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PETROQUEST ENERGY INC (PQUE) Quarterly Report (SEC form 10-Q)
Management's discussion and analysis of financial condition and results of operations, contained in the Company'sAnnual Report on Form 10-K for the year ended December 31, 1998. The results of operations for the three- and nine- month periods ended September 30, 1999 are not necessarily indicative of future financial results. Certain prior period amounts have been reclassified to conform to current period presentation.
NOTE 2 - MERGER OF OPTIMA (U.S.) ENERGY CORPORATION -
On September 1, 1998, the Company completed its transaction to merge its wholly owned subsidiary Optima Energy (U.S.) Corporation with American Explorer, L.L.C. ("American"). Concurrent with the transaction, the Company became a Delaware corporation and converted each share of Optima no par value common stock into one share of the Company's $.001 par value common stock and changed its name from Optima Petroleum Corporation to PetroQuest Energy, Inc. American conducted oil and natural gas exploration activities in the Gulf Coast Region.
Under the terms of the transaction, American merged with the Company in exchange for 7,335,001 shares of the Company's common stock, issued to the three former members of American, representing about 40% of the post acquisition shares outstanding. Additionally, the Company issued 1,667,001 contingent stock rights exchangeable for common shares should the market share price of the Company's common stock exceed $5 per share for 20 consecutive trading days during the three year term of the rights. The rights terminate on September 1, 2001.
The transaction was treated as a purchase for accounting purposes. No value was assigned to the contingent stock rights. The purchase price of approximately $10.6 million was allocated to the assets and liabilities based on estimated fair value.
The operating results of American have been consolidated in the Company's statement of operations since September 1, 1998. The following summarized unaudited income statement data reflects the impact the transaction would have had on the Company's results of operations for the nine- months ended September 30, 1998 had the transaction occurred January 1, 1998.
Proforma Results for the
Nine Months Ended September 30, 1998
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(Unaudited)
Revenues $ 6,088
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Net Loss $ (5,234)
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Loss per common share:
Basic (0.28)
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Diluted (0.28)
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NOTE 3 - EARNINGS PER SHARE -
Basic net income per share of common stock was calculated by dividing net income applicable to common stock by the weighted-average number of common shares outstanding during the period. Diluted net income per share of common stock was calculated by dividing net income applicable to common stock by the weighted-average number of common shares outstanding during the period plus the weighted average number of dilutive stock options granted to outside directors and certain employees which totaled approximately 987,000 shares and 58,512 shares in the third quarter of 1999 and 1998, respectively, and 971,835 shares and 120,845 shares in the first nine months of 1999 and 1998, respectively. Options and warrants which were considered antidilutive because the exercise price of the options exceeded the average price for the applicable period totaled 2,553,696 shares and 848,799 shares in the third quarter of 1999 and 1998, respectively, and 871,575 shares and 1,163,000 shares in the first nine months of 1999 and 1998, respectively.
NOTE 4 - LONG-TERM DEBT -
There are no borrowings under the Company's reducing revolving line of credit at September 30, 1999. The borrowing base is currently being redetermined. Interest under the loan is payable monthly at prime plus 1/2% (8 3/4% at September 30, 1999).
On April 21, 1999, the Company entered into a loan agreement for non-recourse financing to fund completion, flow line and facility costs of its High Island Block 494 property. The property is security for the loan. Interest is payable at 12% and the
lender receives a 2 1/2% overriding royalty interest in the property. For the first three production months, all of the cash flow from the property will be dedicated to payment of principal and interest on the loan. Subsequently, 85% of the cash flow from the property (assuming certain production levels) will be dedicated to debt service. The well began producing during the first part of July 1999. Since payments are made based on production, the current portion of the debt represents payments required from current assets.
NOTE 5 - NEW ACCOUNTING STANDARDS -
In September 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." The Statement establishes accounting and reporting standards that require every derivative instrument (including certain derivative instruments embedded in other contracts) to be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 is effective for the company during the first quarter of the fiscal year 2001.
Because the Company does not currently use derivative instruments, the adoption of SFAS No. 133 will not impact the Company's financial statements.
