for production and
other known changes subsequent to the preparation of the Company's year end
reserve estimates. As a result of this evaluation, the Company determined that
an offshore property had less reserves than as previously estimated.
Accordingly, the Company recorded an impairment loss on the property of
approximately $1.1 million based on production problems encountered during the
second quarter of 1996.
OTHER PROPERTY, PLANT AND EQUIPMENT. Other fixed assets are recorded at cost
and depreciated over their estimated useful lives using the straight-line method
of depreciation.
ABANDONMENT RESERVE. The Company records its estimate of future abandonment
costs of offshore properties. Such costs are accrued using a unit-of-production
method based upon estimated proved recoverable reserves. Abandonment costs are
estimated under current regulations using current costs and are reviewed
periodically and adjusted as new information becomes available. Abandonment
costs on onshore properties are typically nominal due to the salvage value of
well equipment, and accordingly, the Company does not provide for the
abandonment of its onshore properties.
Upon emerging from bankruptcy in July 1993, Edisto E&P entered into a settlement
with the United States Minerals Management Service relating to the estimated
plugging and abandonment costs for 14 Gulf of Mexico OCS leases in which Edisto
E&P owned interests. Pursuant to this settlement, the operator of the leases,
Edisto E&P and other co-lessees were required to provide security for payment of
such costs through quarterly payments to an Abandonment Fund. Following the
Edisto Transaction, the Company continued to be subject to the Abandonment Fund
payments covering the properties in which the Company owns a working interest.
As of June 30, 1996 and December 31, 1995, the Company was subject to total
Abandonment Fund payments of $4.3 million.
As of June 30, 1996 and December 31, 1995, the Company had made payments
totaling $4.1 million and $3.7 million to the Abandonment Fund, respectively.
These payments were applied to the total long-term abandonment reserve of $10.6
million and $10.2 million, as of June 30, 1996 and December 31, 1995,
respectively, resulting in a net long-term abandonment reserve of $6.5 million
as of those dates. The current portion of the
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<PAGE>
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
abandonment reserve was $158,000 and $556,000 as of June 30, 1996 and December
31, 1995, respectively. The current portion of the abandonment reserve is
included in "Accrued Liabilities and Other" and the noncurrent portion is
included in "Other Noncurrent Liabilities" in the consolidated financial
statements.
LEASE OPERATING EXPENSES. In connection with a 1992 sale of certain future
production volumes of oil to Enron Reserve Acquisition Corp., the Company
established a reserve for the expenses associated with the volumes sold and
amortizes this reserve as the volumes are delivered. As of June 30, 1996 and
December 31, 1995, the current balance of this reserve was $1.8 million and the
long-term balance was $3.8 million and $4.6 million, respectively, and are
included in "Accrued Liabilities and Other" and "Other Noncurrent Liabilities"
in the consolidated financial statements.
GAS BALANCING. The Company uses the entitlement method of accounting for gas
imbalances. Receivables resulting from undertakes of gas production at June 30,
1996 and December 31, 1995 were $2.1 million and $1.4 million, respectively, and
are included in "Accounts Receivable - Oil and Gas Production" and "Other
Noncurrent Assets" in the consolidated financial statements. Deferred revenue
and payables resulting from overtakes of gas production at June 30, 1996 and
December 31, 1995 were $2.9 million and $2.7 million, respectively, and are
included in "Deferred Revenue" and "Other Noncurrent Liabilities" in the
consolidated financial statements.
ACCOUNTING FOR INCOME TAXES. The Company records income taxes in accordance
with the Financial Accounting Standards Board - Statement of Financial
Accounting Standards No. 109 ("SFAS No. 109"), "Accounting for Income Taxes."
SFAS No. 109 requires the balance sheet approach of income tax accounting
whereby deferred income taxes are provided at the balance sheet date for the
differences existing in the tax basis of assets and liabilities and their
financial statement carrying amounts.
NET INCOME PER SHARE. Net income per share is computed based on the weighted
average number of shares outstanding which were 10,412,722 and 6,278,821 for the
six months ended June 30, 1996 and 1995, respectively, and 10,412,722 and
6,371,216 for the three months ended June 30, 1996 and 1995, respectively. No
effect has been given to options outstanding under the Company's stock option
plans because their effect is antidilutive or immaterial. In accordance with the
accounting rules for a reverse acquisition, the Company's capital structure was
restated so that Edisto E&P assumed CEC's capital structure as of the date of
the Edisto Transaction (June 26, 1995) and prior period equity balances and
earnings per share were retroactively adjusted to reflect this change.
RISK MANAGEMENT/HEDGING ACTIVITIES. The Company from time to time engages in
commodity hedging activities to minimize the risk of market fluctuations in the
prices of crude oil and natural gas. The hedging objectives include assurance
of stable and known cash flows and fixed favorable prices. The hedges are
effected through the purchase and sale of futures contracts on the New York
Mercantile Exchange ("NYMEX") and price swap agreements with major financial
institutions. Gains or losses on the Company's hedging agreements are deferred
and are recorded as oil and gas sales revenue in the month for which the hedged
transaction is completed.
STATEMENT OF CASH FLOWS. For purposes of the Consolidated Statements of Cash
Flows, the Company considers all highly liquid investments purchased with a
maturity of three months or less to be cash equivalents.
USE OF ESTIMATES. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. All
significant estimates are discussed herein.
-10-
<PAGE>
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) ACQUISITIONS/DISPOSITIONS
EDISTO TRANSACTION
The Edisto Transaction is described in Note 1 herein. As described therein, the
Edisto Transaction has been accounted for as a reverse acquisition since Edisto
acquired control of CEC.
