-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RztyFF+MKSnRiXE4X2AfN3jpVEtDSh2A1N0jqY8DnOMqg2JJf5U03I2vUZ00R8A2 HGBES6kznCDFLosukgA96A== 0000899243-98-000484.txt : 19980330 0000899243-98-000484.hdr.sgml : 19980330 ACCESSION NUMBER: 0000899243-98-000484 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980327 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: BELLWETHER EXPLORATION CO CENTRAL INDEX KEY: 0000319459 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 760437769 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-09498 FILM NUMBER: 98576900 BUSINESS ADDRESS: STREET 1: 1331 LAMAR STREET 2: SUITE 1455 CITY: HOUSTON STATE: TX ZIP: 77010 BUSINESS PHONE: 7136501025 MAIL ADDRESS: STREET 1: 1221 LAMAR STREET 2: STE 1600 CITY: HOUSTON STATE: TX ZIP: 77010-3039 10-K405 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) ( ) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR (X) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from July 1, 1997 to December 31, 1997 Commission File Number 0-9498 BELLWETHER EXPLORATION COMPANY (Exact name of registrant as specified in its charter) Delaware 76-0437769 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1331 Lamar, Suite 1455, Houston, Texas 77010 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (713) 650-1025 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: Common Stock, $0.01 par value NASDAQ/NMS Preferred Stock purchase rights Indicate by check mark whether the registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant at March 20, 1998 was approximately $124,608,080. As of March 20, 1998, the number of outstanding shares of the registrant's common stock was 14,139,924. Documents Incorporated by Reference: Portions of the registrant's annual proxy statement, to be filed within 120 days after December 31, 1997, are incorporated by reference into Part III. BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K Transition Period from July 1, 1997 to December 31, 1997 TABLE OF CONTENTS Page Number ------ PART I Item 1. Business........................................... 3 Item 2. Properties......................................... 11 Item 3. Legal Proceedings.................................. 22 Item 4. Submission of Matters to a Vote of Security Holders 22 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters....................... 23 Item 6. Selected Financial Data............................ 24 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............... 25 Item 8. Financial Statements and Supplementary Data........ 35 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............... 70 PART III Item 10. Directors and Executive Officers of the Registrant. 70 Item 11. Executive Compensation............................. 70 Item 12. Security Ownership of Certain Beneficial Owners and Management........................................ 70 Item 13. Certain Relationships and Related Transactions..... 70 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K....................................... 70 -- Signatures BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES PART I Item 1. Business This annual report on Form 10-K includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934 ("Exchange Act"). All statements other than statements of historical fact included herein regarding the Company's financial position, estimated quantities and net present values of reserves, business strategy, plans and objectives for future operations and covenant compliance, are forward-looking statements. Although the Company believes that the assumptions upon which such forward- looking statements are based are reasonable, it can give no assurances that such assumptions will prove to have been correct. Important factors that could cause actual results to differ materially from the Company's expectations ("cautionary statements") are disclosed under Risk Factors and elsewhere herein. 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 Bellwether Exploration Company ("Bellwether" or the "Company") is an independent energy company engaged in the acquisition, exploitation, development, exploration and production of oil and gas properties and the gathering and processing of natural gas. The Company's principal properties are located in Texas, Louisiana, Alabama, offshore California and the Gulf of Mexico. At December 31, 1997, the Company's estimated net proved reserves totaled 12.2 MMBbl of oil, 2.6 MMBbl of natural gas liquids ("NGL"), and 126.0 Bcf of natural gas for a total of 35.8 million barrels of oil equivalent ("BOE"). On a BOE basis, approximately 59% of the Company's estimated net proved reserves were natural gas at such date. In addition, the Company has interests in natural gas processing plants in California and West Texas. The Company was formed as a Delaware corporation in 1994 to succeed to the business and properties of its predecessor company pursuant to a merger, the primary purpose of which was to change the predecessor company's state of incorporation from Colorado to Delaware. The predecessor company was formed in 1980 from the consolidation of the business and properties of related oil and gas limited partnerships. References to Bellwether or the Company include the predecessor company, unless the context requires otherwise. In order to facilitate greater comparability with its peer group by the financial community, the Company changed its fiscal year to align with the calendar year, beginning January 1, 1998. The six-month transition period of July 1, 1997 through December 31, 1997 ("transition period") precedes the start of the new fiscal year. The unaudited financial information for the six months ended December 31, 1996 ("prior period") is presented for comparative purposes and includes any adjustments (consisting of normal, recurring adjustments) which are, in the opinion of management, necessary for fair presentation. 