NOTE 6 - RELATED PARTY TRANSACTIONS -
In conjunction with the merger discussed at Note 2, the employees and consultants of Optima were terminated. American had no employees. It was managed and its properties (and certain of Optima's properties) were operated by American Explorer, Inc. ("AEI"), a corporation owned by two officers of the Company and former members of American. From September 1, 1998 through December 31, 1998, the Company's properties were operated by AEI and certain management functions were performed by AEI. The officers of AEI are also the officers of the Company. AEI charged the Company a management fee to cover its costs of services for the Company ($600,000 for the four months ended December 31, 1998). At December 31, 1998, the Company owed AEI approximately $1,053,000, which is included in Accounts Payable. Effective January 1, 1999, the Company assumed the operating and management functions from AEI, whose employees became employees of the Company.
NOTE 7 - SALE OF COMMON STOCK AND WARRANTS -
In August, 1999 the Company received the funding of a private placement of 5 million units at a purchase price of $1.00 per unit for a total consideration of $5,000,000 before fees and expenses. Net proceeds of $4,508,000 from sale of the units was allocated between the stock and warrants based on their relative fair market value on the date of the transaction. The proceeds from the private placement will be used for drilling and exploration costs, delay rentals on oil and gas leases and working capital and general corporate purposes.
Each unit sold in the private placement consists of one share of the Company's common stock and one warrant exercisable to purchase one-half a share of the Company's common stock. Each warrant is exercisable at any time through the fourth year after issuance to purchase one-half of a share of the Company's common stock at a per share purchase price of $1.25. In addition, the Company issued to the placement agents of the units, warrants to purchase 500,000 shares of the Company's common stock. The warrants received by the placement agents are exercisable at any time for a period of five years to purchase one share of the Company's common stock at a per share purchase price of $1.25 per share. The Company has agreed to file a registration statement covering the resale of its common stock underlying the units and the shares of its common stock issuable on the exercise of the warrants.
NOTE 8 - FULL COST CEILING WRITE-DOWN -
The Company uses the full cost method of accounting for its investment in oil and natural gas properties. Under the full cost method of accounting, all costs of acquisition, exploration and development of oil and natural gas reserves are capitalized into a "full cost pool" (the "pool") as incurred, and properties in the pool are depleted and charged to operations using the units of production method based on the ratio of current production to total proved future production. Additionally, the cost in excess of the net book value of assets and liabilities acquired in the merger with
American of $7.9 million, discussed above, is recorded in the pool at September 30, 1998, and is subject to depletion or write-down. To the extent that costs capitalized in the pool (net of accumulated depreciation, depletion and amortization) exceed the present value (using a 10% discount rate) of estimated future net cash flow from proved oil and natural gas reserves, and the lower of cost and fair value of unproved properties, excess costs are charged to operations. Once incurred, a write-down of oil and natural gas properties is not reversible at a later date even if oil or natural gas prices increase. The Company was required to write down its asset base at the end of the third quarter of 1998 due primarily to the cost in excess of net book value recorded in the merger with American and significant declines in oil prices during 1998.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
PetroQuest Energy, Inc. is an independent oil and gas company engaged in the development, exploration, acquisition and operation of oil and gas properties onshore and offshore in the Gulf Coast Region. The Company and its predecessors have been active in this area since 1986, which gives the Company extensive geophysical, technical and operational expertise in this area. The Company's business strategy is to increase production, cash flow and reserves through exploration, development and acquisition of properties located in the Gulf Coast Region.
MERGER OF OPTIMA (U.S.) ENERGY CORPORATION -
On September 1, 1998, the Company completed the transaction to merge its wholly owned subsidiary Optima Energy (U.S.)Corporation with American Explorer, L.L.C. ("American"). Concurrent with the transaction, the Company became a Delaware corporation and converted each share of Optima no par value common stock into one share of the Company's $.001 par value common stock and changed its name from Optima Petroleum Corporation to PetroQuest Energy, Inc. American conducted oil and natural gas exploration activities in the Gulf Coast Region.
Under the terms of the transaction, American merged with the Company in exchange for 7,335,001 shares of the Company's common stock, issued to the three former members of American, representing about 40% of the post acquisition shares outstanding. Additionally, the Company issued 1,667,001 contingent stock rights exchangeable for common shares should the market share price of the Company's common stock exceed $5 per share for 20 consecutive trading days during the three year term of the rights. The rights terminate on September 1, 2001.
