SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
----------------------
(Mark One)
X Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 1998
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
Commission file number 33-93722
---------------------------
DENBURY RESOURCES INC.
DENBURY MANAGEMENT, INC.
(Exact name of Registrants as specified in its charter)
Canada Not applicable
Texas 75-2294373
(State or other (I.R.S. Employer
jurisdiction of Identification No.)
incorporation or
organization)
17304 Preston Rd.,
Suite 200 75252
Dallas, TX (Zip code)
(Address of principal
executive offices)
Registrant's telephone number, including area code: (972) 673-2000
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.
Class Outstanding at October 31, 1998
----- -------------------------------
Common Stock, no par value 26,801,680
<PAGE>
DENBURY RESOURCES INC.
INDEX
Part I. Financial Information Page
Consolidated Balance Sheets at September 30, 1998
(Unaudited) and December 31, 1997 3
Consolidated Statements of Operations for the Three
and Nine Months ended September 30, 1998 and
1997 (Unaudited) 4
Consolidated Statements of Cash Flows for the Nine
Months ended September 30, 1998 and 1997 (Unaudited) 5
Notes to Consolidated Financial Statements 6-10
Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-22
Part II. Other Information
Exhibits and Reports on Form 8-K 23
Signatures 24
2
<PAGE>
DENBURY RESOURCES INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands of U.S. Dollars)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---------- ----------
(Unaudited)
Assets
<S> <C> <C>
Current assets
Cash and cash equivalents $ 4,250 $ 9,326
Accrued production receivable 7,276 8,692
Trade and other receivables 13,375 15,362
---------- ----------
Total current assets 24,901 33,380
---------- ----------
Property and equipment (using full cost accounting)
Oil and natural gas properties 499,079 388,766
Unevaluated oil and natural gas properties 66,167 82,798
Less accumulated depreciation and depletion (264,247) (62,732)
---------- ----------
Net property and equipment 300,999 408,832
---------- ----------
Deferred income taxes 35,000 -
Other assets 8,452 5,336
---------- ----------
Total assets $ 369,352 $ 447,548
========== ==========
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable and accrued liabilities $ 16,025 $ 24,616
Oil and gas production payable 7,197 6,052
Current portion of long-term debt - 20
---------- ----------
Total current liabilities 23,222 30,688
---------- ----------
Long-term liabilities
Long-term debt 215,000 240,000
Provision for site reclamation costs 1,292 1,017
Deferred income taxes and other - 15,620
---------- ----------
Total long-term liabilities 216,292 256,637
---------- ----------
Shareholders' equity
Common shares, no par value, unlimited shares
authorized; outstanding - 26,801,680 and
20,388,683 shares at September 30, 1998 and
December 31, 1997, respectively 227,796 133,139
Retained earnings (accumulated deficit) (97,958) 27,084
---------- ----------
Total shareholders' equity 129,838 160,223
---------- ----------
Total liabilities and shareholders' equity $ 369,352 $ 447,548
========== ==========
</TABLE>
(See accompanying notes to Consolidated Financial Statements)
3
<PAGE>
DENBURY RESOURCES INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands except per share amounts)
(Unaudited - U.S. dollars)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
1998 1997 1998 1997
--------- ------- --------- -------
<S> <C> <C> <C> <C>
Revenues
Oil, gas and related product
sales $ 19,263 $20,180 $ 66,959 $60,083
Interest and other income 336 221 1,078 986
--------- ------- --------- -------
Total revenues 19,599 20,401 68,037 61,069
--------- ------- --------- -------
Expenses
Production 6,819 5,425 22,782 15,737
General and administrative 1,543 1,415 4,996 4,535
Interest 4,419 235 12,788 387
Depletion and depreciation 9,070 8,126 37,528 23,224
Franchise taxes 171 103 603 308
Writedown of oil and natural
gas properties - - 165,000 -
--------- ------- --------- -------
Total expenses 22,022 15,304 243,697 44,191
--------- ------- --------- -------
Income (loss) before income taxes (2,423) 5,097 (175,660) 16,878
Income tax benefit (provision) - (1,886) 50,618 (6,245)
--------- ------- --------- -------
Net income (loss) $ (2,423) $ 3,211 $(125,042) $10,633
========= ======= ========= =======
Net income (loss) per common share
Basic $ (0.09) $ 0.16 $ (4.88) $ 0.53
Fully diluted (0.09) 0.15 $ (4.88) 0.50
Average number of common shares
outstanding 26,743 20,273 25,631 20,175
========= ======= ======== =======
</TABLE>
(See accompanying notes to Consolidated Financial Statements)
4
<PAGE>
DENBURY RESOURCES INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Amounts in thousands of U.S. dollars)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
------------------------
1998 1997
--------- ---------
<S> <C> <C>
Cash flow from operating activities:
Net income (loss) $(125,042) $ 10,633
Adjustments needed to reconcile to net cash flow
provided by operations:
Depreciation, depletion and amortization 37,528 23,224
Writedown of oil and natural gas properties 165,000 -
Deferred income taxes (50,618) 6,245
Other 456 64
--------- ---------
27,324 40,166
Changes in working capital items relating to operations:
Accrued production receivable 1,416 4,809
Trade and other receivables 1,987 (10,864)
Accounts payable and accrued liabilities (8,591) 5,955
Oil and gas production payable 1,145 (1,490)
--------- ---------
Net cash flow provided by operations 23,281 38,576
--------- ---------
Cash flow used for investing activities:
Oil and natural gas expenditures (80,222) (54,700)
Acquisition of oil and natural gas properties (13,460) (16,073)
Net purchases of other assets (908) (1,238)
--------- ---------
Net cash used for investing activities (94,590) (72,011)
--------- ---------
Cash flow from financing activities:
Bank repayments (200,000) -
Bank borrowings 50,000 19,900
Issuance of senior subordinated debt 125,000 -
Issuance of common stock 94,657 2,421
Costs of debt financing (3,402) (33)
Other (22) (70)
--------- ---------
Net cash provided by financing activities 66,233 22,218
--------- ---------
Net decrease in cash and cash equivalents (5,076) (11,217)
Cash and cash equivalents at beginning of year 9,326 13,453
--------- ---------
Cash and cash equivalents at end of period $ 4,250 $ 2,236
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 11,374 $ 150
</TABLE>
(See accompanying notes to Consolidated Financial Statements)
5
<PAGE>
DENBURY RESOURCES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1998 and 1997
1. ACCOUNTING POLICIES
Interim Financial Statements
These financial statements and the notes thereto should be read in
conjunction with the Company's annual report on Form 10-K for the year ended
December 31, 1997. Any capitalized items used but not defined in these Notes to
Consolidated Financial Statements have the same meaning given to them in the
Form 10-K.
Accounting measurements at interim dates inherently involve greater
reliance on estimates than at year end and the results of operations for the
interim periods shown in this report are not necessarily indicative of results
to be expected for the fiscal year. In the opinion of management of Denbury
Resources Inc. (the "Company" or "Denbury"), the accompanying unaudited
consolidated financial statements include all adjustments (of a normal recurring
nature) necessary to present fairly the consolidated financial position of the
Company as of September 30, 1998 and the consolidated results of its operations
for the three and nine months ended September 30, 1998 and 1997 and its cash
flow for the nine months ended September 30, 1998 and 1997.
