9-May-2005
Quarterly Report
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
This report includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical facts included in this report, including statements regarding the Company's financial position, adequacy of resources, estimated reserve quantities, business strategies, plans, objectives and expectations for future operations and covenant compliance, are forward-looking statements. The Company can give no assurances that the assumptions upon which such forward-looking statements are based will prove to have been correct. Important factors that could cause actual results to differ materially from the Company's expectations ("Cautionary Statements") are disclosed, in the section entitled "Risk Factors" included in the Company's Annual Report on Form 10-K for the Company's most recent fiscal year, elsewhere in this report and from time to time in other filings made by the Company with the Securities and Exchange Commission. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified by the Cautionary Statements.
General
The Company's revenues, profitability, future growth and the carrying value of its oil and gas properties are substantially dependent on prevailing prices of oil and gas, its ability to find, develop and acquire additional oil and gas reserves that are economically recoverable and its ability to develop existing proved undeveloped reserves. The Company's ability to maintain or increase its borrowing capacity and to obtain additional capital on attractive terms is also influenced by oil and gas prices. Prices for oil and gas are subject to large fluctuations in response to relatively minor changes in the supply of and demand for oil and gas, market uncertainty and a variety of additional factors beyond the control of the Company. These factors include weather conditions in the United States, the condition of the United States economy, the actions of the Organization of Petroleum Exporting Countries, governmental regulations, political stability in the Middle East and elsewhere, the foreign supply of oil and gas, the price of foreign imports and the availability of alternate fuel sources. Any substantial and extended decline in the price of oil or gas would have an adverse effect on the Company's carrying value of its proved reserves, borrowing capacity, revenues, profitability and cash flows from operations. The Company uses derivative financial instruments for price protection purposes on a limited amount of its future production but does not use derivative financial instruments for trading purposes. As of March 31, 2005, the Company had over 60% on an equivalent basis of its remaining 2005 production hedged.
The following discussion is intended to assist in an understanding of the Company's historical financial positions and results of operations. The Company's historical financial statements and notes thereto included elsewhere in this quarterly report contain detailed information that should be referred to in conjunction with the following discussion.
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Liquidity and Capital Resources
Our primary sources of capital are cash flows from operations, borrowings from financial institutions and the sale of debt and equity securities. On March 31, 2005, we had net cash and cash equivalents of $2.9 million and $58.5 million of availability under our senior secured credit facility. Cash provided from operating activities during the three-month period ended March 31, 2005 totaled $21.3 million. Cash provided by operating activities for 2005 has increased compared to 2004 due to higher production as well as increased prices. Net capital expenditures from the cash flow statement for the three-month period ended March 31, 2005 totaled $16.2 million. Dividends paid on preferred stock were $318,000.
On June 15, 2004, we closed on a three-year senior secured credit facility underwritten by Union Bank of California, N.A. The credit facility had an initial borrowing base of $60 million, which subsequent to the first quarter was increased to $70 million. The borrowing base is reviewed and adjusted accordingly semi-annually and can be increased to a maximum of $175 million. As of March 31, 2005 there were no borrowings outstanding under the facility; however, we had an aggregate of $1.5 million in outstanding letters of credit issued under the credit facility. These letters of credit secure obligations under the outstanding hedging contracts described in Note 3 to the Consolidated Financial Statements. The outstanding letters of credit reduce the amount available for borrowings under the credit facility. As a result, $58.5 million was available for future borrowings under the credit facility as of March 31, 2005.
The Indenture governing our 9.75% Senior Notes due 2010, in addition to the senior secured credit facility, contain various covenants, including restrictions on additional indebtedness and payment of cash dividends as well as maintenance of certain financial ratios. We were in compliance with respect to these covenants at March 31, 2005. See Note 5 of the Consolidated Financial Statements for the year ended December 31, 2004 included in our Annual Report on Form 10-K filed March 10, 2005 for a more detailed discussion of long-term debt.
Our capital expenditure plans for 2005, including capitalized interest and general and administrative expenses, will require $80 million of funding. We anticipate that cash flow generated from operations during 2005 and current availability under our senior secured credit facility, if necessary, will provide the $95 million of capital necessary to fund these planned capital expenditures as well as our asset retirement obligations. See the Capital Expenditures section below for a more detailed discussion of our capital expenditures for 2005.
