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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED JUNE 30, 1996 COMMISSION FILE NO. 0-25214
KELLEY OIL & GAS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 76-0082502
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
601 JEFFERSON ST.
SUITE 1100
HOUSTON, TEXAS 77002
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (713) 652-5200
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 the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
TITLE OF CLASS OUTSTANDING AT JULY 31, 1996
Common Stock 98,287,838
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KELLEY OIL & GAS CORPORATION
INDEX
PART I. FINANCIAL INFORMATION PAGE
Consolidated Balance Sheets as of June 30, 1996 (unaudited)
and December 31, 1995 ................................................ 2
Consolidated Statements of Loss for the three months ended
June 30, 1996 and 1995 (unaudited)................................. 3
Consolidated Statements of Loss for the six months ended
June 30, 1996 and 1995 (unaudited)................................. 4
Consolidated Statements of Cash Flows for the six months
ended June 30, 1996 and 1995 (unaudited) ............................. 5
Notes to Consolidated Financial Statements ............................. 6
Management's Discussion and Analysis of Financial Condition
and Results of Operations ............................................. 9
PART II. OTHER INFORMATION............................................. 15
1
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PART I. FINANCIAL INFORMATION
KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
JUNE 30, DECEMBER 31,
1996 1995
------------ -------------
(UNAUDITED)
ASSETS:
Cash and cash equivalents ................. $ 7,119 6,352
Accounts receivable ....................... 15,680 13,753
Accounts receivable - drilling programs ... 1,816 2,035
Prepaid expenses and other current assets . 1,870 557
---------- ---------
Total current assets ................. 26,485 22,697
---------- ---------
Oil and gas properties, successful
efforts method:
Unproved properties, net ............. 13,497 13,050
Properties subject to amortization ... 304,837 287,970
Pipelines and other transportation
assets, at cost ......................... 4,723 4,723
Furniture, fixtures and equipment ......... 1,298 1,233
---------- ---------
324,355 306,976
Less: Accumulated depreciation, depletion
and amortization ........................ (188,232) (178,334)
---------- ---------
Total property and equipment ......... 136,123 128,642
---------- ---------
Other non-current assets (net of
accumulated amortization)................ 1,186 3
---------- ---------
TOTAL ASSETS .............................. $ 163,794 151,342
---------- ---------
---------- ---------
LIABILITIES:
Accounts payable and accrued expenses ..... $ 16,618 19,500
Accounts payable - drilling programs ...... 13,914 12,430
---------- ---------
Total current liabilities ............ 30,532 31,930
Long term debt ............................ --- 22,000
Senior notes .............................. 96,504 95,926
Convertible subordinated debentures ....... 22,301 21,694
Convertible subordinated notes ............ 26,412 25,360
---------- ---------
TOTAL LIABILITIES .................... 175,749 196,910
---------- ---------
STOCKHOLDERS' DEFICIT:
Preferred stock, $1.50 par value--20,000
shares authorized at June 30, 1996 and
December 31,1995; 1,746 and 4,304 shares
issued and outstanding at June 30, 1996
and December 31, 1995, respectively
(liquidation value at June 30, 1996 and
December 31, 1995 of $45,928 and $66,532,
respectively) ........................... 2,618 6,456
Common stock, $.01 par value, 200,000 and
100,000 shares authorized at
June 30, 1996 and December 31, 1995,
respectively; 98,269 and 44,041 shares
issued and outstanding at June 30, 1996
and December 31, 1995, respectively ..... 983 440
Additional paid-in capital ................ 273,060 225,804
Retained deficit .......................... (288,616) (278,268)
---------- ---------
TOTAL STOCKHOLDERS' DEFICIT ..... (11,955) (45,568)
---------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS'
DEFICIT ................................. $ 163,794 151,342
---------- ---------
---------- ---------
See Notes to Consolidated Financial Statements.
2
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KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF LOSS
($ IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
JUNE 30,
-----------------------
1996 1995
-------- ---------
Oil and gas revenues .............................. $ 12,619 9,606
Gas marketing revenues, net ....................... 314 201
Interest and other income ......................... 215 251
-------- ---------
Total revenues ............................... 13,148 10,058
-------- ---------
Production expenses ............................... 2,595 2,781
Exploration costs ................................. 1,413 5,430
General and administrative expenses ............... 2,193 1,618
Interest and other debt expenses .................. 5,911 5,712
Restructuring expense ............................. 2,000 ---
Depreciation, depletion and amortization .......... 3,872 8,355
-------- ---------
Total expenses ............................... 17,984 23,896
-------- ---------
Net loss before income taxes ...................... (4,836) (13,838)
Income taxes ...................................... --- ---
-------- ---------
Net loss .......................................... (4,836) (13,838)
Less: Preferred stock dividends ................... --- (1,764)
-------- ---------
NET LOSS APPLICABLE TO COMMON STOCK ............... $ (4,836) (15,602)
-------- ---------
-------- ---------
Loss per share:
Primary and assuming full dilution:
Net loss ................................... $ (.05) (.36)
-------- ---------
-------- ---------
Average common and common equivalent shares
outstanding:
Primary and assuming full dilution ........... 95,391 43,668
3
See Notes to Consolidated Financial Statements.
