<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
FOR THE FISCAL YEAR ENDED DECEMBER 31, 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 1-12474
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TORCH ENERGY ROYALTY TRUST
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 74-6411424
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
1100 North Market Street, Wilmington, Delaware 19890
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (302) 651-8775
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which
------------------- ------------------------------
registered
----------
Units of Beneficial Interest New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
NONE
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 ______
-----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K (X).
The aggregate market value of outstanding units of beneficial interest of the
registrant held by non-affiliates of the registrant at March 17, 1996 was
approximately $88,150,000.
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TORCH ENERGY ROYALTY TRUST
Annual Report on Form 10-K
For the fiscal year ended December 31, 1996
TABLE OF CONTENTS
PAGE
NUMBER
------
PART I
Item 1. Business............................................. 2
Item 2. Properties........................................... 8
Item 3. Legal Proceedings.................................... 12
Item 4. Submission of Matters to a Vote of Unitholders....... 12
PART II
Item 5. Market for Registrant's Units and Related
Unitholder Matters.................................. 12
Item 6. Selected Financial Data.............................. 12
Item 7. Trustee's Discussion and Analysis of Financial
Condition and Results of Operations.................. 13
Item 8. Financial Statements and Supplementary Data.......... 18
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................. 33
PART III
Item 10. Directors and Executive Officers of the Registrant... 33
Item 11. Executive Compensation............................... 33
Item 12. Security Ownership of Certain Beneficial Owners and
Management.......................................... 34
Item 13. Certain Relationships and Related Transactions....... 34
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K......................................... 36
-- Signatures
1
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TORCH ENERGY ROYALTY TRUST
PART I
ITEM 1. BUSINESS
- -----------------
GENERAL
- -------
The Torch Energy Royalty Trust ("Trust") was formed effective October 1, 1993,
pursuant to a trust agreement ("Trust Agreement") among Wilmington Trust
Company, as trustee ("Trustee"), Torch Royalty Company ("TRC") and Velasco Gas
Company Ltd. ("Velasco") as owners of certain oil and gas properties
("Underlying Properties") and Torch Energy Advisors Incorporated ("Torch") as
grantor. TRC and Velasco created net profits interests ("Net Profits Interests")
and conveyed such interests to Torch. Torch conveyed the Net Profits Interests
to the Trust in exchange for an aggregate of 8,600,000 units of beneficial
interest ("Units"). Such Units were sold to the public through various
underwriters beginning November 1993. Pursuant to the Trust Agreement, Torch
provides accounting, bookkeeping, informational and other services related to
the Net Profits Interests.
The Trust will not terminate prior to January 1, 2003, except upon the
affirmative vote of the holders of not less than 80% of the outstanding Units.
Thereafter, the Trust will terminate upon the first to occur of (i) an
affirmative vote of the holders of not less than 66-2/3% of the outstanding
Units to liquidate the Trust; (ii) such time as the ratio of the cash amounts
received by the Trust from the Net Profits Interests to administrative costs of
the Trust is less than 1.2 to 1.0 for three consecutive quarters; (iii) March 1
of any year if it is determined based on a reserve report as of December 31 of
the prior year that the present value of estimated pre-tax future net cash
flows, discounted at 10%, of proved reserves attributable to the Net Profits
Interests is equal to or less than $25 million; or (iv) December 31, 2012.
After termination of the Trust, the remaining assets of the Trust will be sold,
the proceeds therefrom (after expenses) will be distributed to the unitholders
("Unitholders"). The sole purpose of the Trust is to hold the Net Profits
Interests, to receive payments from TRC and Velasco, and to make payments to
Unitholders. The Trust does not conduct any business activity.
TRC and Velasco, as owners of the Underlying Properties subject to and burdened
by the Net Profits Interests, contracted to sell the oil and gas production from
such properties to Torch Energy Marketing Inc. ("TEMI"), a subsidiary of Torch,
under a purchase contract ("Purchase Contract"). TRC and Velasco receive
payments reflecting the proceeds of oil and gas sold and aggregate these
payments, deduct applicable costs and make payments to the Trustee each quarter
for the amounts due to the Trust. Unitholders receive quarterly cash
distributions relating to oil and gas produced and sold from the Underlying
Properties after October 1, 1993 ("Effective Date"). Amounts received with
respect to production for the period from the Effective Date to November 23,
1993 represented a return of capital to the Unitholders, for Federal income tax
purposes, whereas amounts received with respect to production on or after
November 23, 1993 are considered taxable income to each Unitholder subject to an
allowance for the greater of cost or percentage depletion. Because no
additional properties will be contributed to the Trust, the assets of the Trust
deplete over time and a portion of each cash distribution made by the Trust is
analogous to a return of capital.
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TORCH ENERGY ROYALTY TRUST
On September 30, 1996, Torch Acquisition Company, a company formed by executive
management of Torch, acquired all of the outstanding shares of capital stock of
Torch from United Investors Management Company ("United"), a subsidiary of
Torchmark Corporation. Immediately prior to this transaction, Torch distributed
all of the outstanding capital stock of TRC to United. None of the obligations
of Torch or TRC to the Trust were changed as a result of such transfers and
Torch believes that such transfers will not adversely affect the Trust or the
Unitholders.
The Underlying Properties constitute working interests in the Chalkley Field in
Louisiana ("Chalkley Field"), the Robinson's Bend Field in the Black Warrior
Basin in Alabama ("Robinson's Bend Field"), fields that produce from the Cotton
Valley formations in Texas ("Cotton Valley Fields") and fields that produce from
the Austin Chalk formation in Texas ("Austin Chalk Fields"). The Underlying
Properties represent interests in all productive formations from 100 feet below
the deepest productive formation in each field to the surface when the Trust was
formed. The Trust therefore has no interest in deeper productive formations.
Affiliates and other related parties of Torch also own interests in oil and gas
properties located in the same geographic areas as the Underlying Properties and
own interests in certain of the same wells, which interests are not burdened by
the Net Profits Interests.
Sales of coal seam and tight sands gas attributable to the Net Profits Interests
between November 23, 1993 and January 1, 2003 result in Unitholders receiving
quarterly allocations of tax credits under Section 29 of the Internal Revenue
Code of 1986 ("Section 29 Credit"). In 1996, 1995 and 1994, the Section 29
Credit available for production from qualifying coal seam properties was
approximately $1.03, $1.01 and $1.00, respectively, for each MMBtu of gas
produced and sold. This rate is adjusted annually for inflation. The Section
29 Credit available for production from qualifying tight sands properties is
approximately $0.52 for each MMBtu of gas produced and sold and such amount is
not adjusted for inflation.
Separate conveyances ("Conveyances") were used to transfer the Net Profits
Interests in each state. Net proceeds ("Net Proceeds"), generally defined as
gross revenues received from the sale of production attributable to the
Underlying Properties during any period less property, production, severance and
similar taxes, and development, operating, and certain other costs (excluding
operating and development costs from the Robinson's Bend Field until January 1,
2003), are calculated separately for each Conveyance. If, during any period,
costs and expenses deducted in calculating Net Proceeds exceed gross proceeds
under a Conveyance, neither the Trust nor Unitholders are liable to pay such
excess directly, but the Trust will receive no payments for distribution to
Unitholders with respect to such Conveyance until future gross proceeds exceed
future costs and expenses plus the cumulative excess of such costs and expenses
not previously recouped by TRC and Velasco plus interest thereon. Because
development and operating costs generally are deducted in computing Net
Proceeds, such costs will affect the amounts paid to the Trust from the Net
Profits Interests. The complete definitions of Net Proceeds are set forth in
the Conveyances.
MARKETING ARRANGEMENTS
In connection with the formation of the Trust, TRC, Velasco and TEMI entered
into the Purchase Contract which expires upon the termination of the Trust.
Under the Purchase Contract, TEMI is obligated to purchase all net production
attributable to the Underlying Properties for an index price for
3
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TORCH ENERGY ROYALTY TRUST
oil and gas ("Index Price"), less certain gathering, treating and transportation
charges, which are calculated monthly. The Index Price equals 97% of the average
spot market prices of oil and gas ("Average Market Prices") at the four
locations where TEMI sells production, which, prior to September 1, 2000, is
adjusted to reflect the terms of a hedge contract ("Hedge Contract") to which
TEMI is a party. Under the Hedge Contract, TEMI receives prices specified in the
Hedge Contract ("Specified Prices") for quantities of oil and gas specified
therein ("Specified Quantities"). In calculating the Index Price for gas (which
represents approximately 97% of the estimated reserves as of January 1, 1997, on
a net equivalent Mcf of gas ("Mcfe") basis), the Specified Prices receive a
weighting of approximately one-third through September 1, 1997 and less than 10%
thereafter, and the Average Market Prices receive the balance of the weighting.
The Specified Prices for gas increase each year from $1.79 per MMBtu in 1994 to
$1.89 per MMBtu in 2000 and are adjusted to reflect the difference between the
settlement prices for oil and gas in the futures markets and the Average Market
Prices.
The Purchase Contract also provides that the minimum price paid by TEMI for gas
production is $1.70 per MMBtu ("Minimum Price"). When TEMI pays a purchase
price based on the Minimum Price it receives price credits ("Price Credits"),
equal to the difference between the Index Price and the Minimum Price, that it
is entitled to deduct in determining the purchase price when the Index Price for
gas exceeds the Minimum Price. In addition, if the Index Price for gas exceeds
$2.10 per MMBtu, TEMI is entitled to deduct 50% of such excess ("Price
Differential") from the purchase price. Beginning January 1, 2001, TEMI has an
annual option to discontinue the Minimum Price commitment. However, if TEMI
discontinues the Minimum Price commitment, it will no longer be entitled to
deduct the Price Differential in calculating the purchase price and will forfeit
all accrued Price Credits. TEMI has purchased contracts granting TEMI the right
to sell estimated gas production in excess of the Specified Quantities at a
price intended to limit TEMI's losses in the event the Index Price falls below
the Minimum Price.
Gas production is purchased at the wellhead and, therefore, Net Proceeds do not
include any amounts received in connection with extracting natural gas liquids
from such production at gas processing or treating facilities.
GATHERING, TREATING AND TRANSPORTATION ARRANGEMENTS
The Purchase Contract entitles TEMI to deduct certain gas gathering, treating
and transportation fees in calculating the purchase price for gas in the
Robinson's Bend, Austin Chalk and Cotton Valley Fields. The amounts that may be
deducted in calculating the purchase price for such gas are set forth in the
Purchase Contract and are not affected by the actual costs incurred by TEMI to
gather, treat and transport gas. For the Robinson's Bend Field, TEMI is entitled
to deduct a gathering, treating and transportation fee of $0.26 per MMBtu
adjusted for inflation ($0.272, $0.265 and $0.261 per MMBtu for 1996, 1995 and
1994, respectively), plus fuel usage equal to 5% of revenues, payable to Bahia
Gas Gathering, Ltd. ("Bahia"), a former affiliate of Torch, pursuant to a gas
gathering agreement. On
4
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TORCH ENERGY ROYALTY TRUST
October 1, 1996, Bahia was merged into TEMI. Amounts that would have been
previously payable to Bahia from TEMI will continue to be deducted by TEMI.
Additionally, a fee of $.05 per MMBtu, representing a gathering fee payable to a
non-affiliate of Torch, is deducted in calculating the purchase price for
production from 68 of the 410 wells in the Robinson's Bend Field. TEMI also
deducts $0.38 per MMBtu plus 17% of revenues in calculating the purchase price
for production from the Austin Chalk Fields as a fee to gather, treat and
transport gas production. Effective August 1, 1994, the Purchase Contract was
amended to allow TEMI to deduct from the purchase price for gas a transportation
fee of $.045 per MMBtu for production attributable to certain wells in the
Cotton Valley Fields; such production was transferred to a pipeline with lower
system pressure, and the transportation fee is paid to a third party. No amounts
for gathering, treating or transportation are deducted in calculating the
purchase price from the Chalkley Field.
NET PROFITS INTERESTS
The Net Profits Interests entitle the Trust to receive 95% of the Net Proceeds
attributable to oil and gas produced and sold from wells (other than infill
wells) on the Underlying Properties. In calculating Net Proceeds from the
Robinson's Bend Field, operating and development costs incurred prior to January
1, 2003 are not deducted. In addition, the amounts paid to the Trust from the
Robinson's Bend Field during any calendar quarter are subject to a volume
limitation ("Volume Limitation") equal to the gross proceeds from the sale of
912.5 MMcf of gas (730.0 MMcf of gas before 1995), less property, production,
severance and related taxes. The Robinson's Bend Field production attributable
to the Trust has not met the Volume Limitation since 1994 and is not expected to
do so in the future (See "Item 2. Properties - Description of the Underlying
Properties - Robinson's Bend Field"). The Net Profits Interests also entitle
the Trust to 20% of infill net proceeds drilled on the Underlying Properties.
VOLATILITY OF OIL AND GAS PRICES
The Trust's cash distributions, operating results and the value of the Net
Profits Interest are substantially dependent on prices of gas and, to a lesser
extent, oil. Prices for oil and gas are subject to large fluctuations in
response to relatively minor changes in the supply of and demand for oil and
gas, market uncertainty and a variety of additional factors beyond the control
of Torch. These factors include weather conditions in the United States, the
condition of the United States economy, the actions of the Organization of
Petroleum Exporting Countries, governmental regulation, political stability in
the Middle East and elsewhere, the foreign supply of oil and gas, the price of
foreign imports and the availability of alternate fuel sources. Any substantial
and extended decline in the price of oil and gas would have an adverse effect on
the Trust's revenues, cash distributions and value of the Net Profits Interests.
UNCERTAINTY OF ESTIMATES OF RESERVES AND FUTURE NET CASH FLOWS
Estimates of economically recoverable oil and gas reserves and of future net
cash flows are based upon a number of variable factors and assumptions, all of
which are to some degree speculative and may vary considerably from actual
results. Therefore, actual production, revenues, taxes, and development and
operating expenditures may not occur as estimated. Future results of the Trust
will depend upon
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TORCH ENERGY ROYALTY TRUST
the ability of the owners of the Underlying Properties to develop, produce and
sell its oil and natural gas reserves. The reserve data included herein are
estimates only and are subject to many uncertainties. Actual quantities of oil
and natural gas may differ considerably from the amounts set forth herein. In
addition, different reserve engineers may make different estimates of reserve
quantities and cash flows based upon the same available data.
OPERATING RISKS
Cash payments to the Trust are derived from the production and sale of oil and
gas, which operations are subject to risk inherent in such activities, such as
blowouts, cratering, explosions, uncontrollable flows of oil, gas or well
fluids, fires, pollution and other environmental risks. These risks could
result in substantial losses which are deducted in calculating the Net Proceeds
paid to the Trust due to injury and loss of life, severe damage to and
destruction of property and equipment, pollution and other environmental damage
and suspension of operations.
COMPETITION AND MARKETS
The Trust's distributions are dependent on the price received for gas and, to a
lesser extent, oil production from the Underlying Properties. The gas industry
is highly competitive in all of its phases. In marketing production from the
Underlying Properties, Torch encounters competition from major gas companies,
independent gas concerns, and individual producers and operators. Many of these
competitors have greater financial and other resources than Torch. Competition
may also be presented by alternative fuel sources, including heating oil and
other fossil fuels.
The supply of natural gas capable of being produced in the United States has
exceeded demand in recent years as a result of economic factors, conservation,
lower prices for alternative energy sources and other factors. As a result of
this excess supply of natural gas, natural gas producers have experienced
increased competitive pressure and significantly lower prices. Due to the
restructuring of the industry and the producers' methods of marketing their gas
production, caused mainly by the Federal Energy Regulatory Commission ("FERC")
regulations, minimal gas is sold to pipelines under the previously common take-
or-pay style long-term (15-20 year) contracts. Pipelines have either
renegotiated their obligations to reflect more market-responsive terms or
reduced or ceased their purchases of gas.
Crude oil and natural gas supplies are currently abundant relative to demand in
the worldwide markets for those commodities. Market prices are typically
volatile as a result of uncertainties caused by world events. Demand for
natural gas production has historically been seasonal in nature, and prices for
gas fluctuate accordingly. Weather fluctuations over the last several years and
the ability of markets to access storage, have caused the demand for gas to
decrease, resulting in lower prices received by producers. Consequently, on an
energy equivalent basis, gas has sold at a discount to oil for the past several
years. Such price fluctuations and the continuation of a depressed market for
natural gas will directly impact Trust distributions, estimated reserves
attributable to the Trust and estimated future net revenues from Trust reserves.
In view of the many uncertainties affecting the supply and demand for natural
gas, Torch is unable to make reliable predictions of future gas prices or the
overall effect such prices will have on the Trust.
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TORCH ENERGY ROYALTY TRUST
REGULATION OF NATURAL GAS
The production, transportation and sale of natural gas from the Underlying
Properties are subject to Federal and state governmental regulation, including
regulation of tariffs charged by pipelines, taxes, the prevention of waste, the
conservation of gas, pollution controls and various other matters. The United
States has governmental power to impose pollution control measures.
Federal Regulation
The Underlying Properties will be subject to the jurisdiction of FERC with
respect to various aspects of gas operations including the marketing and
production of gas. The Natural Gas Act and the Natural Gas Policy Act
(collectively, the "Acts") mandate Federal regulation of interstate
transportation of gas. The Natural Gas Wellhead Decontrol Act of 1989 terminated
wellhead price controls on all domestic gas on January 1, 1993. Numerous
questions have been raised concerning the interpretation and implementation of
several significant provisions of the Acts and of the regulations and policies
promulgated by FERC thereunder. A number of lawsuits and administrative
proceedings have been instituted which challenge the validity of regulations
implementing the Acts. In addition, FERC currently has under consideration
various policies and proposals that may affect the marketing of gas under new
and existing contracts. Accordingly, Torch is unable to predict the impact of
any such government regulation.
In the past, Congress has been very active in the area of gas regulation.
Recently enacted legislation repeals incremental pricing requirements and gas
use restraints previously applicable. At the present time, it is impossible to
predict what proposals, if any, might actually be enacted by Congress or the
various state legislatures and what effect, if any, such proposals might have on
the Underlying Properties and the Trust.
