<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
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
-----------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO __________
Commission File Number 1-12474
--------
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 12, 1998 was
approximately $65,037,500.
<PAGE>
TORCH ENERGY ROYALTY TRUST
Annual Report on Form 10-K
For the fiscal year ended December 31, 1997
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
Number
------
PART I
<S> <C> <C> <C>
Item 1. Business...................................................... 3
Item 2. Properties.................................................... 8
Item 3. Legal Proceedings............................................. 10
Item 4. Submission of Matters to a Vote of Unitholders................ 10
PART II
Item 5. Market for Registrant's Units and Related Unitholder Matters.. 11
Item 6. Selected Financial Data....................................... 11
Item 7. Discussion and Analysis of Financial Condition and
Results of Operations......................................... 11
Item 8. Financial Statements and Supplementary Data................... 15
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure........................... 29
PART III
Item 10. Directors and Executive Officers of the Registrant............ 29
Item 11. Executive Compensation........................................ 29
Item 12. Security Ownership of Certain Beneficial Owners
and Management................................................ 29
Item 13. Certain Relationships and Related Transactions................ 29
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K........................................... 31
--- Signatures
</TABLE>
2
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TORCH ENERGY ROYALTY TRUST
PART I
ITEM 1. BUSINESS
This document includes "forward looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act"),
and Section 21E of the Securities Exchange Act of 1934 ("Exchange Act"). All
statements other than statements of historical facts included in this document,
including without limitation, statements under "Discussion and Analysis of
Financial Condition and Results of Operations" regarding the Trust's financial
position and estimated quantities and net present values of reserves, are
forward-looking statements. Although Torch believes that the assumptions upon
which such forward-looking statements are based are reasonable, it can give no
assurances that such assumptions will prove to have been correct. Important
factors that could cause actual results to differ materially from Torch's
expectations ("Cautionary Statements") are disclosed below and elsewhere in this
document. All subsequent written and oral forward-looking statements
attributable to the Trust or persons acting on its behalf are expressly
qualified by the Cautionary Statements.
GENERAL
The Torch Energy Royalty Trust ("Trust") was formed effective October 1, 1993
under the Delaware Business Act, 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 in November 1993. Pursuant to an
administrative services agreement ("Administrative Services Agreement") Torch
provides accounting, bookkeeping, informational and other services related to
the Net Profits Interest.
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. 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.
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 have not and 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
3
<PAGE>
TORCH ENERGY ROYALTY TRUST
each field to the surface when the Trust was formed. The Trust therefore has no
interest in deeper productive formations. Other clients 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
prior to 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 1997, 1996, and 1995, the Section 29 Credit available for
production from qualifying coal seam properties was approximately $1.05, $1.03
and $1.01, 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, 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 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, 1998, on a net
equivalent Mcf of gas ("Mcfe") basis, the Specified Prices received weightings
ranging from approximately 40% to 70% pertaining to production prior to August
31, 1997. Thereafter, the Specified Prices receive a weighting of approximately
10% and less. The Average Market Prices receive the balance of the weighting.
The Specified Prices for gas increase each year from $1.81 per MMBtu in 1995 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
4
<PAGE>
TORCH ENERGY ROYALTY TRUST
deduct 50% of such excess ("Price Differential") in determining 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 $0.260 per
MMBtu adjusted for inflation ($0.274, $0.272 and $0.265 per MMBtu for 1997, 1996
and 1995, respectively), plus fuel usage equal to 5% of revenues, payable to
Bahia Gas Gathering, Ltd. ("Bahia"), an affiliate of Torch, pursuant to a gas
gathering agreement. 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 395 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. TEMI deducts from the
purchase price for gas for production attributable to certain wells in the
Cotton Valley Fields a transportation fee of $0.045 per MMBtu. During the years
ended December 31, 1997, 1996 and 1995, gathering, treating and transportation
fees charged to the Trust by TEMI, attributable to production during the twelve
months ended September 30, 1997, 1996 and 1995 in the Robinson's Bend, Austin
Chalk and Cotton Valley Fields, totaled $1,899,000, $2,068,000 and $2,160,000,
respectively. 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, less property, production, severance and related taxes. The
Robinson's Bend Field production attributable to the Trust did not meet the
Volume Limitation during the three years ended December 31, 1997 and is not
expected to do so in the future.
The Net Profits Interests also entitle the Trust to 20% of the Net Proceeds
(defined below) of wells drilled on the Underlying Properties since the Trust's
establishment into formations in which the Trust has an interest, other than
wells drilled to replace damaged or destroyed wells ("Infill Wells"). Infill
Well Net Proceeds represent the aggregate gross revenues received from Infill
Wells less the aggregate amount of the following Infill Well costs: i) property,
production, severance and similar taxes; ii) development costs; iii) operating
costs; and iv) interest on the recovered portion, if any, of the foregoing costs
computed at a rate of interest announced publicly by Citibank, N.A. in New York
as its base rate.
5
<PAGE>
TORCH ENERGY ROYALTY TRUST
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 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
operation expenditures may not occur as estimated. Future results of the Trust
will depend upon 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 gas production and prices and, to a
lesser extent, oil production and prices from the Underlying Properties. The
gas industry is highly competitive in all of its phases. In marketing
production from the Underlying Properties, TEMI 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 TEMI. Competition may also be presented by alternative fuel sources,
including heating oil and other fossil fuels.
6
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TORCH ENERGY ROYALTY TRUST
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. Such price fluctuations will directly impact Trust
distributions, estimated reserve attributable to the Trust and estimated future
net revenues from Trust reserves.
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.
7
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TORCH ENERGY ROYALTY TRUST
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 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 and will, therefore, not 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 42.7%
working interest (31.8% net revenue interest) in 395 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
$1.05, $1.03 and $1.01 per MMBtu in 1997, 1996 and 1995, respectively. This
rate is adjusted annually for inflation. All of the wells in the Robinson's
Bend Field are operated by a subsidiary 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, less property, production, severance and similar taxes, and
development, operating, and certain other costs (excluding operating and
development costs until January 1, 2003). During 1997, 1996 and 1995, gross
production from the Underlying Properties in the Robinson's Bend Field averaged
774 MMcf, 832 MMcf and 930 MMcf per quarter, respectively, and was therefore
19%, 13% and 3%, respectively, less than the Volume Limitation for the year.
In calculating amounts paid to the Trust, lease operating expenses in the
Robinson's Bend field are not dedcuted until after 2002. When these amounts are
deducted, the amounts paid to the Trust attributable to the Robinson's Bend
field will be reduced substantially. If average prices following 2002 are not
substantially greater than gas prices in December 1997, the Trust's current
reserve reports indicate that the Trust will not receive any payments
attributable to the Robinson's Bend field.
Cotton Valley Fields. The Underlying Properties include an average 52.8%
working interest (40.7% net revenue interest) in 45 wells in four fields that
produce from the Upper and Lower Cotton Valley formations in Texas. 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
productions 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.
8
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TORCH ENERGY ROYALTY TRUST
Austin Chalk Fields. The Underlying Properties include an average of 17.6%
working interest (13.7% net revenue interest) in 90 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. A subsidiary 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, 1997, the gross and net interest
in oil and gas wells for the Underlying Properties:
<TABLE>
<CAPTION>
Gas Wells Oil Wells
----------------------------------------- -----------------------------------------
Gross Net Gross Net
------------------- ----------------- ------------------- -----------------
<S> <C> <C> <C> <C>
Chalkley Field.......................... 6 1.5 --- ---
Robinson's Bend Field................... 395 175.3 --- ---
Cotton Valley Fields.................... 45 23.6 --- ---
Austin Chalk Fields..................... 41 7.8 49 8.6
------------------- ----------------- ------------------- -----------------
Total.............................. 487 208.2 49 8.6
==================== ================= ================== =================
</TABLE>
The following table shows the gross and net acreage for the Underlying
Properties as of December 31, 1997. A gross acre in the following table refers
to the number of acres in which a working interest is owned directly by the
Trust. The number of net acres is the sum of the fractional ownership of
working interests owned directly by the Trust in the gross acres expressed as a
whole number and percentages thereof. A net acre is deemed to exist when the
sum of fractional ownership of working interests in gross acres equals one.
<TABLE>
<CAPTION>
Acreage
----------------------------------------------
Gross Net
--------------------- --------------------
<S> <C> <C>
Chalkley Field......................... 2,152 425
Robinson's Bend Field.................. 33,481 14,307
Cotton Valley Fields................... 6,650 4,162
Austin Chalk Fields.................... 34,642 6,414
--------------------- --------------------
Total............................. 76,925 25,308
===================== ====================
</TABLE>
9
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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
per Mcfe deducted in calculating net profits income and the weighted average
sales price per Mcf of gas and Bbl of oil for production attributable to 1997,
1996 and 1995 cash distributions received by Unitholders (derived from
production during the twelve months ended September 30, 1997, 1996 and 1995,
respectively).
<TABLE>
<CAPTION>
Chalkley, Cotton Valley
and Austin Chalk Fields
-----------------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Production:
Gas (MMcf).............................................. 6,186 8,217 10,764
Oil (Mbbl).............................................. 107 149 210
Weighted average lifting cost per Mcfe....................... $ 0.26 $ 0.20 $ 0.18
Weighted average taxes on production per Mcfe................ $ 0.09 $ 0.07 $ 0.08
Weighted average sales price (b)
Gas ($/Mcf)............................................. $ 1.92 $ 1.71 $ 1.72
Oil ($/Bbl)............................................. $17.06 $17.10 $ 15.89
Robinson's Bend Field
-----------------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Production:
Gas (MMcf).............................................. 3,149 3,415 3,804
Oil (Mbbl).............................................. --- --- ---
Weighted average lifting cost per Mcfe....................... $ ---(a) $ ---(a) $ ---(a)
Weighted average taxes on production per Mcfe................ $ 0.09 $ 0.11 $ 0.07
Weighted average sales price (b)
Gas ($/Mcf)............................................. $ 1.61 $ 1.40 $ 1.46
Oil ($/Bbl)............................................. $ --- $ --- $ ---
</TABLE>
(a) No operating costs will be deducted from the Net Profits Interest in the
Robinson's Bend Field until January 1, 2003. Average lifting costs per Mcfe
were $2.27, $2.35 and $2.86, respectiely, during 1997, 1996 and 1995,
in the Robinson's Bend Field.
(b) Average sales prices are reflective of purchase prices paid by TEMI,
pursuant to the Purchase Contract, less certain gathering, treating and
transportation charges.
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 Unitholder for a vote in 1997.