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KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF LOSS
($ IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
-----------------------
1996 1995
-------- ---------
Oil and gas revenues .............................. $ 25,323 18,523
Gas marketing revenues, net ....................... 708 430
Interest and other income ......................... 529 540
-------- ---------
Total revenues ............................... 26,560 19,493
-------- ---------
Production expenses ............................... 5,167 4,835
Exploration costs ................................. 3,053 7,479
General and administrative expenses ............... 4,826 3,020
Interest and other debt expenses .................. 12,309 9,092
Restructuring expense ............................. 2,000 ---
Depreciation, depletion and amortization .......... 9,553 16,741
-------- ---------
Total expenses ............................... 36,908 41,167
-------- ---------
Net loss before income taxes ...................... (10,348) (21,674)
Income taxes ...................................... --- ---
-------- --------
Net loss .......................................... (10,348) (21,674)
Less: Preferred stock dividends ................... --- (3,102)
-------- ---------
NET LOSS APPLICABLE TO COMMON STOCK ............... $(10,348) (24,776)
-------- ---------
-------- ---------
Loss per share:
Primary and assuming full dilution:
Net loss .................................... $ (.13) (.65)
-------- ---------
-------- ---------
Average common and common equivalent
shares outstanding:
Primary and assuming full dilution ............ 81,848 38,349
4
See Notes to Consolidated Financial Statements.
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KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
($ IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
-----------------------
1996 1995
--------- ---------
OPERATING ACTIVITIES:
Net loss .......................................... $(10,348) (21,674)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation, depletion and amortization ..... 9,553 16,741
Dry hole and impairment costs ................ 201 4,148
Accretion of debt valuation discount ......... 1,019 848
Amortization of debenture and note costs ..... 1,225 243
Accretion of note discount ................... 440 302
Restructuring expense ........................ 1,716 ---
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable ... (1,708) 11,528
Decrease (increase) in prepaid expenses
and other current assets ................... (1,313) (134)
Decrease (increase) in other
non-current assets ......................... (1,629) 1,752
Increase (decrease) in accounts payable
and accrued expenses ....................... (4,297) (23,204)
--------- ---------
Net cash used in operating activities ............. (5,141) (9,450)
--------- ---------
INVESTING ACTIVITIES:
Purchases of property and equipment ............... (16,346) (20,438)
Cash received in consolidation .................... --- 1,596
Proceeds from sale of equipment ................... 293 232
--------- ---------
Net cash used in investing activities ............. (16,053) (18,610)
--------- ---------
FINANCING ACTIVITIES:
Proceeds from long term borrowings ................ 8,000 15,100
Principal payments on long term borrowings ........ (30,000) (100,000)
Proceeds from sale of senior notes ................ --- 99,629
Proceeds from sale of common stock ................ 48,021 16,319
Note offering costs ............................... --- (4,178)
Dividends paid on preferred stock ................. --- (3,102)
Syndication costs charged to equity ............... (4,060) (5)
--------- ---------
Net cash provided by financing activities ......... 21,961 23,763
--------- ---------
Increase (decrease) in cash and cash equivalents .. 767 (4,297)
Cash and cash equivalents, beginning of period .... 6,352 9,268
-------- ---------
Cash and cash equivalents, end of period .......... $ 7,119 4,971
--------- ---------
--------- ---------
5
See Notes to Consolidated Financial Statements.
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KELLEY OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying consolidated financial statements of Kelley Oil & Gas
Corporation (the "Company" or "KOGC") have been prepared by the Company in
accordance with generally accepted accounting principles and reflect all
adjustments (consisting of normal recurring adjustments) necessary for a fair
statement in all material respects of the results for the interim periods
presented. The results of operations for the six months ended June 30, 1996
are not necessarily indicative of results to be expected for the full year.
The accounting policies followed by the Company are set forth in Note 1 to
the financial statements in its Annual Report on Form 10-K for the year ended
December 31, 1995.
Certain financial statement items in the interim 1995 period have been
reclassified to conform to the interim 1996 presentation. In addition, gas
marketing revenues and cost of gas sold have been presented on a net basis for
the periods presented and are reflected in the "Gas marketing revenues, net" on
the Consolidated Statements of Loss.