SENSOR PROPERTIES ACQUISITION
In May and June 1995, prior to the closing of the Edisto Transaction, CEC and
Edisto E&P acquired from Sensor Oil & Gas ("Sensor") certain oil and gas
properties located in Kansas, Oklahoma and Nebraska (the "Sensor Properties").
As of January 1, 1996, these properties had proved oil and gas reserves totaling
approximately 1.4 million barrels of oil and 300 Mmcf of gas. The aggregate
purchase price, including transaction costs, was approximately $8.0 million.
The accompanying Consolidated Statements of Operations includes revenues of
approximately $2.4 million and $1.2 million and direct operating expenses of
$989,000 and $413,000 attributable to the Sensor Properties for the six and
three month periods ended June 30, 1996, respectively.
DISPOSITION OF OIL AND GAS PROPERTIES
In January 1996, the Company sold an offshore oil and gas property for
approximately $2.0 million and recorded a gain of approximately $620,000. In
addition, the Company sold several other nonstrategic oil and gas properties
during the first six months of 1996 for aggregate sale proceeds of approximately
$400,000 which resulted in a gain of approximately $200,000.
(4) RELATED PARTY TRANSACTIONS
In the Edisto Transaction, Edisto retained the tax benefits of the net operating
loss carryforwards ("NOLs") of Edisto E&P. The tax benefits include a $3.3
million NOL usable for regular taxable income and a $3.6 million NOL usable for
alternative minimum taxable income. The Company determined that the use of
these NOLs would reduce its taxes for 1995 by approximately $437,000. In
addition, based on current projections of the Company's future taxable income,
it was determined that the remaining NOLs of Edisto E&P would be a valuable
asset that could be utilized by Convest in the near future. Accordingly, Edisto
allowed Convest to utilize the NOLs of Edisto E&P in consideration for the
payment by Convest of $550,000. At December 31, 1995, the Company recorded a
deferred tax asset of $550,000 and a corresponding account payable to Edisto
which is presented in "Other Noncurrent Assets" and "Accounts Payable -
Affiliates," respectively, in the consolidated financial statements.
During January 1995, CEC entered into a gas marketing agreement with Energy
Source, Inc. ("Energy Source"), a wholly-owned subsidiary of Edisto, whereby
Energy Source markets a substantial portion of the Company's gas production and
assumes certain related administrative functions. Effective November 1, 1995,
the Company and Energy Source extended the term of the agreement to December 31,
1996, with the Company having the right to renegotiate the pricing structure at
each six month interval of the extended term. For the six months ended June 30,
1996, Energy Source marketed approximately 52% of the Company's gas production
for the period. In exchange for its services, Energy Source receives a fee of
no more than 2% of the spot market price. Under the agreement, Energy Source
takes title to the gas before reselling it, thereby creating an account
receivable from Energy Source for the sold gas. At June 30, 1996 and December
31, 1995, the account receivable from Energy Source was $3.7 million and $4.7
million, respectively, which is included in "Accounts Receivable - Oil and Gas
Production" on the Consolidated Balance Sheets. Convest sells such gas to
Energy Source on open credit without requiring a letter of credit or other
security. Management believes the terms of the Energy Source gas marketing
agreement are no less favorable to the Company than those available from
unaffiliated third parties.
-11-
<PAGE>
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Effective July 1, 1995, the Company and Edisto agreed to share certain
administrative costs to reduce the overall cost that would otherwise be incurred
by each of them in the absence of such an arrangement. Under the arrangement,
certain costs associated with shareholder communication services, costs of
computer hardware and software systems and certain administrative staff who
perform duties on behalf of both entities are shared by Convest and Edisto based
on their respective utilization. In addition, the base salary of Michael Y.
McGovern, who serves as the Chairman and Chief Executive Officer of Edisto and
Convest, is shared equally by Edisto and Convest. Mr. McGovern's annual base
salary is $275,000, so Convest reimburses Edisto for one-half of this amount
plus one-half of his payroll taxes and benefits (such as health, disability and
life insurance and 401(k) plan contributions).
Energy Source executes trades of futures contracts for natural gas and crude oil
on the NYMEX on behalf of the Company. These trades are made in connection with
the Company's program to hedge against the volatility of natural gas and crude
oil prices. In this regard, Energy Source acts solely in a ministerial capacity
to purchase or sell the futures contracts at price levels directed by the
Company's management. Energy Source charges a commission of $.0025 per Mcf of
gas or barrel of crude oil for each trade executed.
In July 1996, the Company and Edisto obtained a directors' and officers'
fiduciary insurance policy that covers both companies. The annual insurance
premium was allocated 32% to the Company, for a cost of $96,000, based on the
relative percentage that the assets of the Company bear to the total assets of
both the Company and Edisto.
Each of the affiliated party transactions described above was approved by either
a special committee of the Company's Board, which was composed of outside
directors with no affiliation to Edisto, or the unanimous consent of the
Company's Board. Effective July 1, 1995, the Company's Board of Directors
established the Affiliate Transaction Review Committee which must review and
unanimously approve all affiliated party transactions.
In March 1996, the Board of Directors of Edisto authorized the open market
purchase of up to 1,160,000 shares of Common Stock of Convest from time to time.
The timing and amounts of purchases will be governed by applicable SEC rules and
market conditions. The purpose of the stock purchase is to increase Edisto's
ownership percentage of Convest to over 80% to allow Edisto and Convest to
consolidate for federal income tax purposes. Edisto has existing net operating
loss carryforwards that may be beneficial to Convest if the two companies are
consolidated for tax purposes. In April 1996, Edisto purchased an additional
92,000 shares of Common Stock of Convest, thereby increasing its ownership
interest to approximately 73%.