State Regulation
Many state jurisdictions have at times imposed limitations on the production of
gas by restricting the rate of flow for gas wells below their actual capacity to
produce and by imposing acreage limitations for the drilling of a well. States
may also impose additional regulations of these matters. Most states regulate
the production of gas, including requirements for obtaining drilling permits,
the method of developing new fields, provisions for the unitization or pooling
of gas properties, the spacing, operation, plugging and abandonment of wells and
the prevention of waste of gas resources. The rate of production may be
regulated and the maximum daily production allowable from gas wells may be
established on a market demand or conservation basis or both.
ENVIRONMENTAL REGULATION
Activities on the Underlying Properties are subject to existing Federal, state
and local laws, rules and regulations which govern health, safety, environmental
quality and pollution control. It is anticipated that, absent the occurrence of
an unanticipated event, compliance with existing Federal, state and local laws,
rules and regulations regulating health, safety, the release of materials into
the environment or
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TORCH ENERGY ROYALTY TRUST
otherwise relating to the protection of the environment will not have a material
adverse effect upon the Trust or Unitholders. Torch has informed the Trust that
it cannot predict what effect additional regulation or legislation, enforcement
policies thereunder, and claims for damages to property, employees, other
persons and the environment resulting from operations on the Underlying
Properties could have on the Trust or Unitholders. However, pursuant to the
terms of the Conveyances, any costs or expenses incurred by TRC or Velasco in
connection with environmental liabilities, to the extent arising out of or
relating to activities occurring on, or in connection with, or conditions
existing on or under, the Underlying Properties before October 1, 1993, will be
borne by TRC or Velasco and not the Trust and will not be deducted in
calculating Net Proceeds. Any environmental costs or expenses that are
attributable to TRC's or Velasco's interest in the Underlying Properties that do
not fall within the preceding sentence will be paid by TRC or Velasco but, to
the extent in excess of any insurance proceeds, will be deducted in calculating
Net Proceeds and will, therefore, reduce amounts payable to the Trust.
ITEM 2. PROPERTIES
- -------------------
DESCRIPTION OF THE UNDERLYING PROPERTIES
Chalkley Field. The Underlying Properties in the Chalkley Field, located in
Cameron Parish, Louisiana, include an average 16.2% working interest (12.1% net
revenue interest) in five unitized wells producing from the Miogyp "B" reservoir
and one well producing from the Lower Miogyp reservoir. The wells produce from
a depth in excess of 14,000 feet. The working interest in the well producing in
the Lower Miogyp reservoir is 64.4% (48.3% net revenue interest). A subsidiary
of Exxon Corporation operates the five wells in the Miogyp "B" reservoir, and a
subsidiary of Torch operates the well producing from the Lower Miogyp formation.
Robinson's Bend Field. The Underlying Properties include an average 41.8%
working interest (31.8% net revenue interest) in 410 wells in the Robinson's
Bend Field in the Black Warrior Basin of Alabama. Sales of production of coal
seam gas from the Robinson's Bend Field prior to January 1, 2003 entitle
Unitholders to Section 29 Credits, provided certain requirements are met. The
Section 29 Credit for qualifying coal seam gas production was approximately
$1.03, $1.01 and $1.00 per MMBtu in 1996, 1995 and 1994, respectively. This
rate is adjusted annually for inflation. All of the wells in the Robinson's
Bend Field are operated by an affiliate of Torch.
The amounts paid to the Trust from the Robinson's Bend Field in any calendar
quarter are subject to a Volume Limitation equal to the gross proceeds from the
sale of 912.5 MMcf (730.0 MMcf of gas before 1995), less property, production,
severance and similar taxes, and development, operating, and certain other costs
(excluding operating and development costs until January 1, 2003). During 1996
and 1995, gross production from the Underlying Properties in the Robinson's Bend
Field averaged 832 MMcf and 930 MMcf per quarter, respectively, and was
therefore 13% and 3%, respectively, less than the Volume Limitation for the
year. Gross production in 1994 met the Volume Limitation.
Between January 1 and December 31, 1995, the estimated net proved reserves
attributable to the Underlying Properties in the Robinson's Bend Field decreased
by an estimated 22 Bcf due to downward revisions of previous reserve estimates
made by independent engineers. As a result of this
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TORCH ENERGY ROYALTY TRUST
decrease estimated net proved reserves attributable to the Net Profits Interest
burdening the Underlying Properties in the Robinson's Bend Field decreased 12
Bcf (24%) from January 1 to December 31, 1995. See "Item 1. Uncertainty of
Estimates of Reserves and Future Net Cash Flows" and Note 6 of Notes to
Financial Statements.
Cotton Valley Fields. The Underlying Properties include an average 55.4%
working interest (42.7% net revenue interest) in 41 wells in four fields that
produce from the Upper and Lower Cotton Valley formations in Texas.
Additionally, Underlying Properties in the Cotton Valley Fields include infill
well reserves, estimated by independent reserve consultants, aggregating 12,821
MMcfe at January 1, 1997. A substantial portion of the gas produced and sold
from the Cotton Valley Fields prior to January 1, 2003 will qualify for the
Section 29 tax credits for production of tight sands gas. The Section 29 Credit
for qualifying tight sands gas production is approximately $0.52 per MMBtu and
is not adjusted for inflation. All of the wells in the Cotton Valley Fields are
operated by a subsidiary of Torch.
Austin Chalk Fields. The Underlying Properties include an average 19.6% working
interest (15.3% net revenue interest) in 88 wells in the Austin Chalk Fields of
Central Texas. Production from these fields is derived primarily from the
highly fractured Austin Chalk formation using horizontal drilling techniques. A
substantial portion of the gas produced and sold from these fields prior to
January 1, 2003 will qualify for the Section 29 Credits for tight sands gas. An
affiliate of Torch operates eight wells in the Austin Chalk Fields. A majority
of the wells in the Austin Chalk Fields are operated by Union Pacific Resources
Corporation.
WELL COUNT AND ACREAGE SUMMARY
The following table shows, as of December 31, 1996, the gross and net interest
in oil and gas wells for the Underlying Properties:
Gas Wells Oil Wells
---------------- ---------------
Gross Net Gross Net
--------- ----- --------- ----
Chalkley Field......... 6 1.5 --- ---
Robinson's Bend Field.. 410 175.3 --- ---
Cotton Valley Fields... 41 20.9 --- ---
Austin Chalk Fields.... 39 8.6 49 7.81
--- ----- ---- ----
Total................ 496 206.3 49 7.81
=== ===== ==== ====
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TORCH ENERGY ROYALTY TRUST
The following table shows the gross and net acreage for the Underlying
Properties as of December 31, 1996:
Acreage
---------------
Gross Net
------- ------
Chalkley Field......... 2,152 425
Robinson's Bend Field.. 34,783 14,601
Cotton Valley Fields... 4,411 2,606
Austin Chalk Fields.... 34,862 6,639
------ ------
Total................ 76,208 24,271
====== ======
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TORCH ENERGY ROYALTY TRUST
OIL AND GAS SALES PRICES AND PRODUCTION COSTS
The following table sets forth, for the Underlying Properties, the net
production volumes of gas and oil, the weighted average lifting cost and taxes
on production per Mcfe and weighted average sales price per Mcf of gas and Bbl
of oil for production attributable to 1996, 1995 and 1994 cash distributions to
Unitholders (derived from production during the twelve months ended September
30, 1996, 1995 and 1994, respectively).
Chalkley, Cotton Valley
and Austin Chalk Fields
---------------------------------
1996 1995 1994
---------- ---------- ----------
Production:
Gas (MMcf)...................... 8,217 10,764 14,171
Oil (Mbbl)...................... 149 210 348
Weighted average lifting cost per
Mcfe.............................. $ 0.20 $ 0.18 $ 0.15
Weighted average taxes on
production per Mcfe............... $ 0.07 $ 0.08 $ 0.07
Weighted average sales price (b)
Gas ($/Mcf)..................... $ 1.71 $ 1.72 $ 1.82
Oil ($/Bbl)..................... $17.10 $ 15.89 $ 14.68
Robinson's Bend Field
---------------------------------
1996 1995 1994
------ ------- -------
Production:
Gas (MMcf)...................... 3,415 3,804 3,546
Oil (Mbbl)...................... --- --- ---
Weighted average lifting cost per
Mcfe.............................. $ ---(a) $ ---(a) $ ---(a)
Weighted average taxes on
production per Mcfe............... $ 0.11 $ 0.07 $ 0.07
Weighted average sales price (b)
Gas ($/Mcf)..................... $ 1.40 $ 1.46 $ 1.59
Oil ($/Bbl)..................... $ --- $ --- $ ---
(a) No operating costs will be deducted from the Net Profits Interest in the
Robinson's Bend Field until January 1, 2003.
(b) Average sales prices are reflective of purchase prices paid by TEMI,
pursuant to the Purchase Contract, less certain gathering, treating and
transportation charges.
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TORCH ENERGY ROYALTY TRUST
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
There are no material pending legal proceedings to which the Trust is a party.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF UNITHOLDERS
- ------------------------------------------------------
No matter was submitted to the Unitholders for a vote in 1996.
PART II
ITEM 5. MARKET FOR REGISTRANT'S UNITS AND RELATED UNITHOLDER MATTERS
- ---------------------------------------------------------------------
The Units are listed and traded on the New York Stock Exchange under the symbol
"TRU." At February 28, 1997, there were 8,600,000 Units outstanding and
approximately 810 Unitholders of record. The following table sets forth, for
the periods indicated, the high and low sales prices per Unit on the New York
Stock Exchange and the amount of quarterly cash distributions per Unit made by
the Trust:
Cash
High Low Distributions
---- --- -------------
Quarter ended March 31,
1995....................... $ 18.000 $ 15.500 $ .700
Quarter ended June 30, 1995. $ 19.000 $ 15.125 $ .641
Quarter ended September
30, 1995................... $ 16.125 $ 13.625 $ .630
Quarter ended December 31,
1995....................... $ 15.500 $ 12.125 $ .559
Quarter ended March 31,
1996....................... $ 14.125 $ 8.750 $ .535
Quarter ended June 30, 1996. $ 10.875 $ 8.000 $ .492
Quarter ended September
30, 1996................... $ 10.375 $ 9.125 $ .482
Quarter ended December 31,
1996....................... $ 12.000 $ 9.875 $ .436
ITEM 6. SELECTED FINANCIAL DATA (In thousands, except per Unit amounts)
- --------------------------------
<TABLE>
<CAPTION>
November 24, 1993
(Date of Inception)
to
Year Ended December 31, December 31, 1993
-------------------------------------- -------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C> <C>
Net profits income.......... $ 17,381 $ 22,427 $ 30,039 $ --
Distributable income (loss). $ 16,722 $ 21,787 $ 29,282 $ (168)
Distributions declared...... $ 16,727 $ 21,758 $ 29,300 $ --
Distributable income
(loss) per Unit........... $ 1.94 $ 2.53 $ 3.40 $ (.02)
Distributions per Unit...... $ 1.95 $ 2.53 $ 3.41 $ --
Total assets (at end of
period).................... $121,526 $137,179 $157,593 $180,601
</TABLE>
12
<PAGE>
TORCH ENERGY ROYALTY TRUST
Distributable income of the Trust consists of the excess of net profits income
plus interest income less general and administrative expenses of the Trust. The
Trust recognizes net profits income during the period in which amounts are
received by the Trust. No Net Proceeds attributable to the Net Profits Interest
were received by the Trust prior to January 1, 1994; accordingly, no net profits
income was generated from November 24, 1993 (Date of Inception) to December 31,
1993.
ITEM 7. TRUSTEE'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
- --------------------------------------------------------------------------------
OPERATIONS
----------
The following is a discussion of the Trust's financial condition and results of
operation. This discussion and analysis should be read in conjunction with the
Financial Statements of the Trust and the notes thereto. The Trustee's review
includes certain forward-looking statements reflecting the Trust's expectations
in the near future, however, many factors which may affect the actual results,
especially commodity prices and changing regulation, are difficult to predict.
Accordingly, there is no assurance that the Trust's expectations will be
realized.
DISCUSSION OF YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Because a modified cash basis of accounting is utilized by the Trust, net
proceeds to the Trust for the years ended December 31, 1996, 1995 and 1994 is
derived from actual oil and gas production from October 1, 1995 through
September 30, 1996, October 1, 1994 through September 30, 1995 and October 1,
1993 through September 30, 1994, respectively. Oil and gas sales attributable
to the Underlying Properties for such periods is as follows:
Bbls of Oil
------------------------------------
1996 1995 1994
---------- ---------- ----------
Chalkley Field......... 61,694 92,783 125,143
Robinson's Bend Field.. --- --- ---
Cotton Valley Fields... 7,607 7,506 13,294
Austin Chalk Fields.... 79,289 109,740 209,097
---------- ---------- ----------
Total..... 148,590 210,029 347,534
========== ========== ==========
Mcf of Gas
------------------------------------
1996 1995 1994
---------- ---------- ----------
Chalkley Field......... 5,713,920 7,418,779 9,107,084
Robinson's Bend Field.. 3,415,346 3,804,316 3,546,350
Cotton Valley Fields... 1,734,783 2,215,055 2,903,345
Austin Chalk Fields.... 768,023 1,129,829 2,160,211
---------- ---------- ----------
Total..... 11,632,072 14,567,979 17,716,990
========== ========== ==========
13
<PAGE>
TORCH ENERGY ROYALTY TRUST
For the year ended December 31, 1996, net profits income was $17,381,000, as
compared to $22,427,000 and $30,039,000 for the same periods in 1995 and 1994.
Such decreases are primarily due to normal declines in oil and gas production
attributable to the Underlying Properties and lower average gas prices paid to
the Trust.
Gas production attributable to the Underlying Properties for the year ended
December 31, 1996 was 11,632,072 Mcf, as compared to gas production of
14,567,979 Mcf and 17,716,990 Mcf for the same periods in 1995 and 1994,
respectively. Oil production attributable to the Underlying Properties for the
year ended December 31, 1996 was 148,590 Bbls as compared to 210,029 Bbls and
347,534 Bbls for the same periods in 1995 and 1994.
The average price paid to the Trust for gas during the years ended December 31,
1996 and 1995 was $1.70 per MMBtu as compared to $1.82 per MMBtu for the year
ended December 31, 1994. The average price paid to the Trust for oil during the
years ended December 31, 1996, 1995 and 1994 was $17.10, $15.89 and $14.68 per
Bbl, respectively. When TEMI pays a purchase price for gas based on the Minimum
Price of $1.70 per MMBtu, TEMI receives Price Credits which it is entitled to
deduct in determining the purchase price when the Index Price for gas exceeds
the Minimum Price. As of December 31, 1996, TEMI was entitled to accrued Price
Credits of $317,000, net to the Trust, which TEMI may be entitled to deduct in
calculating the purchase price in the future. Net price credits in the amount
of $2,305,000 were deducted in calculating the purchase price related to
distributions during 1996. During 1995 and 1994, TEMI accumulated price credits
of $2,155,000 and $467,000, respectively.
During the years ended December 31, 1996, 1995 and 1994, lease operating
expenses and capital expenditures (attributable to production during the twelve
months ended September 30, 1996, 1995 and 1994) from the Underlying Properties
in the Chalkley, Cotton Valley and Austin Chalk Fields, totaled $2,081,000,
$2,345,000 and $2,790,000, respectively. In accordance with the Conveyance, no
operating or development costs will be deducted in calculating the net proceeds
from the Robinson's Bend Field prior to January 1, 2003. During the years ended
December 31, 1996, 1995 and 1994, severance tax totaled $1,000,000, $1,163,000
and $1,394,000 (for production during the twelve months ended September 30,
1996, 1995 and 1994), respectively, for all four fields.
General and administrative expenses during the years ended December 31, 1996,
1995 and 1994 amounted to $684,000, $676,000 and $780,000, respectively. These
expenses primarily related to administrative services provided by Torch and the
Trustee.
The foregoing resulted in distributable income of $16,722,000, or $1.94 per
Unit, for the year ended December 31, 1996 as compared to $21,787,000, or $2.53
per Unit, and $29,282,000, or $3.40 per Unit, for the same periods in 1995 and
1994, respectively. Total cash distributions of $16,727,000, or $1.95 per Unit,
were made during the year ended December 31, 1996 as compared to $21,758,000, or
$2.53 per Unit and $29,300,000, or $3.41 per Unit, for the same periods in 1995
and 1994, respectively. The Section 29 Credits relating to qualifying
production from coal seam and tight sands properties, during the twelve months
ended September 30, 1996, 1995 and 1994, totaled approximately $.44, $.49 and
$.40 per Unit, respectively.
14
<PAGE>
TORCH ENERGY ROYALTY TRUST
The Financial Accounting Standards Board issued Statement No. 121 "Accounting
for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed
Of," ("SFAS 121") which was effective January 1, 1996. The statement
established methods for determining and measuring asset impairment and the
required timing of asset impairment evaluations. The impact of adopting SFAS
121 did not have an effect on the Trust's results of operations or financial
position.