3 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES Oil and Gas Activities In 1987 and 1988, the Company merged with two independent oil and gas companies owned by institutional investors and managed by Torch Energy Advisors Incorporated ("Torch"). Since those mergers, the Company has operated under agreements, pursuant to which the Company outsources certain administrative functions to Torch. In August 1994, Bellwether acquired, by merger, certain of the assets, liabilities and properties of Odyssey Partners, Ltd. ("Odyssey"), an exploration company specializing in 3-D seismic and computer-aided exploration ("CAEX") technology, in exchange for 0.9 million shares of Common Stock and $5.6 million in cash. The Odyssey merger provided the Company with significant expertise in 3-D seismic and CAEX technology. On February 28, 1995, Bellwether acquired Hampton Resources Corporation ("Hampton") by merger for $17.0 million in cash and approximately 1.0 million shares of Common Stock. Hampton was a publicly held oil and gas company based in Houston, Texas. In April 1997, the Company acquired oil and gas properties and $13.9 million of working capital from affiliates of Torch ("Partnership Transactions"), for $145.2 million, including a contingent payment of $3.4 million, the amount of which was based on 1997 gas prices. The Company financed the Partnership Transactions and related fees, with $34.1 million net proceeds of a Common Stock offering, $97.0 million net proceeds of $100.0 million offering of 10 7/8% Senior Subordinated Notes due 2007 (the "Offerings")and advances under a new credit facility ("New Credit Facility" or "Senior Credit Facility"). In addition, as consideration for advisory services, Torch was issued 150,000 shares of the Company's common stock and a warrant to purchase 100,000 shares of common stock at $9.90 per share. The warrant and shares were valued at $1.5 million and recorded as a cost of the Partnership Transactions. Subsequent to the Partnership Transaction, the Company identified for divestiture non-core properties including approximately 10% of the estimated net proved reserves attributable to the Partnership Transactions. These properties were primarily small working interests in geographically diverse locations, with generally lower operating margins and limited development potential. Such properties were sold in a series of transactions from May 1997 to December 1997 for aggregate consideration of $24 million. The net proceeds from these divestitures were used to repay indebtedness. Business Strategy Bellwether's strategy is to grow its reserves, production and cash flow through a balanced program of producing property acquisitions and technology driven exploratory drilling focused within core operating areas. The key elements of this strategy are as follows: Core Areas Development The Company will develop core operating areas by increasing its geographic concentration and focusing its activities and ownership on a smaller number of higher value operated properties. The 4 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES Company considers its primary core area to be the Texas Louisiana Gulf Coast. Exploration - The Company's exploration activities will be focused primarily along the Texas Louisiana Gulf Coast, both on and offshore, and in areas where the Company has significant existing assets and infrastructure. Emphasis will be placed on internal prospect generation and strategic relationships with prospect generators who have a demonstrated expertise within a play type or area of interest. The Company will employ the latest technology including advanced 3-D seismic and computer added exploration and will leverage its exploration through play types which allow multiple application of successful exploration concepts. Acquisition - The Company will pursue acquisitions of producing oil and gas properties which increase its interests or concentration in its existing properties and operating areas or which advance its strategic goals. The Company will seek to acquire properties within its core Texas-Louisiana Gulf Coast area and properties which would assist in establishing new core areas. Emphasis will be placed on high quality, high margin properties which are operated, have significant exploitation potential and are on trend with existing exploration concepts. Exploitation - The Company will aggressively exploit its properties to maximize their economic value employing the latest technology including 3-D seismic evaluation, horizontal drilling, enhanced recovery methods and advanced completion and production techniques. Low Cost Structure - The Company will constantly seek to reduce costs and maintain a competitive cost structure. The Company will continually review its property base, divesting non-core or lower margin assets and redeploying capital to a higher use. Markets Bellwether's ability to market oil and gas from the Company's wells depends upon numerous factors beyond the Company's control, including the extent of domestic production and imports of oil and gas, the proximity of the gas production to gas pipelines, the availability of capacity in such pipelines, the demand for oil and gas by utilities and other end users, the availability of alternate fuel sources, the effects of inclement weather, state and federal regulation of oil and gas production and federal regulation of gas sold or transported in interstate commerce. No assurances can be given that Bellwether will be able to market all of the oil or gas produced by the Company or that favorable prices can be obtained for the oil and gas Bellwether produces. In view of the many uncertainties affecting the supply of and demand for oil, gas and refined petroleum products, the Company is unable to predict future oil and gas prices and demand or the overall effect such prices and demand will have on the Company. The marketing of oil and gas by Bellwether can be affected by a number of factors which are beyond the Company's control, the exact effects of which cannot be accurately predicted. Sales to Torch Co-Energy LLC accounted for 22% of transition period 1997 revenues. Sales to Valero Industrial Gas, L.P. accounted for 18.0% of 5 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES fiscal 1997 revenues. Sales to Texas Gas Transmission Corporation, Warren Petroleum Corporation and Koch Industries Inc. accounted for 32.9% of fiscal 1996 revenues. Sales to Texas Gas Transmission Corporation and Warren Petroleum Corporation accounted for 42% of fiscal 1995 revenues. Management of the Company does not believe that the loss of any single customer or contract would materially affect the Company's business. There are no other significant delivery commitments and substantially all of the Company's oil and gas production is sold at market responsive pricing