Net Income and Loss per Common Share
Net income or loss per common share is computed by dividing the net income
or loss by the weighted average number of shares of common stock outstanding. In
accordance with Canadian generally accepted accounting principles ("GAAP"), the
stock options and warrants were included in the calculation of fully diluted
earnings per share but were anti-dilutive to the calculation of losses per
share.
2. NOTES PAYABLE AND LONG-TERM INDEBTEDNESS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
----------- -----------
(Amounts in thousands)
(Unaudited)
<S> <C> <C>
9% Senior Subordinated Notes Due 2008 $ 125,000 $ -
Senior bank loan 90,000 240,000
Other notes payable - 20
Less portion due within one year - (20)
----------- -----------
Total long-term debt $ 215,000 $ 240,000
=========== ===========
</TABLE>
3. DIFFERENCES IN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES BETWEEN CANADA AND
THE UNITED STATES
The consolidated financial statements have been prepared in accordance with
Canadian GAAP. The primary difference between Canadian and U.S. GAAP affecting
the Company's 1998 consolidated financial statements result from the different
methodology for computing fully diluted earnings or losses per common share. For
Canadian purposes, the proceeds from dilutive securities are used to reduce debt
in the calculation. Under U.S. GAAP, Statement of Financial Accounting Standards
("SFAS") No. 128 requires the proceeds from such instruments be used to
repurchase Common Shares. For the three and nine month periods ended September
30, 1998 and the three months ended September 30, 1997, the earnings and losses
per share were the same under U.S. and Canadian GAAP. For
6
<PAGE>
DENBURY RESOURCES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1998 and 1997
the nine months ended September 30, 1997, the fully diluted earnings per share
were $0.49 and $0.50 for U.S. and Canadian GAAP, respectively.
The U.S. full cost accounting rules differ from the Canadian full cost
accounting guidelines followed by the Company. In determining the limitation on
carrying values, U.S. accounting rules require the discounting of estimated
future net revenues from its proved reserves at 10% using constant current
prices following the guidelines of the Securities and Exchange Commission
("SEC") while the Canadian guidelines require the use of the same future net
revenues but on an undiscounted basis and after the deduction of estimated
future administrative and financing costs. The Canadian accounting guidelines
also allow a company to exclude acquired properties from the ceiling test
calculation for up to two years, while the SEC allows an exclusion for only one
year and then only after obtaining approval. See also "Note 4. Property and
Equipment" for a discussion of the application of these rules on the ceiling
test calculation.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (the "Statement"), which establishes
standards for accounting and reporting derivative instruments. SFAS No. 133 is
effective for periods beginning after June 15, 1999; however, earlier
application is permitted. Management is currently not planning on early adoption
of this Statement and has not had an opportunity to evaluate the impact of the
provisions of the Statement on the Company's consolidated financial statements.
4. PROPERTY AND EQUIPMENT
As further discussed in Note 3, the Canadian accounting guidelines allow a
Company to exclude acquired properties from the ceiling test calculation for up
to two years, while the SEC allows an exclusion for only one year and then only
after obtaining approval. During the first quarter of 1998, the Company obtained
approval from the SEC for an exclusion of the Heidelberg Field acquired late in
1997. This exclusion was allowed because the Company believed that, based on its
success with similar properties in Mississippi, the value of the Heidelberg
Field acquired from Chevron and other entities was at least equal to its
carrying cost. Had this property been included in the ceiling test calculation,
the Company would have had a writedown of the property carrying costs as of
March 31, 1998 of approximately $35 million for both U.S. and Canadian GAAP.
During the second quarter of 1998, oil prices continued to decline, with a
drop of approximately $1.45 in the NYMEX oil price from March 31 to June 30,
1998. Furthermore, the gap between the NYMEX oil price and the net field price
widened, causing the net oil price at Heidelberg Field to drop approximately
$1.00 per barrel ("Bbl") more than the decline in the NYMEX price. Due to the
continued low oil prices, in June, 1998 the Company announced that it was
reducing its developmental drilling activity and capital expenditure budget on
its oil properties, including Heidelberg Field, until oil product prices
recover. As a result of this curtailment, it was unlikely that the proved
reserves and production from this property would increase as quickly as
originally anticipated, thus causing a decline in the current value of this
property. Therefore, as of June 30, 1998, the Company included the Heidelberg
Field in the full cost pool for its ceiling test, which resulted in a $165
million writedown of the full cost pool as of the same date. Of this total, $106
million resulted from the inclusion of the Heidelberg Field in the full cost
pool and $28 million related to an impairment of the unevaluated carrying cost
on this same field. As required by U.S. GAAP, this ceiling test was computed
using June 30, 1998 prices, which were equivalent to a NYMEX oil price of $14.00
per Bbl and an average net realized oil price of $8.90 per Bbl. This writedown
was approximately the same for both
7
<PAGE>
DENBURY RESOURCES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1998 and 1997
U.S. and Canadian GAAP. Although this writedown reduced the Company's capital
below the threshold required by the Company's banks and required the Company to
obtain a waiver (which was given), these charges were non-cash and should not
have any direct impact on the Company's liquidity.
As of September 30, 1998, the Company did not require any additional
writedown as oil prices had temporarily increased above the June 30, 1998
levels. However, oil prices have deteriorated since September 30 and as of
October 30, 1998, were at approximately the same level as they were at June 30.
If prices remain at these levels or deteriorate further, the Company may be
faced with an additional writedown at December 31, 1998.
5. CONDENSED CONSOLIDATING FINANCIAL INFORMATION
Denbury Management, Inc. issued 9% Senior Subordinated Notes due 2008
during February 1998 which are fully and unconditionally guaranteed by Denbury
Resources Inc. Denbury Holdings Ltd. was merged into Denbury Resources Inc. in
December 1997 and is not a guarantor of the debt. Condensed consolidating
financial information for Denbury Resources Inc. and Subsidiaries as of
September 30, 1998 and December 31, 1997 and for the nine months ended September
30, 1998 and 1997 is as follows:
DENBURY RESOURCES INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
(Amounts in thousands of U.S. dollars)
<TABLE>
<CAPTION>
September 30, 1998 (Unaudited)
------------------------------------------------
Denbury Denbury Denbury
Management Resources Resources
Inc. Inc. Inc.