Net profits income received by the Trust during the years ended December 31,
1996, 1995, and 1994, derived from production sold during the twelve months
ended September 30, 1996, 1995 and 1994, respectively, was computed as shown in
the following tables:
YEAR ENDED DECEMBER 31, 1996
-----------------------------------
(In thousands)
Chalkley,
Cotton Valley
and Robinson's
Austin Chalk Bend
Fields Field Total
---------------- --------------- --------
Oil and gas revenues............ $ 16,601 $ 4,554
--------- ----------
Direct operating expenses:
Lease operating expenses and
property tax................. 1,778 --
Severance tax................. 653 347
--------- ----------
2,431 347
--------- ----------
Net proceeds before capital
expenditures................... 14,170 4,207
Capital expenditures............ 303 --
--------- ----------
Net proceeds.................... 13,867 4,207
Net profits percentage.......... 95% --
--------- ----------
Net profits income.............. $ 13,174 $ 4,207 $ 17,381
========= ========== ========
15
<PAGE>
TORCH ENERGY ROYALTY TRUST
YEAR ENDED DECEMBER 31, 1996
-----------------------------------
(In thousands)
Chalkley,
Cotton Valley
and Robinson's
Austin Chalk Bend
Fields Field Total
---------------- --------------- --------
Oil and gas revenues............ $ 21,899 $ 4,967
--------- ----------
Direct operating expenses:
Lease operating expenses and
property tax................. 2,147 --
Severance tax................. 928 235
--------- ----------
3,075 235
--------- ----------
Net proceeds before capital
expenditures................... 18,824 4,732
Capital expenditures............ 198 --
--------- ----------
Net proceeds.................... 18,626 4,732
Net profits percentage.......... 95% --
--------- ----------
Net profits income.............. $ 17,695 $ 4,732 $ 22,427
========= ========== =========
16
<PAGE>
TORCH ENERGY ROYALTY TRUST
YEAR ENDED DECEMBER 31, 1996
-----------------------------------
(In thousands)
Chalkley,
Cotton Valley
and Robinson's
Austin Chalk Bend
Fields Field Total
---------------- --------------- --------
Oil and gas revenues............ $ 30,938 $ 4,632
--------- ----------
Direct operating expenses:
Lease operating expenses and
property tax................. 2,448 --
Severance tax................. 1,203 191
--------- -----------
3,651 191
Net proceeds before capital
expenditures................... 27,287 4,441
Capital expenditures............ 342 --
--------- -----------
Net proceeds.................... 26,945 4,441
Net profits percentage.......... 95% --
--------- -----------
Net profits income.............. $ 25,598 $ 4,441 $ 30,039
========= =========== =========
17
<PAGE>
TORCH ENERGY ROYALTY TRUST
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ---------------------------------------------------
INDEX TO FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report................................. 19
Statements of Assets, Liabilities and Trust Corpus at
December 31, 1996 and 1995.................................. 20
Statements of Distributable Income for the Years Ended
December 31, 1996, 1995 and 1994............................ 21
Statements of Changes in Trust Corpus for the Years Ended
December 31, 1996, 1995 and 1994............................ 22
Notes to Financial Statements................................ 23
18
<PAGE>
INDEPENDENT AUDITORS' REPORT
Wilmington Trust Company
as Trustee of Torch Energy Royalty Trust
and to the Unitholders:
We have audited the accompanying statements of assets, liabilities and trust
corpus of the Torch Energy Royalty Trust (the "Trust") as of December 31, 1996
and 1995, and the related statements of distributable income and changes in
trust corpus for each of the three years in the period ended December 31, 1996.
These financial statements are the responsibility of the Trustee. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by the
trustee, as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
As described in Note 2 to the financial statements, these financial statements
have been prepared on a modified cash basis of accounting, which is a
comprehensive basis of accounting other than generally accepted accounting
principles.
In our opinion, such financial statements present fairly, in all material
respects, the assets, liabilities and trust corpus of the Trust as of December
31, 1996 and 1995, and its distributable income and changes in trust corpus for
each of the three years in the period ended December 31, 1996 on the basis of
accounting described in Note 2.
\s\ Deloitte & Touche LLP
- -------------------------
Deloitte & Touche LLP
Houston, Texas
March 18, 1997
19
<PAGE>
TORCH ENERGY ROYALTY TRUST
STATEMENTS OF ASSETS, LIABILITIES AND TRUST CORPUS
(In thousands)
ASSETS
<TABLE>
<CAPTION>
December 31, December 31,
1996 1995
------------ ------------
<S> <C> <C>
Cash................................................... $ 3 $ 9
Net profits interests in oil and gas properties
(net of accumulated amortization of $59,077 and
$43,430 at December 31, 1996 and 1995, respectively). 121,523 137,170
------- --------
$121,526 $137,179
======== ========
LIABILITIES AND TRUST CORPUS
Trust expense payable................................. $ 164 $ 165
Trust corpus.......................................... 121,362 137,014
-------- --------
$121,526 $137,179
======== ========
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
20
<PAGE>
TORCH ENERGY ROYALTY TRUST
STATEMENTS OF DISTRIBUTABLE INCOME
(In thousands, except per Unit amounts)
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Net profits income................................. $17,381 $22,427 $30,039
Interest income.................................... 25 36 23
------- ------- -------
17,406 22,463 30,062
General and administrative expenses................ 684 676 780
------- ------- -------
Distributable income............................... $16,722 $21,787 $29,282
======= ======= =======
Distributable income
per Unit (8,600,000 Units)....................... $ 1.94 $ 2.53 $ 3.40
======= ======= =======
Distributions per Unit............................. $ 1.95 $ 2.53 $ 3.41
======= ======= =======
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
21
<PAGE>
TORCH ENERGY ROYALTY TRUST
STATEMENTS OF CHANGES IN TRUST CORPUS
(In thousands)
Year Ended December 31,
----------------------------------
1996 1995 1994
--------- --------- ----------
Trust corpus, beginning of period....... $ 137,014 $ 157,373 $ 180,433
Amortization of net profits interests... (15,647) (20,388) (23,042)
Distributable income.................... 16,722 21,787 29,282
Distributions to Unitholders............ (16,727) (21,758) (29,300)
--------- --------- ----------
Trust Corpus, end of period............. $ 121,362 $ 137,014 $ 157,373
========= ========= =========
The accompanying notes to financial statements
are an integral part of these statements.
22
<PAGE>
TORCH ENERGY ROYALTY TRUST
Notes to Financial Statements
1. Trust Organization and Provisions
The Torch Energy Royalty Trust ("Trust") was formed effective October 1, 1993,
pursuant to a trust agreement ("Trust Agreement") among Wilmington Trust
Company, as trustee ("Trustee"), Torch Royalty Company ("TRC") and Velasco Gas
Company, Ltd. ("Velasco") as owners of certain oil and gas properties
("Underlying Properties") and Torch Energy Advisors Incorporated ("Torch") as
grantor. TRC and Velasco created net profits interests ("Net Profits Interests")
and conveyed such interests to Torch. Torch conveyed the Net Profits Interests
to the Trust in exchange for an aggregate of 8,600,000 units of beneficial
interest ("Units"). Such Units were sold to the public through various
underwriters beginning November 1993.
The Trust will not terminate prior to January 1, 2003, except upon the
affirmative vote of the holders of not less than 80% of the outstanding Units.
Thereafter, the Trust will terminate upon the first to occur of: (i) an
affirmative vote of the holders of not less than 66-2/3% of the outstanding
Units to liquidate the Trust; (ii) such time as the ratio of the cash amounts
received by the Trust from the Net Profits Interests to administrative costs of
the Trust is less than 1.2 to 1.0 for three consecutive quarters; (iii) March 1
of any year if it is determined based on a reserve report as of December 31 of
the prior year that the present value of estimated pre-tax future net cash
flows, discounted at 10%, of proved reserves attributable to the Net Profits
Interests is equal to or less than $25 million; or (iv) December 31, 2012.
After termination of the Trust, the remaining assets of the Trust will be sold,
and the proceeds therefrom (after expenses) will be distributed to the
unitholders ("Unitholders"). The sole purpose of the Trust is to hold the Net
Profits Interests, to receive payments from TRC and Velasco, and to make
payments to Unitholders. The Trust does not conduct any business activity.
TRC and Velasco receive payments reflecting the proceeds of oil and gas sold
and aggregate these payments, deduct applicable costs and make payments to the
Trustee each quarter for the amounts due to the Trust. Unitholders receive
quarterly cash distributions relating to oil and gas produced and sold from the
Underlying Properties after October 1, 1993 ("Effective Date"). Amounts
received with respect to production for the period from October 1, 1993 to
November 23, 1993 represented a return of capital to the Unitholders for Federal
income tax purposes, whereas amounts received with respect to production after
November 23, 1993 are considered taxable income to each Unitholder subject to an
allowance for the greater of cost or percentage depletion. Because no
additional properties will be contributed to the Trust, the assets of the Trust
deplete over time and a portion of each cash distribution made by the Trust is
analogous to a return of capital.
The only assets of the Trust, other than cash and temporary investments being
held for the payment of expenses and liabilities and for distribution to
Unitholders, are the Net Profits Interests. Under the Trust Agreement, the
Trustee receives the payments attributable to the Net Profits Interests and pays
all expenses, liabilities and obligations of the Trust. The Trustee has the
discretion to establish a cash reserve for the payment of any liability that is
contingent or uncertain in amount or that otherwise is not currently due and
payable. The Trustee is entitled to
23
<PAGE>
TORCH ENERGY ROYALTY TRUST
Notes to Financial Statements
cause the Trust to borrow money to pay expenses, liabilities and obligations
that cannot be paid out of cash held by the Trust. The Trustee is entitled to
cause the Trust to borrow from any source, including from the entity serving as
Trustee, provided that the entity serving as Trustee shall not be obligated to
lend to the Trust. To secure payment of any such indebtedness (including any
indebtedness to the Trustee), the Trustee is authorized to (i) mortgage and
otherwise encumber the entire Trust estate or any portion thereof; (ii) carve
out and convey production payments; (iii) include all terms, powers, remedies,
covenants and provisions it deems necessary or advisable, including confession
of judgement and the power of sale with or without judicial proceedings; and
(iv) provide for the exercise of those and other remedies available to a secured
lender in the event of a default on such loan. The terms of such indebtedness
and security interest, if funds were loaned by the Trustee, must be similar to
the terms which the Trustee would grant to a similarly situated commercial
customer with whom it did not have a fiduciary relationship, and the Trustee
shall be entitled to enforce its rights with respect to any such indebtedness
and security interest as if it were not then serving as Trustee.
The Trustee is authorized and directed to sell and convey the Net Profits
Interests without Unitholder approval in certain instances as described in the
Trust Agreement, including upon termination of the Trust. The Trustee is
empowered by the Trust Agreement to employ consultants and agents (including
Torch Energy) and to make payments of all fees for services or expenses out of
the assets of the Trust.
2. Basis of Accounting
The financial statements of the Trust are prepared on a modified cash basis and
are not intended to present the financial position and results of operations in
conformity with generally accepted accounting principles ("GAAP"). Preparation
of the Trust's financial statements on such basis includes the following:
- - Revenues are recognized in the period in which amounts are received by the
Trust. Therefore, revenues recognized during the years ended December 31,
1996, 1995 and 1994 are derived from oil and gas production sold during the
twelve-month periods ended September 30, 1996, 1995 and 1994, respectively.
General and administrative expenses are recognized on an accrual basis.
- - Amortization of the Net Profits Interests is calculated on a unit-of-
production basis and charged directly to trust corpus.
- - Distributions to Unitholders are recorded when declared by the Trustee.
- - The net carrying value of the Net Profits Interests is limited to the sum of
future net cash flows attributable to the Trust's oil and gas reserves at
year end using current product prices plus the estimated future tax credits
under Section 29 of the Internal Revenue Code of 1986 ("Section 29 Credit")
for Federal income tax purposes. If the net cost of the Net Profits
Interests exceeds this amount, an impairment provision will be recorded and
charged to the trust corpus.
24
<PAGE>
TORCH ENERGY ROYALTY TRUST
Notes to Financial Statements
The financial statements of the Trust differ from financial statements prepared
in accordance with GAAP because net profits income is not accrued in the period
of production and amortization of the Net Profits Interests is not charged
against operating results.
The Financial Accounting Standards Board issued Statement No. 121 "Accounting
for the Impairment of Long-Lived Assets and Long-Lived to be Disposed Of,"
("SFAS 121") effective January 1, 1996. The statement established methods for
determining and measuring asset impairment and the required timing of asset
impairment evaluations. The impact of adopting SFAS 121 did not have an effect
on the Trust's results of operations or financial position.
3. Federal Income Taxes
Tax counsel has advised the Trustee that, under current tax law, the Trust is
classified as a grantor trust for Federal income tax purposes and not an
association taxable as a corporation. However, the opinion of tax counsel is
not binding on the Internal Revenue Service. As a grantor trust, the Trust is
not subject to Federal income tax.
Because the Trust is treated as a grantor trust for Federal income tax purposes
and a Unitholder is treated as directly owning an interest in the Net Profits
Interests, each Unitholder is taxed directly on such Unitholder's pro rata share
of income attributable to the Net Profits Interests consistent with the
Unitholder's method of accounting and without regard to the taxable year or
accounting method employed by the Trust. Amounts payable with respect to the
Net Profits Interests are paid to the Trust on the quarterly record date
established for quarterly distributions in respect to each calendar quarter
during the term of the Trust, and the income, deductions and income tax credits
relating to Section 29 Credits resulting from such payments are allocated to the
Unitholders of record on such date.
4. Distributions and Income Computations
Each quarter the amount of cash available for distribution to Unitholders (the
"Quarterly Distribution Amount") is equal to the excess, if any, of the cash
received by the Trust, on the last day of the second month following the
previous calendar quarter (or the next business day thereafter) ending prior to
the dissolution of the Trust, from the Net Profits Interests then held by the
Trust plus, with certain exceptions, any other cash receipts of the Trust during
such quarter, subject to adjustments for changes made by the Trustee during such
quarter in any cash reserves established for the payment of contingent or future
obligations of the Trust. Based on the payment procedures relating to the Net
Profits Interests, cash received by the Trustee on the last day of the second
month of a particular quarter from the Net Profits Interests generally
represents proceeds from the sale of oil and gas produced from the Underlying
Properties during the preceding calendar quarter. The Quarterly Distribution
Amount for each quarter is payable to Unitholders of record on the last day of
the second month of the calendar quarter unless such day is not a business day
in which case the record date is the next business day thereafter. The Trustee
distributes the Quarterly Distribution Amount within approximately 10 days after
the record date to each person who was a Unitholder of record on the associated
record date.
25
<PAGE>
TORCH ENERGY ROYALTY TRUST
Notes to Financial Statements
5. Related Party Transactions
Marketing Arrangements
TRC and Velasco, as owners of the Underlying Properties subject to and burdened
by the Net Profits Interests, contracted to sell the oil and gas production from
such properties to Torch Energy Marketing, Inc. ("TEMI"), an subsidiary of
Torch, under a purchase contract ("Purchase Contract"). Under the Purchase
Contract, TEMI is obligated to purchase all net production attributable to the
Underlying Properties for an index price for oil and gas ("Index Price"), less
certain gathering, treating and transportation charges, which are calculated
monthly. The Index Price equals 97% of the average spot market prices of oil
and gas ("Average Market Prices") at the four locations where TEMI sells
production, which, prior to September 1, 2000, is adjusted to reflect the
terms of a hedge contract ("Hedge Contract") to which TEMI is a party. Under
the Hedge Contract, TEMI receive prices specified in the Hedge Contract
("Specified Prices") for quantities of oil and gas specified therein ("Specified
Quantities"). While the Index Price calculation reflects the terms of the Hedge
Contract, the Trust's net profits income is not impacted by payments or receipts
made by or received by TEMI in connection with its participation in the Hedge
Contract. In calculating the Index Price for gas (which represents
approximately 97% of the estimated reserves as of January 1, 1997, on an Mcfe
basis), the Specified Prices receive a weighting of approximately one-third
through September 1, 1997 and decline to less than less than 10% thereafter, and
the Average Market Prices receive the balance of the weighting. The Specified
Prices for gas increase each year from $1.79 per MMBtu in 1994 to $1.89 per
MMBtu in 2000 and are adjusted to reflect the difference between the settlement
prices for oil and gas in the futures markets and the Average Market Prices.
The Purchase Contract also provides that the minimum price paid by TEMI for gas
production is $1.70 per MMBtu ("Minimum Price"). When TEMI pays a purchase
price based on the Minimum Price it receives price credits ("Price Credits")
equal to the difference between the Index Price and the Minimum Price that it is
entitled to deduct in determining the purchase price when the Index Price for
gas exceeds the Minimum Price. As of December 31, 1996 and 1995, TEMI had
accumulated aggregate Price Credits of $317,000 and $2,628,000, respectively.
Net Price Credits in the amount of $2,305,000 were deducted in calculating the
purchase price during 1996. In addition, if the Index Price for gas exceeds
$2.10 per MMBtu ("Sharing Price"), TEMI is entitled to deduct 50% of such excess
("Price Differential") from the purchase price. Beginning January 1, 2001, TEMI
has an annual option to discontinue the Minimum Price commitment. However, if
TEMI discontinues the Minimum Price commitment, it will no longer be entitled to
deduct the Price Differential in calculating the purchase price and will forfeit
all accrued Price Credits. TEMI has purchased contracts granting TEMI the right
to sell estimated gas production in excess of the Specified Quantities at a
price intended to limit TEMI's losses in the event the Index Price falls below
the Minimum Price.
26
<PAGE>
TORCH ENERGY ROYALTY TRUST
Notes to Financial Statements
Gross revenues (before deductions for applicable gathering, treating and
transportation charges) from TEMI included in net profits income for the years
ended December 31, 1996, 1995 and 1994 were $23,223,000, $29,025,000 and
$38,664,000, respectively.
Gas production is purchased at the wellhead and, therefore, distributions do not
include any amounts received in connection with extracting natural gas liquids
from such production at gas processing or treating facilities.
Gathering, Treating and Transportation Arrangements
The Purchase Contract entitles TEMI to deduct certain gas gathering, treating
and transportation costs in calculating the purchase price for gas in the
Robinson's Bend, Austin Chalk and Cotton Valley Fields. The amounts that may be
deducted in calculating the purchase price for such gas are set forth in the
Purchase Contract and are not affected by the actual costs incurred by TEMI to
gather, treat and transport gas. In the Robinson's Bend Field, TEMI is entitled
to deduct a gathering, treating and transportation fee of $0.26 per MMBtu
adjusted annually for inflation ($0.272 per MMBtu for 1996, $0.265 per MMBtu for
1995 and $0.261 per MMBtu for 1994), plus fuel usage equal to 5% of revenues,
payable to Bahia Gas Gathering, Ltd. ("Bahia"),a former affiliate of Torch,
pursuant to a gas gathering agreement. On October 1, 1996, Bahia was merged into
TEMI. Amounts that would have been previously payable to Bahia from TEMI will
continue to be deducted by TEMI. Additionally, a fee of $.05 per MMBtu,
representing a gathering fee payable to a non-affiliate of Torch, is deducted in
calculating the purchase price for production from 68 of the 410 wells in the
Robinson's Bend Field. TEMI also deducts $0.38 per MMBtu plus 17% of revenues
in calculating the purchase price for production from the Austin Chalk Fields,
as a fee to gather, treat and transport gas production. Effective August 1,
1994, the Purchase Contract was amended to allow TEMI to deduct from the
purchase price for gas a transportation fee of $.045 per MMBtu for production
attributable to certain wells in the Cotton Valley Fields; such production was
transferred to a pipeline with lower system pressure, and the transportation fee
is paid to a third party. During the years ended December 31, 1996, 1995 and
1994, gathering, treating and transportation fees charged to the Trust by TEMI,
attributable to production during the twelve months ended September 30, 1996,
1995 and 1994 in the Robinson's Bend, Austin Chalk and Cotton Valley Fields,
totaled $2,068,000, $2,160,000 and $3,094,000, respectively. No amounts for
gathering, treating or transportation are deducted in calculating the purchase
price from the Chalkley Field.