NOTE 2 - EQUITY INFUSION
In February 1996, the Company issued 48 million shares of its Common Stock
at $1.00 per share to Contour Production Company L.L.C. ("Contour") upon the
closing of a Stock Purchase Agreement between KOGC and Contour (the "Contour
Transaction"). The newly issued shares represented 49.8% of KOGC's voting power
at the time of the Contour Transaction. In connection with the Contour
Transaction, the Company granted Contour an option (the "Contour Option") to
purchase up to 27 million shares (the "Maximum Option Number") of Common Stock
at $1.00 per share (subject to antidilution adjustments) upon satisfaction of
certain conditions, including the absence of any KOGC debt repurchase or
redemption obligations as a result of the purchase (a "Debt Event"). Contour is
required to exercise the Contour Option for the Maximum Option Number within 30
days after it concludes in its sole discretion that a Debt Event would not occur
as a result of the purchase.
A Debt Event would occur upon (i) a "Change of Control" as defined in the
indenture for the Company's 13 1/2% Senior Notes due 1999 (the "Senior Notes"),
(ii) a "Change in Control" as defined in the indenture for the Company's 7 7/8%
Convertible Subordinated Notes due 1999 (the "7 7/8% Notes") or (iii) a
"Redemption Event" as defined in the indenture for the Company's 8 1/2%
Convertible Subordinated Debentures due 2000 (the "8 1/2% Debentures"). A Debt
Event would entitle each holder of the affected securities to require the
repurchase or redemption of the holder's securities. While the current exercise
of the Contour Option would not cause a Debt Event under the indenture for the 8
1/2% Debentures, it would require waivers or consents from the holders of a
majority in aggregate principal amount of the Senior Notes and 7 7/8% Notes.
NOTE 3 - PRO FORMA DATA FOR THE CONSOLIDATION AND THE CONTOUR TRANSACTION
THE CONSOLIDATION. The Company was formed in 1994 to consolidate the
equity ownership of Kelley Oil & Gas Partners, Ltd. ("Kelley Partners") and
Kelley Oil Corporation ("Kelley Oil"), the managing general partner of Kelley
Partners (the "Consolidation"). The Consolidation was recorded as of
February 7, 1995 for financial accounting purposes. The following table
presents unaudited pro forma results of the Company's operations for the six
months ended June 30, 1995 as if the Consolidation had occurred on January 1,
1995. This information is presented for illustrative purposes only and is
not necessarily indicative of the Company's future financial performance or
results of operations.
6
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(IN THOUSANDS, EXCEPT PER SHARE DATA)
SIX MONTHS
ENDED
JUNE 30,
1995
-----------
Revenues .................................................... $ 22,008
Net loss applicable to common and common equivalent shares .. (25,427)
Net loss per share .......................................... (.60)
THE CONTOUR TRANSACTION. The Company issued 48 million shares of Common
Stock at $1.00 per share to Contour in February 1996 in connection with the
Contour Transaction. The following table reflects the unaudited pro forma
results of the Company's operations for the six months ended June 30, 1996 and
1995 as if the Contour Transaction had occurred on January 1, 1995.
(IN THOUSANDS, EXCEPT PER SHARE DATA)
SIX MONTHS ENDED JUNE 30,
-------------------------
1996 1995
----------- ------------
Net loss applicable to common and common
equivalent shares .............................. $(10,031) (24,267)
Net loss per share ............................... (.11) (.27)
NOTE 4 - PREFERRED AND ESOP PREFERRED STOCK CONVERSIONS
Under the terms of the Certificate of Designation governing the
Company's $2.625 Convertible Exchangeable Preferred Stock (the "Public
Preferred Stock"), the Contour Transaction triggered a special conversion
right under which the conversion price was reduced to $4.00 for a period of
45 days commencing March 13, 1996. In April 1996, 696,823 shares of
Preferred Stock were converted into 4,355,040 shares of the Company's Common
Stock.
In January 1996, the Company suspended the payment of the quarterly
Public Preferred Stock dividend scheduled for February 1, 1996. Future
dividends on the Public Preferred Stock are prohibited under the agreement
covering the Company's credit facility. As of June 30, 1996, $2.3 million or
$1.31 per share in dividends were in arrears, increasing the total
liquidation value to $45.9 million.
The Company had four outstanding series of Cumulative Convertible
Preferred Stock ("ESOP Preferred Stock"), which ranked junior in dividend and
liquidation rights to the Public Preferred Stock. In June 1996, each of the
outstanding 1,861,619 shares of ESOP Preferred Stock was redeemed for one
share of the Company's Common Stock.
NOTE 5 - EMPLOYEE STOCK OPTIONS
In October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("FAS 123"), which established financial accounting
and reporting standards for stock-based employee compensation plans and for
transactions in which an entity issues its equity instruments to acquire
goods and services from nonemployees. FAS 123 requires, among other things,
that compensation cost be calculated for fixed stock options at the grant
date by determining fair value using an option-pricing model. The Company
has the option of recognizing the compensation cost over the vesting period
as an expense in the consolidated statement of operations or making pro forma
disclosures in the notes to financial statements reflecting the effects on
net earnings as if the compensation cost had been recognized in the
consolidated statement of operations. In February 1996 in conjunction with
the Contour Transaction, the Company granted options to purchase 2.5 million
shares of Common Stock at $1.00 per share. The Company adopted FAS 123 in
1996 and will make the required pro forma disclosures in the notes to its
annual financial statements.