10
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TORCH ENERGY ROYALTY TRUST
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 24, 1998, there were 8,600,000 Units outstanding and
approximately 730 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:
<TABLE>
<CAPTION>
Cash
High Low Distributions
------------------- ----------------- --------------------
<S> <C> <C> <C>
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
Quarter ended March 31, 1997 $11.625 $10.250 $.514
Quarter ended June 30, 1997 $10.875 $10.250 $.465
Quarter ended September 30, 1997 $10.750 $ 8.750 $.359
Quarter ended December 31, 1997 $ 9.125 $ 5.500 $.352
</TABLE>
ITEM 6. SELECTED FINANCIAL DATA (In thousands, except per Unit amounts)
<TABLE>
<CAPTION>
November 24, 1993
(Date of
Year Ended December 31, Inception)
--------------------------------------------------------------------------- to
1997 1996 1995 1994 December 31, 1993
--------------- --------------- --------------- --------------- ------------------
<S> <C> <C> <C> <C> <C>
Net profits income $ 15,183 $ 17,381 $ 22,427 $ 30,039 $ ---
Distributable income (loss) $ 14,525 $ 16,722 $ 21,787 $ 29,282 $ (168)
Distributions declared $ 14,534 $ 16,727 $ 21,758 $ 29,300 $ ---
Distributable income
(loss) per Unit $ 1.69 $ 1.94 $ 2.53 $ 3.40 $ (.02)
Distributions per Unit $ 1.69 $ 1.95 $ 2.53 $ 3.41 $ ---
Total assets (at end of
period) $100,845 $121,526 $137,179 $157,593 $180,601
</TABLE>
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. DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
11
<PAGE>
TORCH ENERGY ROYALTY TRUST
OUTLOOK
As the Trust's administrative services provider, Torch plans to upgrade all
major financial and administrative systems to ensure that such systems are Year
2000 compliant. The Year 2000 problem results from data storage of date
information truncating in two places (i.e. 1998 stored as 98). Currently, all
programs storing year information as such recognize the Year 2000 as 00 (or
1900). Torch has implemented a Year 2000 project to identify all critical non-
Year 2000 compliant systems and convert or upgrade all such systems to Year 2000
compliant. Torch does not believe that costs incurred to address the Year 2000
issue with respect to its financial and administrative systems will have any
impact on the Trust's future financial results or operations. At this time,
Torch does not expect the Year 2000 issue to have a significant operational
impact.
RESULTS OF OPERATIONS
DISCUSSION OF YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Because a modified cash basis of accounting is utilized by the Trust, Net
Proceeds to the Trust for the years ended December 31, 1997, 1996 and 1995 is
derived from actual oil and gas production from October 1, 1996 through
September 30, 1997, October 1, 1995 through September 30, 1996 and October 1,
1994 through September 30, 1995, respectively. The following tables set forth,
for the Underlying Properties, oil and gas sales attributable to distributions
received by Unitholders during the three years ended December 31, 1997.
<TABLE>
<CAPTION>
Bbls of Oil
----------------------------------------------------------------------
1997 1996 1995
--------------------- -------------------- -------------------
<S> <C> <C> <C>
Chalkley Field 40,260 61,694 92,783
Robinson's Bend Field --- --- ---
Cotton Valley Fields 6,157 7,607 7,506
Austin Chalk Fields 60,236 79,289 109,740
--------------------- -------------------- -------------------
Total 106,653 148,590 210,029
===================== ==================== ===================
Mcf of Gas
----------------------------------------------------------------------
1997 1996 1995
--------------------- -------------------- -------------------
Chalkley Field 4,195,263 5,713,920 7,418,779
Robinson's Bend Field 3,148,834 3,415,346 3,804,316
Cotton Valley Fields 1,385,461 1,734,783 2,215,055
Austin Chalk Fields 605,455 768,023 1,129,829
--------------------- -------------------- -------------------
Total 9,335,013 11,632,072 14,567,979
===================== ==================== ===================
</TABLE>
For the year ended December 31, 1997, net profits income was $15,183,000, as
compared to $17,381,000 and $22,427,000 for the same periods in 1996 and 1995,
respectively. Such decreases are primarily due to normal declines in oil and
gas production attributable to the Underlying Properties, partially offset by
higher average gas prices paid to the Trust during 1997.
Gas production attributable to the distributions received by Unitholders during
the year ended December 31, 1997 was 9,335,013 Mcf, as compared to gas
production of 11,632,072 Mcf and 14,567,979 Mcf for the same periods in 1996 and
1995, respectively. Oil production attributable to the Underlying Properties
for the year ended December 31, 1997 was 106,653 Bbls as compared to 148,590
Bbls and 210,029 Bbls for the same periods in 1996 and 1995, respectively.
During 1997, five infill wells were drilled and commenced production. Infill
well production totaled 2,075 barrels of oil and 274,577 Mcf of gas during the
year ended December 31, 1997. Distributions
12
<PAGE>
TORCH ENERGY ROYALTY TRUST
received by Unitholders during 1997 were not impacted by these wells as gross
proceeds did not exceed costs and expenses for each of the infill wells.
The average price paid to the Trust for gas during the year ended December 31,
1997 was $1.91 per MMbtu as compared to 1.70 per MMBtu for each of the years
ended December 31, 1996 and 1995. The average price paid to the Trust for oil
during the years ended December 31, 1997, 1996 and 1995 was $17.06, $17.10 and
$15.89 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, 1997, TEMI had no accumulated
Price Credits. Net Price Credits in the amount of $317,000 and $2,305,000 were
deducted in calculating the purchase price related to distributions during 1997
and 1996, respectively. During 1995, TEMI accumulated price credits of
$2,155,000.
Lease operating expenses and capital expenditures deducted in calculating
distributions during the years ended December 31, 1997, 1996 and 1995 totaled
$1,898,000, $2,081,000 and $2,345,000, 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.
Severance tax deducted in calculating distributions during the years ended
December 31, 1997, 1996 and 1995 totaled $860,000, $1,000,000 and $1,163,000,
respectively, for all four fields.
General and administrative expenses during the years ended December 31, 1997,
1996 and 1995 amounted to $678,000, $684,000 and $676,000, respectively. These
expenses primarily relate to administrative services provided by Torch and the
Trustee.
The foregoing resulted in distributable income of $14,525,000, or $1.69 per
Unit, for the year ended December 31, 1997 as compared to $16,722,000, or $1.94
per Unit, and $21,787,000, or $2.53 per Unit, for the same periods in 1996 and
1995, respectively. Total cash distributions of $14,534,000, or $1.69 per Unit,
were made during the year ended December 31, 1997 as compared to $16,727,000, or
$1.95 per Unit, and $21,758,000, or $2.53 per Unit, for the same periods in 1996
and 1995, respectively. The Section 29 Credits relating to qualifying
production from coal seam and tight sands properties, during the twelve months
ended September 30, 1997, 1996 and 1995, totaled approximately $.41, $.44 and
$.49 per Unit, respectively.
13
<PAGE>
TORCH ENERGY ROYALTY TRUST
Net profits received by the Trust during the years ended December 31, 1997,
1996, and 1995, derived from production sold during the twelve months ended
September 30, 1997, 1996 and 1995, respectively, was computed as shown in the
following table (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------------------------------------------------
1997 1996 1995
---------------------------------- ------------------------------ -------------------------------
Chalkley, Chalkley, Chalkley,
Cotton Cotton Cotton
Valley and Valley and Valley and
Austin Robinson's Austin Robinson's Austin Robinson's
Chalk Bend Chalk Bend Chalk Bend
Fields Field Total Fields Field Total Fields Field Total
---------- ---------- --------- ---------- ---------- --------- ---------- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Oil and gas revenues $13,694 $4,807 $16,601 $4,554 $21,899 $ 4,967
--------- ---------- ---------- ---------- ---------- --------
Direct operating expenses:
Lease operating expenses
and property tax 1,801 --(a) 1,778 --(a) 2,147 --(a)
Severance tax 593 267 653 347 928 235
--------- ---------- ---------- ---------- ---------- --------
2,394 267 2,431 347 3,075 235
--------- ---------- ---------- ---------- ---------- --------
Net proceeds before
capital expenditures 11,300 4,540 14,170 4,207 18,824 4,732
Capital expenditures 97 --- 303 --- 198 ---
--------- ---------- ---------- ---------- ---------- --------
Net proceeds 11,203 4,540 13,867 4,207 18,626 4,732
Net profits percentage 95% --- 95% --- 95% ---
--------- ---------- ---------- ---------- ---------- --------
Net profits income $ 10,643 $4,540 $15,183 $13,174 $4,207 $17,381 $17,695 $ 4,732 $22,427
========= ========== ========= ========== ========== ========= ========== ======== =======
</TABLE>
(a) Lease operating expenses are not deducted in calculating Net Proceeds until
January 1, 2003. Lease operating expenses and property taxes were $6,805,
$7,623 and $10,323 during 1997, 1996 and 1995, repectively.
14
<PAGE>
TORCH ENERGY ROYALTY TRUST
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
---------
<S> <C>
Independent Auditors' Reports 16
Statements of Assets, Liabilities and Trust Corpus at December 31, 1997 and 1996 18
Statements of Distributable Income for the Years Ended December 31, 1997, 1996 and 1995 19
Statements of Changes in Trust Corpus for the Years Ended December 31, 1997, 1996 and 1995 20
Notes to Financial Statements 21
</TABLE>
15
<PAGE>
INDEPENDENT AUDITORS' REPORT
Wilmington Trust Company
as Trustee of Torch Energy Royalty Trust
and to the Unitholders:
We have audited the accompanying statement of assets, liabilities and trust
corpus of the Torch Energy Royalty Trust (the "Trust") as of December 31, 1997,
and the related statements of distributable income and changes in trust corpus
for the year then ended. These financial statements are the responsibility of
the Trustee. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
As described in Note 2, the financial statements are prepared on a modified cash
basis of accounting, which is a comprehensive basis of accounting other than
generally accepted accounting principles.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Trust as of December 31,
1997, and the results of its operations and its cash flows for the year then
ended, on the basis of accounting described in Note 2.
/s/ KPMG Peat Marwick LLP
Houston, Texas
March 25, 1998
16
<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 the related statements of distributable income and changes in trust corpus
for each of the two 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 its distributable income and changes in trust corpus for each of
the two 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
17
<PAGE>
TORCH ENERGY ROYALTY TRUST
STATEMENTS OF ASSETS, LIABILITIES AND TRUST CORPUS
(In thousands)
ASSETS
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
-------------------------- --------------------------
<S> <C> <C>
Cash................................................................. $ 7 $ 3
Net profits interests in oil and gas properties (net of accumulated
amortization of $79,762 and $59,077 at December 31, 1997
and 1996, respectively)............................................. 100,838 121,523
-------------------------- --------------------------
$100,845 $121,526
========================== ==========================
LIABILITIES AND TRUST CORPUS
Trust expense payable................................................ $ 177 $ 164
Trust corpus......................................................... 100,668 121,362
-------------------------- --------------------------
$100,845 $121,526
========================== ==========================
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
18
<PAGE>
TORCH ENERGY ROYALTY TRUST
STATEMENTS OF DISTRIBUTABLE INCOME
(In thousands, except per Unit amounts)
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------
1997 1996 1995
------------------ ------------------- ------------------
<S> <C> <C> <C>
Net profits income................................... $15,183 $17,381 $22,427
Interest income...................................... 20 25 36
------------------ ------------------- ------------------
15,203 17,406 22,463
General and administrative expenses.................. 678 684 676
------------------ ------------------- ------------------
Distributable income................................. $14,525 $16,722 $21,787
================== =================== ==================
Distributable income per Unit (8,600,000
Units).......................................... $ 1.69 $ 1.94 $ 2.53
================== =================== ==================
Distributions per Unit............................... $ 1.69 $ 1.95 $ 2.53
================== =================== ==================
</TABLE>
The accompanying notes to financial statements
Are an integral part of these statements.