(5) HEDGING ACTIVITIES
As previously stated, the Company conducts its hedging activities through
futures contracts traded on the NYMEX and price swap agreements with major
financial institutions. Set forth below is the contract amount and term of all
futures contracts held for price risk management purposes by the Company at June
30, 1996 and December 31, 1995:
-12-
<PAGE>
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
June 30, 1996 December 31, 1995
----------------------- ------------------------
Oil(1) Gas Oil(1) Gas
----------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Quantity Sold 286 MBbls 2,350 MMcf 285 MBbls 8,220 MMcf
Maximum Term 6 Months 6 Months 11 Months 10 Months
Average Price $18.14 $1.94 $17.23 $1.86
</TABLE>
- ---------------
(1) Excludes certain oil volumes attributable to the 1992 sale of certain
future production to Enron Reserve Acquisition Corp. which volumes are
subject to a contractual price of $17.00 per barrel.
Gains and losses realized upon settlement of the Company's hedge positions are
deferred and recognized as oil and gas sales revenue in the month of the
underlying physical production being hedged. As of June 30, 1996 and December
31, 1995, the Company recorded deferred hedging losses of $1.1 million and
$421,000, respectively, which is included in "Other Current Assets" in the
accompanying Consolidated Balance Sheets. The cash margin required by the
counterparties to the Company's hedging activities totaled $3.2 million and $5.1
million as of June 30, 1996 and December 31, 1995, respectively, which is
included in "Other Current Assets" in the accompanying Consolidated Balance
Sheets.
As a result of the Company's hedging activities, the Company recorded hedging
losses of approximately $4.5 million and $2.3 million for the six and three
month periods ended June 30, 1996, respectively, and hedging income of
approximately $400,000 and hedging losses of approximately $200,000 for the six
and three months ended June 30, 1995, respectively. Such amounts were recorded
as oil and gas sales revenue in the accompanying Consolidated Statements of
Operations.
(6) INCOME TAXES
The Company records current income taxes based on its estimated actual tax
liability for the year. The Company provides for deferred income taxes under
SFAS No. 109 based upon differences between the tax basis of the Company's
assets and liabilities and their financial statement carrying amounts multiplied
by the Company's expected future effective tax rate.
For the six months and three months ended June 30, 1996, the Company recorded
current income tax expense of $217,000 and $48,000, respectively. The Company
has provided a valuation allowance against substantially all of its net deferred
tax assets as the "more-likely-than-not" criteria for recognition under SFAS No.
109 was not met. At December 31, 1995, the Company purchased approximately $3.3
million of NOL tax benefits from Edisto for $550,000 which is included in "Other
Noncurrent Assets" in the accompanying balance sheets. See Note 4 above
regarding related party transactions. No valuation allowance was taken against
such amount under SFAS No. 109 since the Company anticipates that the purchased
NOLs will be utilized against the Company's current income tax.
(7) LONG-TERM DEBT
On June 26, 1995, simultaneous with the closing of the Edisto Transaction, the
Company entered into an Amended and Restated Secured Revolving Credit Agreement
(the "Agreement") with Bank One, Texas, N.A. ("Bank One"), and Compass Bank-
Houston, N.A. This facility, which terminates January 1, 1998, combined the
existing credit facilities of CEC and Edisto E&P. Bank One serves as agent bank
of the Agreement. The facility is secured by a first lien on all of the
Company's assets, including its oil and gas properties and gas plant. Interest
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<PAGE>
CONVEST ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
on borrowings under the Agreement is computed at (i) the agent bank's prime
lending rate plus 3/4% or (ii) the London Inter Bank Offering Rate ("LIBOR")
plus 2-3/4%. In addition, the Company pays a commitment fee equal to 1/2% on
any commitment amount in excess of outstanding borrowings.
The borrowing base is redetermined semi-annually on or before May 31 and
November 30 of each year by the lending banks based on engineering criteria
established by the banks. As of June 30, 1996 and December 31, 1995, the
borrowing base available under the Agreement was $24.5 and $29.8 million,
respectively, and reduces by $1.0 million per month. During January 1996, the
Company sold its interest in an offshore oil and gas property, and accordingly,
the Company's borrowing base was reduced by approximately $1.8 million
simultaneous with the sale of the property. Based on the Company's borrowing
base in effect on December 31, 1995, after giving effect to the scheduled
monthly borrowing base reductions, the Company's outstanding borrowings exceeded
the borrowing base by $1.6 million at December 31, 1995, and accordingly, such
amount was classified as current at such date.
As of June 30, 1996 and December 31, 1995, outstanding indebtedness under the
Agreement was $11.3 million and $19.2 million, respectively, with an additional
$200,000 of letters of credit outstanding as of those dates, primarily related
to performance bonds issued for oil and gas operations. At June 30, 1996,
substantially all of the Company's outstanding borrowings were subject to LIBOR
interest at an effective rate of approximately 8-1/2% per annum.