(Issuer) (Guarantor) Elimination Consolidated
---------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
ASSETS
Current assets.................$ 24,831 $ 70 $ - $ 24,901
Property and equipment (using
full cost accounting)........ 300,999 - - 300,999
Investment in subsidiaries
(equity method).............. - 129,784 (129,784) -
Other assets................... 43,451 1 - 43,452
---------- ----------- ----------- ------------
Total assets................$ 369,281 $ 129,855 $ (129,784) $ 369,352
========== =========== =========== ============
LIABILITIES AND SHAREHOLDERS'
EQUITY
Current liabilities............$ 23,205 $ 17 $ - $ 23,222
Long-term liabilities.......... 216,292 - - 216,292
Shareholders' equity........... 129,784 129,838 (129,784) 129,838
---------- ----------- ----------- ------------
Total liabilities and
shareholders' equity......$ 369,281 $ 129,855 $ (129,784) $ 369,352
========== =========== =========== ============
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997
------------------------------------------------
Denbury Denbury Denbury
Management Resources Resources
Inc. Inc. Inc.
(Issuer) (Guarantor) Elimination Consolidated
---------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
ASSETS
Current assets.................$ 33,017 $ 363 $ - $ 33,380
Property and equipment (using
full cost accounting)........ 408,832 - - 408,832
Investment in subsidiaries
(equity method)................ - 159,892 (159,892) -
Other assets................... 5,234 102 - 5,336
---------- ----------- ----------- ------------
Total assets................$ 447,083 $ 160,357 $ (159,892) $ 447,548
========== =========== =========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities............$ 30,554 $ 134 $ - $ 30,688
Long-term liabilities.......... 256,637 - - 256,637
Shareholders' equity........... 159,892 160,223 (159,892) 160,223
---------- ----------- ----------- ------------
Total liabilities and
shareholders' equity.....$ 447,083 $ 160,357 $ (159,892) $ 447,548
========== =========== =========== ============
</TABLE>
8
<PAGE>
DENBURY RESOURCES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1998 and 1997
DENBURY RESOURCES INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
(Amounts in thousands of U.S. dollars)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended September 30, 1998
------------------------------------------------
Denbury Denbury Denbury
Management Resources Resources
Inc. Inc. Inc.
(Issuer) (Guarantor) Elimination Consolidated
---------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Revenues.......................$ 19,599 $ - $ - $ 19,599
Expenses....................... 21,987 35 - 22,022
---------- ----------- ----------- ------------
Loss before the following: (2,388) (35) - (2,423)
Equity in net earnings
(losses)of subsidiaries.... - (2,388) 2,388 -
---------- ----------- ----------- ------------
Loss before income taxes....... (2,388) (2,423) 2,388 (2,423)
Income tax benefit............. - - - -
---------- ----------- ----------- ------------
Net loss.......................$ (2,388)$ (2,423)$ 2,388 $ (2,423)
========== =========== =========== ============
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended September 30, 1997
-----------------------------------------------------------
Denbury Denbury Denbury
Management Denbury Resources Resources
Inc. Holdings Inc. Inc.
(Issuer) Ltd. (Guarantor) Elimination Consolidated
---------- --------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Revenues.......................$ 20,400 $ - $ 37 $ (36) $ 20,401
Expenses....................... 15,304 - 36 (36) 15,304
--------- --------- ----------- ----------- ------------
Income before the following: 5,096 - 1 - 5,097
Equity in net earnings of
subsidiaries.............. - 3,210 3,210 (6,420) -
--------- --------- ----------- ----------- ------------
Income before income taxes..... 5,096 3,210 3,211 (6,420) 5,097
Provision for income taxes..... (1,886) - - - (1,886)
--------- --------- ----------- ----------- ------------
Net income.....................$ 3,210 $ 3,210 $ 3,211 $ (6,420) $ 3,211
========= ========= =========== =========== ============
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30, 1998
------------------------------------------------
Denbury Denbury Denbury
Management Resources Resources
Inc. Inc. Inc.
(Issuer) (Guarantor) Elimination Consolidated
---------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Revenues.......................$ 68,035 $ 2 $ - $ 68,037
Expenses....................... 243,566 131 - 243,697
---------- ----------- ----------- ------------
Loss before the following: (175,531) (129) - (175,660)
Equity in net earnings
(losses) of subsidiaries.. - (124,913) 124,913 -
---------- ----------- ----------- ------------
Loss before income taxes....... (175,531) (125,042) 124,913 (175,660)
Income tax benefit............. 50,618 - - 50,618
---------- ----------- ----------- ------------
Net loss.......................$ (124,913)$ (125,042)$ 124,913 $ (125,042)
========== =========== =========== ============
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30, 1997
-----------------------------------------------------------
Denbury Denbury Denbury
Management Denbury Resources Resources
Inc. Holdings Inc. Inc.
(Issuer) Ltd. (Guarantor) Elimination Consolidated
---------- --------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Revenues.......................$ 61,066 $ - $ 105 $ (102) $ 61,069
Expenses....................... 44,191 - 102 (102) 44,191
---------- --------- ----------- ----------- ------------
Income before the following: 16,875 - 3 - 16,878
Equity in net earnings of
subsidiaries.............. - 10,630 10,630 (21,260) -
---------- --------- ----------- ----------- ------------
Income before income taxes..... 16,875 10,630 10,633 (21,260) 16,878
Provision for income taxes..... (6,245) - - - (6,245)
---------- --------- ----------- ----------- ------------
Net income.....................$ 10,630 $ 10,630 $ 10,633 $ (21,260) $ 10,633
========== ========= =========== =========== ============
</TABLE>
9
<PAGE>
DENBURY RESOURCES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1998 and 1997
6. PRODUCT PRICE HEDGING CONTRACTS
During June and July, 1998, the Company entered into two financial
contracts ("collars") to hedge a total of 40 million cubic feet of natural gas
per day ("MMcf/d"). The first natural gas contract for 35 MMcf/d covers the
period from July 1998 to June 1999 and has a floor price of $1.90 per million
British Thermal Units ("MMBtu") and a ceiling price of $2.96 per MMBtu. The
second natural gas contract for five MMcf/d covers the period from September
1998 to August 1999 and has a floor price of $1.90 per MMBtu and a ceiling price
of $2.89 per MMBtu. These contracts cover approximately 100% of the Company's
current net natural gas production.
10
<PAGE>
DENBURY RESOURCES INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following should be read in conjunction with the response to Part I,
Item 1 of this Report and Items 7 and 8 of the Form 10-K. Any capitalized terms
used but not defined in this Item have the same meaning given to them in the
Form 10-K.
Denbury is an independent energy company engaged in acquisition,
development and exploration activities in the U.S. Gulf Coast region, primarily
onshore in Louisiana and Mississippi. Denbury's primary strategy is to acquire
properties which it believes have significant upside potential and increase the
value of these properties through the efficient development, enhancement and
operation of those properties. Denbury's corporate headquarters is in Dallas,
Texas and it has two primary field offices in Houma, Louisiana and Laurel,
Mississippi.
CAPITAL RESOURCES AND LIQUIDITY
As more fully described under "Results of Operations" below, between the
first nine months of 1997 and 1998, the Company's net oil product prices have
decreased 39% ($6.89 per barrel of oil ("Bbl")) and natural gas product prices
have declined by 7% ($0.19 per thousand cubic feet of natural gas ("Mcf")). Due
to this drop in oil and natural gas prices, the Company's cash flow and earnings
have been significantly reduced during 1998. This reduction in cash flow has
also contributed to an increase in the Company's debt levels during the year.