7
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NOTE 6 - RESTRUCTURING EXPENSE
In the second quarter of 1996, the Company incurred a $2 million
restructuring charge associated primarily with staff reductions and related
severance settlements of 12 employees and various reorganization costs, of
which $.3 million has been paid through June 30, 1996. These charges along
with charges incurred in prior periods are included in accounts payable and
accrued expenses on the balance sheet in the amount of $2.2 million, of which
$.5 million is associated with restructuring charges incurred in prior
periods.
8
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
INTRODUCTION. Kelley Oil & Gas Corporation (the "Company" or "KOGC") is
engaged with its subsidiaries and subsidiary partnerships (collectively,
the "Kelley Group") in the development of oil and natural gas properties
located onshore primarily in Louisiana. The Company's strategy has
historically been focused on development drilling and exploration activities
in or near established production areas. The Company intends to continue its
emphasis on development drilling and to augment this strategy with the
acquisition of producing oil and gas reserves. KOGC also owns and operates
natural gas gathering and transportation systems and markets natural gas.
The Company's primary financial objective is capital appreciation through
growth in production, reserves and cash flow.
DRILLING OPERATIONS. During the first half of 1996, the Company
participated in drilling 25 gross (10.41 net) wells. KOGC has further
increased its focus on north Louisiana operations with a 6-rig drilling
program initiated in the second quarter. KOGC is considering industry
partnerships to diversify risks associated with exploring certain of its
south Louisiana properties.
HEDGING ACTIVITIES. KOGC periodically uses forward sales contracts,
natural gas swap agreements and options to reduce exposure to downward price
fluctuations on natural gas production of the Kelley Group. The swap
agreements generally provide for the Kelley Group to receive or make
counterparty payments on the differential between a fixed price and a
variable indexed price for natural gas. Gains and losses realized by the
Kelley Group from hedging activities are included in oil and gas revenues.
Through a combination of natural gas swap agreements and forward sales
contracts, 44.3% of the Kelley Group's natural gas production for the second
quarter of 1996 was affected by hedging transactions at an average Nymex
quoted price of $2.13 per MMBtu, before transaction costs and transportation
costs on gas delivered under forward sales contracts. As of July 31, 1996,
approximately 41.5% of the Kelley Group's anticipated natural gas production
for the balance of 1996 has been hedged by forward sales contracts and
natural gas swap agreements at an average Nymex quoted price of $2.22 per
MMBtu, before transaction and transportation costs. Additionally, the Kelley
Group has secured a price floor on 21.1% of estimated production for the
remainder of the year at an average price of $1.99 per MMBtu, after
transaction costs.
ACCOUNTING TREATMENT OF THE CONSOLIDATION. In February 1995, the equity
interests in Kelley Oil & Gas Partners, Ltd. ("Kelley Partners") and Kelley
Oil Corporation ("Kelley Oil") were consolidated into KOGC (the
"Consolidation"). For financial accounting purposes, the Consolidation was
treated as a purchase by KOGC of the Public Unitholders' interests in the net
assets of Kelley Partners. As a result of the purchase accounting treatment
of the Consolidation, the Company's consolidated financial statements through
the date of the Consolidation reflect Kelley Oil's historical results on a
stand alone basis, with results of combined operations of the Company
recorded thereafter.
PARTNERSHIP MERGER. In March 1996, Kelley Partners was merged into the
Company (the "Partnership Merger") as part of ongoing efforts to streamline
operations and reduce costs. Prior to the Partnership Merger, Kelley
Partners had outstanding 8 1/2% Convertible Subordinated Debentures due 2000
("8 1/2% Debentures) in the aggregate principal amount of $26.9 million and 7
7/8% Convertible Subordinated Notes due 1999 ("7 7/8% Notes") in the
aggregate principal amount at maturity of $34.4 million. Under the terms of
the Consolidation, the 8 1/2% Debentures and 7 7/8% Notes became convertible
into the Company's Common Stock or a combination of its Common and $2.625
Convertible Exchangeable Preferred Stock ("Public Preferred Stock") instead
of units in Kelley Partners ("Units") based on the exchange ratios for the
Units in the Consolidation. In connection with the Partnership Merger, the 8
1/2% Debentures and 7 7/8% Notes became direct obligations of KOGC.