The transaction was treated as a purchase for accounting purposes. No value was assigned to the contingent stock rights. The purchase price of approximately $10.6 million was allocated to the assets and liabilities based on estimated fair value. The
operating results of American have been consolidated in the Company's statement of operations since September 1, 1998.
RESULTS OF OPERATIONS
The following table sets forth certain operating information with respect to the oil and gas operations of the Company for the three- and nine- month periods ended September 30, 1999 and 1998.
Three Months Ended Nine Months Ended
September 30 September 30,
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1999 1998 1999 1998
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Production:
Oil (Bbls) 32,712 16,720 75,106 59,451
Gas (Mcf) 751,470 235,265 1,821,774 460,463
Total Production (Mcfe947,744 335,585 2,272,412 817,169
Sales:
Total oil sales $ 643,114 $ 212,026 $1,203,302 $ 797,285
Total gas sales 1,902,867 547,722 4,053,141 1,062,768
Average sales prices:
Oil (per Bbl) $ 19.66 $ 12.68 $ 16.02 $ 13.41
Gas (per Mcf) 2.53 2.33 2.22 2.31
Per Mcfe 2.69 2.26 2.31 2.28
The net income totaled $212,000 for the quarter ended September 30, 1999 as compared to the net loss of $12 million for the same quarter of 1998. Net loss for the nine months ended September 30, 1999 was approximately $1,046,000 as compared to net loss of approximately $13 million for the first nine months of 1998. The income in 1999 compared to the loss in 1998 for the third quarter and the nine months is primarily the result of the full cost ceiling write-down associated with the merger with American, (see "Full Cost Ceiling Write-Down") and non-recurring cost associated with the merger in 1998. In addition, production has increased as the result of the addition of the American wells and new wells drilled and placed on production.
On a thousand cubic feet equivalent (Mcfe) basis, third quarter 1999 production volumes increased 182% over third quarter 1998 production volumes. For the nine months ended 1999, the increase was 178% compared to the nine months in 1998. This is due to the merger with American and the addition of the CL&F #12 in the Turtle Bayou Field and the C-1 well at High Island 494. The CL&F #12 discovery occurred in the fourth quarter of 1998 and commenced production in December 1998. The C-1 well was placed on production in early July, 1999. The properties previously owned by American produced 185,000 Mcfe and 945,000 Mcfe for the three months and nine months ended September 30, 1999, respectively. The CL&F #12 produced 38,000 Mcfe and 226,000 Mcfe for the three month and nine month periods ended September 30, 1999, respectively. The C-1 well produced 420,000 Mcfe since commencing production this quarter.
Oil and gas sales during the third quarter of 1999 increased 236% to $ 2,557,000, as compared to third quarter 1998 revenues of $760,000. For the first nine months of 1999, oil and gas sales increased 185% to $5,295,000, compared to oil and gas revenues of $1,860,000 during the 1998 period. These increases resulted from the production increases discussed above. Third quarter higher product prices also contributed to the increase. Stated on a Mcfe basis, unit prices received during the third quarter of 1999 were 19% higher than the prices received during the comparable 1998 period, and were basically unchanged for the nine month periods.
Lease operating expenses for the third quarter of 1999 increased to $802,000 from $151,000 during the third quarter of 1998 due primarily to the American merger and the addition of the related properties. Also, operating expenses were added as the result of the new discoveries discussed above. Operating expenses for the nine months ended September 30, 1999 increased to $1,777,000 from $508,000 during the nine months ended September 30, 1998. On a Mcfe basis, operating expenses for the third quarter increased from $ .45 per Mcfe in 1998 to $ .85 in 1999 and increased from $ .62 per mcfe for the first nine months of 1998 to $ .78 for the first nine months in 1999.
General and administrative expenses during the third quarter of 1999 totaled $344,000 as compared to expenses of $840,000 during the 1998 quarter. Not included in the 1999 amount is $320,000 which was capitalized as related directly to the acquisition, exploration and development effort. For the nine month period ended September 30, 1999, general and administrative expenses totaled $1,055,000, (excluding $891,000 which was capitalized), compared to $1,393,000 for the same period in 1998. In total, general and administrative expenses increased in 1999 due to additional staffing levels related to the generation and operation of properties. The third quarter of 1998 included non-recurring costs associated with closing the Company's Vancouver office and termination of Canadian consultants and employees which was more than the cost of the increased staffing in 1999.