With oil prices at one of the lowest levels in recent history and with the
increase in debt during 1998, the Company's total debt, when measured as a
multiple of cash flow, is at one of its highest historical levels.
As of September 30, 1998, the Company had minimal working capital with $90
million of bank debt outstanding ($100 million outstanding as of October 31,
1998) and $125 million outstanding on its Notes. In September, 1998, the banks
completed their regular semi-annual review of the Company's borrowing base based
on June 30, 1998 assets and reserves (See also "Restated Credit Facility"
below). As a result, the Company's borrowing base was reduced from $165 million
to $130 million with the decrease almost entirely due to reduced oil prices.
This leaves approximately $30 million available under the Company's credit line
as of October 31, 1998. The Company's next borrowing base review will be in the
first quarter of 1999 based on December 31, 1998 assets and reserves. If prices
remain low or deteriorate further, it is possible that the banks will further
reduce the borrowing base at that time. Although the Company is not in default
of any of its debt covenants at the present time, a continued low oil price for
an extended period of time could cause the Company to violate its agreements in
the future.
In response to the decline in oil prices, the Company announced in June
1998 that it was curtailing the horizontal drilling program on its oil
properties and generally focusing on projects that may impact future years, such
as expenditures on facilities, waterflood units, and a few higher potential
projects. This modification in the development program was also done at the
Heidelberg Field in Mississippi, a property acquired from Chevron (with
additional minor interests from other third parties) for over $200 million in
December, 1997 (the "Chevron Acquisition").
Overall, capital spending remained at relatively high levels through the
first nine months with total capital expenditures of approximately $93.7
million, which includes $13.5 million of acquisitions. However, approximately
31% or $24.6 million of the development expenditures were directed to long term
projects such as production facilities and waterflood units, plus undeveloped
properties such as acreage and seismic. Expenditures on these types of projects
are not expected to benefit the Company until 1999 and beyond. During the third
quarter, the Company also shifted a portion of its spending from its Mississippi
oil properties to its natural gas properties in Louisiana. A total of $10.8
million was spent in Louisiana in the third quarter of 1998 (62%) as compared to
only 16% of the total budget spent in Louisiana during the first six months.
With continued low oil prices and faced with a rising debt level, during the
latter part of the third quarter the Company took additional steps to reduce its
future capital expenditures to a level that approximates estimated available
cash flow. Although the level of the Company's projected cash flow is highly
11
<PAGE>
DENBURY RESOURCES INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
variable and difficult to predict as it is dependent on product prices, drilling
success and other factors, the Company expects its fourth quarter development
budget to more closely match available cash flow. Therefore, development
spending in the near future should not cause debt to increase much, if any,
beyond its current level. This reduced spending level will cause a corresponding
reduction in the previously anticipated production levels and related cash flow.
It is uncertain whether the Company will be able to maintain its current
production levels with this reduced level of capital expenditures.
In addition to its internal capital expenditure program, the Company has
historically required capital for acquisitions of producing properties, which
have been a major factor in the Company's growth during recent years. The
Company believes that the current price environment may be a good time to pursue
additional acquisitions, but without additional capital, its spending ability is
limited. The Company is currently reviewing its options with regards to raising
additional funds. However, there can be no assurance that the Company will have
capital available to fund acquisitions or that suitable acquisitions can be
identified and completed, nor can there be any assurance that any such
acquisitions will be successful in achieving desired profitability objectives.
Without suitable acquisitions or the capital to fund such acquisitions, the
Company's future growth could be limited or even eliminated.
Although oil prices have fallen substantially during 1998, the Company does
not believe that oil prices will remain this low indefinitely. Any increase in
price would have a positive affect on both earnings and cash flow. The Company
has also built a significant inventory of oil projects that it can commence,
subject to the availability of capital, once oil prices improve.
NATURAL GAS HEDGES
In further response to the decline in oil prices and to mitigate additional
price-related negative effects on the Company's cash flow, in June and July,
1998, the Company entered into two financial contracts ("collars") to hedge a
total of 40 million cubic feet of natural gas per day ("MMcf/d") of natural gas
production. The first natural gas contract for 35 MMcf/d covers the period from
July 1998 to June 1999 and has a floor price of $1.90 per million British
Thermal Units ("MMBtu") and a ceiling price of $2.96 per MMBtu. The second
natural gas contract for five MMcf/d covers the period from September 1998 to
August 1999 and has a floor price of $1.90 per MMBtu and a ceiling price of
$2.89 per MMBtu. These contracts cover approximately 100% of the Company's
current net natural gas production.
FULL COST CEILING TEST
Under full cost accounting rules, each quarter the Company is required to
perform a ceiling test calculation. In determining the limitation on carrying
values, U.S. accounting rules require the discounting of estimated future net
revenues from its proved reserves at 10% using constant current prices following
the guidelines of the Securities and Exchange Commission ("SEC"), while the
Canadian guidelines require the use of the same future net revenues but on an
undiscounted basis and after the deduction of estimated future administrative
and financing costs. The Canadian accounting guidelines also allow a company to
exclude acquired properties from the ceiling test calculation for up to two
years, while the SEC allows an exclusion for only one year and then only after
obtaining approval. The Company obtained approval for such an exclusion from the
SEC and excluded the Heidelberg Field from the full cost ceiling test as of
March 31, 1998 as it believed that, based on its success with similar properties
in Mississippi, the value of this property was at least equal to its carrying
cost. As of March 31, 1998, the inclusion of Heidelberg Field in the ceiling
test would have resulted in a $35 million writedown.
12
<PAGE>
DENBURY RESOURCES INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
During the second quarter of 1998, oil prices continued to decline, with a
drop of approximately $1.45 in the NYMEX oil price from March 31 to June 30,
1998. Furthermore, the gap between the NYMEX oil price and the net realized
price widened, causing the net realized price at Heidelberg Field to drop
approximately $1.00 per Bbl more than the decline in the NYMEX price. As
previously discussed, due to the continued low oil prices, in June 1998 the
Company announced that it was reducing its drilling activity and capital
expenditure budget on its oil properties, including Heidelberg Field, until oil
product prices recover. As a result of this curtailment, it was unlikely that
the proved reserves and production from this property would increase as quickly
as originally anticipated, thus causing a decline in the current value of this
property. Therefore, as of June 30, 1998, the Company included the Heidelberg
Field in the full cost pool for its ceiling test, which resulted in a $165
million writedown of the full cost pool as of the same date. Of this total, $106
million resulted from the inclusion of the Heidelberg Field in the full cost
pool and $28 million related to an impairment of the unevaluated carrying cost
on this same field. As required by U.S. GAAP, this ceiling test was computed
using June 30, 1998 prices, which were equivalent to a NYMEX oil price of $14.00
per Bbl and an average net realized oil price of $8.90 per Bbl. This writedown
was approximately the same for both U.S. and Canadian GAAP. Although this
writedown reduced the Company's capital below the threshold required by the
Company's banks (see also "Restated Credit Facility" below) and required the
Company to obtain a waiver (which was given), these charges were non-cash items
and should not have any direct impact on the Company's liquidity.