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The following table describes our outstanding contractual obligations (in thousands) as of March 31, 2005:
Contractual Less Than One-Three Four-Five After-Five
Obligations Total One Year Years Years Years
Senior Secured Credit Facility $ - $ - $ - $ - $ -
9.75% Senior Notes 200,000 - - - 200,000
Capital Lease (future minimum payments) 2,254 674 723 448 409
Throughput Commitments:
Medusa Spar 16,044 4,268 6,748 5,028 -
Medusa Oil Pipeline 796 242 280 127 147
$ 219,094 $ 5,184 $ 7,751 $ 5,603 $ 200,556
Capital Expenditures
Capital expenditures from the cash flow statement for exploration and development costs related to oil and gas properties totaled approximately $16 million in the three months ended March 31, 2005. We incurred approximately $4 million in the Gulf of Mexico Deepwater Area primarily for the drilling and completion of a development well at North Medusa. Interest of approximately $1 million and general and administrative costs allocable directly to exploration and development projects of approximately $2 million were capitalized for the first three months of 2005. Our Gulf of Mexico Shelf Area expenditures account for the remainder of the total capital expended, which includes the drilling of two shelf wells, one of which will be completed by mid-year, the completion of a 2004 shelf well and the rework of two existing shelf wells.
Capital expenditures for the remainder of 2005 are forecast to be approximately $64 million and include:
• the completion and development of two shelf wells;
• the drilling of a deepwater development well on our deepwater Entrada discovery;
• the non-discretionary drilling of exploratory wells;
• the acquisition of seismic and leases; and
• capitalized interest and general and administrative costs.
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Off-Balance Sheet Arrangements
In December 2003, we announced the formation of a limited liability company, Medusa Spar LLC, which now owns a 75% undivided ownership interest in the deepwater spar production facilities on our Medusa Field in the Gulf of Mexico. We contributed a 15% undivided ownership interest in the production facility to Medusa Spar LLC in return for approximately $25 million in cash and a 10% ownership interest in the LLC. The LLC will earn a tariff based upon production volume throughput from the Medusa area. We are obligated to process our share of production from the Medusa field and any future discoveries in the area through the Spar production facilities. This arrangement allows us to defer the cost of the Spar production facility over the life of the Medusa field. Our cash proceeds were used to reduce the balance outstanding under our senior secured credit facility. The LLC used the cash proceeds from $83.7 million of non-recourse financing and a cash contribution by one of the LLC owners to acquire its 75% interest in the Spar. The balance of Medusa Spar LLC is owned by Oceaneering International, Inc. (NYSE:OII) and Murphy Oil Corporation (NYSE:MUR). We are accounting for our 10% ownership interest in the LLC under the equity method.
Income Taxes
As discussed in Notes 5 of the Consolidated Financial Statements, we established a valuation allowance of $11.5 million as of December 31, 2003. We achieved profitable operations and had income on an aggregate basis for the three-year period ended December 31, 2004. As a result, we reversed the valuation allowance which had a balance of $7.0 million as of December 31, 2004.
During the first quarter of 2004, we revised the valuation allowance as a result of current year ordinary income, the impact of which was included in our effective tax rate and resulted in no net income tax expense (benefit) for the period. We had income tax expense of $4.8 million in the first quarter of 2005.
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Results of Operations
The following table sets forth certain unaudited operating information with
respect to the Company's oil and gas operations for the periods indicated:
Three Months Ended
March 31,
2005 2004
Net production :
Oil (MBbls) 641 439
Gas (MMcf) 2,748 3,108
Total production (MMcfe) 6,593 5,743
Average daily production (MMcfe) 73.3 63.1
Average sales price:
Oil (Bbls) (a) $ 37.46 $ 30.67
Gas (Mcf) 6.92 5.94
Total (Mcfe) 6.52 5.56
Oil and gas revenues:
Oil revenue $ 24,009 $ 13,469
Gas revenue 19,003 18,450
Total $ 43,012 $ 31,919
Oil and gas production costs:
Lease operating expense $ 6,536 $ 5,168
Additional per Mcfe data:
Sales price $ 6.52 $ 5.56
Lease operating expense 0.99 0.90
Operating margin $ 5.53 $ 4.66
Depletion, depreciation and amortization $ 2.34 $ 2.06
General and administrative (net of management fees) $ 0.26 $ 0.66
(a) Below is a reconciliation of the average NYMEX price to the
average realized sales price per barrel of oil:
Average NYMEX oil price $ 49.85 $ 35.14
Basis differentials and quality adjustments (6.33 ) (1.71 )
Transportation (1.31 ) (1.25 )
Hedging (4.75 ) (1.51 )
Average realized oil price $ 37.46 $ 30.67
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Comparison of Results of Operations for the Three Months Ended March 31, 2005 and the Three Months Ended March 31, 2004.