(8) COMMITMENTS AND CONTINGENCIES
Elizabeth Holt, et al. v. Sun E & P Company, et al., No. 3,217 in the 84th
District Court, Hansford County, Texas. This suit was originally filed in
August 1984, seeking to cancel a 13-section lease because there was no gas
production for a period of approximately 120 days in 1983 when the gas
purchaser's pipeline was shutdown for repairs. The plaintiff sought to
terminate the lease by reason of non-production as of September 23, 1983. If
successful, the Company would be liable for damages on past production in the
range of $300,000 to $350,000, plus pre-judgment interest and attorneys fees,
which would total approximately $400,000 to $450,000. At the trial held in
August 1995, the trial judge ruled by interlocutory judgment in the Company's
favor that the lease had been preserved by a timely shut-in payment. The
Company expects this judgment to be appealed, but such appeal may not be made
until after the case has been concluded against the other defendants. A trial
on damages against the other defendants was held in May 1996, but no judgment
has been rendered at this time. The predecessor in interest to Convest has
indemnified the Company to a maximum of $357,000 in value for the well provided
that total damages exceed $250,000.
John S. Turner v. Convest, et al., in the 56th Judicial District Court of
Galveston County, Texas. This lawsuit relates to two title claims involving
interests in an oil and gas property in Galveston County, Texas in which the
Company has a 46% working interest. In the lawsuit, the plaintiff claims that
he is the present owner of the interests and that he is entitled to his
proportionate share of past and future production from the property, plus
punitive damages and attorney's fees. The parties reached a settlement in July
1996 under which Convest will pay the plaintiff $106,000 and will grant a 1.42%
override in the property.
In addition, the Company is named as defendant in several lawsuits arising in
the ordinary course of business. While the outcome of lawsuits and other
proceedings against the Company cannot be predicted with certainty, management
does not expect these matters to have a material adverse effect on the Company's
financial position or results of operations.
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<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Company's consolidated financial statements and the notes thereto.
OVERVIEW AND SIGNIFICANT DEVELOPMENTS
The significant events during the first six months of 1996 are described
below:
RESULTS OF OPERATIONS. The Company had a net loss of $638,000 for the three
months ended June 30, 1996 compared to net income of $1.0 million for the same
period of 1995, and net income of $1.4 million for the six months ended June 30,
1996 compared to net income of $2.9 million for the corresponding period of
1995.
The net loss of $638,000 for the three months ended June 30, 1996 includes (i) a
$1.1 million writedown of the Company's oil and gas properties due to SFAS No.
121, and (ii) exploration costs and leasehold writeoffs of approximately
$750,000 due to two unsuccessful exploratory wells in the South Timbalier
prospect. As described in more detail below, an additional $950,000 of
estimated exploration costs due to these unsuccessful exploratory wells will be
expensed during the third quarter of 1996.
SFAS NO. 121 IMPAIRMENT LOSS. As a result of the Company's SFAS No. 121
evaluation of its proved oil and gas properties for the second quarter of 1996,
the Company determined that an offshore property had less reserves than as
previously estimated. Accordingly, the Company recorded an impairment loss on
the property of approximately $1.1 million based on production problems
encountered during the second quarter of 1996. This impairment loss is
described in more detail in Note 2 to the Consolidated Financial Statements and
"Results of Operations - Impairment of Oil and Gas Properties Under SFAS No.
121" below.
SIGNIFICANT DRILLING OPERATIONS. During 1996, the Company has invested a
substantial portion of its cash flow in drilling operations on its offshore
properties. As described below under "Liquidity and Capital Resources -Capital
Expenditures," the Company's capital expenditure budget for 1996 has increased
from approximately $8.0 million to $15.0 million. The most significant drilling
operations during 1996 are described below.
EUGENE ISLAND 281. During early 1996, the Company participated in the drilling
of a development well in Block 281 of the Eugene Island area in the Gulf of
Mexico. The well was drilled from an existing platform structure at an
estimated completed well cost of approximately $1.0 million, net to the
Company's 37% working interest, and tested at a daily rate of 1,276 barrels of
oil and 1,699 Mcf of gas. The well was connected to existing production
facilities on the platform and is presently flowing at approximately 600 barrels
of oil per day and 300 Mcf of gas per day.
SOUTH TIMBALIER. During April 1996, the Company participated in the drilling of
a development well on Block 221 of the South Timbalier area of the Gulf of
Mexico. The well was drilled from an existing well bore to approximately 12,000
feet. The well encountered productive sands and was tested at a rate of
approximately 7,000 Mcf of gas per day. The cost of drilling this well was
approximately $1.4 million, net to the Company's 40% working interest. This well
is producing at approximately 6,500 Mcf of gas per day and 115 barrels of oil
per day.
During June 1996, the Company participated in the drilling of an 8,000 foot
exploratory test well on a prospect located across Block 144 and Block 109 of
the South Timbalier area. During early July 1996, the well was tested and
encountered no commercial production and was subsequently abandoned. The cost
of the well was approximately $600,000, net to the Company's 50% working
interest. The Company also has written off the approximate $350,000 leasehold
cost of this property.
During early July 1996, the Company participated in a second exploratory well in
the South Timbalier area. The 5,700 foot well was drilled on a prospect
situated across Block 109 and Block 102 and encountered no commercial
production. This well cost approximately $750,000, net to the Company's 50%
interest.
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<PAGE>
GRAND ISLE. During June 1996, the Company participated in the drilling of an
8,000 foot development well on block 82 of the Grand Isle area of the Gulf of
Mexico. The well encountered productive sands and is producing at approximately
4,200 Mcf of gas per day. Total cost of the well was approximately $1.0 million,
net to the Company's 39% working interest.