through a marketing affiliate of Torch. The Company from time to time may enter into crude oil and natural gas price swaps or other similar hedge transactions to reduce its exposure to price fluctuations. Regulation Federal Regulations Sales of Gas. Effective January 1, 1993, the Natural Gas Wellhead Decontrol Act deregulated prices for all "first sales" of gas. Thus, all sales of gas by the Company may be made at market prices, subject to applicable contract provisions. Transportation of Gas. The Company's sales of natural gas are affected by the availability, terms and cost of transportation. The rates, terms and conditions applicable to the interstate transportation of gas by pipelines are regulated by the Federal Energy Regulatory Commission ("FERC") under the Natural Gas Act ("NGA"), as well as under section 311 of the Natural Gas Policy Act ("NGPA"). Since 1985, the FERC has implemented regulations intended to increase competition within the gas industry by making gas transportation more accessible to gas buyers and sellers on an open-access, non-discriminatory basis. Most recently, in Order No. 636, et seq., the FERC promulgated an extensive set of new regulations requiring all interstate pipelines to "restructure" their services. The most significant provisions of Order No. 636 require that interstate pipelines provide firm and interruptible transportation solely on an "unbundled" basis, separate from their sales service, and convert each pipeline's bundled firm city-gate sales service into unbundled firm transportation service and require that pipelines provide firm and interruptible transportation service on a basis that is equal in quality for all gas supplies, whether purchased from the pipeline or elsewhere. The order also recognized that the elimination of city-gate sales service and the implementation of unbundled transportation service would result in considerable costs being incurred by the pipelines. Therefore, Order No. 636 provided mechanisms for the recovery by pipelines from present, former and future customers of certain types of "transition" costs likely to occur due to these new regulations. In subsequent orders, the FERC and the appellate court have substantially upheld the requirements imposed by Order No. 636, although numerous court appeals in which parties have sought review of separate FERC orders implementing Order No. 636 on individual pipeline systems are still pending. In many instances, the result of Order No. 636 and related initiatives has been to substantially reduce or eliminate the interstate 6 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES pipelines' traditional role as wholesalers of natural gas in favor of providing only storage and transportation services. The FERC has announced several important transportation-related policy statements and proposed rule changes, including a statement of policy and request for comments concerning alternatives to its traditional cost-of-service ratemaking methodology to establish the rates interstate pipelines may charge for their services. A number of pipelines have obtained FERC authorization to charge negotiated rates as one such alternative. While the changes being considered would affect the Company only indirectly, they are intended to further enhance competition in natural gas markets. The Company cannot predict what further action the FERC will take on these matters; however, the Company does not believe that it will be affected by any action taken materially differently than other natural gas producers. Sales and Transportation of Oil. Sales of oil and condensate can be made by the Company at market prices not subject at this time to price controls. The price that the Company receives from the sale of these products will be affected by the cost of transporting the products to market. As required by the Energy Policy Act of 1992, the FERC has revised its regulations governing the rates that may be charged by oil pipelines. The new rules, which were effective January 1, 1995, provide a simplified, generally applicable method of regulating such rates by use of an indexing system for setting transportation rate ceilings. In certain circumstances, the new rules permit oil pipelines to establish rates using traditional cost of service and other methods of rate making. Legislative Proposals. In the past, Congress has been very active in the area of gas regulation. There are legislative proposals pending in the state legislatures of various states, which, if enacted, could significantly affect the petroleum industry. At the present time it is impossible to predict what proposals, if any, might actually be enacted by Congress or the various state legislatures and what effect, if any, such proposals might have on the Company's operations. Federal, State or Indian Leases. In the event the Company conducts operations on federal, state or Indian oil and gas leases, such operations must comply with numerous regulatory restrictions, including various nondiscrimination statutes, and certain of such operations must be conducted pursuant to certain on-site security regulations and other appropriate permits issued by the Bureau of Land Management ("BLM") or, in the case of the Company's OCS leases in federal waters, Minerals Management Service ("MMS") or other appropriate federal or state agencies. The Company's OCS leases in federal waters are administered by the MMS and require compliance with detailed MMS regulations and orders. The MMS has promulgated regulations implementing restrictions on various production-related activities, including restricting the flaring or venting of natural gas. In addition, the MMS has proposed to amend its regulations to prohibit the flaring of liquid hydrocarbons and oil without prior authorization. Under certain circumstances, the MMS may require any Company operations on federal leases to be suspended or terminated. Any such suspension or termination could materially and adversely affect the Company's financial condition and operations. The MMS has issued a notice of proposed rule making in which it 7 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES proposes to amend its regulations governing the calculation of royalties and the valuation of crude oil produced from federal leases. Among other matters, this proposed rule would amend the valuation procedure for the sale