As of September 30, 1998, the Company did not require any additional
writedown as oil prices had temporarily increased above the June 30, 1998
levels. However, oil prices have deteriorated since September 30 and as of
October 30, 1998, were at approximately the same level as they were at June 30.
If prices remain at these levels or deteriorate further, the Company may be
faced with an additional writedown at December 31, 1998.
RESTATED CREDIT FACILITY
The Company has a credit facility (the "Credit Facility") with NationsBank
of Texas, N.A., as agent and part of a group of eight other banks. The Credit
Facility was increased in size from $150 million to $300 million in December
1997 and the borrowing base was increased to $260 million in order to fund the
Chevron Acquisition. The December 31, 1997 outstanding balance of $240 million
was reduced to $40 million as of February 26, 1998 after application of the net
proceeds from the Debt and Equity Offerings and the TPG Purchase (collectively
the "Capital Transactions" as herein defined), net of $9.8 million of additional
borrowings.
The Credit Facility consists of a five-year revolving credit facility and
after the Capital Transactions had a borrowing base of $165 million. This
borrowing base is subject to review every six months and the Credit Facility is
secured by substantially all of the Company's oil and natural gas properties,
except for those acquired in the Chevron Acquisition. Interest is payable on the
revolving credit facility at either the prime rate or, depending on the
percentage of the borrowing base that is outstanding, at rates ranging from
LIBOR plus 7/8% to LIBOR plus 1 3/8%. The Credit Facility has several
restrictions, including, among others: (i) a prohibition on the payment of
dividends; (ii) a requirement for a minimum equity balance; (iii) a requirement
to maintain positive working capital (as defined in the Credit Agreement); (iv)
a minimum interest coverage test; and (v) a prohibition on most debt, lien and
corporate guarantees.
As previously discussed in "Capital Resources and Liquidity", the latest
semi-annual credit review of the borrowing base was just completed based on June
30, 1998 assets and reserves. As a result of this review, the Company's
borrowing base was reduced from $165 million to $130 million with the decrease
almost entirely due to reduced oil prices. This leaves the Company with
approximately $30 million available under its credit line as of October 31,
1998.
13
<PAGE>
DENBURY RESOURCES INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
1998 PUBLIC DEBT AND EQUITY OFFERING
On February 26, 1998, the Company closed its public sale of 5,240,780
Common Shares (which included the underwriter's over-allotment option of 683,580
Common Shares) at a price of $16.75 per share and a net price to the Company of
$15.955 per share (the "Equity Offering"). Concurrently with the Equity
Offering, affiliates of the Texas Pacific Group ("TPG"), the Company's largest
shareholder, purchased 313,400 Common Shares from the Company at $15.955 per
share, equal to the price to the public per share less underwriting discounts
and commissions (the "TPG Purchase"). The net proceeds to the Company from the
Equity Offering and TPG Purchase were approximately $88.6 million, before
offering expenses.
Concurrently with the Equity Offering and TPG Purchase, Denbury Management
Inc., a wholly owned subsidiary of the Company, issued $125 million in aggregate
principal amount of 9% Senior Subordinated Notes Due 2008 (the "Debt Offering"
and the "Notes"). These Notes contain certain debt covenants, including
covenants that limit (i) indebtedness, (ii) certain payments including
dividends, (iii) sale/leaseback transactions, (iv) transactions with affiliates,
(v) liens, (vi) asset sales, and (vii) mergers and consolidations. The net
proceeds to the Company from the Debt Offering were approximately $121.8
million, before offering expenses.
The total net proceeds from the debt and equity offerings (the "Capital
Transactions") were approximately $209.5 million after deducting total offering
expenses of $900,000. The Company used these proceeds to reduce outstanding
borrowings under the Company's bank credit facility, the majority of which had
been borrowed to fund the $202 million acquisition of properties from Chevron
(the "Chevron Acquisition") in December 1997.
SOURCES AND USES OF FUNDS
During the first nine months of 1998, the Company spent approximately $80.2
million on exploration and development activities and approximately $13.5
million on acquisitions. The exploration and development expenditures included
approximately $48.7 million spent on drilling, $17.1 million on geological,
geophysical and acreage expenditures and $14.4 million on workover costs. These
expenditures were funded by bank debt and cash flow from operations.
During the first nine months of 1997, the Company spent approximately $54.7
million on oil and natural gas development activities and approximately $16.1
million on acquisitions. The development expenditures included approximately
$38.2 million spent on drilling, $6.7 million on geological, geophysical and
acreage expenditures and the balance of $9.8 million was spent on workover
costs. These expenditures were funded by available cash, cash flow from
operations and bank debt.
ACQUISITION UPDATES
On December 30, 1997, the Company acquired oil properties in the Heidelberg
Field, Jasper County, Mississippi, from Chevron for approximately $202 million,
plus other minor interests from other third parties. The Chevron Acquisition
represents the largest acquisition by the Company to date. The average net daily
production from these properties during the fourth quarter of 1997 was
approximately 2,800 barrels of oil per day ("Bbls/d") and 650 thousand cubic
feet of natural gas per day ("Mcf/d"). During the first nine months of 1998, the
average net daily
14
<PAGE>
DENBURY RESOURCES INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
production increased to approximately 3,600 BOE/d and was approximately 4,200
BOE/d during the third quarter. This increase resulted primarily from 8
horizontal wells drilled during the first six months; however, as a result of
low oil prices, the Company has postponed the drilling of 14 other horizontal
wells originally planned for 1998. Because of this reduction in planned drilling
expenditures, the production is not expected to materially change at Heidelberg
Field during the remainder of 1998. The Company has not halted its planned
expenditures on the East Heidelberg waterflood unit and other facilities,
although these expenditures are not expected to have any current impact on
production rates. The Company does anticipate some positive production response
from the waterflood at Heidelberg during 1999, although it is difficult to
predict the magnitude of such a response.
The Company completed several property acquisitions during 1996, the
largest of which was the acquisition of producing oil and natural gas
properties, principally in Mississippi and Louisiana, for approximately $37.2
million from Amerada Hess, effective May 1, 1996 (the "Hess Acquisition"). The
average daily production from the properties included in the Hess Acquisition
during May and June 1996, the first two months of ownership, was approximately
2,945 BOE/d. The average daily production on these properties had increased to
5,969 BOE/d during the fourth quarter of 1997 and 8,900 BOE/d during the first
nine months of 1998. During the third quarter of 1998, the average production on
these properties began to decline and for the quarter averaged 7,600 BOE/d. The
decrease is primarily due to production declines on several horizontal oil wells
drilled at Eucutta Field in late 1997 and early 1998 and the lack of subsequent
development work to replace this production.
PROPOSED CHANGE IN LEGAL DOMICILE
The board of directors of Denbury Resources Inc. ("DRI") has approved DRI
changing its legal domicile from Canada to the United States. The Company
currently anticipates that in the fourth quarter of 1998 it will file a
registration statement with the SEC containing a form of proxy statement to be
used to solicit shareholder approval of such action. A special meeting of
shareholders is likely to be held during the first quarter of 1999 to vote upon
this proposal. If approved by the shareholders and completed, this transaction
would not have any impact on the general operations or business of the Company.