9
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PUBLIC PREFERRED STOCK SPECIAL CONVERSION RIGHT. In March 1996, a
special conversion right (the "Special Conversion Right") for the Public
Preferred Stock was triggered by KOGC's issuance of 48 million shares of
its Common Stock to Contour Production Company L.L.C. ("Contour") under a
Stock Purchase Agreement between KGOC and Contour (the "Contour
Transaction"). Under the Special Conversion Right, the conversion price of
the Public Preferred Stock was reduced to $4.00 for a period of 45 days ended
April 25, 1996. A total of 696,823 shares of Public Preferred Stock were
tendered pursuant to the Special Conversion Right, resulting in the issuance
of 4,355,040 shares of Common Stock and a reduction in the outstanding Public
Preferred Stock to 1,745,500 shares as of April 30, 1996. Although dividends
on the Public Preferred Stock ("Preferred Stock") were suspended in January
1996, the decrease in outstanding Public Preferred Stock will reduce future
dividend arrearages. See "Liquidity and Capital Resources" below.
RESTRUCTURING EXPENSE. In the second quarter of 1996, the Company
incurred a $2.0 million restructuring charge, associated with management
realignment and termination settlements. Of this amount $.3 million was paid
in the second quarter with the balance of $1.7 million included in accounts
payable and accrued expenses on the balance sheet. Management anticipates an
additional restructuring charge will be incurred by the end of 1996.
EMPLOYEE STOCK OPTIONS. In October 1995, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("FAS 123"), which established
financial accounting and reporting standards for stock-based employee
compensation plans and for transactions in which an entity issues its equity
instruments to acquire goods and services from nonemployees. In February
1996 in conjunction with the Contour Transaction 2.5 million options were
granted at $1.00 per share. The Company adopted FAS 123 in 1996 and will make
the required pro forma disclosures in the notes to the annual financial
statements.
RESULTS OF OPERATIONS
QUARTERS ENDED JUNE 30, 1996 AND 1995. The Company's oil and gas
revenues of $12.6 million for the second quarter of 1996 increased 31.3%
compared to $9.6 million in the same quarter last year. Production of
natural gas during the current quarter increased 5.6% to 5,036,000 Mcf from
4,767,000 Mcf in the second quarter of 1995, while the average price of
natural gas increased 36.4% to $2.25 per Mcf in the current quarter from
$1.65 per Mcf in the corresponding quarter last year. Production of crude
oil and natural gas liquids in the current quarter totaled 55,450 barrels,
with an average sales price of $23.21 per barrel compared to 86,835 barrels
at $19.12 per barrel in the second quarter of 1995, representing a volume
decrease of 36.1% and a price increase of 21.4%.
For the second quarter 1996, gas marketing revenues from natural gas
marketing and transportation operations, net of associated costs, increased
50.0% to $.3 million from $.2 million for the same quarter of 1995.
Production expenses for the second quarter of 1996 decreased 7.1% to
$2.6 million from $2.8 million in the same quarter last year, reflecting
lower severance taxes in the current quarter. On a unit of production basis,
production expenses decreased to $.49 per Mcfe in the second quarter of 1996
from $.53 per Mcfe in the corresponding quarter last year.
KOGC expensed exploration costs of $1.4 million in the second quarter of
1996 and $5.4 million in the corresponding quarter of 1995, a decrease of
74.1%, primarily reflecting the Company's temporary suspension of exploratory
drilling and focus on lower risk activities during the current quarter. The
decrease in these expenses also reflects lower geological and geophysical
expenses and unproved leasehold impairment provisions.
General and administrative expenses of $2.2 million in the second
quarter of 1996 increased 37.5% compared to $1.6 million in the corresponding
quarter last year. The increase was primarily attributable to added expenses
associated with management realignments implemented in connection with the
Contour Transaction. On a unit of production basis, these expenses increased
from $.31 per Mcfe in the second quarter of 1995 compared to $.41 per Mcfe in
the current quarter. KOGC is pursuing cost containment measures and
anticipates a reduction in general and administrative expense levels
commencing in 1997.
10
<PAGE>
Interest and other debt expenses of $5.9 million in the current quarter
increased 3.5% from $5.7 million in the same quarter last year. The increase
in interest expense resulted primarily from higher interest rates under
KOGC's 13 1/2% Senior Notes due 1999 (the "Senior Notes") than the $90
million of bank debt refinanced with proceeds from the Senior Note offering
in June 1995 and higher average debt levels during the current quarter. See
"Liquidity and Capital Resources" below. In addition to its interest
expense, the Company recorded noncash charges in the second quarter of 1996
of $.5 million for amortization of debt issuance costs, $.2 million for
accretion of note discount and $.5 million for accretion of debt valuation
discount.