of federal royalty oil. The Company cannot predict what action the MMS will take on this matter, nor can it predict at this stage of the proceeding how the Company might be affected by this proposed amendment to the MMS' royalty regulations. The Mineral Leasing Act of 1920 (the "Mineral Act") prohibits direct or indirect ownership of any interest in federal onshore oil and gas leases by a foreign citizen of a country that denies "similar or like privileges" to citizens of the United States. Such restrictions on citizens of a "non- reciprocal" country include ownership or holding or controlling stock in a corporation that holds a federal onshore oil and gas lease. If this restriction is violated, the corporation's lease can be canceled in a proceeding instituted by the United States Attorney General. Although the regulations of the BLM (which administers the Mineral Act) provide for agency designations of non- reciprocal countries, there are presently no such designations in effect. The Company owns interests in numerous federal onshore oil and gas leases. It is possible that the Common Stock will be acquired by citizens of foreign countries, which at some time in the future might be determined to be non- reciprocal under the Mineral Act. State Regulations. Most states regulate the production and sale of oil and gas, including requirements for obtaining drilling permits, the method of developing new fields, the spacing and operation of wells and the prevention of waste of oil and gas resources. The rate of production may be regulated and the maximum daily production allowable from both oil and gas wells may be established on a market demand or conservation basis or both. The Company owns certain natural gas pipeline facilities that it believes meet the traditional tests the FERC has used to establish a pipeline's status as a gatherer not subject to FERC jurisdiction under the NGA. State regulation of gathering facilities generally includes various safety, environmental, and in some circumstances, nondiscriminatory take requirements, but does not generally entail rate regulation. Natural gas gathering may receive greater regulatory scrutiny at both state and federal levels in the post-Order No. 636 environment. The Company may enter into agreements relating to the construction or operation of a pipeline system for the transportation of gas. To the extent that such gas is produced, transported and consumed wholly within one state, such operations may, in certain instances, be subject to the jurisdiction of such state's administrative authority charged with the responsibility of regulating intrastate pipelines. In such event, the rates which the Company could charge for gas, the transportation of gas, and the construction and operation of such pipeline would be subject to the rules and regulations governing such matters, if any, of such administrative authority. Environmental Regulations General. The Company's activities are subject to existing federal, state and local laws and regulations governing environmental quality and 8 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES pollution control. Activities of the Company with respect to gas facilities, including the operation and construction of pipelines, plants and other facilities for transporting, processing, treating or storing gas and other products, are also subject to stringent environmental regulation by state and federal authorities including the Environmental Protection Agency ("EPA"). Risks are inherent in oil and gas exploration and production operations, and no assurance can be given that significant costs and liabilities will not be incurred in connection with environmental compliance issues. The Company cannot predict what effect future regulation or legislation, enforcement policies issued thereunder, and claims for damages to property, employees, other persons and the environment resulting from the Company's operations could have on its activities. Solid and Hazardous Waste. The Company currently owns or leases, and has in the past owned or leased, numerous properties that for many years have been used for the exploration and production of oil and gas. Although the Company believes it has utilized operating and waste disposal practices that were standard in the industry at the time, hydrocarbons or other solid wastes may have been disposed or released on or under the properties owned or leased by the Company or on or under locations where such wastes have been taken for disposal. In addition, many of these properties have been owned or operated by third parties. The Company had no control over such parties' treatment of hydrocarbons or other solid wastes and the manner in which such substances may have been disposed or released. State and federal laws applicable to oil and gas wastes and properties have gradually become stricter over time. Under these new laws, the Company could be required to remove or remediate previously disposed wastes (including wastes disposed or released by prior owners or operators) or property contamination (including groundwater contamination by prior owners or operators) or to perform remedial plugging operations to prevent future contamination. The Company generates wastes, including hazardous wastes, that are subject to the federal Resource Conservation and Recovery Act ("RCRA") and comparable state statutes. The EPA and various state agencies have limited the approved methods of disposal for certain hazardous and non-hazardous wastes. Furthermore, it is possible that certain wastes generated by the Company's oil and gas operations that are currently exempt from treatment as "hazardous wastes" may in the future be designated as "hazardous wastes" under RCRA or other applicable statutes, and therefore be subject to more rigorous and costly operating and disposal requirements. Superfund. The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), also known as the "Superfund" law, imposes liability, without regard to fault or the legality of the original conduct, on certain classes of persons with respect to the release of a "hazardous substance" into the environment. These persons include the owner and operator of a disposal site where a release occurred and any company that disposed or arranged for the disposal of the hazardous substance released at the site. CERCLA also authorizes the EPA