Oil and Gas Production and Revenues
Total oil and gas revenues increased 35% to $43.0 million in the first quarter of 2005 from $31.9 million in the first quarter of 2004. The increase was primarily due to higher product prices and higher production from our deepwater property, Medusa. Total production for the first quarter of 2005 increased by 15% versus the first quarter of 2004.
Production from Medusa began late in the fourth quarter of 2003 from one well with five additional wells completed through August 2004. In the first quarter of 2004, there were two wells producing with a third well completed in the middle of March 2004. In the first quarter of 2005, all six wells were producing, which resulted in increased production for the first quarter of 2005 compared to the first quarter of 2004.
Gas production during the first quarter of 2005 totaled 2.7 Bcf and generated $19.0 million in revenues compared to 3.1 Bcf and $18.5 million in revenues during the same period in 2004. The average gas price after hedging impact for the first quarter of 2005 was $6.92 per Mcf compared to $5.94 per Mcf for the same period last year. The decrease in production was primarily due to normal and expected decline in production from our Mobile area properties and older properties. The decrease was partially offset by higher production from Medusa and production from our new wells at High Island Block 119.
Oil production during the first quarter of 2005 totaled 641,000 barrels and generated $24.0 million in revenues compared to 439,000 barrels and $13.5 million in revenues for the same period in 2004. The average oil price received after hedging impact in the first quarter of 2005 was $37.46 per barrel compared to $30.67 per barrel in 2004. The increase in production for the first quarter of 2005 compared to the first quarter of 2004 was due to the higher production from Medusa.
Lease Operating Expenses
Lease operating expenses for the three-month period ending March 31, 2005 increased to $6.5 million compared to $5.2 million for the same period in 2004. The 26% increase was primarily due to lease operating expenses related to our deepwater property, Medusa, which had higher throughput charges as a result of higher production rates and the addition of our High Island Block 119 field, which began producing in the third quarter of 2004.
Depreciation, Depletion and Amortization
Depreciation, depletion and amortization for the three months ending March 31, 2005 and 2004 was $15.4 million and $11.8 million, respectively. The 30% increase was due to higher production volumes for the first quarter of 2005 compared to the same period last year and a higher average depletion rate.
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Accretion Expense
Accretion expense for the three-month periods ended March 31, 2005 and 2004 of $861,000 and $816,000, respectively, represents accretion for our asset retirement obligations. The increase was due to the addition of new plugging and abandonment obligations. See Note 7 to the Consolidated Financial Statements.
General and Administrative
General and administrative expenses, net of amounts capitalized, were $1.7 million and $3.8 million for the three-month periods ended March 31, 2005 and 2004, respectively. The 55% decrease was a result of a charge of $2.6 million that was incurred in the first quarter of 2004 for the early retirement of two executive officers of the Company. The decrease was partially offset by reduced capitalized overhead in the first quarter of 2005.
Interest Expense
Interest expense decreased by 22% to $4.6 million during the three months ended March 31, 2005 from $5.9 million during the three months ended March 31, 2004. This is a result of lower debt levels and lower interest rates due to the refinancing of debt in December 2003 and during the six-month period ended June 30, 2004, partially funded by proceeds from an equity offering completed in the second quarter of 2004. In addition, amortization of deferred financing costs and bond discounts decreased due to the write-off of unamortized deferred financing costs and bond discounts associated with the early extinguishment of debt.
Loss on Early Extinguishment of Debt
A loss of $2.5 million was recognized in the first quarter of 2004 for the write-off of unamortized deferred financing costs and bond discounts associated with the early extinguishment of the $22.9 million of 10.125% Senior Subordinated Notes due July 31, 2004, the $40 million of 10.25% Senior Subordinated Notes due September 15, 2004 and the remaining $10 million of 12% senior loans due in 2005 plus a 1% pre-payment premium.
Income Taxes
Income tax expense was $4.8 million for the three-month period ended March 31, 2005 compared to zero for the same period last year. We had established a valuation allowance of $11.5 million as of December 31, 2003. We revised the valuation allowance in the first quarter of 2004 as a result of first quarter ordinary income, the impact of which was included in our effective tax rate and resulted in no net income tax expense (benefit) for the first quarter of 2004. At year-end, the remaining balance in the valuation allowance was reversed. See Note 5 to the Consolidated Financial Statements for a detailed discussion of the valuation allowance.