19
<PAGE>
TORCH ENERGY ROYALTY TRUST
STATEMENTS OF CHANGES IN TRUST CORPUS
(In thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------
1997 1996 1995
------------------- ------------------ ------------------
<S> <C> <C> <C>
Trust corpus, beginning of year......................... $121,362 $137,014 $157,373
Amortization of Net Profits Interests................... (20,685) (15,647) (20,388)
Distributable income.................................... 14,525 16,722 21,787
Distributions to Unitholders............................ (14,534) (16,727) (21,758)
------------------- ------------------ ------------------
Trust Corpus, end of year............................... $100,668 $121,362 $137,014
=================== ================== ==================
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
20
<PAGE>
TORCH ENERGY ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS
1. Nature of Operations
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 in 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. 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 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 by 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 by entitled to enforce
21
<PAGE>
TORCH ENERGY ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS
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) 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,
1997, 1996 and 1995 are derived from oil and gas production sold during the
twelve-month periods ended September 30, 1997, 1996 and 1995, 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
estimated future net cash flows attributable to the Trust's oil and gas
reserves 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 Interest exceeds this amount, an
impairment provision will be recorded and charged to the trust corpus.
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.
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
22
<PAGE>
TORCH ENERGY ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS
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 Interest, cash received by the Trust 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 Trust distributes
the Quarterly Distribution Amount is distributed within approximately 10 days
after the record date to each person who was a Unitholder of record on the
associated record date.
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"), a 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 receives 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, 1998, on an Mcfe basis), the Specified
Prices are adjusted to reflect the difference between the settlement prices for
oil and gas in the futures markets and the Average Market Prices. The Specified
Price per MMBtu during the three years ended December 31, 1997 ranged from $1.81
to $1.84 and received weightings of approximately 40% to 70%. Thereafter, the
Specified Price for gas receives a weighting of approximately 10% and less and
increases each year from $1.85 per MMBtu in 1998 to $1.89 in 2000.
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. Net Price Credits in the amount of $317,000 and
$2,305,000 were deducted in
23
<PAGE>
TORCH ENERGY ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS
calculating the purchase price related to distributions during 1997 and 1996,
respectively. Price Credits aggregating $2,155,000 were accumulated during
1995. TEMI had no accumulated price credits as of December 31, 1997. In
addition, if the Index Price for gas exceed $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.
Gross revenues (before deductions for applicable gathering, treating and
transportation charges) from TEMI included in net profits income for the years
ended December 31, 1997, 1996 and 1995 were $20,401,000, $23,223,000 and
$29,025,000, 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 ($0.274, $0.272 and $0.265 per MMBtu for 1997,
1996 and 1995, respectively), plus fuel usage equal to 5% of revenues, payable
to Bahia Gas Gathering, Ltd. ("Bahia"), an affiliate of Torch, pursuant to a gas
gathering agreement. 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 395 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. TEMI deducts from the
purchase price for gas in the Cotton Valley Fields a transportation fee of
$0.045 per MMBtu for production attributable to certain wells. This
transportation fee is paid to a third party. During the years ended December 31,
1997, 1996 and 1995, gathering, treating and transportation fees charged to the
Trust by TEMI, attributable to production during the twelve months ended
September 30, 1997, 1996 and 1995 in the Robinson's Bend, Austin Chalk and
Cotton Valley Fields, totaled $1,899,000, $2,068,000 and $2,160,000,
respectively. No amounts for gathering, treating or transportation are deducted
in calculating the purchase price from the Chalkley Field.
Operator Overhead Fees
A subsidiary of Torch operates certain oil and gas interests burdened by the Net
Profits Interests. The Underlying Properties are charged, on the same basis as
other third parties, for all customary expenses and costs reimbursements
associated with these activities. Operator overhead fees deducted from the Net
Proceeds computations for the Chalkley, Cotton Valley and Austin Chalk fields
totaled $182,000, $181,000, and $180,000 for the years ended December 31, 1997,
1996 and 1995, respectively. In
24
<PAGE>
TORCH ENERGY ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS
accordance with the Conveyance, no overhead fees were deducted in calculating
the Net Proceeds from the Robinson Bend properties.
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 of Labor, Bureau of Labor
Statistics. Administrative services fees of $366,000 were paid by the Trust to
Torch in each of the years ended December 31, 1997 and 1996. Such fees were
$356,000 during the year ended December 31, 1995.
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 have not and will not adversely affect the
Trust or the Unitholders.
Compensation of the Trustee and Transfer Agent
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 were $56,000 in each of the years ended December 31,
1997, 1996 and 1995. 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.,
Ryder Scott Company 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.
25
<PAGE>
TORCH ENERGY ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS
Reserve Quantities:
The following table sets forth the estimated total 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, 1997, 1996 and 1995, 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, 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.
Year-end reserves at December 31, 1997 were 42.0 billion cubic feet equivalent
("Bcfe") compared to 1996 year-end reserves of 58.2 Bcfe. The reduction in
reported reserves includes 1997 production of 7.5 Bcfe and a negative reserve
revision of 8.7 Bcfe. The Trust's 8.7 Bcfe reserve revision was composed
primarily of revisions to the Chalkley Field (3.8 Bcfe) and the Cotton Valley
Fields (3.6 Bcfe), resulting from steeper decline curves used to estimate
reserves at year-end 1997.
In addition, a negative reserve revision for the Robinson's Bend Field (1.0
Bcfe) was attributable to lower year-end 1997 pricing. The December 1997 year-
end NYMEX price (defined below) for natural gas was $2.68 per MMBtu in 1997,
compared to $3.70 for the same period in 1996. The NYMEX price represents the
average settlement price of the natural gas futures contracts on the New York
Mercantile Exchange for the last three trading days of the corresponding month's
contract. The Trust's interest in the Robinson's Bend Field does not bear
operating costs until 2003, at which time cash flows from the Robinson's Bend
Field will be reduced substantially by the deduction of operating expenses. If
natural gas prices after 2002 do not substantially exceed prices received at
year end 1997, the Trust anticipates that all of the cash flows from the
Robinson's Bend properties will be used to pay operating expenses and, as a
result, the Trust will not receive net profits payments attributable to the
Robinson's Bend field.
<TABLE>
<CAPTION>
Description 1997 1996 1995
- --------------------------------- -------------------------- -------------------------- ---------------------------
Oil Gas Oil Gas Oil Gas
(Mbbl) (MMcf) (Mbbl) (MMcf) (Mbbl) (MMcf)
---------- ----------- ---------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Proved reserves at beginning of 293 56,455 349 63,725 411 81,991
year
Revisions (42) (8,474) 35 428 58 (7,016)
Extensions and discoveries --- --- 4 1,500 --- ---
Production (49) (7,177) (95) (9,198) (120) (11,250)
---------- ----------- ---------- ----------- ----------- -----------
Proved reserves at end of year 202 40,804 293 56,455 349 63,725
========== =========== ========== =========== =========== ===========
Proved developed reserves at
beginning of year 270 51,027 332 60,342 399 79,607
========== =========== ========== =========== =========== ===========
Proved developed reserves at end
of year 191 38,359 270 51,027 332 60,342
========== =========== ========== =========== =========== ===========
</TABLE>
26
<PAGE>
TORCH ENERGY ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS
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, 1997, 1996 and 1995 are presented in the following
table:
<TABLE>
<CAPTION>
December 31,
------------------------------------------------
1997 1996 1995
------------ --------------- --------------
<S> <C> <C> <C>
Future cash inflows $121,836 $241,221 $192,513
Future costs and expenses (27,536) (81,239) (58,640)
------------ --------------- --------------
Net future cash flows 94,300 159,982 138,873
Discount at 10% for timing of cash flows (29,671) (63,957) (50,112)
------------ --------------- --------------
Present value of future net cash flows for proved reserves $ 64,629 $ 96,025 $ 83,761
============ =============== ==============
</TABLE>
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, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1997 1996 1995
------------ --------------- --------------
<S> <C> <C> <C>
Balance at beginning of year $ 96,025 $ 83,761 $ 91,374
Production (14,756) (17,213) (21,197)
Accretion to discount 9,603 8,376 9,137
Extensions and discoveries ---- 1,773 ---
Revision of prior-year estimates, change in prices
and other (26,243) 19,328 4,447
------------ --------------- --------------
Balance at end of year $ 64,629 $ 96,025 $ 83,761
============ =============== ==============
</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, 1997, 1996, and 1995. Such estimates are based upon
the production estimates set forth in the reserve reports prepared by
independent reserve engineers. The qualifying tight sands Section 29 Tax Credit
estimate was computed utilizing a rate of approximately $.52 per MMBtu. The
qualifying coal seam Section 29 Tax Credit estimate was computed utilizing a
constant rate of approximately $1.05, $1.03 and $1.01 per MMBtu for 1997, 1996
and 1995, respectively.
<TABLE>
<CAPTION>
December 31,
------------------------------------------------
1997 1996 1995
------------ --------------- --------------
<S> <C> <C> <C>
Undiscounted $13,974 $ 17,391 $21,746
============ =============== ==============
Discounted present value at 10% $10,739 $ 12,863 $15,525
============ =============== ==============
</TABLE>
27
<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:
<TABLE>
<CAPTION>
Distributable
Net Profits Distributable Income
Income Income Per Unit
----------------------- --------------------- ----------------------
<S> <C> <C> <C>
Quarter ended March 31, 1997.................... $ 4,579 $ 4,417 $0.51
Quarter ended June 30, 1997..................... 4,162 3,994 0.46
Quarter ended September 30, 1997................ 3,252 3,087 0.36
Quarter ended December 31, 1997................. 3,190 3,027 0.36
----------------------- --------------------- ----------------------
$15,183 $14,525 $1.69
======================= ===================== ======================
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
======================= ===================== ======================
</TABLE>
28
<PAGE>
TORCH ENERGY ROYALTY TRUST
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
During February 1998 the firm of Deloitte & Touche LLP was replaced as the
Trust's principal independent accountant and auditors to audit all the Trust's
financial statements with the firm of KPMG Peat Marwick LLP. The Trust does not
and has not during the past three years had disagreements with Deloitte & Touche
LLP concerning their audit or the application of accounting principles.