and, in some cases, third parties, to take actions in response to threats to the public health or the environment and to seek to recover from the responsible classes of persons the costs of such action. In the course of its operations, the Company has generated and will generate wastes that may fall within CERCLA's definition 9 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES of "hazardous substances." The Company may also be an owner of sites on which "hazardous substances" have been released. The Company may be responsible under CERCLA for all or part of the costs to clean up sites at which such wastes have been disposed. Oil Pollution Act. The Oil Pollution Act of 1990 (the "OPA") and regulations thereunder impose certain duties and liabilities on "responsible parties" related to the prevention of oil spills and damages resulting from such spills in United States waters. A "responsible party" includes the owner or operator of an onshore facility, vessel or pipeline, or the lessee or permittee of the area in which an offshore facility is located. The OPA assigns liability to each responsible party for oil removal costs and a variety of public and private damages. While liability limits apply in some circumstances, a party cannot take advantage of liability limits if the spill was caused by gross negligence or willful misconduct or resulted from violation of a federal safety, construction or operating regulation. If the party fails to report a spill or to cooperate fully in the cleanup, liability limits also do not apply. Few defenses exist to the liability imposed by the OPA. The failure to comply with OPA requirements may subject a responsible party to civil or even criminal liability. The OPA also imposes ongoing requirements on a responsible party, including proof of financial responsibility to cover at least some costs in a potential spill. Certain amendments to the OPA that were enacted in 1996 require owners and operators of offshore facilities that have a worst case oil spill potential of more than 1,000 barrels to demonstrate financial responsibility in amounts ranging from $10 million in specified state waters to $35 million in federal OCS waters, with higher amounts, up to $150 million in certain limited circumstances, where the MMS believes such a level is justified by the risks posed by the quantity or quality of oil that is handled by the facility. On March 25, 1997, the MMS promulgated a proposed rule implementing these OPA financial responsibility requirements. The Company believes that it currently has established adequate proof of financial responsibility for its offshore facilities. However, the Company cannot predict whether the financial responsibility requirements under the OPA amendments or the proposed rule will result in the imposition of substantial additional annual costs to the Company in the future or otherwise materially adversely affect the Company. The impact of the financial responsibility requirements is not expected to be any more burdensome to the Company than it will be to other similarly or less capitalized owners or operators in the Gulf of Mexico and offshore California. Air Emissions. The operations of the Company are subject to local, state and federal laws and regulations for the control of emissions from sources of air pollution. Administrative enforcement actions for failure to comply strictly with air regulations or permits may result in the payment of civil penalties and, in extreme cases, the shutdown of air emission sources. The Company believes it is in compliance with all air emission regulations. OSHA and other Regulations. The Company is subject to the requirements of the federal Occupational Safety and Health Act ("OSHA") and comparable state statutes. The OSHA hazard communication standard, the EPA community right-to- know regulations under Title III of CERCLA and similar state 10 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES statutes require the Company to organize and/or disclose information about hazardous materials used or produced in the Company's operations. The Company believes that it is in substantial compliance with these applicable requirements. Competition The oil and gas industry is highly competitive in all of its phases. Bellwether encounters competition from other oil and gas companies in all areas of the Company's operations, including the acquisition of reserves and producing properties and the marketing of oil and gas. Many of these companies possess greater financial and other resources than Bellwether. Competition for producing properties is affected by the amount of funds available to the Company, information about a producing property available to the Company and any standards established by the Company for the minimum projected return on investment. Because gathering systems and related facilities are the only practical method for the intermediate transportation of gas, competition for gas delivery is presented by other pipelines and gas gathering systems. Competition may also be presented by alternate fuel sources. ITEM 2. PROPERTIES Reserves The Company holds interests in oil and gas properties, all of which are located in the United States. The Company's principal developed properties are located in Texas, Louisiana, Alabama, offshore California and the Gulf of Mexico. Estimated net proved oil and gas reserves at December 31, 1997 decreased approximately 4% from June 30, 1997, primarily as a result of the sale of non-core oil and gas properties containing approximately 800,000 BOE of associated reserves and a downward revision of 1.0 million BOE due to an error in the calculation of reserves at June 30, 1997. The Company has not filed oil or gas reserve information with any foreign government or Federal authority or agency. 11 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES The following table sets forth certain information, as of December 31, 1997, which relates to fields which hold approximately 75% of the Company's proved oil and gas reserves:
Six Month Transition Net Proved Reserves Period Net Production ------------------------------------------------------------------ OIL & OIL & NGL GAS BOE NGL GAS BOE FIELD (MBBLS) (MMCF) (MBBLS) (MBBLS) (MMCF) (MBBLS) - ----------------------------------------------------------------------------------------------------------- Waddell Ranch field, TX 6,137 9,833 7,775 230 394 296 Point Pedernales field, offshore CA 3,873 1,486 4,121 191 80 204 Blue Creek field, AL --- 11,072 1,845 --- 474 79 Robinson's Bend field, AL --- 5,466 911 --- 203 34 Ship Shoal Complex, Gulf of Mexico 940 6,400 2,006 164 929 319 High Island Block A-334 field, Gulf of Mexico 260 7,769 1,555 19 1,109 204 Cove field, offshore TX 14 7,012 1,183 6 1,278 219 Giddings field, TX 358 4,574 1,120 65 678 178 Reddell field, LA 72 4,127 760 6 264 50 South Marsh Island Block 269 field, Gulf of Mexico 184 2,748 642 16 218 52 Porters Creek field, TX 61 4,348 786 5 341 62 La Rica field, TX 3 6,223 1,040 1 243 42 West Chalkley field, LA 19 3,484 600 2 244 43 East Cameron Block 17, offshore LA 15 3,245 556 3 503 87 Fort Trinidad field, TX 634 899 784 30 114 49 Rocky Creek field, TX 7 3,945 665 1 326 55 Happy field, TX 409 80 422 56 3 56 Others 1,823 43,249 9,031 259 3,792 891 --------------------------------- ----------------------------- 14,809 125,960 35,802 1,054 11,193 2,920 ================================= =============================
In general, estimates of economically recoverable oil and natural gas reserves and of the future net cash flows therefrom are based upon a number of variable factors and assumptions, such as historical production from the properties, assumptions concerning future oil and natural gas prices and future operating costs and the assumed effects of regulation by governmental agencies, all of which may vary considerably from actual results. All such estimates are to some degree speculative, and classifications of reserves are only attempts to define the degree of speculation involved. Estimates of the economically recoverable oil and natural gas reserves attributable to any particular group of properties, classifications of such reserves based on risk of recovery and estimates of future net cash flows expected therefrom, prepared by different engineers or by the same engineers at different times, may vary substantially. The Company's actual production, revenues, severance and excise taxes and development and operating expenditures with respect to its reserves will vary from such estimates, and such variances could be material. Estimates with respect to proved reserves that may be developed and produced in the future are often based upon volumetric calculations and upon analogy to similar types of reserves rather than actual production history. 12 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES Estimates based on these methods are generally less reliable than those based on actual production history. Subsequent evaluation of the same reserves based upon production history will result in variations, which may be substantial, in the estimated reserves. In accordance with applicable requirements of the Securities and Exchange Commission ("SEC"), the estimated discounted future net cash flows from estimated proved reserves are based on prices and costs as of the date of the estimate unless such prices or costs are contractually determined at such date. Actual future prices and costs may be materially higher or lower. Actual future net cash flows also will be affected by factors such as actual production, supply and demand for oil and natural gas, curtailments or increases in consumption by natural gas purchasers, changes in governmental regulations or taxation and the impact of inflation on costs. Acreage The following table sets forth the acres of developed and undeveloped oil and gas properties in which the Company held an interest as of December 31, 1997. Undeveloped acreage is considered to be those leased acres on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil and gas, regardless of whether or not such acreage contains proved reserves. A gross acre in the following table refers to the number of acres in which a working interest is owned directly by the Company. The number of net acres is the sum of the fractional ownership of working interests owned directly by the Company in the gross acres expressed as a whole number and percentages thereof. A net acre is deemed to exist when the sum of fractional ownership of working interests in gross acres equals one.
Gross Net ------- ------- Developed Acreage.... 455,581 109,134 Undeveloped Acreage.. 122,352 43,387 ------- ------- Total............ 577,933 152,521 ======= =======
Bellwether believes that the title to its oil and gas properties is good and defensible in accordance with standards generally accepted in the oil and gas industry, subject to such exceptions which, in the opinion of the Company, are not so material as to detract substantially from the use or value of such properties. The Company's properties are typically subject, in one degree or another, to one or more of the following: royalties and other burdens and obligations, express or implied, under oil and gas leases; overriding royalties and other burdens created by the Company or its predecessors in title; a variety of contractual obligations (including, in some cases, development obligations) arising under operating agreements, farmout agreements, production sales contracts and other agreements that may affect the properties or their titles; back-ins and reversionary interests arising under purchase agreements and leasehold assignments; liens that arise in the normal course of operations, such as those for unpaid taxes, statutory liens securing obligations to unpaid suppliers and contractors and contractual liens under operating agreements; pooling, unitization and communitization agreements, declarations and orders; and easements, restrictions, rights-of-way and other matters that commonly affect oil and gas producing property. To the extent that such burdens and obligations 13 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES affect the Company's rights to production revenues, they have been taken into account in calculating the Company's net revenue interests and in estimating the size and value of the Company's reserves. Bellwether believes that the burdens and obligations affecting the Company's properties are conventional in the industry for properties of the kind owned by the Company. Productive Wells The following table sets forth Bellwether's gross and net interests in productive oil and gas wells as of December 31, 1997. Productive wells are defined as producing wells and wells capable of production.