However, it would give the Company more flexibility with regard to its capital
structure and certain regulatory issues. A more detailed analysis of the
transaction can be obtained by reviewing the prospectus when it is available.
However, if management determines that such change of domicile will result a
significant amount of tax being paid by the Company or its shareholders, then
such proposal may be delayed or abandoned.
RESULTS OF OPERATIONS
Operating Income
While production volumes were 57% higher on a BOE basis during the first
nine months of 1998 as compared to the first nine months of 1997, operating
income decreased slightly due to a 29% decline in product prices (on a BOE
basis), as set forth in the following chart.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
- --------------------------------- -------------------- ------------------
1998 1997 1998 1997
- --------------------------------- --------- -------- -------- -------
<S> <C> <C> <C> <C>
AVERAGE DAILY PRODUCTION VOLUME:
Bbls 12,764 8,148 14,373 7,615
Mcf 39,829 36,282 39,255 36,061
BOE 19,402 14,195 20,916 13,292
</TABLE>
15
<PAGE>
DENBURY RESOURCES INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
- --------------------------------- -------------------- ------------------
1998 1997 1998 1997
- --------------------------------- --------- -------- -------- -------
<S> <C> <C> <C> <C>
UNIT PRICES
Oil price per barrel ("Bbl") $ 9.30 $ 16.12 $ 10.64 $ 17.53
Gas price per thousand cubic
feet ("Mcf") 2.28 2.43 2.35 2.54
NETBACK PER BOE (1):
Sales price $ 10.79 $ 15.45 $ 11.73 $ 16.56
Production expenses (3.82) (4.15) (3.99) (4.34)
--------- -------- -------- -------
Production netback $ 6.97 $ 11.30 $ 7.74 $ 12.22
--------- -------- -------- -------
OPERATING INCOME (THOUSANDS)
Oil sales $ 10,921 $ 12,085 $ 41,748 $36,436
Natural gas sales 8,342 8,095 25,211 $23,647
Less production expenses (6,819) (5,425) (22,782) (15,737)
--------- -------- -------- -------
Operating income $ 12,444 $ 14,755 $ 44,177 $44,346
- --------------------------------- --------- -------- -------- -------
<FN>
(1) Barrel of oil equivalent using the ratio of one barrel of oil to 6 Mcf of
natural gas ("BOE").
</FN>
</TABLE>
The production increases between 1997 and 1998 were fueled by both internal
growth from the Company's development and exploration programs and from the
acquisition of producing properties during 1997, particularly the Chevron
Acquisition in December 1997. The properties included in the Chevron Acquisition
contributed approximately 4,200 BOE/d to the increase during the third quarter
of 1998 and 3,600 BOE/d during the first nine months of 1998, with the remainder
of the increase almost solely as a result of internal development, primarily on
the properties acquired in the Hess Acquisition. During the third quarter and
first nine months of 1998, the production from these Hess properties averaged
7,600 BOE/d and 8,900 BOE/d respectively, a 41% and 86% increase from the
average of 5,373 BOE/d and 4,794 BOE/d during the comparable periods of 1997.
The production on these Hess Properties has begun to decline in the third
quarter (See "Acquisition Updates" above).
Although 1998 production has increased substantially over 1997 levels, when
comparing the second and third quarters of 1998 the Company experienced a
decline in overall production rates for the first time in several years. This
was due to (i) shutting in uneconomic wells, (ii) declines on existing
production, particularly the horizontal wells, and (iii) the postponement of
several oil development projects due to the low oil prices.
Oil and gas revenue increased as a result of the large increase in
production, although the revenue increase was not proportional to the production
increase due to a substantial decline in oil product prices. Between the third
quarter of 1997 and 1998, oil product prices decreased 42% ($6.82 per Bbl) while
natural gas product prices declined 6% ($0.15 per Mcf). When comparing the
prices for the comparable nine month periods, oil product prices decreased 39%
($6.89 per Bbl) and natural gas product prices declined by 7% ($0.19 per Mcf).
Production and operating expenses increased between 1997 and 1998 primarily
due to an increase in the number of properties, with the largest increase coming
from the addition of properties acquired in the Chevron Acquisition. Even though
the number of properties increased, production increased at a faster pace
allowing the Company to reduce its production and operating expenses on a BOE
basis by 8% when comparing the respective 1998 periods to 1997.
16
<PAGE>
DENBURY RESOURCES INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the properties acquired in the Hess Acquisition, the operating expenses
declined from the 1996 level of $5.35 per BOE to $4.56 per BOE for 1997 and were
further reduced to $3.14 for the first nine months of 1998. This reduction is
largely attributable to the Company's emphasis in 1997 and early 1998 on
horizontal drilling on these properties and the resulting increases in
production. The Company was also able to lower costs during the third quarter of
1998 by shutting in uneconomical wells and through other general cost saving
measures. The Company has been able to achieve these reductions in operating
expenses per BOE even though the Company's production has become even more
weighted towards oil (which has higher operating costs) with approximately 69%
of the Company's first nine months of 1998 production coming from oil as
compared to 57% during the first nine months of 1997.
The operating expenses per BOE for the properties acquired in the Chevron
Acquisition averaged $4.27 per BOE for the third quarter of 1998 and $4.90 per
BOE for the first nine months of 1998, both significant declines from the
average of approximately $6.38 per BOE when the properties were owned by
Chevron.
General and Administrative Expenses
General and administrative ("G&A") expenses have increased as set forth
below along with the Company's growth.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
- -------------------------------- ------------------ -------------------
1998 1997 1998 1997
- -------------------------------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
NET G&A EXPENSES (THOUSANDS)
Gross expenses $ 4,631 $ 3,328 $ 14,382 $ 9,999
State franchise taxes 171 103 603 308
Operator overhead charges (2,455) (1,398) (7,375) (3,789)
Capitalized exploration expenses (633) (515) (2,011) (1,675)
-------- -------- -------- --------
Net expenses $ 1,714 $ 1,518 $ 5,599 $ 4,843
-------- -------- -------- --------
Average G&A cost per BOE $ 0.96 $ 1.16 $ 0.98 $ 1.33
Employees as of September 30 208 141 208 141
- -------------------------------- -------- -------- -------- --------
</TABLE>
On a BOE basis, G&A costs decreased 17% from the third quarter of 1997 to
the comparable period in 1998 and 26% when comparing the first nine months of
1998 to the first nine months of 1997, in part because of increased production
on both an absolute and per well basis and also from general cost saving
measures, particularly during the third quarter of 1998. Furthermore, the
respective well operating agreements allow the Company, when it is the operator,
to charge a well with a specified overhead rate during the drilling phase and to
also charge a monthly fixed overhead rate for each producing well. As a result
of the increased drilling activity in early 1998 and the addition of several
producing wells acquired in the Chevron Acquisition, the percentage of gross G&A
recovered through these types of allocations (listed in the above table as
"Operator overhead charges") increased when compared to the corresponding
periods in 1997. During the third quarter of 1997, approximately 42% of gross
G&A was recovered by operator overhead charges, while during the third quarter
of 1998 this recovery increased to 53%. This difference was even more pronounced
when comparing the respective first nine months, with approximately 38% of gross
G&A
17
<PAGE>
DENBURY RESOURCES INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
recovered by operator overhead charges during the first nine months of 1997 as
compared to approximately 51% during the comparable period of 1998. This
significant increase in overhead recoveries is not expected to be as pronounced
during the remainder of 1998 as a result of the curtailed drilling expenditures
on oil properties, thus reducing the amount of overhead recovered from drilling
wells which will result in a net increase in future G&A expenses.