Administrative Services Agreement
Pursuant to the Trust Agreement, Torch and the Trust entered into an
administrative services agreement, effective October 1, 1993. The Trust is
obligated, throughout the term of the Trust, to pay to Torch each quarter an
administrative services fee for accounting, bookkeeping, informational and other
services relating to the Net Profits Interests. The administrative services fee
is $87,500 per calendar quarter commencing October 1, 1993. The amount of the
administrative services fee is adjusted annually, based upon the change in the
Producer's Price Index as published by the Department
27
<PAGE>
TORCH ENERGY ROYALTY TRUST
Notes to Financial Statements
of Labor, Bureau of Labor Statistics. Administrative services fees paid by the
Trust to Torch in 1996, 1995, and 1994 were $366,000, $356,000 and $350,000,
respectively.
On September 30, 1996, Torch Acquisition Company, a company formed by executive
management of Torch, acquired all of the outstanding shares of capital stock of
Torch from United Investors Management Company ("United"), a subsidiary of
Torchmark Corporation. Immediately prior to this transaction, Torch distributed
all of the outstanding capital stock of TRC to United. None of the obligations
of Torch or TRC to the Trust were changed as a result of such transfers and
Torch believes that such transfers will not adversely affect the Trust or the
Unitholders.
Compensation of the Trustee and Transfer Agent
Upon execution of the Trust Agreement, Torch paid aggregate acceptance fees of
$15,000 to the Trustee which were reimbursed to Torch by the Trust. The Trust
Agreement provides that the Trustee be compensated for its administrative
services, out of the Trust assets, in an annual amount of $41,000, plus an
hourly charge for services in excess of a combined total of 250 hours annually
at its standard rate. The Trustee receives a transfer agency fee of $5.00
annually per account (minimum of $15,000 annually), subject to change each
December, beginning December 1994, based upon the change in the Producer's Price
Index as published by the Department of Labor, Bureau of Labor Statistics, plus
$1.00 for each certificate issued. Total administrative and transfer agent fees
charged by the Trustee was $56,000 in each year ended December 31 1996, 1995 and
1994. The Trustee is also entitled to reimbursement for out-of-pocket expenses.
6. Supplemental Oil and Gas Information (Unaudited)
Total proved oil and gas reserves attributable to the Net Profits Interests are
primarily based upon reserve reports prepared by T.J. Smith and Company, Inc.,
Netherland, Sewell & Associates, Inc. and H.J. Gruy and Associates, Inc.,
independent reserve engineers. Future net cash flows were computed by applying
end-of-period Purchase Contract prices for oil and gas to estimated future
production, less the estimated future expenditures (based on current costs) to
be incurred in developing and producing the reserves. In accordance with terms
of the Robinson's Bend Field Conveyance, no operating or developing costs prior
to January 1, 2003 were deducted from the Robinson's Bend Field future net
revenues.
Reserves Quantities:
The following table sets forth the estimated total proved and proved developed
oil and gas reserves attributable to the Trust's Net Profits Interests (all
located in the United States) for the years ended December 31, 1996, 1995 and
1994, based on reserve reports prepared by independent petroleum consultants.
As a net profits interest does not entitle the Trust to a specific quantity of
oil or gas but to a portion of oil and gas sufficient to yield a specified
portion of the net proceeds derived therefrom,
28
<PAGE>
TORCH ENERGY ROYALTY TRUST
Notes to Financial Statements
proved reserves attributable to a net profits interest are calculated by
deducting an amount of oil or gas sufficient, if sold at the prices used in
preparing the reserve estimates for the Underlying Properties, to pay an amount
of applicable future estimated production expenses, development costs and taxes
for such Underlying Properties. The use of this convention to estimate reserve
volumes attributable to the Net Profits Interests is standard practice in the
industry.
29
<PAGE>
TORCH ENERGY ROYALTY TRUST
Notes to Financial Statements
<TABLE>
<CAPTION>
Description 1996 1995 1994
- ----------- ------------------------ ---------------------- ---------------------
Oil Gas Oil Gas Oil Gas
--- --- --- --- --- ---
(Mbbl) (MMcf) (Mbbl) (MMcf) (Mbbl) (MMcf)
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Proved reserves at beginning of year.. 349 63,725 411 81,991 787 104,174
Revisions............................. 35 428 58 (7,016) (152) (8,245)
Extensions and discoveries............ 4 1,500 --- --- --- ---
Production............................ (95) (9,198) (120) (11,250) (224) (13,938)
--- ------ ---- ------- ---- -------
Proved reserves at end of year........ 293 56,455 349 63,725 411 81,991
=== ====== ==== ======= ==== =======
Proved developed reserves at
beginning of year..................... 332 60,342 399 79,607 787 104,174
=== ====== ==== ======= ==== =======
Proved developed reserves at
end of year........................... 270 51,027 332 60,342 399 79,607
=== ====== ==== ======= ==== =======
</TABLE>
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil
and Gas Reserves (in thousands):
Estimated future net cash flows from the Net Profits Interests in proved oil and
gas reserves at December 31, 1996, 1995 and 1994 are presented in the following
table. Because of the difficulty in determining the timing of the recoupment of
the Price Credits, no adjustment has been made in the present value of estimated
future net cash flows attributable to the Net Profits Interests.
<TABLE>
<CAPTION>
December 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Future cash inflows....................... $241,221 $192,513 $199,676
Future costs and expenses................. (81,239) (58,640) (58,212)
-------- -------- --------
Net future cash flows..................... 159,982 133,873 141,464
Discount at 10% for timing of cash flows.. (63,957) (50,112) (50,090)
-------- -------- --------
Present value of future net cash flows
for proved reserves..................... $ 96,025 $ 83,761 $ 91,374
======== ======== ========
</TABLE>
30
<PAGE>
TORCH ENERGY ROYALTY TRUST
Notes to Financial Statements
The following table sets forth the changes in the present value of estimated
future net revenues from proved reserves attributable to the Trust's Net Profits
Interests during the years ended December 31, 1996, 1995 and 1994:
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------
1996 1995 1994
---------------------------------
<S> <C> <C> <C>
Balance at beginning of year............ $ 83,761 $ 91,374 $149,413
Increase (decrease) due to:
Production.............................. (17,213) (21,197) (27,885)
Accretion to discount................... 8,376 9,137 14,941
Extensions and discoveries.............. 1,773 --- ---
Revision of prior-year estimates,
change in prices and other............. 19,328 4,447 (45,095)
-------- -------- --------
Balance at end of year.................. $ 96,025 $ 83,761 $ 91,374
======== ======== ========
</TABLE>
Estimates of future net cash flows from proved reserves of gas and oil
condensate were made in accordance with Financial Accounting Standards Board
Statement 69, "Disclosure about Oil and Gas Producing Activities." The Trust
has not filed or included in reports to any other Federal authority or agency
any estimates of proved net oil and gas reserves.
The following table summarizes the estimated Section 29 Credits attributable to
the Trust's Net Profits Interest, for qualifying coal seam and tight sand
production, at December 31, 1996, 1995, and 1994. Such estimates are based upon
the production estimates set forth in the reserve reports prepared by
independent petroleum consultants. The qualifying tight sands Section 29 Tax
Credit estimate was computed utilizing a rate of $.52 per MMBtu. The qualifying
coal seam Section 29 Tax Credit estimate was computed utilizing a constant rate
of $1.03, $1.01 and $1.00 per MMBtu for 1996, 1995 and 1994, respectively.
December 31,
------------------------------
1996 1995 1994
---- ---- ----
Undiscounted...................... $ 17,391 $ 21,746 $ 33,227
======== ======== ========
Discounted present value at 10%... $ 12,863 $ 15,525 $ 22,425
======== ======== ========
31
<PAGE>
TORCH ENERGY ROYALTY TRUST
Notes To Financial Statements
7. Quarterly Financial Data (Unaudited - in thousands, except per Unit amounts)
The following table sets forth, for the periods indicated, summarized quarterly
financial data:
Distributable
Net Profits Distributable Income
Income Income Per Unit
----------- ------------- -------------
Quarter ended March 31, 1995...... $ 6,199 $ 6,033 $ 0.70
Quarter ended June 30, 1995....... 5,668 5,478 0.64
Quarter ended September 30, 1995.. 5,613 5,473 0.64
Quarter ended December 31, 1995... 4,947 4,803 0.55
--------- ---------- --------
$ 22,427 $ 21,787 $ 2.53
========= ========== ========
Quarter ended March 31, 1996...... $ 4,747 $ 4,605 $ 0.53
Quarter ended June 30, 1996....... 4,411 4,226 0.49
Quarter ended September 30, 1996.. 4,334 4,189 0.49
Quarter ended December 31, 1996... 3,889 3,702 0.43
--------- ---------- --------
$ 17,381 $ 16,722 $ 1.94
========= ========== ========
32
<PAGE>
TORCH ENERGY ROYALTY TRUST
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------
The Registrant has no directors or executive officers. The Trustee is a
corporate trustee that may be removed as trustee under the Trust Agreement, with
or without cause, at a meeting duly called and held by the affirmative vote of
Unitholders of not less than a majority of all the Units then outstanding. Any
such removal of the Trustee shall be effective only at such time as a successor
trustee fulfilling the requirements of Section 3807(a) of the Delaware Business
Trust Act has been appointed and has accepted such appointment.
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
The following is a description of certain fees and expenses paid or borne by the
Trust, including fees paid to Torch, the Trustee, the Transfer Agent or their
affiliates.
Ongoing Administrative Expenses. The Trust is responsible for paying all legal,
accounting, engineering and stock exchange fees, printing costs and other
administrative and out-of-pocket expenses incurred by or at the direction of the
Trustee in its capacity as Trustee and/or transfer agent.
Compensation of the Trustee and Transfer Agent. Upon execution of the Trust
Agreement, Torch paid aggregate acceptance fees of $15,000 to the Trustee which
were reimbursed to Torch by the Trust. The Trust Agreement provides that the
Trustee be compensated for its administrative services, out of the Trust assets,
in an annual amount of $41,000, plus an hourly charge for services in excess of
a combined total of 250 hours annually at its standard rate. The Trustee
receives a transfer agency fee of $5.00 annually per account (minimum of $15,000
annually), subject to change each December, beginning December 1994, based upon
the change in the Producer's Price Index as published by the Department of
Labor, Bureau of Labor Statistics, plus $1.00 for each certificate issued. The
Trustee is entitled to reimbursement for out-of-pocket expenses.
Fees to Torch. Torch will receive, throughout the term of the Trust, an
administrative services fee for accounting, bookkeeping and informational
services relating to the Net Profits Interests as described below in "Item 13 -
Administrative Services Agreement."
33
<PAGE>
TORCH ENERGY ROYALTY TRUST
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
The following table sets forth as of February 14, 1997 information with respect
to the only Unitholder who was known to the Trustee to be a beneficial owner of
more than five percent of the outstanding Units.
NAME AND ADDRESS NUMBER OF UNITS
OF BENEFICIAL OWNER BENEFICIALLY OWNED PERCENT
- -------------------- ------------------- -------
FMR Corp. 437,000 5.08%
82 Devonshire Street
Boston, MA 02109-3614
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------------------------------------------------------
Administrative Services Agreement
Pursuant to the Trust Agreement, Torch and the Trust entered into an
Administrative Services Agreement effective October 1, 1993. The following
summary of certain provisions of the Administrative Services Agreement does not
purport to be complete and is subject to, and is qualified in its entirety by
reference to, the provisions of the Administrative Services Agreement.
The Trust is obligated, throughout the term of the Trust, to pay to Torch each
quarter an administrative services fee for accounting, bookkeeping,
informational and other services relating to the Net Profits Interests. The
administrative services fee is $87,500 per calendar quarter commencing October
1, 1993. The amount of the administrative services fee is adjusted annually,
beginning January 1, 1994, based upon the change in the Producer's Price Index
as published by the Department of Labor, Bureau of Labor Statistics.
Administrative services fees paid by the Trust to Torch in 1996, 1995 and 1994
were $366,000, $356,000 and $350,000, respectively.
Marketing Arrangements
TRC and Velasco, as owners of the Underlying Properties subject to and burdened
by the Net Profits Interests, contracted to sell the oil and gas production from
such properties to TEMI under a Purchase Contract. Under the Purchase
Contract, TEMI is obligated to purchase all net production attributable to the
Underlying Properties for an Index Price for oil and gas less certain gathering,
treating and transportation charges, which are calculated monthly. The Purchase
Contract also provides that the Minimum Price paid by TEMI for gas production is
$1.70 per MMBtu. When TEMI pays a purchase price based on the Minimum Price it
receives price credits equal to the difference between the Index Price and the
Minimum Price that it is entitled to deduct in determining the purchase price
when the Index Price for gas exceeds the Minimum Price. As of December 31, 1996
and 1995, TEMI had accumulated aggregate Price Credits of $317,000 and
$2,628,000, respectively.
34
<PAGE>
TORCH ENERGY ROYALTY TRUST
Gross revenues (before deductions for applicable gathering, treating and
transportation charges) from TEMI included in net profits income for the years
ended December 31, 1996, 1995 and 1994 were $23,223,000, $29,025,000 and
$38,664,000, respectively.
Gathering, Treating and Transportation Arrangements
The Purchase Contract entitles TEMI to deduct certain gas gathering, treating
and transportation costs in calculating the purchase price for gas in the
Robinson's Bend, Austin Chalk and Cotton Valley Fields. The amounts that may be
deducted in calculating the purchase price for such gas are set forth in the
Purchase Contract and are not affected by the actual costs incurred by TEMI to
gather, treat and transport gas. In the Robinson's Bend Field, TEMI is entitled
to deduct a gathering, treating and transportation fee of $0.26 per MMBtu
commencing October 1, 1993 adjusted for inflation ($0.272, $0.265 and $0.261
per MMBtu for 1996, 1995 and 1994, respectively), plus fuel usage equal to 5% of
revenues, payable to Bahia Gas Gathering, Ltd. ("Bahia"), a former affiliate of
Torch, pursuant to a gas gathering agreement. On October 1, 1996, Bahia was
merged into TEMI. Amounts that would have been previously payable to Bahia from
TEMI will continue to be deducted by TEMI. Additionally, a fee of $0.05 per
MMBtu, representing a gathering fee payable to a non-affiliate of Torch, is
deducted in calculating the purchase price for production from 68 of the 410
wells in the Robinson's Bend Field. TEMI also deducts $0.38 per MMBtu plus 17%
of revenues in calculating the purchase price for production from the Austin
Chalk Fields, as a fee to gather, treat and transport gas production. Effective
August 1, 1994, the Purchase Contract was amended to allow TEMI to deduct from
the purchase price for gas a transportation fee of $0.045 per MMBtu for
production attributable to certain wells in the Cotton Valley Fields; such
production was transferred to a pipeline with lower system pressure and the
transportation fee is paid to a third party. During the years ended December 31,
1996, 1995 and 1994, gas gathering, treating and transportation fees charged to
the Trust by TEMI, attributable to production during the 12 months ended
September 30, 1996, 1995 and 1994 in the Robinson's Bend, Austin Chalk and
Cotton Valley Fields, totaled $2,068,000, $2,160,000 and $3,094,000,
respectively. No amounts for gathering, treating or transportation are deducted
in calculating the purchase price from the Chalkley Field.
35
<PAGE>
TORCH ENERGY ROYALTY TRUST
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
- ------------------------------------------------------------------------
(a) The following documents are filed as part of this report:
1. Financial Statements:
Torch Energy Royalty Trust
Independent Auditors' Report
Statements of Assets, Liabilities and Trust Corpus at
December 31, 1996 and 1995
Statements of Distributable Income for the Years Ended
December 31, 1996, 1995 and 1994
Statements of Changes in Trust Corpus for the Years Ended December
31, 1996, 1995 and 1994
Notes to Financial Statements
36
<PAGE>
TORCH ENERGY ROYALTY TRUST
Torch Energy Advisors Incorporated and Subsidiaries ("Torch") and Torch's
Predecessor ("Predecessor")
Independent Auditors' Report
Consolidated Balance Sheet of Torch as of December 31, 1996 and the
Related Consolidated Statements of Operations, Stockholders' Equity
and Cash Flows for the Period October 1, 1996 through December 31, 1996
Consolidated Balance Sheet of Predecessor as of December 31, 1995 and the
Related Predecessor's Consolidated Statements of Operations,
Predecessor's Equity and Cash Flows for the Period January 1, 1996 through
September 30, 1996 and for the Years Ended December 31, 1995 and 1994
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Financial statement schedules are omitted because of the absence of conditions
under which they are required or because the required information is included in
the financial statements and notes thereto.
3. Exhibits
EXHIBIT
NUMBER EXHIBITS
- ------ --------
4. - Instruments defining the rights of security holders, including
indentures.
4.1 - Form of Torch Energy Royalty Trust Agreement.*
4.2 - Form of Louisiana Trust Agreement.*
4.3 - Specimen Trust Unit Certificate.*
4.4 - Designation of Ancillary Trustee.*
10. - Material contracts.
10.1 - Purchase Agreement between TRC, Velasco and TEMI.*
10.2 - Gas Gathering Agreement between TEMI and Bahia Gas Gathering, Ltd.*
10.3 - Amendment to Gas Gathering Agreement.*
10.4 - Water Gathering and Disposal Agreement between Torch Energy Associates,
Ltd. and Velasco.*
10.5 - Form of Texas Conveyance.*
10.6 - Form of Louisiana Conveyance.*
10.7 - Form of Alabama Conveyance.*
10.8 - Standby Performance Agreement between Torch and the Trust.*
10.9 - Amendment to Water Gathering Contract.*
10.10- First Amendment to Oil and Gas Purchase Contract (previously filed on
Form 10-Q for the quarter ended September 30, 1994).
37
<PAGE>
TORCH ENERGY ROYALTY TRUST
23. - Consents of experts and counsel.
23.1 - Consent of T.J. Smith and Company, Inc.
23.2 - Consent of H.J. Gruy and Associates, Inc.
23.3 - Consent of Netherland, Sewell & Associates, Inc.
27 - Financial Data Schedule
99. - Additional Exhibits.
99.1 - Financial Statements of Torch Energy Advisors Incorporated.
* Incorporated by reference from Registration Statements on Form S-1 of Torch
Energy Advisors Incorporated (Registration No. 33-68688) dated November 16,
1993.