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. 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 related to the Net Profits Interests as described below in "Item 13 -
Administrative Services Agreement."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
As of March 10, 1998, no person or group of persons was known by the Trust to be
the beneficial owner of more than 5% of the Units. The Trust has no officers or
directors.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Administrative Services Agreement
Pursuant to the Trust Agreement, Torch and the Trust entered into the
Administrative Services Agreement effective October 1, 1993. The following
summary of certain provisions of the Administrative Services
29
<PAGE>
TORCH ENERGY ROYALTY TRUST
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, adjusted annually,
based upon the change in the Producer's Price Index as published by the
Department of Labor, Bureau of Labor Statistics. Administrative services fees
of $366,000 were paid by the Trust to Torch in each of the years ended 1997 and
1996. Such fees were $356,000 during the year ended December 31, 1995.
Marketing Arrangement
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,
1997, TEMI had no accumulated Price Credits. Net Price Credits in the amount of
$317,000 and $2,305,000 were deducted in calculating the purchase price related
to distributions during 1997 and 1996, respectively. During 1995, TEMI
accumulated Price Credits of $2,155,000.
Gross revenues (before deductions for applicable gathering, treating and
transportation charges) from TEMI included in net profits income for the years
ended December 31, 1997, 1996 and 1995 were $20,401,000, $23,223,000 and
$29,025,000, 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 ($0.274, $0.272 and $0.265 per
MMBtu for 1997, 1996 and 1995, respectively), plus fuel usage equal to 5% of
revenues, payable to Bahia Gas Gathering, Ltd. ("Bahia"), an affiliate of Torch,
pursuant to a gas gathering agreement. 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 to the 395 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. TEMI deducts from the
purchase price for gas a transportation fee of $0.045 MMBtu for production
attributable to certain wells in the Cotton Valley Fields. During the years
ended December 31, 1997, 1996 and 1995, gas gathering, treating and
transportation fees charged to the Trust by TEMI, attributable to production
during the 12 months ended September 30, 1997, 1996 and 1995 in the Robinson's
Bend, Austin Chalk and Cotton Valley Fields, totaled $1,899,000, $2,068,000 and
$2,160,000, respectively. No amounts for gathering, treating or transportation
are deducted in calculating the purchase price from the Chalkley Field.
30
<PAGE>
TORCH ENERGY ROYALTY TRUST
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
The following documents are filed as part of this report:
(a) 1. Financial Statements:
Torch Energy Royalty Trust
Independent Auditors' Reports
Statements of Assets, Liabilities and Trust Corpus at December 31, 1997
and 1996
Statements of Distributable Income for the Years Ended December 31, 1997,
1996 and 1995
Statements of Changes in Trust Corpus for the Years Ended December 31,
1997, 1996 and 1995
Notes to Financial Statements
Torch Energy Advisors Incorporated and Subsidiaries ("Torch") and Torch's
Predecessor ("Predecessor")
Independent Auditors' Report
Consolidated Balance Sheet of Torch as of December 31, 1997 and 1996 and
the Related Consolidated Statements of Operations, Stockholders' Equity
and Cash Flows for the Period October 1, 1996 through December 31, 1996
Predecessor's Consolidated Statement of Operations, Predecessor's Equity
and Cash Flows for the Period January 1, 1996 through September 30, 1996
and for the Year Ended December 31, 1995
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.
Exhibits
3. EXHIBIT
NUMBER EXHIBIT
---------------
4. - Instruments of 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.*
31
<PAGE>
TORCH ENERGY ROYALTY TRUST
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).
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 Ryder Scott Company
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:
The Trust filed Form 8-K on March 24, 1998 reporting a change in the Trust's
certifying accountants.
32
<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 25, 1998
(The Trust has no directors or executive officers.)
33
<PAGE>
TORCH ENERGY ROYALTY TRUST
Torch Energy Royalty Trust
1100 North Market Street
Wilmington, Delaware 19890
Attention: Corporate Trust Administration
Legal Counsel
Butler & Binion, L.L.P.
Houston, Texas
Tax Counsel
Butler & Binion, L.L.P.
Houston, Texas
Auditors
KPMG Peat Marwick LLP
Houston, Texas
Transfer Agent and Registrar
Wilmington Trust Company
1100 North Market Street
Wilmington, Delaware 19890
Attention: Corporate Trust Administration
<PAGE>
INDEPENDENT AUDITORS' REPORT
----------------------------
The Board of Directors
Torch Energy Advisors Incorporated:
We have audited the accompanying consolidated balance sheets of Torch Energy
Advisors Incorporated and subsidiaries as of December 31, 1997 and 1996 and the
related consolidated statements of operations, stockholders' equity and cash
flows for the year ended December 31, 1997 and the period October 1, 1996
through December 31, 1996 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 year ended December 31, 1995. 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 as of December 31, 1997 and 1996
and the results of their operations and their cash flows and those of their
Predecessor for the year ended December 31, 1997, the period October 1, 1996
through December 31, 1996, the period January 1, 1996 through September 30, 1996
and for the year ended December 31, 1995, in conformity with generally accepted
accounting principles.
As discussed in Notes 1 and 8, 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.
/s/ KPMG PEAT MARWICK LLP
March 27, 1998
Houston, Texas
1
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands)
ASSETS
------
<TABLE>
<CAPTION>
December 31,
-------------------------------------------
1997 1996
-------- --------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 49,900 $ 26,262
Accounts receivable - product marketing 55,588 70,531
Accounts receivable - joint interest billing 7,903 8,939
Accounts receivable - oil and gas and other 23,840 36,488
Due from affiliates 3,890 8,648
Other current assets 3,154 1,683
-------- --------
Total current assets 144,275 152,551
-------- --------
PROPERTY AND EQUIPMENT, AT COST:
Oil and gas (successful efforts method) 6,354 18,164
Other fixed assets 5,543 4,843
-------- --------
11,897 23,007
Accumulated depreciation, depletion and amortization (2,179) (847)
-------- --------
9,718 22,160
-------- --------
DUE FROM AFFILIATES 1,850 ---
NOTES RECEIVABLE 13,363 2,000
INVESTMENT IN MARKETABLE SECURITIES 1,650 ---
EQUITY INVESTMENTS 1,928 12,812
INVESTMENTS AT COST 2,521 ---
OTHER ASSETS 1,142 616
-------- --------
$176,447 $190,139
======== ========
</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' EQUITY
------------------------------------
<TABLE>
<CAPTION>
December 31,
----------------------------
1997 1996
-------- --------
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable - product marketing $ 56,957 $ 60,025
Accounts payable - joint interest billing 3,199 20,762
Advances from participant 666 741
Accrued liabilities 24,527 22,060
Note payable to bank 60 ---
Due to affiliates 572 6,161
Revenue, royalty and production taxes payable 30,516 42,280
-------- --------
Total current liabilities 116,497 152,029
-------- --------
OTHER LIABILITIES 7,535 7,452
-------- --------
NOTE PAYABLE TO BANK 10,614 ---
-------- --------
SENIOR SUBORDINATED
NOTE PAYABLE - AFFILIATE 25,500 25,500
-------- --------
DEFERRED INCOME TAXES --- 908
-------- --------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, par value $1.00, 1,000 shares
authorized, issued and outstanding 1 1
Additional paid-in capital 1,999 1,999
Unrealized gain in value of investment in
equity securities, net 394 ---
Retained earnings 13,907 2,250
-------- --------
Total stockholders' equity 16,301 4,250
-------- --------
$176,447 $190,139
======== ========
</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>
Year October 1, January 1, Year
Ended through through Ended
December 31, December 31, September 30, December 31,
1997 1996 1996 1995
(Company) (Company) (Predecessor) (Predecessor)
----------- ------------ ------------- -------------
<S> <C> <C> <C> <C>
REVENUES:
Oil and gas revenues............................... $18,522 $ 6,327 $ 9,942 $15,403
Product marketing, net............................. 5,333 1,726 8,063 11,512
Service fees....................................... 26,034 7,110 23,651 18,620
Overhead fees...................................... 8,962 2,356 9,028 12,603
Interest and other income.......................... 5,328 841 1,803 1,506
Net gain on sale of assets......................... --- --- 5,787 10,807
------- ------- ------- -------
Total revenues................................... 64,179 18,360 58,274 70,451
------- ------- ------- -------
COSTS AND EXPENSES:
Oil and gas operating expenses..................... 8,936 2,678 4,188 3,908
Depreciation, depletion and amortization........... 2,307 847 6,553 12,883
Provision for impairment of oil and gas
properties....................................... --- --- --- 16,000
General and administrative expenses................ 37,062 10,116 27,795 34,556
Interest expense................................... 2,816 588 1,033 2,404
Other expense...................................... 701 16 3,120 3,512
------- ------- ------- -------
Total costs and expenses....................... 51,822 14,245 42,689 73,263
------- ------- ------- -------
Equity in earnings (loss) of affiliates
and investees...................................... (159) (135) (179) 1,532
------- ------- ------- -------
INCOME (LOSS) BEFORE INCOME TAXES
AND MINORITY INTEREST.............................. 12,198 3,980 15,406 (1,280)
Income taxes (benefit)................................ 115 1,267 2,277 (4,231)
Minority interest..................................... 426 463 --- ---
------- ------- ------- -------
NET INCOME............................................ $11,657 $ 2,250 $13,129 $ 2,951
======= ======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' AND PREDECESSOR'S EQUITY
YEAR ENDED DECEMBER 31, 1997 AND OCTOBER 1, 1996 THROUGH DECEMBER 31, 1996 AND
JANUARY 1, 1996 THROUGH SEPTEMBER 30, 1996
AND YEAR ENDED DECEMBER 31, 1995
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
UNREALIZED GAIN TOTAL
ADDITIONAL (LOSS) IN VALUE OF STOCKHOLDERS' AND
COMMON STOCK PAID-IN INVESTMENT IN EQUITY RETAINED PREDECESSOR'S
SHARES AMOUNT CAPITAL SECURITIES, NET EARNINGS EQUITY
------ ------ ----------- --------------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1995 (Predecessor)............ 1 $ 1 $ 32,142 $ 2,372 $ 42,567 $ 77,082
Unrealized loss in value of investment in
equity securities (net of deferred income 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 gain in value of investment in
equity securities (net of deferred income 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.............................. 1 1 1,999 --- --- 2,000
Net income........................................ --- --- --- --- 2,250 2,250
----- ----- -------- -------- -------- --------
Balance, December 31, 1996 (Company).............. 1 1 1,999 --- 2,250 4,250
Unrealized gain in value of investment in
equity securities.............................. --- --- --- 394 --- 394
Net income........................................ --- --- --- --- 11,657 11,657
----- ----- -------- -------- -------- --------
Balance, December 31, 1997 (Company).............. 1 $ 1 $ 1,999 $ 394 $ 13,907 $ 16,301
===== ===== ======== ======== ======== ========
</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>
Year October 1, January 1, Year
Ended through through Ended
December 31, December 31, September 30, December 31,
1997 1996 1996 1995
----------- ----------- ------------ -----------
(Company) (Company) (Predecessor) (Predecessor)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 11,657 $ 2,250 $ 13,129 $ 2,951
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation, depletion and
amortization and impairment provision........... 2,307 847 6,553 28,883
Amortization of deferred revenues................ --- --- (2,161) (2,882)
Equity in (earnings) loss of affiliates and
investees....................................... 159 135 179 (1,532)
Transaction fee.................................. (1,256) --- --- ---
Minority interest................................ 426 463 --- ---
Deferred income taxes............................ (908) 908 6,315 (12,241)
(Gain) loss on sale of oil and gas
properties...................................... --- --- (3,271) 144
Gain on sale of marketable securities............ --- --- (2,516) (10,951)
Changes in assets and liabilities:
Accounts receivable.............................. 28,627 (43,896) 13,589 15,007
Due from affiliates.............................. 2,908 24,064 (19,657) (12,599)