Gross Net -------- ------ Oil Wells.. 1,192.00 169.79 Gas Wells.. 809.00 142.13 -------- ------ Total.. 2001.00 311.92 ======== ======
Production The Company's principal production volumes during the transition period ended December 31, 1997 were from the states of Louisiana, Texas, Alabama and offshore California in federal waters and from the Gulf of Mexico in federal and state waters. Data relating to production volumes, average sales prices, average unit production costs and oil and gas reserve information appear in Note 13 of the Notes to Consolidated Financial Statements-Supplemental Information. Drilling Activity and Present Activities During the three-year period ended June 30, 1997 and the transition period ended December 31, 1997, the Company's principal drilling activities occurred in the continental United States and offshore Texas, Louisiana and California in federal and state waters. The following table sets forth the results of drilling activity for the last three fiscal years and the transition period. Gross wells, as it applies to wells in the following tables, refers to the number of wells in which a working interest is owned directly by the Company. A "net well" is deemed to exist when the sum of fractional ownership working interests in gross wells equals one. The number of net wells is the sum of the fractional ownership of working interests owned directly by the Company in gross wells expressed as whole numbers and percentages thereof.
Exploratory Wells --------------------------------------------------------- Gross Net --------------------------------------------------------- Dry Dry Productive Holes Total Productive Holes Total --------------------------------------------------------- Fiscal 1995 3 4(1) 7 .27 .65 .92 Fiscal 1996 1 3 4 .06 .24 .30 Fiscal 1997 3 4 7 .75 .74 1.49 Six Month Transition 1997 2 2 4 .28 .78 1.06
14 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES
Development Wells ------------------------------------------------------ Gross Net ------------------------------------------------------ Dry Dry Productive Holes Total Productive Holes Total ------------------------------------------------------ Fiscal 1995 1 2 3 .30 .18 .48 Fiscal 1996 21 1 22 1.66 .90 2.56 Fiscal 1997 52 2 54 5.34 .63 5.97 Six Month Transition 1997 30 5 35 2.40 1.19 3.59
(1) Includes well drilled on the Serj Permit in Tunisia. The Company had 18 wells in the process of being drilled as of December 31, 1997. Gas Plant and Gas Gathering Facilities As of December 31, 1997 the Comapany owned interests in the following gas plants and gas gathering system:
Transition Period 1997 -------------------------------------------------------- Capacity Throughput Ownership Facility State Operator MMCFD MMCFD Interest - --------------------- ---------- ------------------------------- -------------------------------------------------------- Point Pedernales Gas Plant CA Torch Energy Marketing Inc 13 4.5 19.70% Snyder Gas Torch Energy Plant TX Marketing Inc. 60 12 11.98% Diamond M- Exxon Company, Sharon Ridge U.S.A. Gas Plant (1) TX (1) (1) (1) Monroe Gas West Monroe Gas Gathering Gathering Corp., a System(2) LA Subsidiary of the (2) (2) 100% Company
(1) The Company has a 35.78% interest in the operations of the former Diamond M- Sharon Ridge Gas Plant. This plant was dismantled in December 1993, and the gas is being processed by Snyder Gas Plant pursuant to a processing agreement. (2) The Company owns a gas gathering system in Union Parish, Louisiana. In March 1996, the liability for a gas purchase contract covering natural gas owned by the Company and others was assumed by the Company. All operations from that date are recorded as a reduction to the liability. 15 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES Risk Factors Volatility of Oil and Gas Prices and Markets The Company's financial condition, operating results, future growth and the carrying value of its oil and gas properties are substantially dependent on prevailing prices of oil and gas. The Company's ability to maintain or increase its borrowing capacity and to obtain additional capital on attractive terms is also substantially dependent upon 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 regulation, political stability in the Middle East and elsewhere, the foreign supply of oil and gas, the price of foreign imports and the availability of alternate fuel sources. Any substantial and extended decline in the price of oil or gas would have an adverse effect on the Company's carrying value of its proved reserves, its borrowing capacity, its ability to obtain additional capital, and its revenues, profitability and cash flows. Volatile oil and gas prices make it difficult to estimate the value of producing properties in connection with acquisitions and often cause disruption in the market for oil and gas producing properties, as buyers and sellers have difficulty agreeing on such value. Price volatility also makes it difficult to budget for and project the return on acquisitions and exploitation, development and exploration projects. The availability of a ready market for the Company's oil and natural gas production also depends on a number of factors, including the demand for and supply of oil and natural gas and the proximity of reserves to, and the capacity of, oil and natural gas gathering systems, pipelines or trucking and terminal facilities. Wells may temporarily be shut-in for lack of a market or due to inadequacy or unavailability of pipeline or gathering system capacity. Ability to Replace Reserves The Company's future performance depends upon its ability to find, develop and acquire additional oil and gas reserves that are economically recoverable. The proved reserves of Bellwether will generally decline as reserves are depleted. The Company therefore must locate and develop or acquire new oil and gas reserves to replace those being depleted by production. Because the Company's reserves are characterized by relatively rapid decline