EXPENSE FOR UNSUCCESSFUL WELLS. Since the Company follows the successful
efforts method of accounting, the drilling costs and the leasehold writeoffs of
approximately $1.7 million for the two unsuccessful South Timbalier exploratory
wells will be expensed based on the costs incurred during the second and third
quarters of 1996. Although the two wells were completed in July 1996, the
leasehold writeoffs and a portion of the exploration costs were incurred prior
to that time. Therefore, $750,000 of this cost was expensed during the second
quarter of 1996 while approximately $950,000 of additional costs will be
expensed during the third quarter of 1996.
PROPERTY SALES. During January 1996, the Company sold its interest in Vermilion
Block 284 for approximately $2.0 million. The Company also sold other
nonstrategic oil and gas properties during 1996 for aggregate sales proceeds of
approximately $400,000. As a result of these sales, the Company recorded a gain
of approximately $820,000 during 1996.
REPAYMENT OF OUTSTANDING DEBT. During 1996, the Company has repaid a net $8.0
million of outstanding debt under its long-term credit facility. The Company
used the $2.0 million proceeds received from the Vermilion 284 property sale and
approximately $6.0 million of cash flow from operations to make this debt
repayment.
LIQUIDITY AND CAPITAL RESOURCES
CREDIT FACILITY AND LONG-TERM DEBT
On June 26, 1995, simultaneous with the closing of the Edisto Transaction, the
Company entered into a new joint credit agreement covering both the Edisto E&P
and CEC properties. This facility, which terminates January 1, 1998, combined
the existing credit facilities of CEC and Edisto E&P. This facility is secured
by a first lien on substantially all of the Company's assets, including its oil
and gas properties and gas plant.
The borrowing base under the facility is subject to redetermination semi-
annually (on or before May 31 and November 30) using engineering determinations
and pricing and other assumptions designated by the bank group. Effective May
1, 1996, the new borrowing base under the credit facility was $25.5 million,
based on the lending banks' semi-annual redetermination, which began reducing by
$1.0 million per month beginning June 1, 1996. As of June 30, 1996, outstanding
indebtedness under the agreement was $11.3 million with an additional $200,000
of letters of credit outstanding.
The Company's borrowing capacity will be substantially reduced over the next
year (by at least $12.0 million) unless there is substantial improvement in oil
and gas prices or the Company is successful in proving up additional reserve
quantities. On the other hand, should prices fall below those currently
experienced and/or should the Company's reserve base be subject to downward
revision, the amount of the credit reduction could increase and such increase
could be substantial. Based on the borrowing base redetermination received in
May 1996 coupled with the repayment of outstanding borrowings during 1996, the
Company was not required to classify any of its outstanding long-term borrowings
as current at June 30, 1996. The Company feels that sufficient cash flow will
be derived from its oil and gas sales to meet its scheduled future debt
repayments. As stated above, however, the borrowing base and the amount of
current maturities of debt is subject to change.
WORKING CAPITAL
At June 30, 1996, the Company had a working capital deficit of approximately
$675,000. The primary cause of the working capital deficit is the
classification as current liabilities of the accrued liabilities for abandonment
costs, operating expenses attributable to the sale of a production payment on
two properties, and gas imbalance liabilities (deferred revenues), all of which
are expected to be paid during the next 12 months. There is no offsetting
current asset for any of these liabilities; rather, they will to be repaid using
cash flow from operations of the Company's oil and gas properties, which are
reflected as a long-term asset on the Consolidated Balance Sheets in accordance
with generally accepted accounting principles.
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<PAGE>
The Company's ability to reduce the existing working capital deficit while
maintaining an active drilling program and normal operations will depend upon
the net cash flows generated from its oil and gas properties. In this regard,
the Company's future net revenues are expected to decline significantly during
the remainder of 1996 and beyond due to the rapid depletion of the Company's
offshore oil and gas properties. This will result in reduced discretionary cash
flow available for expansion of existing operations, new acquisitions and
general corporate purposes. However, based on current conditions, management
believes that the Company has the financial capability to satisfy its working
capital deficit and debt service requirements, while sustaining capital
expenditures and meeting operating needs arising in the ordinary course of
business.
CAPITAL EXPENDITURES
As previously stated, the Company has devoted a substantial portion of its
available cash flow to drilling opportunities on its offshore properties and the
reduction of its outstanding borrowings under its long-term credit facility. In
addition to the drilling activity discussed, the Company has been notified by
the operators of several of its offshore properties of their intentions to
propose additional exploratory and development drilling activity during the
remainder of 1996. Therefore, the Company has increased its original capital
expenditure budget for 1996 from approximately $8.0 million to approximately
$15.0 million.
If the Company does not participate in a drilling operation proposed on one of
its properties, under the terms of the pertinent Joint Operating Agreement, the
Company could be subject to a substantial penalty being imposed on its interest
in a specific well. Accordingly, management plans to carefully evaluate all
proposed projects which represent a substantial draw on corporate resources or
which reduce near term liquidity. In addition, the Company continues to
evaluate possible acquisition and divestiture opportunities in an effort to
upgrade the Company's reserve base, primarily in geographic areas where the
Company possesses operating expertise and where the property profiles have a
longer reserve life.
It is anticipated that the Company's 1996 exploratory and development drilling
operations will be funded with cash flow from the Company's oil and gas
properties. However, significant changes in oil and gas prices or significant
revisions in the reserve volumes securing the Company's long-term credit
facility could require management to dedicate all or a substantial portion of
the Company's cash flow to meet working capital needs and debt maturities,
thereby precluding the Company from participating in proposed drilling
opportunities.
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<PAGE>
RESULTS OF OPERATIONS
The following table highlights the production volumes, average oil and gas
prices and revenues received by the Company and production and operating
expenses for the six month and three month periods ended June 30, 1996 and 1995.