Depreciation, depletion and amortization ("DD&A") decreased 53.6% from
$8.4 million in the second quarter of 1995 to $3.9 million in the current
quarter, primarily as a result of lower depletion rates following impairment
charges aggregating $150.1 million recognized in the fourth quarter of 1995
against the carrying value of KOGC's oil and gas properties under the
Financial Accounting Standards Board's Statement No. 121, Accounting for the
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of ("FAS
121") and from an increase in quantities of proved developed reserves. On a
unit of production basis, DD&A for oil and gas activities decreased from
$1.58 per Mcfe in the second quarter 1995 to $.72 per Mcfe in the current
quarter.
KOGC recognized net losses of $4.8 million in the second quarter of 1996
and $13.8 million in the same quarter last year. The decline in the net
losses was primarily attributable to higher oil and gas prices and lower DD&A
and exploration costs, partially offset by higher interest and general and
administrative expenses. The net loss attributable to common shares in the
second quarter of 1995 was increased by $1.8 million of preferred stock
dividends, which were suspended in January 1996.
PRO FORMA COMPARISON. Because the Company's historical results for
periods prior to the Consolidation reflect operations of Kelley Oil alone,
they are not comparable with its operating results after February 1995, which
reflect the Company's combined operations following the Consolidation.
Accordingly, the following discussion of comparative results of operations
for the six months ended June 30, 1996 and 1995 reflects pro forma
information for the six months ended June 30, 1995, giving effect to the
Consolidation from the beginning of the year. The Company believes this
provides a more meaningful comparison of results and operational trends than
a comparison based on historical results.
SIX MONTHS ENDED JUNE 30, 1996 AND 1995. The Company's oil and gas
revenues of $25.3 million for the first half of 1996 increased 20.5% compared
to $21.0 million on a pro forma basis in the same period last year.
Production of natural gas during the current period decreased 2.5% to
9,904,000 Mcf from 10,158,000 Mcf in the first half of 1995, while the
average price of natural gas increased 34.9% to $2.32 per Mcf in the current
period from $1.72 per Mcf in the corresponding period last year. Production
of crude oil and natural gas liquids in the current period totaled 120,263
barrels, with an average sales price of $21.34 per barrel compared to 198,657
barrels at $17.55 per barrel in the first half of 1995, representing a volume
decrease of 39.5% and a price increase of 21.6% on a pro forma basis.
For the first six months of 1996, gas marketing revenues from natural
gas marketing and transportation operations, net of associated costs,
increased 75.0% to $.7 million from $.4 million for the same period in 1995.
Production expenses for the first half of 1996 decreased 5.5% to $5.2
million from $5.5 million in the same period last year on a pro forma basis,
reflecting lower severance taxes in the current period. On a unit of
production basis, production expenses remained constant at $.48 per Mcfe for
both periods in 1996 and 1995.
KOGC expensed exploration costs of $3.1 million in the first half of
1996 and $7.8 million on a pro forma basis in the corresponding period of
1995, a decrease of 60.3%, primarily reflecting the Company's temporary
suspension of exploratory drilling and focus on lower risk activities during
the current period. The decrease in these expenses also reflects lower
geological and geophysical expenses and unproved leasehold impairment
provisions.
11
<PAGE>
General and administrative expenses of $4.8 million in the first six
months of 1996 increased 41.2% compared to $3.4 million on a pro forma basis
in the corresponding period last year. The increase was primarily
attributable to added expenses associated with management realignments
implemented in connection with the Contour Transaction and $650,000 in
bonuses awarded prior to the closing of the Contour Transaction. On a unit
of production basis, these expenses increased from $.30 per Mcfe in the first
half of 1995 to $.45 per Mcfe in the current period. KOGC is pursuing cost
containment measures and anticipates a reduction in general and
administrative expense levels commencing in 1997.
Interest and other debt expenses of $12.3 million in the current period
increased 24.2% from $9.9 million on a pro forma basis in the first six
months of 1995. The increase in interest expense resulted primarily from
higher interest rates under the Senior Notes than under the $90 million of
bank debt refinanced with proceeds from the Senior Note offering in June 1995
and higher average debt levels during the current period. See "Liquidity and
Capital Resources" below. In addition to its interest expense, the Company
recorded noncash charges in the first half of 1996 of $1.2 million for
amortization of debt issuance costs, $.4 million for accretion of note
discount and $1.0 million for accretion of debt valuation discount.
DD&A decreased 44.5% from $17.3 million on a pro forma basis in the
first half of 1995 to $9.6 million in the current period, primarily as a
result of lower depletion rates following impairment charges aggregating
$150.1 million recognized in the fourth quarter of 1995 against the carrying
value of KOGC's oil and gas properties under FAS 121 and from an increase in
quantities of proved developed reserves. On a unit of production basis, DD&A
for oil and gas activities decreased from $1.53 per Mcfe in the first half of
1995 to $.90 per Mcfe in the current period.