Interest expense increased due to the addition of the debt associated with the American merger and the addition of the non-recourse financing associated with the completion, flow line and facility cost of High Island Block 494 property.
Depreciation, depletion and amortization ("DD&A") expense for the nine months ended September 30, 1999 increased 69% from the 1998 period, resulting from the additions to property cost on the balance sheet for the American properties. On a Mcfe basis, which reflects the changes in production, the DD&A rate for the first nine months of 1999 was $1.35 per Mcfe compared to $2.22 per Mcfe for the same period in 1998. For the third quarter of 1999, DD&A per mcfe was $1.10 compared to $1.55 for the comparable period in 1998.
LIQUIDITY AND CAPITAL RESOURCES
Working Capital and Cash Flow. Working capital (before considering the current portion of debt) decreased from $0.1 million deficit at December 31, 1998 to a deficit of $0.4 million at September 30, 1999. This was caused primarily by funds expended for principal payments on debt and oil and gas properties.
The Company has no borrowings under its reducing revolving line of credit. The borrowing base of this facility is currently being redetermined. Interest under the loan is payable monthly at prime plus 1/2% (8 3/4% at September 30, 1999).
On April 21, 1999, the Company entered into a loan agreement for non-recourse financing to fund completion, flow line and facility costs of its High Island Block 494 property. Interest is payable at 12% and the lender received a 2 1/2% overriding royalty interest in the property as security for the loan. For the first three production months, all of the net cash flow from the property will be dedicated to payment of principal and interest on the loan. Subsequently, 85% of the net cash flow from the property (assuming certain production levels) will be dedicated to debt service. The well began producing during the first part of July 1999.
For the first nine months of 1999, net cash flow from operations before working capital changes increased from a negative $266,000 in 1998 to $2,012,000 in 1999. This was the result of the addition of the American properties, the CL&F #12 discovery in the Turtle Bayou Field and the C-1 Well discovery at High Island 494.
In August, the Company completed a private placement of 5 million units at a purchase price of $1.00 per unit for a total consideration of $5,000,000 before fees and expenses. Net proceeds of $4,508,000 from the private placement will be used for drilling and exploration costs, delay rentals on oil and gas leases, and working capital and general corporate purposes. Each unit sold in the private placement consists of one share of the Company's common stock and one warrant exercisable to purchase one-half a share of the Company's common stock. Each warrant is exercisable at any time through the fourth year after issuance to purchase one-half of a share of the Company's common stock at a per share purchase price of $1.25. In addition, the Company issued to the placement agents of the units, warrants to purchase 500,000 shares of the Company's common stock. The warrants received by the placement agents are exercisable at any time for a period of five years to purchase one share of the Company's common stock at a per share purchase price of $1.25 per share. The Company has agreed to file a registration statement covering the resale of its common stock underlying the units and the shares of its common stock issuable on the exercise of the warrants. Funds not expended in the third quarter for the purposes stated above were used to pay down the Company's reducing revolving line of credit.
Management believes the funds received from the private placement will be sufficient in the near term to fund exploration activities, operations and debt service. Future activities will depend on the success of current exploration and potential additional financing which may be obtained including the sale of additional equity and debt securities and additional bank financing. There can be no assurances that such additional financing will be available on acceptable terms, if at all.
Year 2000 Compliance. During 1998, the Company's executive management and Board of Directors implemented a program to identify, evaluate and address the Company's Year 2000 ("Y2K") risks to ensure that all its Information Technology ("IT") Systems and Non-IT Systems will be able to process dates from and after January 1, 2000 without critical systems failure. In addition to evaluating its own systems, the Company has assessed the Y2K risks associated with its significant customers and suppliers.
The Company has evaluated its IT Systems for Y2K compliance. As part of this evaluation, the Company contracted third-party consultants to assist in the identification and replacement of non-compliant IT Systems. During 1998, the Company modified all IT Systems for Y2K compliance. These modifications were completed in the third quarter of 1999.
The Non-IT Systems were assessed to determine which systems would be affected by Y2K issues. All necessary replacements or modifications have been made.