<TABLE>
<CAPTION>
For the Six Months For the Three Months
Ending June 30, Ending June 30,
------------------------------- -------------------------------
Percentage Percentage
1996 1995 Change 1996 1995 Change
-------- ---------- --------- -------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
PRODUCTION VOLUMES:
Oil (Mbbls) 460 592 (22%) 243 303 (20%)
Gas (including NGL's)(Mmcf) 7,006 10,148 (31%) 3,434 5,143 (33%)
BOE (Mbbls)(1) 1,627 2,284 (29%) 815 1,161 (30%)
PRICES:
Oil ($/Bbl) $ 17.05 $ 16.91 1% $ 16.81 $ 17.06 (1%)
Gas ($/Mcf) $ 1.92 $ 1.56 23% $ 1.77 $ 1.50 18%
GROSS OIL AND GAS REVENUE (IN THOUSANDS):
Oil $ 7,845 $10,011 (22%) $ 4,085 $ 5,168 (21%)
Gas (including NGL's) 13,484 15,834 (15%) 6,085 7,734 (21%)
------- ------- ------- -------
Total Oil and Gas Revenue $21,329 $25,845 (17%) $10,170 $12,902 (21%)
======= ======= ======= =======
PRODUCTION EXPENSES (IN THOUSANDS):
Lease Operating Expenses $ 7,636 $ 9,041 (16%) $ 3,675 $ 4,689 (22%)
Production Taxes 617 611 1% 307 309 (1%)
------- ------- ------- -------
Total Production Expenses $ 8,253 $ 9,652 (14%) $ 3,982 $ 4,998 (20%)
======= ======= ======= =======
ABANDONMENT AND EXPLORATION COSTS $ 921 $ 498 85% $ 878 $ 133 560%
======= ======= ======= =======
GENERAL AND ADMINISTRATIVE EXPENSE $ 2,281 $ 2,606 (12%) $ 1,042 $ 1,453 (28%)
======= ======= ======= =======
INTEREST EXPENSE $ 674 $ 1,134 (41%) $ 307 $ 568 (46%)
======= ======= ======= =======
DEPRECIATION, DEPLETION & AMORTIZATION
OF OIL AND GAS PROPERTIES $ 7,857 $10,873 (28%) $ 3,745 $ 5,752 (35%)
======= ======= ======= =======
PRODUCTION COSTS PER BOE $ 5.07 $ 4.23 20% $ 4.89 $ 4.30 14%
======= ======= ======= =======
DEPRECIATION, DEPLETION & AMORTIZATION
PER BOE $ 4.83 $ 4.76 1% $ 4.60 $ 4.95 (7%)
======= ======= ======= =======
</TABLE>
(1) Natural gas is converted into oil equivalents at a rate of six Mcf per each
barrel of oil.
The following comparison of results of operations of the Company for the six
and three month periods ended June 30, 1996 and 1995 was prepared from the
combined results of operations of CEC and Edisto E&P as if the Edisto
Transaction had occurred on January 1, 1995, with the preacquisition net loss of
CEC for the respective periods being eliminated for purposes of determining net
income. See Note 1 under "Notes to Consolidated Financial Statements" for
additional information regarding the reverse acquisition method of accounting
used for the Edisto Transaction.
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<PAGE>
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 1996 AND 1995.
Revenues. Oil and gas revenue decreased by approximately $4.5 million or 17%
between the six month periods ended June 30, 1996 and 1995. The average price
the Company received for its oil and gas sales increased by 1% and 23%,
respectively, between the corresponding periods. Oil and gas production
decreased by 22% and 31%, respectively. The decrease in production volumes was
due primarily to the sale of producing oil and gas properties coupled with the
steep production decline associated with the Company's offshore Gulf of Mexico
properties. The effects of these production declines was partially offset by
the additional drilling on the Company's South Timbalier Block 144 property
completed in late 1995 and the addition of the Sensor properties purchased in
mid 1995. As previously stated, the Company's offshore properties are subject
to inherent steep production declines. In order to minimize the future effects
of such declines, the Company must replace its reserves through its exploratory
and development drilling and acquisition activities.
Price Risk Management/Hedging. The Company uses a combination of futures
contracts traded on the NYMEX and price swaps with major financial institutions
to hedge against the volatility of natural gas and oil prices. Gains and losses
recognized upon settlement of the Company's hedge positions are deferred and
recognized as oil and gas sales revenue in the month of the underlying physical
production being hedged. As a result of the Company's hedging activities, the
Company recorded hedging losses of approximately $4.5 million for the six month
period ended June 30, 1996, and hedging income of approximately $400,000 for the
corresponding period of 1995. Such amounts were recorded as oil and gas sales
revenue in the accompanying statements of operations, and accordingly, such
amounts are reflected in the per unit price the Company received for its oil and
gas sales.
The hedges affecting 1996 were implemented early in the fourth quarter of 1995
when oil and gas prices were substantially lower. These hedges were made as a
defensive measure to assure stable cash flows in 1996. The past harsh winter,
however, drove prices up substantially which caused the hedging losses in 1996.
Production Expenses. Production expenses decreased by approximately $1.4
million or 14% between the corresponding periods. The decrease in production
expenses is primarily due to a decrease in workover activity during the six
months ended June 30, 1996, and the sale of producing oil and gas properties
during 1995 and early 1996. The decline in production expenses was offset by
the incremental operating expenses associated with the Sensor properties.