(b) Report on Form 8-K:
None filed in the quarter ended December 31, 1996.
38
<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.
TORCH ENERGY ROYALTY TRUST
By: Wilmington Trust Company
Trustee
By:/s/ Bruce L. Bisson
--------------------
Vice President
Date: March 24, 1997
(The Trust has no directors or executive officers.)
39
<PAGE>
TORCH ENERGY ROYALTY TRUST
Torch Energy Royalty Trust
1100 North Market Street
Wilmington, Delaware 19890
Legal Counsel
Butler & Binion, L.L.P.
Houston, Texas
Tax Counsel
Butler & Binion, L.L.P.
Houston, Texas
Auditors
Deloitte & Touche LLP
Houston, Texas
Transfer Agent and Registrar
Wilmington Trust Company
1100 North Market Street
Wilmington, Delaware 19890
40
<PAGE>
In view of the possible materiality of the financial condition of Torch Energy
Advisors Incorporated ("Torch") financial condition to the Minimum Price
commitment, which relates to the Purchase Contract between the Trust and Torch,
Torch's financial statements are provided as an exhibit to the Trust's annual
report on Form 10-K. Upon the termination of the Minimum Price commitment, such
financial statements will not be included in this annual filing.
41
<PAGE>
EXHIBIT 23.1
CONSENT OF T.J. SMITH AND COMPANY, INC.
We hereby consent to the use of our report dated March 4, 1997 regarding
Torch Energy Royalty Trust and to reference to our Firm included in this Form
10-K.
T.J. SMITH AND COMPANY, INC.
By: /s/ Timothy Smith
--------------------------------------
Houston, Texas
March 21, 1997
<PAGE>
EXHIBIT 23.2
CONSENT OF H. J. GRUY AND ASSOCIATES, INC.
We hereby consent to the use of our report dated February 11, 1997
regarding Torch Energy Royalty Trust and to reference to our Firm included in
this Form 10-K.
H. J. GRUY AND ASSOCIATES, INC.
By:/s/ H.J. Gruy and Associates, Inc.
-------------------------------------
Houston, Texas
March 20, 1997
<PAGE>
EXHIBIT 23.3
CONSENT OF INDEPENDENT PETROLEUM ENGINEERS AND GEOLOGISTS
We hereby consent to the inclusion of the information from our reports
dated February 21 and February 25, 1997, setting forth our estimate of reserves
and revenue to the Torch Energy Royalty Trust interest, as of January 1, 1997,
and from our reports dated February 20 and February 24, 1997, setting forth our
estimate of reserves and future revenue to the interest owned by affiliates of
Torch Energy Advisors Incorporated in the Underlying Properties, as of January
1, 1997, and to all references to our firm included or made as part of this Form
10-K.
NETHERLAND, SEWELL & ASSOCIATES, INC.
By: /s/ Frederic D. Sewell
---------------------------
Dallas, Texas
March 21, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 3
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 121,523
<DEPRECIATION> 0
<TOTAL-ASSETS> 121,526
<CURRENT-LIABILITIES> 164
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 121,362
<TOTAL-LIABILITY-AND-EQUITY> 121,526
<SALES> 0
<TOTAL-REVENUES> 17,406
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 684
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 16,722
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 16,722
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
<PAGE>
EXHIBIT 99.1
INDEPENDENT AUDITORS' REPORT
----------------------------
The Board of Directors
Torch Energy Advisors Incorporated:
We have audited the accompanying consolidated balance sheet of Torch Energy
Advisors Incorporated and subsidiaries as of December 31, 1996 and the related
consolidated statements of operations, stockholders' equity and cash flows for
the period October 1, 1996 through December 31, 1996 and the consolidated
balance sheet of the Company's Predecessor as of December 31, 1995 and the
related Predecessor's consolidated statements of operations, predecessor's
equity and cash flows for the period January 1, 1996 through September 30, 1996
and for the years ended December 31, 1995 and 1994. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Torch
Energy Advisors Incorporated and subsidiaries and their Predecessor as of
December 31, 1996 and 1995, respectively, and the results of their operations
and their cash flows and those of their Predecessor for the period October 1,
1996 through December 31, 1996 and the period January 1, 1996 through September
30, 1996 and for the years ended December 31, 1995 and 1994, respectively, in
conformity with generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, the Company
adopted the provisions of Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be
Disposed of", as of December 31, 1995.
As discussed in Notes 1 and 7, on September 30, 1996, certain members of the
Predecessor's management purchased the Predecessor. The consolidated financial
statements of the Company reflect assets and liabilities at fair value at the
date of the purchase. As a result, the consolidated financial statements of the
Company are presented on a different basis than those of the Predecessor and,
therefore, are not comparable in all respects.
March 25, 1997
Houston, Texas
<PAGE>
<TABLE>
<CAPTION>
TORCH ENERGY ADVISORS INCORPORATED AND SUBSIDIARIES
---------------------------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
(Amounts in Thousands)
ASSETS
------
December 31,
-----------------------
1996 1995
-------- --------
(Company) (Predecessor)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents.............. $ 26,262 $ 11,165
Investment in time deposits............ --- 36,066
Accounts receivable - product marketing 70,531 38,771
Accounts receivable - joint interest 8,939 8,354
billing...............................
Accounts receivable - oil and gas and 36,488 12,646
other.................................
Due from affiliates.................... 8,648 29,262
Note receivable from parent............ --- 17,748
Oil and gas property held for sale..... --- 67,337
Other current assets................... 1,683 5,772
--------- -----------
Total current assets............... 152,551 227,121
--------- -----------
PROPERTY AND EQUIPMENT, AT COST:
Oil and gas (successful efforts method) 18,164 22,552
Other fixed assets..................... 4,843 22,499
--------- -----------
23,007 45,051
Accumulated depreciation, depletion
and amortization...................... (847) (16,925)
--------- -----------
22,160 28,126
--------- -----------
NOTES RECEIVABLE........................ 2,000 ---
INVESTMENT IN EQUITY SECURITIES......... --- 4,307
INVESTMENT IN AFFILIATES................ 12,812 6,073
OTHER ASSETS............................ 616 3,990
-------- -----------
$190,139 $269,617
======== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED AND SUBSIDIARIES
----------------------------------------------------
CONSOLIDATED BALANCE SHEETS (CONTINUED)
---------------------------------------
(Amounts in Thousands, except Share Data)
LIABILITIES AND STOCKHOLDERS' AND PREDECESSOR'S EQUITY
------------------------------------------------------
<TABLE>
<CAPTION>
December 31,
-----------------------------------
1996 1995
(Company) (Predecessor)
CURRENT LIABILITIES:
<S> <C> <C>
Accounts payable - product marketing.. 60,025 $ 42,316
Accounts payable - joint interest billing 20,762 12,872
Advances from participants............ 741 2,172
Accrued liabilities................... 22,060 10,668
Note payable to bank.................. --- 3,400
Due to affiliates..................... 6,161 55,937
Revenue, royalty and production taxes payable 42,280 19,981
------------- ---------------
Total current liabilities.......... 152,029 147,346
------------- ---------------
OTHER LIABILITIES....................... 7,452 14,102
------------- ---------------
NOTE PAYABLE TO PARENT.................. --- 16,999
------------- ---------------
SENIOR SUBORDINATED
NOTE PAYABLE - AFFILIATE............... 25,500 ---
------------- ---------------
DEFERRED REVENUE........................ --- 11,698
------------- ---------------
DEFERRED INCOME TAXES................... 908 1,878
------------- ---------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' AND PREDECESSOR'S EQUITY:
Common stock, par value $.01, 200,000 shares
authorized, issued and outstanding at
December 31, 1996; and par
value $1.00, 1,000 shares authorized, issued
and outstanding at December 31, 1995. 2 1
Additional paid-in capital............ 1,998 32,142
Unrealized loss in value of investment in
equity securities, net............... --- (67)
Retained earnings..................... 2,250 45,518
------------- ---------------
Total stockholders' and predecessors' equity 4,250 77,594
------------- ---------------
190,139 $269,617
============= ===============
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED AND SUBSIDIARIES
---------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
(Amounts in Thousands)
<TABLE>
<CAPTION>
October 1, January 1,
through through Year Ended December 31,
December 31, September 30, -----------------------
1996 1996 1995 1994
------- ------- ------- -------
(Company) (Predecessor) (Predecessor) (Predecessor)
<S> <C> <C> <C> <C>
REVENUES:
Oil and gas revenues.................. $ 6,327 $ 9,942 $15,403 $18,742
Product marketing, net................ 2,771 8,063 11,512 17,373
Management fees....................... 5,774 23,651 18,620 17,236
Overhead fees......................... 2,356 9,028 12,603 10,748
Interest and other income............. 841 1,803 1,506 4,002
Net gain on sale of assets............ --- 5,787 10,807 266
---------- ------------ -------------- -------------
Total revenues...................... 18,069 58,274 70,451 68,367
---------- ------------ -------------- -------------
COSTS AND EXPENSES:
Oil and gas operating expenses........ 2,678 4,188 3,908 4,575
Depreciation, depletion and
amortization......................... 847 6,553 12,883 15,143
Provision for impairment of oil and
gas properties.......................... --- --- 16,000 ---
General and administrative expenses... 9,825 27,795 34,556 35,725
Interest expense...................... 588 1,033 2,404 1,279
Other expense......................... 16 3,120 3,512 245
---------- ------------ -------------- -------------
Total costs and expenses........... 13,954 42,689 73,263 56,967
---------- ------------ -------------- -------------
Equity in earnings (loss) of affiliates
and investees........................... (135) (179) 1,532 1,313
---------- ------------ -------------- -------------
INCOME (LOSS) BEFORE INCOME TAXES AND
MINORITY INTEREST...................... 3,980 15,406 (1,280) 12,713
Income taxes (benefit).................. 1,267 2,277 (4,231) 3,265
Minority interest....................... 463 --- --- 19
---------- ------------ -------------- -------------
NET INCOME.............................. $ 2,250 $13,129 $ 2,951 $ 9,429
========== ============ ============== =============
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' AND PREDECESSOR'S EQUITY
OCTOBER 1, 1996 THROUGH DECEMBER 31, 1996 AND
JANUARY 1, 1996 THROUGH SEPTEMBER 30, 1996
AND THE YEARS ENDED DECEMBER 31, 1995 AND 1994
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
UNREALIZED GAIN TOTAL
(LOSS) IN VALUE OF STOCKHOLDERS' AND
COMMON ADDITIONAL INVESTMENT IN EQUITY RETAINED PREDECESSOR'S
SHARES STOCK PAID-IN CAPITAL SECURITIES, NET EARNINGS EQUITY
--------- ------ --------------- --------------------- --------- ------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1994
(Predecessor)............. 1 $ 1 $ 32,142 $ --- $ 33,138 $ 65,281
Unrealized gain in value
of investment in
equity securities (net
of deferred taxes
of $1,277)............... --- --- --- 2,372 --- 2,372
Net income................. --- --- --- --- 9,429 9,429
------ ------ -------- ------- -------- --------
Balance, December 31, 1994
(Predecessor)............ 1 1 32,142 2,372 42,567 77,082
Unrealized loss in value
of investment in
equity securities (net
of deferred tax
benefit of $1,316)....... --- --- --- (2,439) --- (2,439)
Net income................. --- --- --- --- 2,951 2,951
------ ------ -------- ------- -------- --------
Balance, December 31, 1995
(Predecessor)............ 1 1 32,142 (67) 45,518 77,594
Unrealized loss in value
of investment in
equity securities (net
of deferred tax
expense of $6,265)....... --- --- --- 11,635 --- 11,635
Parent Contribution........ --- --- 10,105 --- --- 10,105
---
Cash Dividend to Torchmark. --- --- --- (35,625) (35,625)
Distribution of investment ---
in securities............. --- --- (11,568) (58,212) (69,780)
---
Net Income................. --- --- --- --- 13,129 13,129
------ ------ -------- ------- -------- --------
Balance, September 30, 1996
(Predecessor)............ 1 1 42,247 --- (35,190) 7,058
Transfer of equity of
Predecessor............... (1) (1) (42,247) --- 35,190 (7,058)
Issuance of common stock
pursuant to Management
Buyout.................... 200 2 1,998 --- --- 2,000
Net Income................. --- --- --- --- 2,250 2,250
------ ------ -------- ------- -------- --------
Balance, December 31, 1996
(Company)................. 200 $ 2 $ 1,998 $ --- $ 2,250 $ 4,250
====== ====== ======== ======= ========= ========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED AND SUBSIDIARIES
---------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(Amounts in Thousands)
<TABLE>
<CAPTION>
October 1, January 1,
through through
December 31, September 30, Year Ended December 31,
-----------------------
1996 1996 1995 1994
---------- -------- -------- --------
(Company) (Predecessor) (Predecessor) (Predecessor)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................. $ 2,250 $ 13,129 $ 2,951 $ 9,429
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation, depletion and
amortization and impairment
provision......................... 847 6,553 28,883 15,143
Amortization of deferred revenues.... --- (2,161) (2,882) (2,223)
Equity in (earnings) loss of
affiliates and
investees.......................... 135 179 (1,532) (1,313)
Minority interest.................... 463 --- --- 19
Deferred income taxes................ 908 6,315 (12,241) (1,716)
(Gain) loss on sale of oil and gas
properties......................... --- (4,960) 144 (266)
Gain on sale of Nuevo stock.......... --- --- (10,951) ---
Gain on sale of Gulf Canada stock.... --- (2,516) ---
Loss on sale of Point Pedernales..... --- 1,689 --- ---
Changes in assets and liabilities:
Accounts receivable.................. (43,896) 13,589 15,007 (32,272)
Due from affiliates.................. 24,064 (19,657) (12,599) 10,518
Other current assets................. 4,895 (885) (3,846) (49)
Accounts payable and accrued 13,846 (19,021) (33,702) 31,464
liabilities.........................
Due to affiliates.................... (5,567) 12,069 26,912 6,375
Revenue, royalty and production
taxes payable...................... 333 17,006 2,670 173
Other................................ (532) (11,482) 10,479 (4,268)
---------- ------------- --------- --------
Net cash flows provided by (used in)
operating activities................... $ (2,254) $ 9,847 $ 9,293 $ 31,014
---------- ------------- --------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED AND SUBSIDIARIES
---------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(Amounts in Thousands)
<TABLE>
<CAPTION>
October 1, January 1,
through through
December 31, September 30, Year Ended December 31,
------------------------
1996 1996 1995 1994
-------- -------- -------- ---------
(Company) (Predecessor) (Predecessor) (Predecessor)
<S> <C> <C> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES:
Time deposits.......................... $ --- $ 36,066 $(36,066) $ ---
Acquisition escrow deposit............. --- --- 10,961 (10,961)
Note receivable from officers.......... (2,000) --- --- ---
Proceeds from the sale of assets
held for sale........................ --- --- --- 25,065
Investment in assets held for sale..... --- 9,248 (2,841) (80,728)
Proceeds from the sale of assets....... 1,200 16,335 6,970 3,104
Proceeds from the sale of equity
investments.......................... --- 4,208 102,166 ---
Investment in property and equipment... (816) (13,982) (9,911) (43,553)
Investment in affiliates and other
equity interest....................... (389) (4,448) (72,086) ---
Distributions from investments in --- --- 1,197 351
affiliates............................
Cash acquired in Management
Buyout............................... 6,502 --- --- ---
Cash paid to Torchmark in
Management Buyout.................... (15,500) --- --- ---
-------- -------- ---------- ---------
Net cash flows provided by (used in)
investing activities.................. $(11,003) $ 47,427 $ 390 $(106,722)
-------- -------- ---------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
7
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Amounts in Thousands)
<TABLE>
<CAPTION>
October 1, January 1,
through through Year Ended December 31,
December 31, September 30, --------------------------
1996 1996 1995 1994
-------- -------- -------- --------
(Company) (Predecessor) (Predecessor) (Predecessor)
<S> <C> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from note payable to bank...................... $ --- $ --- $ 43,400 $ 60,370
Repayment of note payable to bank....................... --- --- (45,000) (55,370)
Repayment of note payable to parent..................... --- --- (30,000) ---
Proceeds from note payable to parent.................... --- --- 30,000 ---
Payment of dividend to parent........................... --- (32,625) --- ---
Parent contribution..................................... --- 10,105 --- ---
Repayment of line of credit to bank..................... --- (3,400) --- ---
-------- -------- -------- --------
Net cash flows provided by (used in)
financing activities................................... --- (28,920) (1,600) 5,000
-------- -------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ (13,257) 28,354 8,083 (70,708)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............ 39,519 11,165 3,082 73,790
-------- -------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 26,262 $ 39,519 $ 11,165 $ 3,082
======== ======== ======== ========
Supplemental disclosures of cash flow information:
Cash paid (received) during the period for:
Interest.............................................. $ 168 $ 985 $ 6,492 $ 1,961
======== ======== ======== ========
Income taxes.......................................... $ --- $ 5,026 $ (5,137) $ 16,811
======== ======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
8
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
----------------------------------
AND SUBSIDIARIES
----------------
Notes to Consolidated Financial Statements (Continued)
------------------------------------------------------
1. ORGANIZATION
------------
Torch Energy Advisors Incorporated (TEAI or the Company) provides oil and
natural gas management and advisory services to corporations, insurance
companies, private and public pension funds, foundations, endowments,
foreign investors, private investors and public oil and gas companies. The
Company is registered as an investment advisor under the Investment
Advisors Act of 1941. Since inception, the Company has invested over $1
billion on behalf of its clients. The Company is headquartered in Houston,
Texas, and maintains a representative office in Washington, D.C. and
operational district offices in Texas, Oklahoma, California and Alabama.