Other current assets............................. (1,471) 4,895 (885) (3,846)
Accounts payable and accrued liabilities......... (15,846) 13,846 (19,021) (33,702)
Due to affiliates................................ (5,589) (5,567) 12,069 26,912
Revenue, royalty and production
taxes payable................................... (11,764) 333 17,006 2,670
Other............................................ (2,496) (532) (11,482) 10,479
-------- -------- --------- --------
Net cash flows provided by (used in) operating
activities........................................... $ 6,754 $ (2,254) $ 9,847 $ 9,293
-------- -------- --------- --------
- ------------------
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Amounts in Thousands)
<TABLE>
<CAPTION>
Year October 1, January 1, Year
Ended through through Ended
December 31, December 31, September 30, December 31,
1997 1996 1996 1995
----------- ----------- ------------ -----------
(Company) (Company) (Predecessor) (Predecessor)
<S> <C> <C> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES:
Time deposits........................................ $ --- $ $ 36,066 $(36,066)
Acquisition escrow deposit........................... --- --- --- 10,961
Note receivable from officers........................ 826 (2,000) --- ---
Notes receivable..................................... (11,389) --- --- ---
Investment in assets held for sale................... --- --- --- (2,841)
Proceeds from sale of assets held for sale........... --- --- 9,248 ---
Proceeds from the sale of assets..................... 25,353 1,200 16,335 6,970
Proceeds from the sale of equity investments......... --- --- 4,208 102,166
Investment in property and equipment................. (5,572) (816) (13,982) (9,911)
Investment in equity interests....................... (1,131) (389) (4,448) (72,086)
Investments at cost.................................. (2,521) --- --- ---
Distributions from investments in affiliates......... 644 --- --- 1,197
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............................. $ 6,210 $(11,003) $ 47,427 $ 390
-------- -------- --------- -------
</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>
Year October 1, January 1, Year
Ended through through Ended
December 31, December 31, September 30, December 31,
1997 1996 1996 1995
----------- ------------ ------------- -------------
(Company) (Company) (Predecessor) (Predecessor)
<S> <C> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from note payable to bank............................ $10,674 $ --- $ --- $ 43,400
Repayment of note payable to bank............................. --- --- --- (45,000)
Repayment of note payable to parent........................... --- --- --- (30,000)
Proceeds from note payable to parent.......................... --- --- --- 30,000
Payment of dividend to parent................................. --- --- (35,625) ---
Parent contribution........................................... --- --- 10,105 ---
Repayment of line of credit to bank........................... --- --- (3,400) ---
------- -------- -------- --------
Net cash flows provided by (used in)
financing activities........................................... 10,674 --- (28,920) (1,600)
------- -------- -------- --------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS............................................... 23,638 (13,257) 28,354 8,083
CASH AND CASH EQUIVALENTS AT BEGINNING
OF PERIOD...................................................... 26,262 39,519 11,165 3,082
------- -------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD....................... $49,900 $ 26,262 $ 39,519 $ 11,165
======= ======== ======== ========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest.................................................... $ 2,338 $ 168 $ 985 $ 6,492
======= ======== ======== ========
Income taxes................................................ $ 797 $ --- $ 5,026 $ (5,137)
======= ======== ======== ========
</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 an
extensive array of specialized outsourcing services to companies primarily
in the energy industry. Services include accounting and finance,
information technology, procurement, oil and gas operations, hydrocarbon
marketing, and property acquisitions and divestitures. TEAI also provides
growth capital, in the form of mezzanine finance and equity capital, to
independent oil and gas producers. Since 1981, the Company's clients have
included insurance companies, corporate and public pension funds,
foundations, endowments, foreign investors and public oil and gas
companies. Since inception, the Company has invested approximately $1.6
billion on behalf of the Company and its clients. The Company is
headquartered in Houston, Texas, and maintains 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") (See Note 8.) Torchmark
retained a warrant for 10% of TAC'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. During
1997, MHC was merged into TAC.
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") were
accounted for under the equity method due to the Company's ability to
exercise significant influence over operating and financial policies of the
investees until April 1997 at which time the partnerships were sold to
Bellwether Exploration Company ("Bellwether"). All significant
intercompany accounts and transactions have been eliminated.
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. As the Company effectively controls the
venture through management contracts and execution of the day-to-day
operating and financial decisions, the activities for this venture are
included in the financial statements with the unaffiliated party's interest
reflected as minority interest. 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 owned a 50% interest in both limited liability companies until
March 1997 at which time the companies were sold. Prior to March 1997, the
activities are consolidated in the financial statements with the
unaffiliated parties' interest reflected as minority interest. Effective
June 30, 1997, the Company purchased The Procurement Centre ("TPC") to
obtain the benefit of TPC's experience and expertise in providing
consulting and outsourcing
9
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
services for the procurement of materials and services, inventory
management, logistics and other administrative services. The Company paid
$300,000 to obtain a 75% interest in TPC. The activities of TPC subsequent
to the acquisition are consolidated in the financial statements with the
unaffiliated parties' interest reflected as a minority interest. Prior
activities of TPC are not material.
Torch Energy Finance Fund LPI ("TEFF"), a Texas limited liability
partnership, was formed on September 6, 1995 and amended on July 14, 1997
for the purpose of providing growth capital to small and mid-size oil and
gas companies for use in acquisition and exploitation opportunities. Torch
Energy Finance Company ("TEFC"), a wholly owned subsidiary, serves as the
sole general partner (10%) and the Company serves as the sole limited
partner (90%). Activities for TEFF are consolidated in the Company's
financial statements. Advances to third party oil and gas companies are
recorded as notes receivable and equity positions are carried at cost. As
per the terms of their equity investments, TEFF does not participate in the
day-to-day operating and financial decisions of those parties.
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.
INVESTMENT IN MARKETABLE 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 or trading securities at December 31,
1997. The Company has available-for-sale securities which are recorded at
fair value, with unrealized gains and losses, excluded from earnings and
reported as a separate component of the stockholders' equity, net of
deferred income 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
10
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
oil, was $1.12, $1.66, $5.26 and $8.09 during the year ended December 31,
1997, the periods October 1, 1996 through December 31, 1996 and January 1,
1996 through September 30, 1996, and the year ended December 31, 1995,
respectively.
The Company recognizes an impairment loss when the carrying amount of a
long-lived asset exceeds the sum of the estimated undiscounted future cash
flow of the asset. 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. During 1995, a provision of $16 million was charged
against operations as a result of the adoption of this policy. The Company
incurred no such writedown during the year ended December 31, 1997 or 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. No such
allowance was required during the year ended December 31, 1997, 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, 1997 and
1996, the Company's liabilities due to gas sales in excess of its entitled
share were approximately $.47 million and $3.9 million, respectively, and
the receivables for gas sales less than the Company's entitled share were
approximately $.53 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 treated as a hedge are deferred and recognized in revenue
when the hedged crude oil and natural gas are sold. At December 31, 1997,
the Company had a deferred gain of $.3 million. There were no deferred
gains or losses at December 31, 1996. Oil and gas revenues and product
marketing margin were decreased by a total of $2.3 million in 1997,
decreased by $.1 million for the period October 1,
11
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1996 through December 31, 1996, increased by $.8 million for the period
January 1, 1996 through September 30, 1996 and decreased by $.8 million in
1995 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 immediately recognized in
income.
MAJOR CUSTOMER -
One customer accounted for 26% and a different customer accounted for 18.5%
of the gross gas marketing revenues during the year ended December 31, 1997
and the period October 1, 1996 through December 31, 1996, respectively.
There were no customers that accounted for more than 10% of the Company's
gross gas marketing revenues for the period January 1, 1996 through
September 30, 1996 and the year ended December 31, 1995. Revenues from two
customers, Bellwether and Nuevo Energy Company ("Nuevo"), include $29
million and $6.6 million in service and overhead fees for the year ended
December 31, 1997 and the period October 1, 1996 through December 31, 1996,
respectively. The Company does not believe that it is dependent upon any
particular customer for sales of oil and gas. Management services
contracts with Bellwether and Nuevo extend through the end of 2000 and
1999, respectively. The loss of one or both of these contracts would have
a material effect on the Company.
INCOME TAXES -
Effective in 1997, TEAI and its subsidiaries elected to be treated as
qualified subchapter S subsidiaries under Section 1361 (b) (3) of the
Internal Revenue Code of 1986. The effect of the election is that TAC will
file an S corporation tax return that includes TEAI and subsidiaries. Each
TAC stockholder is responsible for reporting its share of taxable income or
loss and no federal income taxes are recorded by the Company, except for a
tax on excess net passive income and certain built-in gains, if applicable.
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. For the
applicable reporting period prior to 1997, deferred income 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 income 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 affiliated entities and investees, including oil and gas limited
partnerships. Bellwether and Nuevo were affiliates of the Predecessor. 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. The Company's total
management fees received from related parties amounted to $1.8 million and
$2.8 million for the year ended December 31, 1997 and the period October 1,
1996 through December 31, 1996, respectively. The Predecessor's total
management fees received from related parties amounted to $23.7 million
(includes $8 million related to Nuevo's purchase of Unocal California
properties) and $18.6 million for the period January 1, 1996 through
September 30, 1996, and the year ended December 31, 1995, 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 $4.7 million, $.8 million, $4.0
million and $2.7 million for the year ended December 31, 1997, the periods
October 1,1996 through December 31, 1996 and January 1, 1996 through
September 30, 1996, and the year ended December 31,1995, 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 year ended
December 31, 1997, the periods October 1, 1996 through December 31, 1996
and January 1, 1996 through September 30, 1996, and the year ended December
31, 1995 for these activities was $3.6 million, $1.2 million, $5.7 million
and $7.4 million, respectively.
OTHER -
Interest expense paid to Torchmark totaled $.6 million and $1.2 million for
the period January 1, 1996 through September 30, 1996, and for the year
ended December 31, 1995. No interest expense was paid to related entities
for the year ended December 31, 1997 and the period October 1, 1996 through
December 31, 1996.