Production expenses per barrel of oil equivalent ("BOE") was $5.07 and $4.23 for
the six months ended June 30, 1996 and 1995, respectively. The increase in
production expense per BOE is caused by the decreased offshore production
without a corresponding decrease in production expense.
Abandonment and Exploration Costs. Abandonment and exploration costs
increased by $423,000 between the corresponding periods. The Company accrues
its estimated cost of abandonment of its offshore properties. Based upon a
review of the reserve for abandonment, it was determined that the Company had
substantially provided for its future abandonment liability, and accordingly, no
additional accrual was provided for 1996.
During the second quarter of 1996, the Company expensed approximately $750,000
of exploration costs and leasehold writeoffs associated with two unsuccessful
South Timbalier exploratory wells based on the costs incurred. The Company will
expense approximately $950,000 of additional costs during the third quarter of
1996 related to these wells.
Impairment of Oil and Gas Properties Under SFAS No. 121. Prior to 1995, the
Company provided an impairment reserve for proved oil and gas properties to the
extent that total capitalized costs less accumulated depreciation and depletion,
exceed undiscounted future net revenues attributable to proved oil and gas
reserves on an overall basis. During March 1995, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standard No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of" ("SFAS No. 121"). SFAS No. 121 requires the Company to provide
an impairment reserve for proved oil and gas properties to the extent that total
capitalized costs, less accumulated depreciation and depletion, exceed
undiscounted expected future cash flows attributable to proved oil and gas
reserves on a property-by-property basis. The Company adopted the provisions of
SFAS No. 121 during the fourth quarter of 1995.
The Company regularly assesses the need for an impairment of its oil and gas
properties. The Company's SFAS No. 121 evaluation for the second quarter of
1996 was prepared using the Company's 1995 year end reserve
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<PAGE>
estimates adjusted for production and other known changes subsequent to the
preparation of the Company's year end reserve estimates. As a result of this
evaluation, the Company determined that an offshore property had less reserves
than as previously estimated. Accordingly, the Company recorded an impairment
loss on the property of approximately $1.1 million based on production problems
encountered during the second quarter of 1996.
General and Administrative Expenses. General and administrative expenses
decreased by approximately $325,000 between the corresponding periods. The
primary contributor to the decrease in general and administrative expense was
the inclusion of employee severance cost in 1995 subsequent to the Company's
reorganization upon closing of the Edisto Transaction. In addition, the Company
incurred lower office rent expense after Edisto E&P terminated its existing
office lease in mid 1995.
Interest Expense. Interest expense decreased by approximately 41% due to the
repayment of a short-term promissory note issued in connection with the
Company's purchase of the oil and gas assets of a former affiliate. The short-
term promissory note was repaid simultaneously with the closing of the Edisto
Transaction. In addition, the Company repaid a substantial portion of its
outstanding borrowings under its long-term credit facility during 1996.
Depreciation, Depletion and Amortization ("DD&A"). DD&A on oil and gas
properties decreased by approximately $3.0 million or 28% between the
corresponding periods. The decrease in DD&A was due primarily to the production
declines discussed above. DD&A per BOE was $4.83 for the six month period ended
June 30, 1996, compared to $4.76 for the corresponding period of 1995.
Gain on Asset Sales. In mid-January 1996, the Company completed the sale of
an offshore oil and gas property for sale proceeds of approximately $2.0
million, which resulted in a gain of approximately $620,000. In addition, the
Company sold several other nonstrategic oil and gas properties during 1996 for
aggregate sale proceeds of approximately $400,000, which resulted in a gain of
approximately $200,000.
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 1996 AND 1995.
Revenues. Oil and gas revenue decreased by approximately $2.7 million or 21%
between the three month periods ended June 30, 1996 and 1995. The average price
the Company received for its oil and gas sales decreased by 1% while the price
received for natural gas sales increased by 18%. As previously discussed, the
primary reason for the decease in oil and gas sales volumes was due to the sale
of several properties during 1995 and 1996 coupled with the steep productions
declines on the Company's offshore properties.
Price Risk Management/Hedging. As previously stated, the Company uses futures
contracts and swap agreements to hedge its oil and gas production thereby
assuring stable cash flow. As a result of the sharp increase in oil and gas
prices during the past winter, the Company has experienced losses associated
with the contracts. For the three months ended June 30, 1996, the Company has
recorded hedging losses of approximately $2.3 million compared to hedging losses
of $200,000 for the corresponding period of 1995. As previously stated, the
Company records gains and losses realized on its hedging activities as oil and
gas sales revenue, accordingly, such amounts are reflected in the per unit price
the Company received for its oil and gas sales.
Production Expenses. Production expenses decreased by approximately $1.0
million or 20% between the three months ended June 30, 1996 and 1995. The
decrease in production expenses was primarily due to the aforementioned decrease
in workover expense. Production expenses per BOE were $4.89 and $4.30 between
the corresponding periods.
Abandonment and Exploration Costs. Abandonment and exploration costs
increased by $745,000 between the corresponding periods. The Company accrues
its estimated cost of abandonment of its offshore properties. Based upon a
review of the reserve for abandonment, it was determined that the Company had
substantially provided for its future abandonment liability, and accordingly, no
additional accrual was provided for 1996.
During the second quarter of 1996, the Company expensed approximately $750,000
of exploration costs and leasehold writeoffs associated with two unsuccessful
South Timbalier exploratory wells based on the costs incurred.
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<PAGE>
The Company will expense approximately $950,000 of additional costs during the
third quarter of 1996 related to these wells.
General and Administrative Expenses. As previously stated, the Company
recorded employee severance expense during 1995 in conjunction with its
reorganization following the Edisto Transaction. As a result, general and
administrative expense decreased in 1996 by approximately 28%.