The assessment of third parties has the primary purpose of determining any disruptions in operations due to non-compliance by an outside organization. This was determined by contacting the Company's suppliers and customers to determine their level of Y2K compliance and the steps they are taking towards compliance. Based on the responses thus far, no corrective measures are necessary.
Total costs incurred to-date for consultants, software and hardware applications for Y2K compliance are approximately $40,000. No additional costs are anticipated. The Company does not separately account for the internal costs incurred for its
Y2K Compliance efforts.
Based on risk assessments, the Company believes the most likely Y2K related failure would be a temporary disruption in certain materials and services provided by third-parties, which would not be expected to have a material adverse effect on the Company's financial condition or results of operations. If it is determined that Y2K related failure would have a material adverse effect on the Company, contingency plans will be developed. There can be no assurance that the Company will not be materially adversely affected by Y2K problems.
Full Cost Ceiling Write-Down. The Company uses the full cost method of accounting for its investment in oil and natural gas properties. Under the full cost method of accounting, all costs of acquisition, exploration and development of oil and natural gas
reserves are capitalized into a "full cost pool" (the "pool") as incurred, and properties in the pool are depleted and charged to operations using the units of production method based on the ratio of current production to total proved future production. Additionally, the cost in excess of the net book value of assets and liabilities acquired in the merger with American of $7.9 million, discussed above, is recorded in the pool at September 30, 1998, and is subject to depletion or write-down. To the extent that costs capitalized in the pool (net of accumulated depreciation, depletion and amortization) exceed the present value (using a 10% discount rate) of estimated future net cash flow from proved oil and natural gas reserves, and the lower of cost and fair value of unproved properties, excess costs are charged to operations. Once incurred, a write-down of oil and natural gas properties is not reversible at a later date even if oil or natural gas prices increase. The Company was required to write down its asset base at the end of the third quarter of 1998 due primarily to the cost in excess of net book value recorded in the merger with American and significant declines in oil prices during 1998.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Report includes certain statements that may be deemed to be "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical facts, included in this Report that address activities, events or developments that the Company expects, believes or anticipates will or may occur in the future, including drilling of wells, reserve estimates, future production of oil and gas, future cash flows and other such matters are forward-looking statements. These statements are based on certain assumptions and analyses made by the Company in light of its experience and its perception of historical trends, current conditions, expected future
developments and other factors it believes are appropriate under the circumstances. Such forward-looking statements are subject to certain risks, uncertainties and other factors, many of which are beyond the control of the Company, which could cause actual results to differ materially from those currently anticipated. These factors include, without limitation, the numerous uncertainties inherent in estimating quantities of proven oil and gas reserves and in projecting future rates of production and timing of development expenditures which may vary significantly from reserves and production estimates; the results of exploratory and developmental drilling; operating hazards attendant to the oil and gas business, including downhole drilling and completion risks that are generally not recoverable from third parties or insurance; actions or inactions of third-party operators of the Company's properties; lease and rig availability; the successful identification, acquisition and development of properties; changes in the price received for oil and/or gas which may effect results of operations and cash flows; the demand for and supply of gas and oil; the weather; pipeline capacity; general economic conditions; governmental regulation; changes in interest rates; the Company's ability to find and retain skilled personnel; labor relations; Year 2000 compliance by the Company and third parties; competitors of the Company having greater resources than those of the Company; or other unanticipated external developments materially impacting the Company's operational and financial performance. Readers are cautioned that any such statements are not guarantees of future performance and the Company can give no assurances that actual results or developments will not differ materially from those projected in the forward-looking statements. Stockholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are only made as of the date of this Report and the Company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or
circumstances.
Item 3. DISCLOSURE ABOUT MARKET RISKS
The Company's indebtedness under its line of credit is variable rate financing. The Company believes that its exposure to market risk relating to interest rate risk is not material. The Company believes that its business operations are not exposed to market risks relating to foreign currency exchange risk or equity price risk.
Price Risk
The Company's revenues are derived from the sale of its crude oil and- natural gas production. Based on projected annual sales volumes for the remaining three months of 1999, a 10% decline in the prices the Company receives for its crude oil and natural gas production would have an approximate $350,000 impact on the Company's revenues. |