KOGC recognized net losses of $10.3 million in the first half of 1996
and $21.9 million on a pro forma basis in the same period last year. The
decline in the net losses was primarily attributable to higher oil and gas
prices and lower DD&A and exploration and dry hole costs, partially offset by
higher interest and general and administrative expenses. The net loss
attributable to common shares in the first half of 1995 was increased by $3.5
million of Preferred Stock dividends, which were suspended in January 1996.
The results of operations for the quarter and six months ended June 30,
1996 are not necessarily indicative of results to be expected for the full
year.
LIQUIDITY AND CAPITAL RESOURCES
CONTOUR TRANSACTION. In February 1996, following discussions with
potential acquirors, the Company issued 48 million shares of its Common Stock
at $1.00 per share to Contour Production Company L.L.C. ("Contour") upon the
closing of a Stock Purchase Agreement between KOGC and Contour. The newly
issued shares represented 49.8% of KOGC's voting power at the time of the
Contour Transaction. In connection with the Contour Transaction, the Company
(i) entered into an Option Agreement with Contour (the "Contour Option
Agreement"), (ii) obtained consents from its principal stockholders, subject
to compliance with applicable securities laws, to amend its Certificate of
Incorporation to increase its authorized Common Stock from 100 million shares
to 200 million shares, (iii) entered into employment agreements with John F.
Bookout, President of Contour, and other new executives named by him, (iv)
reduced the size of its Board to seven members and reconstituted the Board
with three continuing directors and four designees of Contour, and (v)
replaced its credit facility with a new $35 million facility.
Although the Contour Transaction has provided KOGC with the means to
continue its drilling operations in 1996 with the objective of increasing its
cash flow and reserves, the Company continues to have over $161 million face
amount of public debt outstanding, requiring $18.5 million in annual interest
payments. The Company also may incur new bank borrowings to fund part of its
drilling and acquisition activities for 1996. In addition, although
dividends are prohibited under the agreement covering the Company's credit
facility and are currently restricted under the indenture for the Senior
Notes, the outstanding Preferred Stock requires dividend accruals aggregating
$4.6 million
12
<PAGE>
annually and carries liquidation preferences over the Common Stock currently
totaling $45.9 million. KOGC's debt instruments also impose restrictions on
the Company's activities, including its use of funds and acquisitions.
Under the Contour Option Agreement, Contour has undertaken to provide
the Company with $27 million in additional financing through the purchase of
27 million shares (the "Maximum Option Number") of Common Stock at $1.00 per
share (subject to antidilution adjustments) upon satisfaction of certain
conditions, including the absence of any KOGC debt repurchase or redemption
obligations as a result of the purchase (a "Debt Event"), but not later than
January 2000. A Debt Event would occur upon (i) a "Change of Control" as
defined in the indenture for the Senior Notes, (ii) a "Change in Control" as
defined in the indenture for the 7 7/8% Notes or (iii) a "Redemption Event"
as defined in the indenture for the 8 1/2% Debentures. A Debt Event with
respect to either series of Notes or the 8 1/2% Debentures would entitle each
holder of the affected securities to require the repurchase or redemption of
the holder's securities. Contour is required to exercise the Contour Option
for the Maximum Option Number within 30 days after it concludes in its sole
discretion that a Debt Event would not occur as a result of the purchase.
While the current exercise of the Contour Option would not cause a Debt Event
under the indenture for the 8 1/2% Debentures, it would require waivers or
consents from the holders of a majority in aggregate principal amount of the
Senior Notes and 7 7/8% Notes. The Company is currently reviewing its
options for modifying its existing capital structure with the objectives of
improving its liquidity, increasing its operational flexibility and
permitting the exercise of the Contour Option.
LIQUIDITY. Net cash used in operating activities, before working
capital adjustments, during the first six months of 1996 aggregated $5.1
million. The Company's cash position was increased during the first six
months of 1996 through the proceeds of $8.0 million in bank borrowings and
$48 million from the issuance of 48 million shares of Common Stock in the
Contour Transaction, partially offset by $4.0 million of transaction costs.
Funds used in investing and financing activities were comprised of net
property and equipment expenditures of $16.3 million, principal payments of
$30.0 million on bank borrowings and $8.9 million for working capital. As a
result of these activities, cash and cash equivalents increased from $6.4
million at December 31, 1995 to $7.1 million as of June 30, 1996. As of that
date, KOGC had a working capital deficit of $4.0 million, compared to a
working capital deficit of $9.2 million at the end of 1995.
In February 1996, the Company repaid outstanding bank borrowings of
$30.0 million under its prior credit facility with proceeds from the Contour
Transaction. In connection with the Contour Transaction, KOGC replaced that
facility with a new $35.0 million revolving credit facility agented by Texas
Commerce Bank National Association ("Credit Facility"). The borrowers under
the Credit Facility are Kelley Oil and Kelley Operating Company, Ltd., with
the Company and its subsidiary partnerships as guarantors. Under the terms
of the Senior Note indenture, Credit Facility borrowings will be limited to
$30.0 million until KOGC's year end reserves exceed reported volumes as of
January 1, 1995 as adjusted for subsequent asset sales. There were no
outstanding borrowings under the Credit Facility at June 30, 1996.