Interest Expense. Interest expense decreased by approximately 46% between the
corresponding periods. As previously stated, the Company repaid a short-term
note payable to an affiliate in 1995 and repaid a substantial portion of its
outstanding long-term borrowings in 1996.
Depreciation, Depletion and Amortization ("DD&A"). DD&A on oil and gas
properties decreased by approximately $2.0 million or 35% between the
corresponding periods. As previously stated, the decrease in DD&A was directly
related to the previously mentioned production declines.
Impairment of Oil and Gas Properties Under SFAS No. 121. The Company's SFAS
No. 121 evaluation for the second quarter of 1996 was prepared using the
Company's 1995 year end reserve estimates adjusted for production and other
known changes subsequent to the preparation of the Company's year end reserve
estimates. As a result of this evaluation, the Company determined that an
offshore property had less reserves than as previously estimated. Accordingly,
the Company recorded an impairment loss on the property of approximately $1.1
million based on production problems encountered during the second quarter of
1996.
INFLATION AND CHANGING PRICES
While the costs of operations have been, and will continue to be, affected by
inflation and the success of acquisition, drilling and workover activities, oil
and gas prices have fluctuated in recent years and generally have not followed
the same pattern as inflation. As a result, the Company from time to time
engages in commodity hedging activities to minimize the risk of market
fluctuations associated with the price of crude oil and natural gas production.
The hedging objectives include assurance of stable and known minimum cash flows
and fixing favorable prices. See Notes 2 and 5 of the "Notes to Consolidated
Financial Statements" included herein.
The Company will continue to monitor energy prices and may enter into
subsequent hedging transactions in the ordinary course of business as management
deems appropriate. Management cannot predict at what level product prices will
be sustained due to factors beyond the Company's control, such as worldwide oil
supplies and regional world politics.
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<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Note 8 of the "Notes to the Consolidated Financial Statements" is incorporated
herein by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The annual meeting of shareholders of the Company was held on June 3, 1996
(the "Meeting"). The purposes of the Meeting were to (i) elect a board of
seven directors, (ii) to approve the adoption of the 1995 Stock Incentive
Plan, and (iii) to ratify the selection of Arthur Andersen LLP as the
independent public accountants of the Company for 1996. A total of
9,193,152 shares or 88.3% of the 10,412,722 outstanding shares of Convest's
Common Stock, par value $.01 per share, entitled to vote at the Meeting
were voted in person or by proxy.
Results of voting on the election of directors are as follows:
<TABLE>
<CAPTION>
Shares Shares Present
Director Nominee Shares For Withheld But Not Voting
- ---------------- ---------- -------- ---------------
<S> <C> <C> <C>
Timothy J. Andrews 9,060,044 133,108 0
E. Murray Gullatt 9,059,785 133,367 0
Richard T. Howell 9,059,916 133,236 0
Vernon T. Jones, Sr. 9,059,995 133,157 0
Michael Y. McGovern 9,059,867 133,285 0
Franklin Myers 9,060,239 132,913 0
Leonard B. Rosenberg 9,059,747 133,405 0
</TABLE>
The following votes were cast with respect to the approval of the 1995 Stock
Incentive Plan:
<TABLE>
<CAPTION>
Shares For Shares Against Shares Abstaining Broker Non-Votes
- ---------- -------------- ----------------- ----------------
<S> <C> <C> <C>
8,148,103 228,324 39,713 777,012
</TABLE>
The following votes were cast with respect to the ratification of Arthur
Andersen LLP as the Company's independent public accountants for 1996.
<TABLE>
<CAPTION>
Shares For Shares Against Shares Abstaining Broker Non-Votes
- ---------- -------------- ----------------- ----------------
<S> <C> <C> <C>
9,160,220 8,611 24,321 0
</TABLE>
ITEM 6. (A) EXHIBITS.
27 - Financial Data Schedule
None.
(B) REPORTS ON FORM 8-K
None.
-22-
<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.
CONVEST ENERGY CORPORATION
(Registrant)
By: /s/ Gary L. Pittman
--------------------------------------
Gary L. Pittman
Executive Vice President and Chief Financial
Officer
(Principal Accounting Officer)
Date: August 13, 1996
-23-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 2ND QUARTER
10-Q 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-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<CASH> 2,625
<SECURITIES> 0
<RECEIVABLES> 8,059
<ALLOWANCES> (820)
<INVENTORY> 0
<CURRENT-ASSETS> 15,254
<PP&E> 112,182
<DEPRECIATION> 55,591
<TOTAL-ASSETS> 74,675
<CURRENT-LIABILITIES> 15,929
<BONDS> 0
0
0
<COMMON> 104
<OTHER-SE> 36,362
<TOTAL-LIABILITY-AND-EQUITY> 74,675
<SALES> 22,033
<TOTAL-REVENUES> 23,055
<CGS> 0
<TOTAL-COSTS> 8,485
<OTHER-EXPENSES> 12,230<F1>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 674
<INCOME-PRETAX> 1,666
<INCOME-TAX> 217
<INCOME-CONTINUING> 1,449
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,449
<EPS-PRIMARY> 0.14
<EPS-DILUTED> 0.14
<FN>
<F1>"OTHER-EXPENSES" INCLUDES $7.9 MILLION OF DEPRECIATION, DEPLETION AND
AMORTIZATION AND $1.1 MILLION OF IMPAIRMENT OF OIL AND GAS PROPERTIES
</FN>
</TABLE>