4. INCOME TAXES
------------
The Company's and Predecessor's income tax provision for the year ended
December 31, 1997, the periods October 1, 1996 through December 31, 1996
and January 1, 1996 through September 30, 1996, and the year ended December
31, 1995 is comprised of the following (amounts in thousands):
<TABLE>
<CAPTION>
Year October 1, January 1, Year
Ended through through Ended
December 31, December 31, September 30, December 31,
1997 1996 1996 1995
------------ ----------- ------------- -------------
(Company) (Company) (Predecessor) (Predecessor)
<S> <C> <C> <C> <C>
Current income tax expense (benefit)
Federal(1)..................................... $ 548 $ 307 $(4,248) $ 7,576
State.......................................... 475 52 210 434
------ ------ ------- --------
1,023 359 (4,038) 8,010
------ ------ ------- --------
Deferred income tax expense (benefit)
Federal....................................... (809) 809 5,747 (12,302)
State......................................... (99) 99 568 61
------ ------ ------- --------
(908) 908 6,315 (12,241)
------ ------ ------- --------
$ 115 $1,267 $ 2,277 $ (4,231)
====== ====== ======= ========
</TABLE>
(1) The 1997 amount relates to revisions of 1996 tax expense estimates.
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>
Year October 1, January 1, Year
Ended through through Ended
December 31, December 31, September 30, December 31,
1997* 1996 1996 1995
----------- ------------ ------------- -------------
(Company) (Company) (Predecessor) (Predecessor)
<S> <C> <C> <C> <C>
Statutory tax rate ---% 34% 35% (35)%
State 3 3 3 25
Section 29 tax credits --- (1) (23) (335)
Nondeductible travel and entertainment --- --- --- 4
Other (2) --- --- 10
---- ---- ---- -----
Effective tax rate 1% 36% 15% (331)%
==== ==== ==== =====
</TABLE>
Included in due to affiliates at December 31, 1997 and 1996 is the
Company's current income tax payable of $485,000 and $307,000,
respectively, due to TAC.
The tax effects of temporary differences that give rise to significant
portions of the deferred tax liabilities (assets) at December 31, 1996 are
as follows (amounts in thousands):
<TABLE>
<CAPTION>
December 31,
1996*
------------
<S> <C>
Oil and gas exploration and
development costs................................... $ 898
Oil and gas property sales.............................. ---
Hedge revenue........................................... ---
Other................................................... 101
-----
Gross deferred tax liabilities.......................... 999
-----
Assets held for sale.................................... ---
Deferred revenue........................................ ---
Other .................................................. (91)
-----
Gross deferred tax assets............................... (91)
-----
Net deferred tax liabilities............................ $ 908
=====
</TABLE>
*Effective January 1, 1997, the Company elected to be treated as a
subchapter S corporation (See Note 2).
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.
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 9), generating a pre-tax
gain of approximately $2.5 million. In April 1996, the Predecessor
received 1.3 million Nuevo shares (See Note 9) 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 8). In April 1997, the Company received 150,000 Bellwether shares and
a warrant to purchase 100,000 shares for the sale of certain partnerships
(See Note 9).
At December 31, 1997, the Company recorded $.4 million in unrealized gains
due to the difference between cost and market value in its investment in
Bellwether, resulting in a carrying value of $1.7 million. During the
period January 1, 1996 through September 30, 1996, the Company recorded
$16.1 million and $1.8 million in unrealized gains 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. Carrying value of the investment in
Bellwether approximated fair value for the period January 1, 1996 through
September 30, 1996. There were no equity securities for the period October
1, 1996 through December 31, 1996.
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.
6. NOTES RECEIVABLE
----------------
On April 29, 1997, TEFF was issued a promissory note for up to $12.5
million from TEC Resources, LLC ("TEC") as evidence of TEFF's loan
agreement entered into on April 29, 1997 with TEC. An initial advance of
the loan was made to TEC on April 29, 1997 for costs and expenses
associated with certain oil and gas properties. The loan agreement
provides that additional advances be made upon TEC's request at TEFF's sole
discretion. Certain oil and gas property, other properties and all
subsequently acquired assets of TEC secure the promissory note, which
matures on April 28, 2001. On December 31, 1997, the outstanding balance
under the loan agreement was $6.8 million. Interest accrues on
indebtedness at 10% and is payable quarterly to the extent that there is
positive cash flow from TEC's operations for the quarter then ended.
On July 17, 1997, TEFF was issued a promissory note for up to $5.25 million
from NRC Development, LLC ("NRC") and NRC Pipeline, LLC as evidence of
TEFF's loan agreement entered into on July 17, 1997 with NRC and NRC
Pipeline, LLC. An initial advance of the loan was made to NRC on July 17,
1997 for costs and expenses associated with certain oil and gas properties.
The loan agreement provides that additional advances be made upon NRC's
request at TEFF's sole discretion. Certain oil and gas property, other
properties and all subsequently acquired assets of NRC or NRC Pipeline, LLC
secure the promissory note, which matures on July 17, 2002. On December
31, 1997, the outstanding balance under the loan agreement was $4 million.
Interest accrues on indebtedness at 15% and is payable quarterly to the
extent that there is positive cash flow from NRC's operations for the
quarter then ended.
16
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In December 1996, the Company was issued promissory notes from the
Company's officers totaling $2 million. Interest accrues on indebtedness at
8%. Principal and interest payments are due annually through December 31,
2002.
7. RETIREMENT PLANS AND OTHER POSTRETIREMENT BENEFITS
--------------------------------------------------
During the year 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 for the year ended December 31, 1995. The savings
plan was funded by employee and Predecessor contributions. The
Predecessor's contributions for this plan totaled $.6 million for the year
ended December 31, 1995.
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
related 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 $.9 million for the year
ended December 31, 1997 and $.2 million and $.6 million for the periods
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 up to an additional 3% of
each employee's salary for the previous year to the plan. The Company's
contributions to this plan total $1 million for the year ended December 31,
1997 and $.3 million and $.9 million for the periods 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. Effective January 1, 1998,
the Company waived the minimum one year employment requirement for 401(k)
retirement plan participation.
8. 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 9) 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 and $2.6 million for the period January 1, 1996 through September
30, 1996 and the year ended December 31, 1995, 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
17
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
projections, a liability of $.3 million is recorded at December 31, 1997.
No such liability was recorded at December 31, 1996.
9. ACQUISITIONS AND DISPOSITIONS OF ASSETS
---------------------------------------
On January 25, 1995, through a participation agreement, the Predecessor 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.
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.
In April 1997, the Company sold its interest in oil and gas properties of
certain partnerships, under which the Company was a general partner and
provided management services, to Bellwether, a publicly traded oil and gas
company for which the Company acts as manager pursuant to a management
agreement, and a third party for $18.4 million and $3 million,
respectively. In addition, the Company received 150,000 shares of
Bellwether common stock valued at $8.375 per share and a warrant to
purchase 100,000 shares at $9.90 per share as a fee for advisory services
rendered in connection with the sale. During 1997, the Company sold its
interest in a gathering company to a third party for $1.8 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. During
1995, the Predecessor sold its interest in certain oil and gas properties
to a third party for $6.6 million.
18
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. OTHER LONG-TERM LIABILITIES
---------------------------
Other long-term liabilities at December 31, 1997 and 1996 consist of the
following (amounts in thousands):
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Royalties payable.............. $2,086 $2,086
Litigation provision........... 1,107 1,273
Minority interest.............. 1,556 493
Other.......................... 2,786 3,600
------ ------
$7,535 $7,452
====== ======
</TABLE>
11. 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. 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 year ended December 31, 1997, the
Company purchased 9,085 MMCF of gas and 93 Mbbls of oil at an average of
$2.13 per MCF and $16.40 per Bbl. During the periods October 1, 1996 to
December 31, 1996 and January 1, 1996 to September 30, 1996, the Company
purchased 2,604 MMCF 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. Under
the Hedge Contract, monthly quantities of gas hedged decreased from 575,667
MMbtus of gas in 1995 to 17,250 MMbtus of gas in 2000 and monthly
quantities of oil hedged decrease from 7,167 Bbls in 1995 to 167 Bbls in
2000. The price received for gas under the Hedge Contract increases from
$1.83 per MMbtu in 1995 to $1.89 per MMbtu in 2000. The price received for
oil under the Hedge Contract increases from $19.85 per Bbl in 1995 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 minimum price obligation
Purchase Contract. Under these contracts, monthly quantities hedged
decrease from 20,950 MMbtus per day in 1995 to 16,989 MMbtus per day in
2001 with floor pricing ranging from $1.84 to $1.81 per MMbtu.
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 TAC's $25.5 million Senior
Subordinated Note (the "Note") payable to Torchmark as part of the purchase
price for the Management Buyout. The Note accrues interest at 9% per annum,
payable semiannually, and the principal is due and payable on September 30,
2004.
LINE OF CREDIT -
The Company maintains a $13 million credit facility (the "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 ($8 million at December 31, 1997), 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 (7.47% at December 31, 1997). The Credit
Facility contains, among other terms, 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. At December 31, 1997 and 1996, there is no
outstanding balance under the line of credit.
On July 16, 1997, TEFF entered into at $90 million credit facility (the
"TEFF Facility") with a bank. Ordinary interest accrues on indebtedness,
at TEFF's option, at the bank's prime rate plus 0.5% (9% at December 31,
1997) or LIBOR plus 2.0% (7.97% at December 31, 1997) if the loans
outstanding are less than or equal to the portfolio base ($4.2 million at
December 31, 1997); and at the bank's prime rate plus 5.5% (14% at December
31, 1997) or LIBOR plus 7.0% (12.97% at December 31, 1997) of the portion
of loans outstanding in excess of the portfolio base. If the outstanding
balance under the TEFF Facility exceeds $75 million, then the ordinary
interest rate shall be reduced by 0.5%. In addition to ordinary interest,
TEFF accrues interest expense for net cash flow and net sales proceeds
earned from investing the TEFF Facility (NCFI). The TEFF Facility provides
that NCFI be paid through December 31, 2011 at which time the bank's right
to receive NCFI shall terminate. No such interest was incurred for the
year ended December 31, 1997. The TEFF Facility contains, among other
terms, provisions for the maintenance of certain financial ratios and
restrictions on additional debt. All security in the investments currently
owned by TEFF or hereafter acquired and proceeds thereof, secure the TEFF
Facility, which matures on December 21, 2003. At December 31, 1997, the
outstanding balance under the TEFF Facility was $10.6 million at a weighted
average interest rate of 11%.
On November 14, 1997, TPC entered into a $200,000 credit facility (the "TPC
Facility") with a bank. Interest accrues on indebtedness at the bank's
prime rate (8.5% at December 31, 1997). All accounts receivable currently
owned by TPC or hereafter acquired and proceeds thereof, but not the
contracts themselves, secure the TPC Facility which matures on November 2,
1998. At December 31, 1997, the outstanding balance under the TPC Facility
was $60,000. The TPC Facility's carrying value approximated fair value as
this note bears interest at a rate which approximates current market rates.