Until September 1996, TEAI (the "Predecessor" when discussing periods prior
to September 30, 1996) operated as a single business segment and was a
wholly owned subsidiary of Torchmark Corporation ("Torchmark"), an
insurance and financial services holding company headquartered in
Birmingham, Alabama. On September 30, 1996, certain members of the
Predecessor's executive management, through the formation of Management
Holding Company (MHC) and Torch Acquisition Company (TAC), purchased TEAI
from Torchmark (the "Management Buyout"). Torchmark retained a warrant for
10% of the Company's common stock on a fully diluted basis. The Management
Buyout was recorded using the purchase method of accounting as TEAI's
executive management had no ownership in the Predecessor.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
PRINCIPLES OF CONSOLIDATION -
The consolidated financial statements include the accounts of the Company,
its wholly owned subsidiaries and its majority owned subsidiaries. The
Company's investments in 15 oil and gas partnerships ("partnerships") are
accounted for under the equity method due to the Companys ability to
exercise significant influence over operating and financial policies of the
investees. All significant intercompany accounts and transactions have
been eliminated. Effective December 1, 1994, the Company adopted the cost
method of accounting for its long-term investment in Nuevo Energy Company
("Nuevo").The Company had previously used the equity method of accounting
to record its investment in Nuevo. Using the equity method, the Company
recognized equity in earnings of $.5 million related to Nuevo during the
year ended December 31, 1994. In 1995, the Company sold its investment in
Nuevo. In March 1996, the Company received 1.3 million Nuevo shares in
exchange for certain California offshore oil properties. In September 1996,
these shares were transferred to Torchmark in connection with the
Management Buyout (See Notes 5 and 11).
Effective November 1, 1996 Torch Energy Marketing, Inc. (TEMI), a wholly
owned subsidiary, formed a limited liability company with an unaffiliated
party to conduct gas marketing activities. TEMI acts as a manager and owns
a 50% interest in this venture. During 1996, the Company formed two
limited liability companies with an unaffiliated party to provide certain
management, administrative and support services to a foreign party. The
Company owns a 50% interest in both limited liability companies. As the
Company effectively controls the ventures through management contracts and
execution of the day-to-day operating and financial decisions, the
activities for these ventures are included in the financial statements with
the unaffiliated parties interest reflected as minority interest.
9
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
----------------------------------
AND SUBSIDIARIES
----------------
Notes to Consolidated Financial Statements (Continued)
------------------------------------------------------
CASH AND CASH EQUIVALENTS -
Cash in excess of the Company's daily requirements is generally invested in
short-term highly liquid investments with original maturities of three
months or less. Such investments are carried at cost, which approximates
fair value and, for purposes of reporting cash flows, are considered to be
cash equivalents.
TIME DEPOSITS -
Time deposits represent short-term highly liquid investments with original
maturities of three months or less. Such investments are carried at cost,
which approximates fair value (See Note 12).
INVESTMENT IN EQUITY SECURITIES -
Marketable investment securities are classified in three categories:
trading, available-for-sale, or held-to-maturity. Trading securities are
bought and held principally for the purpose of selling such securities in
the near term. Held-to-maturity securities are those securities in which
the Company has the ability and intent to hold the security until maturity.
All other securities not included in trading or held-to-maturity are
classified as available-for-sale.
The Company has no held-to-maturity, available-for-sale or trading
securities at December 31, 1996. The Predecessor had available-for-sale
securities which were recorded at fair value, with unrealized gains and
losses, excluded from earnings and reported as a separate component of
Predecessor's equity, net of deferred taxes.
Dividend and interest income are recognized when earned. Realized gains
and losses for securities classified as available-for-sale were included in
earnings and were derived using the specific identification method for
determining the cost of securities sold.
PROPERTY AND EQUIPMENT -
Oil and gas properties are accounted for on the successful efforts method
whereby costs, including lease acquisition and intangible drilling costs
associated with exploration efforts which result in the discovery of proved
reserves and costs associated with development wells, whether or not
productive, are capitalized. Gain or loss is recognized when a property is
sold or ceases to produce and is abandoned. Capitalized costs of producing
oil and gas properties are amortized using the unit-of-production method
based on units of proved reserves as estimated by independent petroleum
engineers. Depreciation, depletion and amortization of oil and gas
properties on a net equivalent barrel basis, assuming six MCF equal one net
equivalent barrel of oil, was $1.66, $5.26, $8.09 and $8.58 during the
periods October 1, 1996 through December 31, 1996 and January 1, 1996
through September 30, 1996, and the years ended December 31, 1995 and 1994,
respectively.
Prior to December 31, 1995, the Company determined the impairment of oil
and gas properties on a world-wide basis. In the event that the total
capitalized costs of oil and gas properties were to exceed estimated
10
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
----------------------------------
AND SUBSIDIARIES
----------------
Notes to Consolidated Financial Statements (Continued)
------------------------------------------------------
undiscounted after tax future net revenues, such excess costs would be
charged to current operations as a valuation provision. Based on this
review no such provision was required during 1994. In March 1995, the
Financial Accounting Standards Board issued Statement 121, "Accounting for
the Impairment of long-lived Assets and for long-lived Assets to be
Disposed of" ("Statement 121"). This statement requires that an impairment
loss be recognized when the carrying amount of an asset exceeds the sum of
the estimated future cash flow (undiscounted) of the asset. Under
Statement 121, the Predecessor reviewed the impairment of proved oil and
gas properties on a depletable unit basis. For each depletable unit
determined to be impaired, an impairment loss equal to the difference
between the carrying value and the fair value of the depletable unit was
recognized. Fair value, on a depletable unit basis, was estimated to be
the present value of expected future cash flows computed by applying
estimated future oil and gas prices, as determined by management, to
estimated future production of oil and gas reserves over the economic lives
of the reserves. As a result of the Company's election to adopt Statement
121 on December 31, 1995, a provision of $16 million was charged against
operations during 1995. The Company incurred no such writedown during the
periods October 1, 1996 to December 31, 1996 and January 1, 1996 to
September 30, 1996.
Costs of acquiring undeveloped oil and gas leases are capitalized and
assessed periodically to determine whether an impairment has occurred;
appropriate valuation allowances are established when necessary. During
1994, a provision of $1.1 million was recorded and is included in
depreciation, depletion and amortization expense. No such provision was
required during the periods October 1, 1996 to December 31, 1996 and
January 1, 1996 to September 30, 1996 and the year ended December 31, 1995.
Fixed assets are depreciated on a straight-line basis over their estimated
useful lives. Leasehold improvements, which are recorded at cost, are
amortized on a straight-line basis over their estimated useful lives or the
life of the lease, whichever is shorter.
GAS BALANCING -
The Company uses the entitlement method for recording sales of natural gas.
Under the entitlement method of accounting, revenue is recorded based on
the Company's net revenue interest in production. Deliveries of natural
gas in excess of the Company's net revenue interest are recorded as
liabilities and under-deliveries are recorded as assets. Production
imbalances are recorded at the lower of the sales price in effect at the
time of production or the current market value. At December 31, 1996 and
1995, the Company's liabilities due to gas sales in excess of its entitled
share were approximately $3.9 million and $5.8 million, respectively, and
the receivables for gas sales less than the Company's entitled share were
approximately $1.4 million and $1.4 million, respectively.
DERIVATIVES -
The Company participates in certain crude oil and natural gas price swaps
to reduce its exposure to price fluctuations. Settlement of gains and
losses on price swap contracts are realized monthly, generally based upon
the difference between the contract price and the average closing New York
Mercantile Exchange (NYMEX) price and are reported as a component of oil
and gas revenues. Gains or losses attributable to the termination of a
swap contract are deferred and recognized in revenue when the hedged crude
oil and natural gas are sold. There were no deferred gains or losses at
December 31, 1996 or 1995. Product
11
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
----------------------------------
AND SUBSIDIARIES
----------------
Notes to Consolidated Financial Statements (Continued)
------------------------------------------------------
marketing margin was decreased by $.1 million for the period October 1,
1996 through December 31, 1996, increased by $.8 million for the period
January 1, 1996 through September 30, 1996 and decreased by $.8 million and
$1.1 million in 1995 and 1994, respectively, as a result of such hedging
activity.
Gains and losses on other derivative financial instruments that qualify as
a hedge of firmly committed or anticipated purchases and sales of oil and
gas commodities are deferred and recognized in income when the related
hedged transaction occurs. Gains or losses on derivative financial
instruments that do not qualify as a hedge are recognized in income
currently.
MAJOR CUSTOMER -
During the period October 1, 1996 through December 31, 1996, one customer
accounted for 16% of the Company's combined revenues. There were no
customers that accounted for more than 10% of the Company's revenues for
the period January 1, 1996 through September 30, 1996 and the years ended
December 31, 1995 and 1994. The Company does not believe that it is
dependent upon any particular customer for sales of oil and gas.
INCOME TAXES -
MHC has applied with the Internal Revenue Service to be treated as an S
Corporation for income tax purposes effective in 1997. Each MHC
stockholder will be responsible for reporting its share of taxable income
or loss and no federal income taxes will be recorded by the Company, except
for a tax on excess net passive income and certain built-in gains.
Prior to the consummation of the Management Buyout, the Predecessor and its
subsidiaries were included in Torchmark's consolidated Federal income tax
return. Income taxes were recorded as if the Predecessor and its
subsidiaries filed a separate return and the Predecessor and its
subsidiaries received a current benefit to the extent their losses were
used in Torchmark's consolidated tax return. Taxes on income were reduced
by utilizable tax credits in Torchmark's consolidated tax return.
Subsequent to the Management Buyout, the Company is included in MHC's
consolidated federal income tax return and income taxes are recorded as if
a separate return is filed by the Company and its subsidiaries.
Deferred taxes are accounted for using the asset and liability method of
accounting for income taxes. Under this method, deferred income taxes are
recognized for the tax consequences of "temporary differences" by applying
enacted statutory tax rates applicable to future years to differences
between the financial statement carrying amounts and the tax basis of
existing assets and liabilities. The effect on deferred taxes of a change
in tax rates is recognized in income in the period the change occurs.
RECLASSIFICATIONS -
Certain reclassifications of prior period statements have been made to
conform with current reporting practices.
12
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
----------------------------------
AND SUBSIDIARIES
----------------
Notes to Consolidated Financial Statements (Continued)
------------------------------------------------------
USE OF ESTIMATES -
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities to prepare these financial statements in
conformity with generally accepted accounting principles. Actual results
could differ from those estimates.
3. RELATED PARTY TRANSACTIONS-
---------------------------
NOTE RECEIVABLES -
On December 31, 1995, the Predecessor was issued a non-interest bearing
note of approximately $18 million from Torchmark to replace an intercompany
obligation of an affiliate. The note was forgiven by the Predecessor as a
result of the Management Buyout.
ASSET MANAGEMENT -
The Company provides management services relating to oil and gas operations
for third-party investors, affiliated entities, and investees, including
oil and gas limited partnerships, Bellwether Exploration Company
("Bellwether"), and Nuevo. In accordance with the management agreements,
the Company provides various accounting and administrative services for a
fixed or variable fee. In addition, the Company receives additional
compensation for services related to property or corporate acquisitions or
divestitures. Total management fees received from such related parties
amounted to $5.8 million, $23.7 million (includes $8 million related to
Nuevo's purchase of Unocal California properties), $18.6 million and $17.2
million for the periods October 1, 1996 through December 31, 1996 and
January 1, 1996 through September 30, 1996, and the years ended December
31, 1995 and 1994, respectively.
In the ordinary course of business, the Company incurs intercompany
balances resulting from the payment of costs and expenses on behalf of
related parties and from charging management fees under the terms of the
respective management and administrative agreements. Such amounts are
settled on a regular basis, generally monthly.
PRODUCT MARKETING -
The Company markets oil and natural gas production for properties in which
related parties own interests. The Company's marketing fee ranges from .5%
to 3% of revenues; such charge is customary within the oil and gas
industry. Such revenues amounted to $.8 million, $4.0 million, $2.7
million and $2.1 million for the periods October 1,1996 through December
31, 1996 and January 1, 1996 through September 30, 1996, and the years
ended December 31,1995 and 1994, respectively.
WELL OPERATIONS -
The Company operates properties in which related parties own interests.
These entities are charged for all customary expenses and cost
reimbursements associated with such activities on the same basis as third
13
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
----------------------------------
AND SUBSIDIARIES
----------------
Notes to Consolidated Financial Statements (Continued)
------------------------------------------------------
parties. Operators overhead charged to affiliates for the periods October
1, 1996 through December 31, 1996 and January 1, 1996 through September 30,
1996, and the years ended December 31, 1995 and 1994 for these activities
was $1.2 million, $5.7 million, $7.4 million and $6.4 million,
respectively.
OTHER -
Interest expense paid to related entities totaled $.6 million, $1.2 million
and $.9 million for the period January 1, 1996 through September 30, 1996,
and for the years ended December 31, 1995 and 1994. No interest expense
was paid to related entities for the period October 1, 1996 through
December 31, 1996.
J.P. Bryan, an owner of MHC, is also chairman of Nuevo, Bellwether and Gulf
Canada. The Company received $3.4 million, in management fees from these
entities for the period October 1, 1996 through December 31, 1996.
4. INCOME TAXES
------------
The Company's and Predecessor's income tax provision for the periods
October 1, 1996 through December 31, 1996 and January 1, 1996 through
September 30, 1996, and the years ended December 31, 1995 and 1994 is
comprised of the following (amounts in thousands):
<TABLE>
<CAPTION>
October 1, January 1,
through through Year Ended December 31,
December 31, September 30, ----------------------------
1996 1996 1995 1994
-------------- ------------- -------------- ------------
(Company) (Predecessor) (Predecessor) (Predecessor)
<S> <C> <C> <C> <C>
Current income tax expense (benefit)
Federal............................... $ 307 $(4,248) $ 7,576 $ 4,810
State................................. 52 210 434 171
-------------- ------------- -------------- ------------
359 (4,038) 8,010 4,981
-------------- ------------- -------------- ------------
Deferred income tax expense (benefit)
Federal............................... 809 5,747 (12,302) (1,925)
State................................. 99 568 61 209
-------------- ------------- -------------- ------------
908 6,315 (12,241) (1,716)
-------------- ------------- -------------- ------------
$1,267 $ 2,277 $ (4,231) $ 3,265
============== ============= ============== ============
</TABLE>
14
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company's effective income tax rate differed from the statutory tax
rate as follows:
<TABLE>
<CAPTION>
October 1, 1996 January 1, 1996
through through Year Ended December 31,
December 31, September 30, -----------------------------
1996 1996 1995 1994
---------------- ----------------- ------------- --------------
(Company) (Predecessor) (Predecessor) ((Predecessor)
<S> <C> <C> <C> <C>
Statutory tax rate 34% 35% (35)% 35%
State 3 3 25 2
Section 29 tax credits (1) (23) (335) (11)
Nondeductible travel and
entertainment --- --- 4 ---
Other --- --- 10 ---
------------ ---------------- ------------- --------------
Effective tax rate 36% 15% (331)% 26%
============ ================ ============= ==============
</TABLE>
Included in due to affiliates at December 31, 1996 and 1995 is the
Company's current income tax payable of $307,000 due to MHC and the
Predecessor's current income tax payable of $5.8 million - due to Torchmark,
respectively.
The tax effects of temporary differences that give rise to significant
portions of the deferred tax liabilities (assets) at December 31, 1996, 1995
and 1994 are as follows (amounts in thousands):
<TABLE>
<CAPTION>
December 31,
December 31, -----------------------
1996 1995 1994
------------ ---------- ----------
(Company) (Predecessor) (Predecessor)
<S> <C> <C> <C>
Oil and gas exploration and
development costs $ 898 $ 7,034 $ 7,846
Investment in Nuevo --- --- 7,648
Oil and gas property sales --- 516 ---
Hedge revenue --- 1,618 1,855
Other 101 2,052 2,204
-------- -------- ---------
Gross deferred tax liabilities 999 11,220 19,553
-------- -------- ---------
Assets held for sale --- (5,248) ---
Deferred revenue --- (4,094) (4,118)
Other (91) --- ---
-------- -------- ---------
Gross deferred tax assets (91) (9,342) (4,118)
-------- -------- ---------
Net deferred tax liabilities $ 908 $ 1,878 $ 15,435
======== ======== =========
</TABLE>
The Company has determined that the deferred tax assets are more likely
than not to be realized and a valuation allowance for such assets is not
required at December 31, 1996, 1995 or 1994, respectively.
15
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. Investments in Equity Securities
In March 1996, the Predecessor sold 17 million shares of Gulf Canada
Resources Ltd. ("Gulf Canada") shares (See Note 8), generating a pre-tax gain
of approximately $2.5 million. In April 1996, the Predecessor received 1.3
million Nuevo shares (See Notes 8 and 11) in exchange for certain California
offshore oil properties. In September 1996, the Predecessor's interest in Gulf
Canada consisting of .9 million shares and 5.6 million warrants, Nuevo and an
approximate 1% common stock interest in Bellwether was transferred to Torchmark
in connection with the Management Buyout (See Note 7).
During the period January 1, 1996 through September 30, 1996, the
Company recorded $16.1 million and $1.8 million in unrealized gains due to the
difference between cost and market value in its investments in Nuevo and Gulf
Canada, resulting in a carrying value at the time of the Management Buyout of
$51.8 million and $6.0 million, respectively. At December 31, 1995, the
carrying value of the investment in Gulf Canada of $3.9 million included an
unrealized loss of $.1 million. At December 31, 1994, the carrying value of
the investment in Nuevo of $26.4 million included an unrealized gain of $3.6
million. Carrying value of the investment in Bellwether approximated fair
value for the period January 1, 1996 through September 30, 1996 and the years
ending December 31, 1995 and 1994. There are no equity securities for the
period October 1, 1996 through December 31, 1996.
At December 31, 1995, the investments in equity securities consist of
the Predecessor's interest in Gulf Canada and Bellwether.
In September 1995, the Predecessor sold its then approximate 14%
investment in Nuevo for $34 million, generating a pre-tax gain of approximately
$11 million.
There were no purchases or sales of equity securities during 1994.
6. Retirement Plans and Other Postretirement Benefits
During the two years ended December 31, 1995, employees of the
Predecessor were covered by Torchmark's retirement plans, including a defined
benefit pension plan and a defined contribution savings plan.
Net periodic pension costs for the defined benefit plan were calculated
on the projected unit credit actuarial cost method. The Predecessor's pension
expense was $1.3 million and $1.1 million for the years ended December 31, 1995
and 1994, respectively. The savings plan was funded by employee and
Predecessor contributions. The Predecessor's contributions for this plan
totaled $.6 million for each of the years ended December 31, 1995 and 1994.
16
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Effective January 1, 1996, the Predecessor terminated its participation
in the above plans and established a 401(k) retirement plan. During the period
January 1, 1996 to September 30, 1996, the Predecessor contributed $1.3 million
to the terminated plan leaving a balance of $2.1 million in accrued pension
liabilities. This accrual was reversed into income as the Company has no
requirements to contribute future fundings to the terminated plan. The 401(k)
retirement plan is funded by employee and Company contributions. Employees may
contribute up to 12% of their salaries and the Company matches 50% of employee
contributions up to 6%. The Company's contributions to this plan total $.2
million and $.6 million for the period October 1, 1996 through December 31,
1996 and January 1, 1996 through September 30, 1996, respectively. In
addition, the Company established a discretionary 401(k) retirement plan.