Interest on borrowings under the Credit Facility is payable at a rate
equal to (i) the higher of 1/2% above the agent bank's prime rate or 1%
above the federal funds rate in effect from time to time or (ii) at the
Company's election, 1 1/2% above a quoted Libor rate, together with a
quarterly commitment fee equal to 3/8% per annum of the unused portion of
the available borrowing base. The agreement for the Credit Facility requires
the payment of interest only until March 15, 1999, when all borrowings will
be repayable, subject to mandatory prepayment with net proceeds from asset
sales in excess of related borrowing base reductions.
Borrowings under the Credit Facility are secured by mortgages on
substantially all of the oil and gas assets of the Company and its
subsidiaries, together with a security interest in production proceeds from
oil and gas sales. The agreement covering the Credit Facility prohibits the
payment of dividends, requires the consent of the lenders for third party
borrowings or extraordinary transactions and provides financial covenants for
KOGC, including a maximum ratio of total funded debt to earnings before
interest, taxes and noncash charges and a minimum interest coverage ratio.
13
<PAGE>
CAPITAL COMMITMENTS. In February 1994, the Kelley Partners 1994
Development Drilling Program (the "1994 DDP") completed a public offering of
20,864,414 units at $3.00 per unit on a preemptive basis to Unitholders in
Kelley Partners. Kelley Oil subscribed for 18,821,655 units in addition to
its 3.94% general partner interest in the 1994 DDP. An additional 342,234
units were subscribed by Kelley Oil following investor defaults. As a
result, Kelley Oil's subscription commitment to the 1994 DDP increased to
$60.1 million or 92.15% of the 1994 DDP's total committed capital (the "KOIL
Share"), with other unitholders committing for the balance or 7.85% of the
1994 DDP's total committed capital (the "Outside Share"), payable in each
case 10% on subscription and the balance through the end of November 1994.
As of June 30, 1996, Kelley Oil had contributed $42.4 million to the 1994
DDP, together with interest at a market rate on the portion of its commitment
that remained outstanding after November 1994.
The 1994 DDP's partnership agreement provides that any contributions of
the partners not used or committed to be used for drilling activities during
the two-year period from the commencement of operations through February 29,
1996 (the "Commitment Period") be distributed to the partners on a pro rata
basis as a return of capital. Based on the amount of committed capital
actually used and committed to drilling activities by the end of the
Commitment Period, Kelley Oil determined the adjusted level of committed
partnership capital at $60.7 million in accordance with the 1994 DDP's
partnership agreement, and the 1994 DDP then distributed $.3 million
representing the Outside Share of uncommitted capital to its unitholders
other than Kelley Oil in March 1996 as a return of capital. Because the KOIL
Share of committed capital exceeded its capital contributions at that time,
Kelley Oil did not receive a distribution of uncommitted capital. Kelley Oil
intends to contribute the unfunded portion of its commitment, aggregating
$10.0 million as of August 12, 1996 after giving effect to the reduction in
the 1994 DDP's committed capital, together with interest, as funds are needed
for completion of the 1994 DDP's drilling program.
The Company anticipates that cash flow from operations and available
borrowings under the Credit Facility will be adequate to fund its capital
expenditure requirements for 1996. In addition, while exercise of the
Contour Option cannot be assured prior to January 2000, any proceeds received
under the Contour Option Agreement will be used to support drilling and
acquisition activities. To fully realize its financial objectives of growth
in production and reserves the Company could be required to pursue other
financing alternatives.
14
<PAGE>
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 31, 1996, the Company held its annual meeting of stockholders.
All of the incumbent directors listed in the Company's proxy statement for
the meeting were reelected. The number of votes cast for and against each
nominee are set forth below.
VOTES
VOTES FOR WITHHELD
------------- ------------
John F. Bookout 90,434,111 873,041
John J. Conklin, Jr. 90,393,283 913,869
Ralph P. Davidson 90,245,219 1,061,933
William J. Murray 90,386,944 920,208
Ogden M. Phipps 90,447,433 859,719
Michael B. Rothfeld 90,439,492 867,660
Ward W. Woods 90,446,892 860,260
The Stockholders also approved the Company's 1996 Incentive Stock Option
Plan at the annual meeting. The number of votes cast for and against are set
forth below.
VOTES
VOTES FOR WITHHELD
------------- ------------
82,419,833 4,109,243
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KELLEY OIL & GAS CORPORATION
Date: August 14, 1996 By: /S/ WILLIAM C. RANKIN
------------------------
William C. Rankin
Senior Vice President and
Chief Financial Officer
(Duly Authorized Officer)
(Principal Financial Officer)
16
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