20
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. 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 $1.7 million, $.6
million, $1.6 million and $2.3 million for the year ended December 31,
1997, the periods October 1, 1996 through December 31, 1996 and January 1,
1996 through September 30, 1996, and the year ended December 31, 1995,
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, 1997 (amounts in
thousands):
<TABLE>
<CAPTION>
Operating
Year Ending December 31, Leases
------------------------ -----------------------
<S> <C>
1998.................. $ 1,470
1999.................. 1,647
2000.................. 1,639
2001.................. 1,623
2002.................. 1,833
Thereafter............ 7,421
-------
$15,633
=======
</TABLE>
14. FINANCIAL DERIVATIVES
---------------------
The Company has only limited involvement with derivative financial
instruments. They are primarily 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, 1997, the Company had natural gas swap
agreements with broker-dealers to exchange monthly payments on notional
quantities amounting to 34 million MMBTU over the ensuing 4 years. Under
the swap agreements, the Company will realize an average floor price of
$1.87 per MMBTU. Under a 16 Mbbl oil swap agreement, the Company will
realize a floor price of $20.11 per barrel. At December 31, 1997, the
Company also had various swap agreements on notional quantities of 6
million MMBTUs at an average sales price of $2.24 per MMBTU. The Company
uses futures contracts to hedge fixed price commitments resulting from its
gas marketing activities.
21
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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, 1997.
<TABLE>
<CAPTION>
(Amounts in thousands) Carrying Approximate
Value Fair Value
-------- -----------
<S> <C> <C>
Derivative assets:
Crude Oil price swaps $ --- $ 67
Natural gas price swaps --- 129
Long-term debt (See Note 12) 25,500 25,500
Line of credit - TEFF (See Note 12) 10,614 10,614
Line of credit - TPC (See Note 12) 60 60
</TABLE>
The Company is exposed to credit losses in the event of nonperformance by
the counterparties to its derivative 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.
15. 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 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 9). 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 and $3.2 million for the period January 1, 1996 through
September 30, 1996 and the year ended December 31, 1995, respectively.
16. 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, and T.J. Smith &
Company, Inc. and by in-house reserve engineers. These estimates are
inherently imprecise and subject to revisions from time to time.
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
22
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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. Prior to 1997, tax expense was
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. Effective in 1997, the Company
is an S-Corporation for income tax purposes and has a zero effective income
tax rate (See Note 2). 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.
COSTS INCURRED -
The following table sets forth the capitalized costs incurred in oil and
gas activities for the years ended December 31, 1997, 1996 and 1995
(amounts in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------
1997 1996 1995
------------ ----------- ------------
<S> <C> <C> <C>
Cost incurred during the year
Property acquisition.................................. $ --- $ --- $ ---
Exploration........................................... --- --- ---
Development........................................... 2,739 9,078 2,443
------ ------ ------
$2,739 $9,078 $2,443
====== ====== ======
</TABLE>
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):
<TABLE>
<CAPTION>
December 31,
-----------------------------------
1997 1996 1995
---------- --------- ---------
<S> <C> <C> <C>
Capitalized costs:
Proved properties........................................... $ 6,354 $18,164 $22,552
Unevaluated properties...................................... --- --- ---
------- ------- -------
Total capitalized costs..................................... 6,354 18,164 22,552
Accumulated depreciation, depletion and
amortization................................................ (1,148) (698) (7,261)
------- ------- -------
Net capitalized costs....................................... $ 5,206 $17,466 $15,291
======= ======= =======
</TABLE>
23
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
RESULTS OF OPERATIONS FOR PRODUCING ACTIVITIES (AMOUNTS IN THOUSANDS) -
<TABLE>
<CAPTION>
Year October 1, January 1, Year
Ended through through Ended
December 31, December 31, September 30, December 31,
1997 1996 1996 1995
-------------- ------------ ------------- -------------
(Company) (Company) (Predecessor) (Predecessor)
<S> <C> <C> <C> <C>
Revenues from oil and gas producing
activities............................................ $18,522 $ 6,327 $ 9,942 $ 15,403
Production costs....................................... (8,936) (2,678) (4,188) (3,908)
Depreciation, depletion and
amortization....................................... (1,380) (698) (3,922) (9,956)
Provision on impairment on oil and
gas properties..................................... --- --- --- (16,000)
Income tax provision *................................. --- (1,003) (641) 5,061
------- ------- ------- -------
Results of operations from producing
activities (excluding corporate
overhead and interest costs)....................... $ 8,206 $ 1,948 $ 1,191 $ (9,400)
======= ======= ======= ========
</TABLE>
* No income tax provision is recorded in 1997 as the Company elected
subchapter S corporation status effective January 1, 1997 (See Note 2).
24
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
RESERVES-
The Company's estimated total proved and proved developed reserves of oil and
gas for the years ended December 31, 1997, 1996 and 1995 are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------------- ----------------- ---------------
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.............. 1,430 122,801 1,294 11,158 3,119 28,287
Purchases of reserves
in place....................... --- --- 226 94,272 --- ---
Sales of reserves in place...... (1,312) (10,261) (2,740) (2,091) (654) (7,144)
Revisions of previous
estimates...................... (4) 14,539 (75) (1,609) 118 (957)
Transfer (to)/from assets held
for sale....................... --- --- 3,054 15,556 (806) (5,056)
Extensions and discoveries...... --- --- 41 10,714 22 383
Production...................... (67) (6,974) (370) (5,199) (505) (4,355)
------ ------- ------ ------- ----- ------
Proved reserves at end
of year........................ 47 120,105 1,430 122,801 1,294 11,158
====== ======= ====== ======= ===== ======
Proved developed reserves -
Beginning of year............... 1,141 111,166 992 9,583 2,562 24,251
====== ======= ====== ======= ===== ======
End of year..................... 38 115,540 1,141 111,166 992 9,583
====== ======= ====== ======= ===== ======
</TABLE>
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):
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------
1997 1996 1995
------- --------- -----------
<S> <C> <C> <C>
Future cash inflows........ $ 296,161 $ 499,396 $ 44,310
Future production costs.... (213,799) (274,243) (14,982)
Future development costs... (3,715) (8,390) (2,575)
--------- --------- ---------
Future net inflows before
income tax................ 78,647 216,763 26,753
Future income taxes*....... --- (68,539) (5,894)
--------- --------- ---------
Future net cash flows...... 78,647 148,224 20,859
10% discount factor........ (40,760) (75,345) (6,191)
--------- --------- --------
Standardized measure of
discounted future cash
flows..................... $ 37,887 $ 72,879 $ 14,668
========= ========= ========
</TABLE>
* No income tax provision is recorded in 1997 as the Company
elected subchapter S corporation status effective January 1,
1997 (See Note 2).
25
<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,
-------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Standardized measure -
Beginning of year........................ $ 72,879 $ 14,668 $ 36,483
Sales, net of production costs........... (9,586) (9,403) (11,495)
Transfer (to)/from assets held for sale.. --- 23,445 (5,417)
Purchases of reserves in-place........... --- 68,698 ---
Net change in prices and
production costs........................ (46,379) 406 4,147
Extensions, discoveries and
improved recovery, net of future
production and development costs........ --- 8,008 266
Changes in estimated future
development costs....................... (930) (786) (147)
Development costs incurred during
the period.............................. 2,739 9,078 2,443
Revisions of quantity estimates.......... 4,700 (349) (271)
Accretion of discount.................... 10,260 1,692 3,648
Net change in income taxes............... 29,724 (27,467) (2,257)
Sales of reserves in-place............... (26,810) (18,686) (8,513)
Changes in production rates and
other................................... 1,290 3,575 (4,219)
-------- -------- --------
Standardized measure -
end of year.............................. $ 37,887 $ 72,879 $ 14,668
======== ======== ========
</TABLE>
26
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
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, 1997, 1996 AND 1995
Revenues
The Company engages in two principal lines of business: providing
technical and administrative services to energy companies, primarily through
outsourcing arrangements; and providing growth capital to independent oil and
gas companies. In addition, the Company also receives revenue from interests it
holds in oil and gas properties, most of which were acquired in conjunction with
the Management Buyout.
The Company's service activities, which include accounting and
finance, information technology, oil and gas operations and engineering,
hydrocarbon marketing, acquisitions and divestitures, and various administrative
services, accounted for over 50% of revenues in 1997. Revenues for such service
activities are received under various outsourcing and management contracts and
classified either as Service Fees or Overhead Fees. Service Fees include
payments for management and administrative services, certain hydrocarbon
marketing activities, and consulting services as well as transaction fees
received for arranging or advising clients on acquisitions, divestitures or
financings. The Company also receives substantial fees related to oil and gas
field operations and gas plant operations, which it classifies as Overhead Fees.
Overhead Fees are a combination of fees paid by clients and reimbursements
received from working interest owners customarily paid to the operator of oil
and gas properties.
Service Fees totaled $26.0 million in 1997, up 40% from the 1995
figure of $18.6 million. Fees were down, however, from the 1996 high of $30.8
million due primarily to the $8.0 million transaction fee recorded in 1996 for
arranging and advising Nuevo on its nearly $500 million purchase of Unocal's
California properties. The Company's contracts for outsourcing and management
services differ from contract to contract in how the Company is paid for its
services. Certain contracts contain provisions whereby the Company is paid
based upon the amount of book assets and operating cash flow of its clients.
Others are based upon a set fee or a pricing formula related to the activities
performed. As such, Service Fees may fluctuate from year to year based on the
level of activity of the Company's clients or other industry and economic
factors, such as the level of oil and gas prices. The Company expects to grow
Service Fees in future years by adding additional outsourcing contracts with new
clients and expanding the level of activities for existing clients.
Overhead Fees equaled $9.0 million in 1997, down from $11.4 million
and $12.6 million in 1996, and 1995 respectively. The reduction in 1997 is
primarily due to the acquisition of certain oil and gas property interests in
September 1996 for which the Company previously received Overhead Fees from
Torchmark. The Company no longer records Overhead Fees related to its
management of these properties. To a lesser extent, the 1997 decrease was
related to the sale of various non-core properties by clients.
The Company's principal oil and gas properties relate to production
payments obtained in conjunction with the Management Buyout in September 1996.
The Company's major properties are coal-seam gas fields
1
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED
(Unaudited)
located in Alabama and Wyoming. The Company also holds interests in gas fields
in Texas and Louisiana. Oil and gas revenues for 1997 were $18.5 million, up
13.5% from 1996 oil and gas revenues of $16.3 million. This increase is mainly
attributable to the acquisition of property interests in the Management Buyout,
which more than offset the sale of certain oil and gas properties in September
1996 and April 1997 (See Notes 8 and 9 of the Notes to the Consolidated
Financial Statements). 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 acquisition of property interests in September 1996 as a
result of the Management Buyout, partially offset by the sale of certain oil and
gas properties in December 1995 (See Notes 8 and 9 of the Notes to the
Consolidated Financial Statements).