During the first quarter of the year, the Company has the option of
contributing an additional 3% of each employee s salary for the previous year
to the plan. The Company's estimated contributions to this plan total $.3
million and $.9 million for the period October 1, 1996 through December 31,
1996 and January 1, 1996 through September 30, 1996. For both plans, an
employee is required to have been employed a minimum of one year by the Company
prior to participation.
7. Management Buyout
On September 30, 1996, the Management Buyout occurred whereby certain
members of the Company's executive management purchased the Company from
Torchmark for $41 million; $25.5 million in the form of a senior subordinated
note payable (See Note 12) and $15.5 million in cash. Immediately prior to the
Management Buyout, the Predecessor dividended its investments in Nuevo, Gulf
Canada and Bellwether and certain other assets to Torchmark (See Note 8) and
received a cash contribution from Torchmark for $10.5 million. As a result of
this transaction, the Company received working and other interests in oil and
gas properties. Predecessor management fees related to the properties conveyed
to TEAI were $1.9 million, $2.6 million and $2.8 million for the period January
1, 1996 through September 30, 1996 and the years ended December 31, 1995 and
1994, respectively. In addition, the Company received interests in certain
properties in exchange for consideration of up to $7 million, which is payable
solely out of production and is contingent upon the properties achieving
pricing and profitability thresholds. Based upon current pricing and
profitability projections, no liability has been recorded as of December 31,
1996.
8. Acquisitions and Dispositions of Assets
On January 25, 1995, through a participation agreement,
and an investor group led by the Predecessor closed a $55 million treasury
share offering issued by Gulf Canada. The Predecessor purchased 17.9 million
Ordinary shares at Can $5.375 (US $3.80) per share and received 13.75 million
warrants to purchase Ordinary shares at Can $6.25 (US $4.42) per share for a
total purchase price of $71.5 million.
In December 1995, the Predecessor entered into a series of transactions
which resulted in the sale of 17 million of the Gulf Canada shares to an
affiliate of the Predecessor s principal lender for $68 million. In connection
with the transaction, the Predecessor had certain performance obligations;
$36.1 million of time deposits collaterized the transaction until such
obligations were satisfied. In March 1996, the performance obligations were
satisfied and the Predecessor recognized a pre-tax gain of approximately $2.5
million upon the sale of the Gulf Canada stock. In September 1996, the
remaining .9 million Gulf Canada shares were transferred to Torchmark in
conjunction with the Management Buyout.
17
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In April 1996, the Predecessor received 1.3 million Nuevo shares at $28
per share in exchange for certain California offshore oil properties. A loss
of $1.7 million was recognized on this disposition. In September 1996, these
shares were transferred to Torchmark in conjunction with the Management Buyout.
The Predecessor used the cost method of accounting for both the Gulf
Canada and Nuevo investments.
In December, 1993, the Predecessor sold its interest in certain
offshore oil and gas assets to a subsidiary of Norcen Resources Ltd. ("Norcen"),
for $61 million and the assumption of $50 million of debt (See Note 12).
Such transaction resulted in a pre-tax gain of $22 million. In December 1995,
the Predecessor recorded a charge of $1.9 million regarding the settling of
certain matters on the Norcen transaction. Prior to July 1994, the Predecessor
invested $17.8 million of net proceeds in producing oil and gas properties thus
effecting a like kind exchange for Federal income tax purposes.
During 1995, the Predecessor sold its interest in certain oil and gas
properties to a third party for $6.6 million. During the period January 1,
1996 through September 30, 1996, the Predecessor sold its interest in certain
oil and gas properties to a third party for $16.3 million, generating a pre-
tax gain of $4.9 million.
9. Other Long-Term Liabilities
Other long-term liabilities at December 31, 1996 and 1995 consist of
the following (amounts in millions):
1996 1995
-------- ---------
Gas balancing obligations . . $ --- $ 4.4
Employee benefit liabilities. --- 3.6
Royalties payable . . . . . . 2.1 1.7
Litigation provision. . . . . 1.3 ---
Minority Interest . . . . . . .5 ---
Other . . . . . . . . . . . . 3.6 4.4
-------- ---------
$ 7.5 $ 14.1
======== =========
10. Torch Energy Royalty Trust
The Company serves as sponsor and operator of a majority of the
properties in which the Torch Energy Royalty Trust (the "Trust") owns a net
profits interest. The Company recorded deferred revenues of $12.1 million
relating to the Trust (See Note 13). In connection with the formation of the
Trust, the Company entered into an oil and gas purchase contract ("Purchase
Contract") which expires on the termination date of the Trust, the earliest of
which is January 1, 2003. Under the Purchase Contract, the Company is
obligated to purchase all net production attributable to the Trust properties
for indexed prices for oil and gas. Such prices are calculated monthly and are
generally based on the average spot market prices of oil and gas, adjusted to
reflect the terms of a hedge contract ("Hedge Contract"), which expires in the
year 2000, to which the Company is a party. The Purchase Contract also
provides that a minimum price of $1.70 per MMbtu will be paid by the Company
for gas production. During the periods October 1, 1996 to December 31, 1996
and January 1, 1996 to September 30, 1996, the Company purchased 2,604 MMCF
18
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
and 8,488 MMCF of gas, respectively, and 35 Mbbls and 109 Mbbls of oil,
respectively, at an average price of $2.06 and $1.80 per MCF, respectively, and
$18.17 and $17.40 per Bbl, respectively. During the year ended December 31,
1995, the Company purchased 13,640 MMCF of gas and 188 Mbbls of oil at an
average of $1.81 per MCF and $16.10 per Bbl. During the year ended December 31,
1994, the Company purchased 16,511 MMCF of gas and 298 MBbls of oil at an
average price of $1.90 per MCF and $14.96 per Bbl. Under the Hedge Contract,
monthly quantities of gas hedged decreased from 598,750 MMbtus of gas in 1994 to
17,250 MMbtus of gas in 2000 and monthly quantities of oil hedged decrease from
7,750 Bbls in 1994 to 167 Bbls in 2000. The price received for gas under the
Hedge Contract increases from $1.81 per MMbtu in 1994 to $1.89 per MMbtu in
2000. The price received for oil under the Hedge Contract increases from $19.80
per Bbl in 1994 to $20.20 per Bbl in 2000.
Additionally, the Company has purchased contracts expiring December
2001 to further limit its exposure to losses under the Purchase Contract.
Under these contracts, monthly quantities hedged decrease from 31,870 MMbtus
per day in 1994 to 21,236 MMbtus per day in 2001 with pricing ranging in excess
of $1.70 per MMbtu.
11. Oil and Gas Property Held for Sale
As manager of various institutional partnerships and public investors,
the Company acquires oil and gas properties on behalf of these managed clients.
The portion of the costs expected to be conveyed to these entities is
capitalized as oil and gas property held for sale. These capitalized costs
also include acquisition financing costs, evaluation, holding and closing
costs. In addition, net operating revenues generated from these properties
during the period from the date of acquisition to the date the properties are
conveyed to the purchasing entities reduce the carrying amount of oil and gas
properties held for sale. Proved reserves associated with the oil and gas
property held for sale are not considered in the calculation of depreciation,
depletion and amortization and are excluded from all supplemental oil and gas
disclosures.
In December 1995, $5.2 million of the Predecessor's oil and gas assets,
which exclude the working interests associated with net profit interests owned
by certain institutional investment programs and the Trust, were reclassified
as oil and gas property held for sale since such assets were contemplated to be
sold during 1996. During 1995 and 1994 such properties generated $7.2 million
and $9.4 million of oil and gas revenues, net of lease operating expenses.
These assets were recorded at fair value in accordance with Statement 121 (See
Note 2). During 1996, these assets were sold. In addition, during 1996 $17.0
million of certain oil and gas assets were reclassified from oil and gas
property held for sale as the Company determined these assets would continue to
be held. In April 1996, $41.1 million of California offshore oil properties
classified as oil and gas property held for sale at December 31, 1995 and the
related deferred income tax liability of $3.7 million was exchanged for 1.3
million Nuevo shares at $28 per share (See Note 8).
19
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. Debt
Senior Subordinated Note Payable - Affiliate
On September 30, 1996, the Company recorded a $25.5 million Senior
Subordinated Note payable to Torchmark as part of the purchase price for the
Management Buyout. This note accrues interest at 9% per annum, 7% payable
semiannually and 2% payable upon maturity or prepayment of the note. The
principal of this note is due and payable on September 30, 2004.
Line of Credit -
The Company maintains a $13 million credit facility with a bank.
Interest accrues on indebtedness, at the Company's option, at the bank's prime
rate if less than 50% of revolver borrowing base is outstanding ($10 million at
December 31, 1996), plus .25% if 50% or more, but less than 75% of revolver
borrowing base is outstanding or plus .50% if 75% or more of revolver borrowing
base is outstanding; or the London Interbank Offered Rate ("LIBOR") plus 1.5%
if less than 50% of revolver borrowing base is outstanding, 1.75% if 50% or
more, but less than 75% of revolver borrowing base is outstanding or 2% if 75%
or more of revolver borrowing base is outstanding (8.25% at December 31, 1996).
The loan agreement with the bank contains, among other things, provisions for
the maintenance of certain financial ratios and restrictions on additional
debt. Certain oil and gas properties, stock and fixed assets secure the credit
facility which matures on September 30, 1999. There is no outstanding balance
under the line of credit at December 31, 1996. Prior to September 30, 1996,
the Predecessor had a $50 million credit facility with a bank. Interest
accrued on indebtedness at the Predecessor s option, at the bank s prime rate
plus .5% or the LIBOR plus 2%. At December 31, 1995, the Predecessor had
pledged substantially all of its oil and gas property interests and $36.1
million of time deposits as collateral under this facility. At December 31,
1995 and 1994, the outstanding balance under the line of credit was $3.4
million and $5.0 million, respectively. The bank credit facility s carrying
value approximates fair value as these notes bear interest at rates which
approximate current market rates.
Notes Payable to Parent -
In January 1993, the Predecessor borrowed $67 repay a credit facility with
a syndicate of banks. accrued interest at 9.375% per annum, payable monthly, and
matured in January 1994 at which time the credit facility was extended to
January 1996. In December 1993, $50 million of debt was assumed by Norcen in
conjunction with the property sale of certain offshore assets (See Note 8). At
December 31, 1995, the outstanding balance of the note payable to Parent was $17
million. On September 30, 1996, the balance was extinguished in conjunction with
the Management Buyout.
13. Deferred Revenue
Deferred revenue at December 31, 1995 related to prepaid management
fees to be earned in conjunction with the formation of the Trust and a
commission related to the Gulf Canada transaction. For the Trust
20
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
fees, deferred revenue was being amortized, based on estimated production
presented in reserve reports, through 2003. For Gulf Canada fees, deferred
revenue was being amortized over three years as the Predecessor maintained
certain responsibilities under a participation agreement (See Note 8). In
conjunction with the Management Buyout, Torchmark was distributed the Gulf
Canada stock and assumed the responsibilities under the participation agreement.
No deferred revenue was recorded in conjunction with the Management Buyout.
Predecessor management fees related to these properties were $2.5 million, $3.2
million and $2.4 million for the period January 1, 1996 through September 30,
1996 and the years ended December 31, 1995 and 1994, respectively.
14. Commitments and Contingencies
Litigation -
The Company is involved in certain litigation arising out of the normal
course of business, none of which, in the opinion of the Company, will have any
material adverse effect on the financial position or results of operations of
the Company as a whole. Certain lawsuits to which the Company was a party were
assumed by Torchmark as a result of the Management Buyout.
Lease Obligations -
Rental expense for operating leases was approximately $.6 million, $1.6
million, $2.3 million and $2.2 million for the periods October 1, 1996 through
December 31 1996 and January 1, 1996 through September 30, 1996 and the years
ended December 31, 1995 and 1994, respectively.
Future minimum payments under all noncancellable leases, including
amounts allocable to affiliates, having initial terms of one year or more
consisted of the following as of December 31, 1996 (amounts in thousands):
Operating
Year Ending December 31, Leases
------------------------ ----------
1997 . . . . . . . . $ 2,195
1998 . . . . . . . . 1,440
1999 . . . . . . . . ---
2000 . . . . . . . . ---
2001 . . . . . . . . ---
Thereafter . . . . . ---
----------
$ 3,635
==========
21
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. Financial Derivatives
The Company has only limited involvement with derivative financial
instruments and does not use them for trading purposes. They are used to
manage well-defined commodity price risks.
The Company uses oil and gas swap agreements to hedge anticipated
purchases for pricing commitments of crude oil and natural gas. Under the swap
agreements, the Company receives or makes payments based on the differential
between a specified price and the actual price of crude oil and natural gas.
At December 31, 1996, the Company had natural gas swap agreements with broker-
dealers to exchange monthly payments on notional quantities amounting to 48
million MMBTU over the ensuing 5 years. Under the swap agreements, the Company
will realize an average floor price of $1.87 per MMBTU. Under a 71 Mbbl oil
swap agreement, the Company will realize a floor price of $19.98 per barrel.
At December 31, 1996, the Company also had a swap agreement on notional
quantities of 9.2 million MMBtus under which prices are capped at $2.37
decreasing to $2.22 over the remaining five years.
Determination of Fair Values of Financial Instruments
Fair value for cash, short-term investments, receivables, other assets
and payables approximates carrying value. The following table details the
carrying values and approximate fair values of the Company's other investments
and derivative financial instruments at December 31, 1996.
(Amounts in thousands) Carrying Approximate
Value Fair Value
----------- -----------
Derivative assets:
Crude Oil price swaps $ --- $ (206)
Natural gas price swaps --- (1,945)
Long-term debt (See Note 12) 25,500 25,500
The Company is exposed to credit losses in the event of nonperformance
by the counterparties to its nonderivative financial assets but has no
off-balance- sheet credit risk of accounting loss. The Company anticipates,
however, that counterparties will be able to fully satisfy their obligations
under the contracts. Futures contracts are guaranteed settlement by the NYMEX
and have nominal credit risk.
16. Subsequent Events (unaudited)
In March 1997, Bellwether, a publicly traded oil and gas company for
which the Company acts as manager pursuant to a management agreement, filed a
registration statement which facilitates the purchase of oil and gas properties
of certain partnerships under which the Company is a general partner and
provides management services. As a result, it is anticipated that the Company
will receive an estimated $18.4 million for its interests in these properties.
In addition, the Company will receive .15 million shares of Bellwether common
stock and warrants to purchase an additional .1 million shares of Bellwether
common stock at $12.90 per share as a fee for advising Bellwether in connection
with the sale. Management fees earned from the partnerships were $.9 million,
$2.7 million, $3.5 million and $4.0 million for the periods October 1, 1996
through December 31, 1996 and January 1, 1996 through September 30, 1996 and
for
22
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
the years ended December 31, 1995 and 1994, respectively. Consummation of
the anticipated transaction will result in increased Bellwether management
fees. There can be no assurance that this transaction will be completed.
17. Noncash Transactions
During 1996, $17 million of certain oil and gas assets were
reclassified from oil and gas property held for sale as the Company determined
these assets would continue to be held (See Note 11).
In April 1996, the Predecessor received 1.3 million Nuevo shares in
exchange for $41.1 million of certain California offshore oil properties (See
Notes 5, 8 and 11). As part of the consideration on this exchange, Nuevo
assumed a deferred federal income tax liability of $3.7 million.
18. Supplementary Oil and Gas Data (unaudited)
Oil and Gas Producing Activities -
Included herein is information with respect to oil and gas acquisition,
exploration, development and production activities, which is based on estimates
of year-end oil and gas reserve quantities and estimates of future development
costs and production schedules. Reserve quantities and future production are
primarily based upon reserve reports prepared by independent petroleum
engineering firms of Gruy Engineering Corporation, H.J. Gruy and Associates,
Inc., Ryder Scott Company, Netherland, Sewell & Associates, Inc., and T.J.
Smith & Company, Inc. and by in-house reserve engineers. These estimates are
inherently imprecise and subject to substantial revision.
Estimates of future net cash flows from proved reserves of gas, oil,
condensate and natural gas liquids (NGL's) were made in accordance with
Financial Accounting Standards Board Statement No. 69, "Disclosures about Oil
and Gas Producing Activities." The estimates are based on prices in effect at
year-end. Estimated future cash inflows are reduced by estimated future
development and production costs based on year-end cost levels, assuming
continuation of existing economic conditions, and by estimated future income
tax expense. Tax expense is calculated by applying the existing statutory tax
rates, including any known future changes, to the pre-tax net cash flows, less
depreciation of the tax basis of the properties and depletion allowances
applicable to the gas, oil, condensate and NGL's production. The results of
these disclosures should not be construed to represent the fair market value of
the Company's oil and gas properties. A market value determination would
include many additional factors including: (i) anticipated future increases or
decreases in oil and gas prices and production and development costs; (ii) an
allowance for return on investment; (iii) the value of additional reserves, not
considered proved at the present, which may be recovered as a result of further
exploration and development activities; and (iv) other business risks.