Interest and Financing Expenses
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------ ------------------ -----------------
AMOUNTS IN THOUSANDS EXCEPT PER UNIT
AMOUNTS 1998 1997 1998 1997
- ------------------------------------ -------- ------- -------- -------
<S> <C> <C> <C> <C>
Interest expense $ 4,419 $ 235 $ 12,788 $ 387
Non-cash interest expense (170) (20) (456) (64)
-------- ------- -------- -------
Cash interest expense 4,249 215 12,332 323
Interest and other income (336) (221) (1,078) (986)
-------- ------- -------- -------
Net interest expense (income) $ 3,913 $ (6) $ 11,254 $ (663)
-------- ------- -------- -------
Average interest expense (income)
per BOE $ 2.19 $ 0.00 $ 1.97 $ (0.18)
Average debt outstanding 205,217 10,375 198,890 3,610
- ------------------------------------ -------- ------- -------- -------
</TABLE>
During the first nine months of 1997 the Company had minimal debt
outstanding as virtually all bank debt had been retired during the fourth
quarter of 1996 with proceeds from a public offering of Common Shares completed
in October 1996. Conversely, in December 1997, the Company borrowed $202 million
to fund the Chevron Acquisition, resulting in $240 million of outstanding bank
debt during January and most of February 1998. On February 26, 1998 this bank
debt was repaid with proceeds from the Capital Transactions, leaving a bank
balance of $40 million for the rest of the first quarter of 1998, plus $125
million of debt from the issuance of the Notes. This bank debt increased to $70
million during the second quarter of 1998 and to $90 million by the end of the
third quarter ($100 million by October 31, 1998). These transactions resulted in
substantially higher interest expense for the third quarter and first nine
months of 1998 as compared to the comparable periods of 1997, on both an
absolute and BOE basis.
Depletion, Depreciation and Site Restoration
Depletion, depreciation and amortization ("DD&A") has increased along with
the additional capitalized cost and increased production. DD&A per BOE increased
from $6.50 for 1997 to $7.25 for the first half of 1998 primarily as a result of
the decline in oil price. The reduced oil price causes wells to reach the end of
their economic life much sooner and also makes certain proved undeveloped
locations uneconomical, both of which reduce the reserve quantities. This
reduction due to price amounted to approximately 7.2 million Bbls based on a
comparison with reserves calculated using the December 31, 1997 and June 30,
1998 prices. The DD&A rate was reduced to $5.08 per BOE for the third quarter of
1998 primarily due to the reduction in the cost basis as a result of the
writedown at June 30, 1998 (see "Full Cost Ceiling Test").
Under full cost accounting rules, each quarter the Company is required to
perform a ceiling test calculation. See "Full Cost Ceiling Test" for a
discussion of the writedown taken as of June 30, 1998.
18
<PAGE>
DENBURY RESOURCES INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company also provides for the estimated future costs of well
abandonment and site reclamation, net of any anticipated salvage, on a
unit-of-production basis. This provision is included in the DD&A expense.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
- --------------------------------- -------------------- ------------------
AMOUNTS IN THOUSANDS EXCEPT PER
UNIT AMOUNTS 1998 1997 1998 1997
- --------------------------------- --------- -------- -------- -------
<S> <C> <C> <C> <C>
Depletion and depreciation $ 8,984 $ 8,050 $ 37,254 $22,899
Site restoration provision 86 76 274 325
--------- -------- -------- -------
Total amortization $ 9,070 $ 8,126 $ 37,528 $23,224
--------- -------- -------- -------
Average DD&A cost per BOE $ 5.08 $ 6.22 $ 6.57 $ 6.40
- --------------------------------- --------- -------- -------- -------
</TABLE>
Income Taxes
Due to a net operating loss of the U.S. subsidiary each year for tax
purposes, the Company does not have any current tax provision. The deferred
income tax provision as a percentage of net income varies slightly depending on
the mix of Canadian and U.S. expenses. In addition, as a result of the
previously discussed $165 million writedown of its oil and natural gas
properties and the resultant net pre-tax loss of $172.2 million as of June 30,
1998, an income tax provision for the first six months using the effective tax
rate of 37% would have resulted in a $48 million deferred tax asset. Since the
Company currently has a large tax net operating loss, it was uncertain whether
this total tax asset could ultimately be realized. As such, the Company impaired
and reduced the deferred tax asset by $13 million, resulting in a net asset of
$35 million and a 29% effective tax benefit rate for the first half of 1998.
Since this deferred tax asset was previously impaired as of June 30, 1998, the
Company did not realize any tax benefit from the loss for the third quarter of
1998.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
- --------------------------------- -------------------- -------------------
1998 1997 1998 1997
- --------------------------------- --------- -------- --------- --------
<S> <C> <C> <C> <C>
Deferred income taxes (thousands) $ - $ 1,886 $ (50,618) $ 6,245
Average income tax costs
(benefit) per BOE - $ 1.44 $ (8.86) $ 1.72
Effective tax rate - 37% 29% 37%
- --------------------------------- --------- -------- --------- --------
</TABLE>
Results of Operations
Even though production was up during 1998 and most expenses, other than
interest expense, have shown a strong improvement on a BOE basis, as a result of
the decline in product prices, net income and cash flow from operations
decreased substantially on both a gross and per share basis between both periods
of 1997 and 1998 as set forth below. In addition, at June 30, 1998, the Company
incurred a $165 million non-cash charge to operations to writedown the carrying
value of its oil and natural gas properties as previously discussed.
19
<PAGE>
DENBURY RESOURCES INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
- --------------------------------------- ------------------ ------------------
AMOUNTS IN THOUSAND EXCEPT PER SHARE
AMOUNTS 1998 1997 1998 1997
- --------------------------------------- -------- -------- --------- -------
<S> <C> <C> <C> <C>
Net income (loss) $ (2,423) $ 3,211 $(125,042) $10,633
Net income (loss) per common share:
Basic $ (0.09) $ 0.16 $ (4.88) $ 0.53
Fully diluted (0.09) 0.15 (4.88) 0.50
Cash flow from operations (1) $ 6,817 $ 13,243 $ 27,324 $40,166
- --------------------------------------- -------- -------- --------- -------
<FN>
(1) Represents cash flow provided by operations, exclusive of the net change in
non-cash working capital balances.