In 1997, the Company provided growth capital to oil and gas companies
through TEFF, a fund formed to provide small to mid-size companies with capital
for acquisition and exploitation opportunities. TEFF was formed in September
1995, but its resources were expanded in July 1997, when the Company reached an
agreement with the Bank of Montreal to provide additional capital for TEFF. The
Company records interest income from parties financed by TEFF. In 1997, such
revenues totaled $.7 million. Prior to 1997, the Company's financings were
structured as equity interest rather than notes.
The Company also engages in various hydrocarbon marketing and trading
activities related to its service business. Revenues for these activities are
recorded net of the cost of goods purchased for trading purposes. Net product
marketing revenues decreased to $5.3 million in 1997 from $9.8 million and $11.5
million in 1996 and 1995, respectively.
From time to time, the Company has sold interests in various oil and
gas properties and securities. 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. In April 1997, the Company sold its
interest in oil and gas properties of certain partnerships to Bellwether for
$18.4 million. As a fee for advisory services rendered in connection with the
sale, the Company received .15 million shares of Bellwether common stock at
$8.375 per share and a warrant to purchase .1 million shares at $9.90 per share.
(See Notes 1, 5 and 9 of the Notes to Consolidated Financial Statements).
Expenses
The Company includes in general and administrative expense all of the
personnel and administrative costs of providing services to its clients pursuant
to its outsourcing agreements, with the exception of field operating personnel,
which are charged directly to the client's operations. Because general and
administrative expense includes the cost of client service, the level of expense
recorded by the Company from year to year is subject to variability related to
client activity level in much the same way as revenue.
2
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED
(Unaudited)
General and administrative expenses totaled $37.1 million, $37.9 million and
$34.6 million in 1997, 1996 and 1995 respectively.
Oil and gas expenses for 1997 totaled $8.9 million, up 29% from $6.9
million in 1996. 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 September 1996 and April
1997 (see Notes 8 and 9 of the Notes to the Consolidated Financial Statements).
The average unit production cost per Mcfe in 1997 was $1.21 as compared to an
average unit production cost per Mcfe in 1996 of $.92. 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 8 and
9 of Notes to Consolidated Financial Statements).
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).
Interest expense increased by 75% to $2.8 million in 1997 from $1.6
million in 1996. Such increase is primarily due to 9% interest recorded on $25.5
million Senior Subordinated Note payable to Torchmark. 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.
Equity in Earnings of Affiliates and Investees
Equity in earnings of affiliates and investees consists of oil and
gas partnership interests and other investments.
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. As the Company effectively controls the venture,
the activities are included in the financial statements with the unaffiliated
parties interest reflected as minority interest.
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 owned a 50% interest in both limited
liability companies until March 1997 at which time the companies were sold.
Prior to March 1997, the activities for these ventures were included in the
financial statements with the unaffiliated parties interest reflected as
minority interest.
3
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED
(Unaudited)
Effective June 30, 1997, the Company purchased The Procurement Centre
("TPC") to obtain the benefit of TPC's experience and expertise in providing
consulting and outsourcing services for the procurement of materials and
services, inventory management, logistics and other administrative services.
The Company owns a 75% interest in TPC and the activities are included in the
financial statements with the unaffiliated parties interest reflected as
minority interest.
Net Income
The foregoing activities resulted in the following net income
(amounts in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- ---------
<S> <C> <C> <C>
Income (loss) before income taxes and
minority interest...................... $12,198 $19,386 $(1,280)
Net income.............................. $11,657 $15,379 $ 2,951
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $6.8 million, $7.6
million and $9.3 million for the years ended December 31, 1997, 1996 and 1995,
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 $5.6 million, $14.8 million and $9.9
million on investments in property and equipment in 1997, 1996 and 1995,
respectively. In April 1997, the Company sold its interest in certain oil and
gas properties of certain partnerships to Bellwether and a third party
generating $18.4 million and $3 million, respectively, in cash (See Note 9 of
the Notes to Consolidated Financial Statements). 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 9 of the Notes to Consolidated
Statements). In December 1995, the Company recorded a charge of $1.9 million
regarding the settling certain offshore oil and gas assets in the Gulf of
Mexico. 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 in 1995 for acquisitions of oil and gas
properties sold to institutional investors participating in various current
programs or third parties. No such events occurred in 1997 and 1996.
4
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED
(Unaudited)
Financing Activities
The Company maintains a $13 million credit facility (the "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 ($8 million at December 31, 1997), 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
(7.47% at December 31, 1997). The Credit Facility contains, among other terms,
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. At December 31, 1997
and 1996, there is no outstanding balance under the line of credit.
On July 16, 1997, TEFF entered into at $90 million credit facility
(the "TEFF Facility") with a bank. Ordinary interest accrues on indebtedness,
at TEFF's option, at the bank's prime rate plus 0.5% (9% at December 31, 1997)
or LIBOR plus 2.0% (7.97% at December 31, 1997) if the loans outstanding are
less than or equal to the portfolio base ($4.2 million at December 31, 1997);
and at the bank's prime rate plus 5.5% (14% at December 31, 1997) or LIBOR plus
7.0% (12.97% at December 31, 1997) of the portion of loans outstanding in excess
of the portfolio base. If the outstanding balance under the TEFF Facility
exceeds $75 million, then the ordinary interest rate shall be reduced by 0.5%.
In addition to ordinary interest, TEFF accrues interest expense for net cash
flow and net sales proceeds earned from investing the TEFF Facility (NCFI). The
TEFF Facility provides that NCFI be paid through December 31, 2011 at which time
the bank's right to receive NCFI shall terminate. No such interest was incurred
for the year ended December 31, 1997. The TEFF Facility contains, among other
terms, provisions for the maintenance of certain financial ratios and
restrictions on additional debt. All security in the investments currently
owned by TEFF or hereafter acquired and proceeds thereof, secure the TEFF
Facility, which matures on December 21, 2003. At December 31, 1997, the
outstanding balance under the TEFF Facility was $10.6 million at a weighted
average interest rate of 11%.
On November 14, 1997, TPC entered into a $200,000 credit facility (the
"TPC Facility") with a bank. Interest accrues on indebtedness at the bank's
prime rate (8.5% at December 31, 1997). All accounts receivable currently owned
by TPC or hereafter acquired and proceeds thereof, but not the contracts
themselves, secure the TPC Facility which matures on November 2, 1998. At
December 31, 1997, the outstanding balance under the TPC Facility was $60,000.
The TPC Facility's carrying value approximated fair value as this note bears
interest at a rate which approximates current market rates.
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, payable
semiannually, and the principal is due and payable on September 30, 2004.
5
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED
(Unaudited)
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, 1997, the Company had natural gas swap agreements with broker-
dealers to exchange monthly payments on notional quantities amounting to 34
million MMBTU over the ensuing 4 years. Under the swap agreements, the Company
will realize an average floor price of $1.87 per MMBTU. Under a 16 Mbbl oil
swap agreement, the Company will realize a floor price of $20.11 per barrel. At
December 31, 1997, the Company also had various swap agreements on notional
quantities of 6 million MMBTUs at an average sales price of $2.24 per MMBTU.
Outlook
The Company has adopted a $10.9 million capital budget for the year
ending December 31, 1998 primarily for the recompletion of certain properties,
information technology and investments in affiliates. The Company believes its
working capital and cash flows provided by operating activities are sufficient
to meet these capital commitments.
The Company plans to upgrade all major financial and administrative
systems to ensure that such systems are Year 2000 compliant. The Year 2000
problem results from data storage of date information truncating to two places
i.e. 1998 stored as 98. Currently, all programs storing year information as
such recognize the Year 2000 as 00 (or 1900). The Company has implemented a
Year 2000 project to identify all critical non-Year 2000 compliant systems and
convert or upgrade all such systems to Year 2000 compliant. Management does not
believe that costs incurred to address the Year 2000 issue with respect to its
financial and administrative systems will have a material impact on the
Company's future financial results or operations. At this time, the Company
does not expect the Year 2000 issue to have a significant operational impact.
The Company is uncertain as to how it will be indirectly affected by the impact
of the Year 2000 issue on the companies with which it conducts business.
Inflation has not had a material impact on the Company and is not
expected to have a material effect in the future.
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS 130"), which establishes standards for reporting and display of
comprehensive income and its components. The components of comprehensive income
refer to revenues, expenses, gains and losses that are excluded from net income
under current accounting standards, including unrecognized foreign currency
translation items, minimum pension liability adjustments and unrealized gains
and losses on certain investments in debt and equity securities. SFAS 130
requires that all items that are recognized under accounting standards as
components of comprehensive income be reported in a financial statement
displayed in equal prominence with other financial statements; the total of
other comprehensive income for a period is required to be transferred to a
component of equity that is separately displayed in a statement of financial
position at the end of an accounting period. SFAS 130 is effective for both
interim and annual periods beginning after December 15, 1997, at which time the
Company will adopt the provisions.
6
<PAGE>
TORCH ENERGY ADVISORS INCORPORATED
AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED
(Unaudited)
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 131"). SFAS 131 establishes standards for the manner public
enterprises are required to report information about operating segments in
annual financial statements and requires the reporting of selected information
about operating segments in interim financial reports issued to shareholders.
SFAS 131 also establishes standards for related disclosures about products and
services, geographic areas, and major customers. SFAS 131 is effective for
periods beginning after December 15, 1997, at which time the Company will adopt
the provisions.
7
<PAGE>
EXHIBIT 23.1
CONSENT OF T.J. SMITH AND COMPANY, INC.
We hereby consent to the use of our report dated March 11, 1998 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 18, 1998
<PAGE>
EXHIBIT 23.2
CONSENT OF H.J. GRUY AND ASSOCIATES, INC.
We hereby consent to the use of our report dated March 9, 1998 regarding
Torch Energy Royalty Trust and to reference to our firm in this Form 10-K.
H.J. GRUY AND ASSOCIATES, INC.
By: /s/ H.J. Gruy and Associates, Inc.
----------------------------------
Houston, Texas
March 25, 1998
<PAGE>
EXHIBIT 23.3
CONSENT OF RYDER SCOTT COMPANY
We hereby consent to the use of our report dated March 10, 1998 regarding
Torch Energy Royalty Trust interest and to reference to our firm included in
this Form 10-K.
RYDER SCOTT COMPANY
By: /s/ Ryder Scott Company
----------------------------------
Houston, Texas
March 25, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 7
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 100,838
<DEPRECIATION> 0
<TOTAL-ASSETS> 100,845
<CURRENT-LIABILITIES> 177
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 100,668
<TOTAL-LIABILITY-AND-EQUITY> 100,845
<SALES> 0
<TOTAL-REVENUES> 15,203
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 678
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 14,525
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 14,525
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
<PAGE>
EXHIBIT 99.1
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.