23
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Costs incurred -
The following table sets forth the capitalized costs incurred in oil
and gas activities for the years ended December 31, 1996, 1995 and 1994
(amounts in thousands):
Year Ended December 31,
----------------------------
1996 1995 1994
--------- -------- --------
Costs incurred during the year:
Property acquisition. . . . . . . $ --- $ --- $ 26,069
Exploration . . . . . . . . . . . --- --- ---
Development . . . . . . . . . . . 9,078 2,443 11,034
--------- -------- --------
$ 9,078 $ 2,443 $ 37,103
========= ======== ========
Capitalized costs relating to oil and gas activities -
The following table sets forth the capitalized costs relating to oil and gas
activities and the associated accumulated depreciation, depletion and
amortization (amounts in thousands):
December 31,
----------------------------
1996 1995 1994
-------- -------- --------
Capitalized costs:
Proved properties . . . . . . . . $ 18,164 $ 22,552 $ 79,627
Unevaluated properties. . . . . . --- --- ---
-------- -------- --------
Total capitalized costs . . . . . 18,164 22,552 79,627
Accumulated depreciation,
depletion and amortization . . . (698) (7,261) (32,271)
-------- -------- --------
Net capitalized costs . . . . . . $ 17,466 $ 15,291 $ 47,356
======== ======== ========
24
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Results of Operations for producing activities (amounts in thousands) -
<TABLE>
<CAPTION>
October 1, January 1,
through through Year Ended December 31,
December 31, September 30, -----------------------
1996 1996 1995 1994
------------ ------------ ---------- ----------
(Company) (Predecessor) (Predecessor) (Predecessor)
<S> <C> <C> <C> <C>
Revenues from oil and gas producing activities......... $ 6,327 $ 9,942 $ 15,403 $ 18,742
Production costs....................................... (2,678) (4,188) (3,908) (4,575)
Depreciation, depletion and amortization............... (698) (3,922) (9,956) (12,778)
Provision on impairment on oil and gas
properties............................................ --- --- (16,000) ---
Income tax provision................................... (1,003) (641) 5,061 (486)
------------ ------------ ---------- ----------
Results of operations from producing activities
(excluding corporate overhead and interest
costs)................................................ $ 1,948 $ 1,191 $ (9,400) $ 903
============ ============ =========== ==========
</TABLE>
Reserves-
The Company's estimated total proved and proved developed reserves of oil
and gas for the years ended December 31, 1996, 1995 and 1994 are as follows:
<TABLE>
<CAPTION>
1996 1995 1994
----------------- ---------------- ---------------
Oil Gas Oil Gas Oil Gas
(Mbbl) (Mmcf) (Mbbl) (Mmcf) (Mbbl) (Mmcf)
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Proved reserves at
beginning of year ................. 1,294 11,158 3,119 28,287 1,732 17,365
Purchases of reserves
in place........................... 226 94,272 --- --- 2,178 15,717
Sales of reserves in place......... (2,740) (2,091) (654) (7,144) (171) (121)
Revisions of previous
estimates.......................... (75) (1,609) 118 (957) (30) (1,075)
Transfer (to)/from assets held
for sale........................... 3,054 15,556 (806) (5,056) --- ---
Extensions and discoveries......... 41 10,714 22 383 62 1,420
Production......................... (370) (5,199) (505) (4,355) (652) (5,019)
------ ------- ------ ------ ------ ------
Proved reserves at end
of year............................ 1,430 122,801 1,294 11,158 3,119 28,287
====== ======= ====== ====== ====== ======
Proved developed reserves -
Beginning of year.................. 992 9,583 2,562 24,251 1,470 15,477
====== ======= ====== ====== ====== ======
End of year........................ 1,141 111,166 992 9,583 2,562 24,251
====== ======= ====== ====== ====== ======
</TABLE>
25
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Discounted future net cash flows -
The standardized measure of discounted future net cash flows and changes
therein related to proved oil and gas reserves are shown below (amounts in
thousands):
Year Ended December 31,
-------------------------------
1996 1995 1994
--------- -------- --------
Future cash inflows.................... $ 499,396 $ 44,310 $ 96,106
Future production costs................ (274,243) (14,982) (35,398)
Future development costs............... (8,390) (2,575) (8,693)
--------- -------- --------
Future net inflows before income tax... 216,763 26,753 52,015
Future income taxes.................... (68,539) (5,894) (5,107)
--------- -------- --------
Future net cash flows.................. 148,224 20,859 46,908
10% discount factor.................... (75,345) (6,191) (10,425)
--------- -------- --------
Standardized measure of discounted
future net cash flows................. $ 72,879 $ 14,668 $ 36,483
========= ======== ========
26
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following are the principal sources of change in the standardized
measure of discounted future net cash flows (amounts in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Standardized measure -
Beginning of year........................... $ 14,668 $ 36,483 $ 22,560
Sales, net of production costs.............. (9,403) (11,495) (14,167)
Transfer (to)/from assets held for sale..... 23,445 (5,417) ---
Purchases of reserves in-place.............. 68,698 --- 17,520
Net change in prices and
production costs........................... 406 4,147 (1,300)
Extensions, discoveries and
improved recovery, net of future
production and development costs........... 8,008 266 60
Changes in estimated future
development costs.......................... (786) (147) 1,048
Development costs incurred during
the period................................. 9,078 2,443 11,034
Revisions of quantity estimates............. (349) (271) (961)
Accretion of discount....................... 1,692 3,648 2,293
Net change in income taxes.................. (27,467) (2,257) 366
Sales of reserves in-place.................. (18,686) (8,513) (742)
Changes in production rates and
other...................................... 3,575 (4,219) (1,228)
--------- --------- ---------
Standardized measure -
End of year................................. $ 72,879 $ 14,668 $ 36,483
========= ========= =========
</TABLE>
27
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
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AND SUSIDIARIES
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED
(Unaudited)
The following should be read in conjunction with the consolidated financial
statements, and the related notes thereto, of Torch Energy Advisors Incorporated
and its subsidiaries (the "Company").
DISCUSSION OF YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The following table sets forth certain information about the Company for
the periods presented (in thousands of dollars):
<TABLE>
<CAPTION>
DECEMBER 31, Increase (Decrease)
------------ ---------------------
1996 1995 1994 1996-1995 1995-1994
------ ------------ ------ ---------- ----------
<S> <C> <C> <C> <C> <C>
PRODUCTION:
Oil and gas
condensate
(MBBL)............... 370 505 652 (26.7)% (22.5)%
Natural gas (MMCF).... 5,199 4,355 5,019 19.4 % (13.2)%
AVERAGE SALES PRICE:
Oil and gas
condensate
(per BBL)............ $16.76 $16.67 $ 14.96 .5 % 11.4 %
Natural gas (per
MCF)................. $ 1.92 $ 1.60 $ 1.79 20.0 % (10.6)%
Average Unit Production
Cost Per Mcfe (a)...... $ 0.92 $ 0.53 $ 0.51 73.6 % 3.9 %
Average Unit Depletion
Rate Per Mcfe (b)...... $ 0.62 $ 1.35 $ 1.43 (54.1)% (5.6)%
</TABLE>
Management Fee
Revenues................ $29,425 $18,620 $17,236 58.0 % 8.0 %
(a) Costs incurred to operate and maintain wells and related equipment and
facilities including ad valorem and severance taxes.
(b) 1996 reflects the impact of the Management Buyout at September 30, 1996.
1
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TORCH ENERGY ADVISORS INCORPORATED
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AND SUSIDIARIES
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Revenues
Oil and gas revenues for 1996 were $16.3 million, up 6% from oil and gas
revenues of $15.4 million in 1995. Such increase is mainly attributable to the
receipt of certain oil and gas properties in September 1996 as a result of the
Management Buyout offset by the sale of certain oil and gas properties in
December 1995 (See Notes 7 and 8 of the Notes to Consolidated Financial
Statements). Oil revenues decreased 25% to $6.3 million in 1996 from $8.4
million in 1995. Gas revenues increased 43% to $10.0 million in 1996 from $7.0
million in 1995. Revenues are favorably impacted due to increased pricing
during 1996. Oil and gas revenues for 1995 were $15.4 million, down 18% from
oil and gas revenues of $18.7 million in 1994. Such decrease is mainly
attributable to the sale of certain assets in March 1995, changes in prices and
low volumes. Oil revenues decreased 14% to $8.4 million in 1995 from $9.8
million in 1994. Gas revenues decreased 21% to $7.0 million in 1995 from $8.9
million in 1994. During 1995 and 1994, all gas production owned by the Company
was sold at spot prices.
Management fees totaled $29.4 million, $18.6 million and $17.2 million in
1996, 1995 and 1994, respectively. Such fees are expected to decrease during
1997 as a result of the Management Buyout (See Notes 7 and 13 of the Notes to
Consolidated Financial Statements). Assets under management increased to $1.7
billion in 1996 from $1.0 billion in 1995. Assets under management decreased to
$1.0 billion in 1995 from $1.3 billion in 1994.
In September 1995, the Company sold its approximate 14% investment in Nuevo
for $34 million, generating a pre-tax gain of approximately $11 million. In
March 1996, the Company sold 17 million Gulf Canada shares, generating a pre-tax
gain of approximately $2.5 million. In April 1996, the Company received 1.3
million Nuevo shares in exchange for certain California offshore oil properties.
A loss of $1.7 million was recognized on this disposition. In September 1996,
the Company's interest in Gulf Canada and Nuevo was transferred to Torchmark in
connection with the Management Buyout. In August 1996 and September 1996, the
Company sold its interest in certain oil and gas properties to a third party for
$16.3 million, generating a pre-tax gain of $4.9 million. (See Notes 1, 5 and 8
of the Notes to Consolidated Financial Statements).
Expenses
Oil and gas expenses for 1996 totaled $6.9 million, up 77% from 1995 oil
and gas operating expenses of $3.9 million. Such increase is mainly
attributable to the receipt of certain oil and gas properties in September 1996
as a result of the Management Buyout offset by the sale of certain oil and gas
properties in December 1995 (See Notes 7 and 8 of the Notes to Consolidated
Financial Statements). The average unit production cost per Mcfe in 1996 was
$.92 as compared to an average unit production cost per Mcfe in 1995 of $.53.
Oil and gas expenses for 1995 totaled $3.9 million, down 15% from 1994 oil and
gas operating expenses of $4.6 million. Such decrease is mainly attributable to
the sale of certain assets in March 1995. The average unit production cost per
Mcfe in 1995 was $.53 as compared to an average unit production cost per Mcfe in
1994 of $.51.
The Company elected to adopt Statement 121 on December 31, 1995 resulting
in a provision of $16 million being charged against operations during 1995 (See
Note 2 of the Notes to Consolidated Financial Statements).
2
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TORCH ENERGY ADVISORS INCORPORATED
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AND SUSIDIARIES
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General and administrative expenses totaled $37.6 million, $34.6 million
and $35.7 million in 1996, 1995 and 1994, respectively.
Interest expense decreased by 33% to $1.6 million in 1996 from $2.4 million
in 1995. Such decrease is primarily due to $30 million of borrowings from
Torchmark which was outstanding from January to March of 1995 (See Note 12 of
the Notes to Consolidated Financial Statements). Interest expense increased by
85% to $2.4 million in 1995 from $1.3 million in 1994. Such increase is
primarily due to $30 million of borrowings from Torchmark and utilizing the
Company's credit facility to purchase Gulf Canada stock.
Product Marketing Activities
The product marketing, net decreased by 6% to $10.8 million in 1996 from
$11.5 million in 1995. The product marketing operating margin decreased by 34%
to $11.5 million in 1995 from $17.4 million in 1994. Such decrease mainly
resulted from a one-time fee earned by the Company in connection with a gas
purchase contract in 1994 (See Note 10 of the Notes to Consolidated Financial
Statements).
Equity in Earnings of Affiliates and Investees
Equity in earnings of affiliates and investees consists of Nuevo, oil and
gas partnership interests and other investments. Effective December 1, 1994,
the Company adopted the cost method of accounting for its long-term investment
in Nuevo Energy Company ("Nuevo"). The Company had previously used the equity
method of accounting to record its investment in Nuevo. Using the equity
method, the Company recognized equity in earnings of $.5 million related to
Nuevo during the year ended December 31, 1994. In 1995, the Company sold its
investment in Nuevo. In March 1996, the Company received 1.3 million Nuevo
shares in exchange for certain California offshore oil properties. In September
1996, these shares were transferred to Torchmark in connection with the
Management Buyout (See Notes 1 and 5 of the Notes to Consolidated Financial
Statements).
Minority Interest
Effective November 1, 1996 Torch Energy Marketing, Inc. (TEMI), a wholly
owned subsidiary, formed a limited liability company with an unaffiliated party
to conduct gas marketing activities. TEMI acts as a manager and owns a 50%
interest in this venture. During 1996, the Company formed two limited liability
companies with an unaffiliated party to provide certain management,
administrative and support services to a foreign party. The Company owns a 50%
interest in both limited liability companies. As the Company effectively
controls the ventures, the companies' activities for these ventures is included
in the financial statements with the unaffiliated parties interest reflected as
minority interest.
3
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TORCH ENERGY ADVISORS INCORPORATED
----------------------------------
AND SUSIDIARIES
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Net Income
The foregoing activities resulted in the following net income (amounts in
thousands):
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- -------
<S> <C> <C> <C>
Income (loss) before income taxes and
minority interest..................... $19,386 $(1,280) $12,713
Net income............................. $15,379 2,951 $ 9,429
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $ 7.6 million, $9.3 million
and $31.0 million for the years ended December 31, 1996, 1995 and 1994,
respectively. In each of the years considered, operating cash flows were
affected by significant changes in assets and liabilities due to the Company
incurring costs, in the ordinary course of business, on behalf of its managed
entities. In December 1995, $5.2 million of the Company's oil and gas assets,
which exclude the working interests associated with net profit interests owned
by certain institutional investment programs and the Trust, were reclassified as
oil and gas property held for sale since such assets were contemplated to be
sold during 1996. The Company spent $14.8 million, $9.9 million and $43.6
million on investments in property and equipment in 1996, 1995 and 1994,
respectively. In August 1996 and September 1996, the Company sold its interest
in certain oil and gas properties to a third party generating $16.3 million in
cash (See Note 8 of the Notes to Consolidated Statements). A significant amount
of the 1994 capital expenditures were funded by proceeds the Company received in
December 1993 in connection with the sale of its interest in certain offshore
oil and gas assets in the Gulf of Mexico for $61 million and the assumption of
$50 million of debt. Such transaction resulted in a gain of $22.0 million. In
December 1995, the Company recorded a charge of $1.9 million regarding the
settling of this transaction. In September 1995, the Company sold its
approximate 14% investment in Nuevo generating $34 million in cash (See Note 5
of the Notes to Consolidated Financial Statements).
The Company spent $2.8 million and $80.7 million in 1995 and 1994,
respectively, for acquisitions of oil and gas properties sold to institutional
investors participating in various current programs or third parties. No such
events occured in 1996.
Financing Activities
In September 1996, the Company negotiated a $13 million credit facility
with a bank. Interest accrues on indebtedness, at the Company's option, at the
bank's prime rate if less than 50% of revolver borrowing base is outstanding
($10 million at December 31, 1996), plus .25% if 50% or more, but less than 75%
of revolver borrowing base is outstanding or plus .5% if 75% or more of revolver
borrowing base is outstanding; or the London Interbank Offered Rate ("LIBOR")
plus 1.5% if less than 50% of revolver borrowing base is outstanding, 1.75% if
50% or more, but less than 75% of revolver borrowing base is outstanding or 2%
if 75% or more of revolver borrowing base is outstanding (8.25% at December 31,
1996). The loan agreement with the bank contains, among other things, provisions
for the maintenance of certain financial ratios and restrictions on additional
debt. Certain oil and gas properties, stock and fixed assets secure the credit
facility which matures on September 30, 1999. There is no outstanding balance
under the line of credit at December 31, 1996. Prior to September 30, 1996, the
Company had a $50 million credit facility with a bank. Interest
4
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TORCH ENERGY ADVISORS INCORPORATED
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AND SUSIDIARIES
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accrued on indebtedness at the Company's option, at the bank's prime rate plus
.5% or the LIBOR plus 2%. At December 31, 1995, the Company had pledged
substantially all of its oil and gas property interests and $36.1 million of
time deposits as collateral under this facility. At December 31, 1995 and 1994,
the outstanding balance under the line of credit was $3.4 million and $5.0
million, respectively. The bank credit facility's carrying value approximates
fair value as these notes bear interest at rates which approximate current
market rates.
In January 1993, the Company borrowed $67 million from Torchmark to repay a
credit facility with a syndicate of banks. Such promissory note accrued
interest at 9.375% per annum, payable monthly, and matured in January 1994 at
which time the credit facility was extended to January 1996. In December 1993,
$50 million of debt was assumed by the buyer in conjunction with the property
sale of certain offshore assets (See Note 8 of the Notes to Consolidated
Financial Statements).
In December 1995, the Company entered into a series of transactions which
resulted in the sale of 17 million of the Gulf Canada shares to an affiliate of
the Company's principal lender for $68 million. In connection with the
transaction, the Company had certain performance obligations; $36.1 million of
time deposits collaterized this transaction until such obligations were
satisfied in March 1996.
At December 31, 1995 and 1994, the outstanding balance of the note payable
to Torchmark was $17 million. At December 31, 1996, there is no outstanding
balance as a result of the Management Buyout.
On September 30, 1996, the Company recorded a $25.5 million Senior
Subordinated Note payable to Torchmark as part of the purchase price for the
Management Buyout. This note accrues interest at 9% per annum, 7% payable
semiannually and 2% payable upon maturity or prepayment of the note. The
principal of this note is due and payable on September 30, 2004.
Crude Oil and Natural Gas Price Swaps
The Company uses oil and gas swap agreements to hedge anticipated purchases
for pricing commitments of crude oil and natural gas. Under the swap
agreements, the Company receives or makes payments based on the differential
between a specified price and the actual price of crude oil and natural gas. At
December 31, 1996, the Company had natural gas swap agreements with broker-
dealers to exchange monthly payments on notional quantities amounting to 47
million MMBTU over the ensuing 5 years. Under the swap agreements, the Company
will realize an average floor price of $1.87 per MMBTU. Under a 71 Mbbl oil
swap agreement, the Company will realize a floor price of $19.98 per barrel. At
December 31, 1996, the Company also had a swap agreement on notional quantities
of 9.2 million MMBtus under which prices are capped at $2.37 decreasing to $2.22
over the remaining five years.
Outlook
In March 1997, Bellwether, a publicly traded oil and gas company for which
the Company acts as manager pursuant to a management agreement, filed a
registration statement which facilitates the purchase of oil and gas properties
of certain partnerships under which the Company is a general partner and
provides management services. As a result, it is anticipated that the Company
will receive an estimated $18.4 million for its interests in these properties.
In addition, the Company will receive
5
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
----------------------------------
AND SUSIDIARIES
---------------
.15 million shares of Bellwether common stock and warrants to purchase an
additional .1 million shares of Bellwether common stock at $12.90 per share as a
fee for advising Bellwether in connection with the sale. Management fees earned
from the partnerships were $.9 million, $2.7 million, $3.5 million and $4.0
million for the periods October 1, 1996 through December 31, 1996 and January 1,
1996 through September 30, 1996 and for the years ended December 31, 1995 and
1994, respectively. Consummation of the anticipated transaction will result in
increased Bellwether management fees. There can be no assurances that this
transaction will be completed.
Inflation has not had a material impact on the Company and is not expected
to have a material effect in the future.
6