</FN>
</TABLE>
The following table summarizes the cash flow, DD&A and results of
operations on a BOE basis for the comparative periods. Each of the individual
components are discussed above.
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
- --------------------------------------- ------------------- ----------------
Per BOE Data 1998 1997 1998 1997
- --------------------------------------- -------- -------- ------- ------
<S> <C> <C> <C> <C>
Revenue $ 10.79 $ 15.45 $ 11.73 $16.56
Production expenses (3.82) (4.15) (3.99) (4.34)
- --------------------------------------- -------- -------- ------- ------
Production netback 6.97 11.30 7.74 12.22
General and administrative (0.96) (1.16) (0.98) (1.33)
Interest and other income (expense) (2.19) 0.00 (1.97) 0.18
- --------------------------------------- -------- -------- ------- ------
Cash flow from operations(a) 3.82 10.14 4.79 11.07
DD&A (5.08) (6.22) (6.57) (6.40)
Deferred income taxes - (1.44) 8.86 (1.72)
Writedown of oil and natural gas
properties - - (28.90) -
Other non-cash items (0.10) (0.02) (0.08) (0.02)
- --------------------------------------- -------- -------- ------- ------
Net income (loss) $ (1.36) $ 2.46 $(21.90) $ 2.93
- --------------------------------------- -------- -------- ------- ------
<FN>
(a) Represents cash flow provided by operations, exclusive of the net change in
non-cash working capital balances.
</FN>
</TABLE>
Year 2000 Issues
Year 2000 issues relate to the ability of computer programs or equipment to
accurately calculate, store or use dates after December 31, 1999. These dates
can be handled or interpreted in a number of different ways, but the most common
error is for the system to contain a two digit year which may cause the system
to interpret the year 2000 as 1900. Errors of this type can result in system
failures, miscalculations and the disruption of operations, including, among
other things, a temporary inability to process transactions, send invoices or
engage in similar normal business. In response to the year 2000 issues, the
Company has developed a strategic plan divided into the following phases:
inventory, product compliance based on vendor representations and in-house
testing, third party integration and development of a contingency plan.
All of the Company's processing needs are handled by third party systems,
none of which have been substantially modified and all of which have been
purchased within the last few years. Therefore, the Company's initial review of
its systems with regard to year 2000 issues required an inventory of its systems
and a review of the vendor
20
<PAGE>
DENBURY RESOURCES INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
representations. The Company has substantially completed this initial review of
its information systems, which should be finalized during the fourth quarter of
1998. The licensor of the Company's core financial software system has certified
that such software is Year 2000 compliant. Additionally, most other less
critical software systems, various types of equipment and non-information
technology have been reviewed and based on vendor representations, are either
compliant, will be compliant with the next forthcoming software release or are
systems that are not date specific. This initial review will be followed by
in-house testing of the core systems and the Company expects this to be
completed by the end of the first quarter of 1999.
The Company believes that the potential impact, if any, of these systems
not being Year 2000 compliant will, at most, require employees to manually
complete otherwise automated tasks or calculations. Furthermore, the Company
does not expect that any additional training would be required to perform these
tasks on a manual basis due to the level of experience of its personnel and the
routine nature of the tasks being performed. If, based on the results of its
in-house testing, the Company should determine that certain systems are not Year
2000 compliant and it appears as though the system is not likely to be compliant
within a reasonable time period, the Company will either elect to perform the
task manually or will attempt to purchase a different system for that particular
task and convert before December 31, 2000. The Company does not believe that
either option would impact the Company's ability to continue exploration,
drilling, production or sales activities although the task may require
additional time and personnel to complete the same function or may require
incremental time and personnel during 1999 for a conversion to a new system.
After the completion of its in-house testing, the Company will further develop a
contingency plan as required. This final step is expected to be completed during
the second quarter of 1999.
The Company has initiated the third party integration phase and will
continue to have formal communications with its significant suppliers, business
partners and customers to determine the extent to which the Company is
vulnerable to those third parties' failure to correct their own Year 2000
issues. This portion of the review is expected to be completed during the first
quarter of 1999. Several of these third parties have provided certain favorable
representations as to their year 2000 readiness. However, there can be no
guarantee that the systems of other companies on which the Company relies will
be timely converted or that the conversion will be compatible with the Company's
systems. However, the Company believes that it can locate other vendors,
purchasers and third party contractors, if necessary, in order to maintain its
normal operations.
The Company has, and will continue to, utilize both internal and external
resources to complete tasks and perform testing necessary to address the Year
2000 issue. The Company has not incurred, and does not anticipate that it will
incur, any significant costs relating to the assessment and remediation of Year
2000 issues.
Forward-Looking Information
The statements contained in this Quarterly Report on Form 10-Q ("Quarterly
Report") that are not historical facts, including, but not limited to,
statements found in this Management's Discussion and Analysis of Financial
Condition and Results of Operations, are forward-looking statements, as that
term is defined in Section 21E of the Securities and Exchange Act of 1934, as
amended, that involve a number of risks and uncertainties. Such forward-looking
statements may be or may concern, among other things, capital expenditures,
drilling activity, acquisition plans and proposals and dispositions, development
activities, cost savings, production efforts and volumes, hydrocarbon reserves,
hydrocarbon prices, liquidity, regulatory matters and competition. Such
forward-
21
<PAGE>
looking statements generally are accompanied by words such as "plan,"
"estimate," "expect," "predict," "anticipate," "projected," "should," "assume,"
"believe" or other words that convey the uncertainty of future events or
outcomes. Such forward-looking information is based upon management's current
plans, expectations, estimates and assumptions and is subject to a number of
risks and uncertainties that could significantly affect current plans,
anticipated actions, the timing of such actions and the Company's financial
condition and results of operations. As a consequence, actual results may differ
materially from expectations, estimates or assumptions expressed in or implied
by any forward-looking statements made by or on behalf of the Company. Among the
factors that could cause actual results to differ materially are: fluctuations
of the prices received or demand for the Company's oil and natural gas, the
uncertainty of drilling results and reserve estimates, operating hazards,
acquisition risks, requirements for capital, general economic conditions,
competition and government regulations, as well as the risks and uncertainties
discussed in this Quarterly Report, including, without limitation, the portions
referenced above, and the uncertainties set forth from time to time in the
Company's other public reports, filings and public statements.
22
<PAGE>
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K during the Third Quarter of 1998
Exhibits:
---------
None
Reports on Form 8-K:
--------------------
None
23
<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.
DENBURY RESOURCES INC.
DENBURY MANAGEMENT, INC.
(Registrant)
By: /s/ Phil Rykhoek
----------------------------------
Phil Rykhoek
Chief Financial Officer
By: /s/ Bobby Bishop
----------------------------------
Bobby Bishop
Chief Accounting Officer &
Controller
Date: November 6, 1998
24
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACED FROM THE
DENBURY RESOURCES INC. SEPTEMBER 30, 1998 FORM 10-Q AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<NAME> Denbury Resources Inc.
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