rates, without successful exploration, development or acquisition activities, the Company's revenues will decline rapidly. No assurances can be given that the Company will be able to find and develop or acquire additional reserves at an acceptable cost. Acquisition Risks The Company's rapid growth in recent years has been attributable in significant part to acquisitions of oil and gas properties. The Company expects to continue to evaluate and, where appropriate, pursue acquisition 16 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES opportunities on terms management considers favorable to the Company. There can be no assurance that suitable acquisition candidates will be identified in the future, or that the Company will be able to finance such acquisitions on favorable terms. In addition, the Company competes against other companies for acquisitions, and there can be no assurances that the Company will be successful in the acquisition of any material property interests. Further, there can be no assurances that any future acquisitions made by the Company will be integrated successfully into the Company's operations or will achieve desired profitability objectives. The successful acquisition of producing properties requires an assessment of recoverable reserves, exploration and exploitation potential, future oil and natural gas prices, operating costs, potential environmental and other liabilities and other factors beyond the Company's control. In connection with such an assessment, the Company performs a review of the properties that it believes to be generally consistent with industry practices. Nonetheless, the resulting assessments are inexact and their accuracy is inherently uncertain, and such a review may not reveal all existing or potential problems, nor will it necessarily permit the Company to become sufficiently familiar with the properties to fully assess their merits and deficiencies. Inspections may not always be performed on every well, and structural and environmental problems are not necessarily observable even when an inspection is undertaken. In addition, sellers of properties may be unwilling or financially unable to indemnify the Company for known liabilities at the time of an acquisition. Additionally, significant acquisitions can change the nature of the operations and business of the Company depending upon the character of the acquired properties, which may be substantially different in operating and geologic characteristics or geographic location than existing properties. While the Company's operations are focused in Texas, Louisiana, Alabama, offshore California and the Gulf of Mexico, there is no assurance that the Company will not pursue acquisitions or properties located in other geographic areas. In connection with the Partnership Transactions, Bellwether assumed or otherwise became liable for all obligations with respect to operations of the properties acquired in such transactions, including environmental and operational liabilities, unknown liabilities, and liabilities arising prior to the closing date. Drilling Risks Drilling activities are subject to many risks, including the risk that no commercially productive reservoirs will be encountered. There can be no assurance that new wells drilled by the Company will be productive or that the Company will recover all or any portion of its investment. Drilling for oil and natural gas may involve unprofitable efforts, not only from dry wells, but from wells that are productive but do not produce sufficient net revenues to return a profit after drilling, operating and other costs. The cost of drilling, completing and operating wells is often uncertain and cost overruns are common. The Company's drilling operations may be curtailed, delayed or canceled as a result of numerous factors, many of which are beyond 17 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES the Company's control, including title problems, weather conditions, compliance with governmental requirements and shortages or delays in the delivery of equipment and services. Substantial Capital Requirements The Company makes, and will continue to make, substantial capital expenditures for the exploitation, exploration, acquisition and production of oil and gas reserves. Historically, the Company has financed these expenditures primarily with cash generated by operations, proceeds from bank borrowings and sales of its Common Stock. The Company believes that it will have sufficient cash flows provided by operating activities, the proceeds of the equity offerings and borrowings under the Senior Credit Facility to fund such planned capital expenditures. If revenues or the Company's borrowing base decrease as a result of lower oil and gas prices, operating difficulties or declines in reserves, the Company may have limited ability to expend the capital necessary to undertake or complete future drilling programs. There can assurance that additional debt or equity financing or cash generated by operations will be available to meet these requirements. Significant Leverage and Debt Service The Company's level of indebtedness has several important effects on its future operations, including (i) a substantial portion of the Company's cash flow from operations must be dedicated to the payment of interest on its indebtedness and will not be available for other purposes, (ii) covenants contained in the Company's debt obligations require the Company to meet certain financial tests, and other restrictions limit its ability to borrow additional funds or to dispose of assets and may affect the Company's flexibility in planning for, and reacting to, changes in its business, including possible acquisition activities and (iii) the Company's ability to obtain financing in the future for working capital, capital expenditures, acquisitions, general corporate purposes or other purposes may be impaired. The Company's ability to meet its debt service obligations and to reduce its total indebtedness will be dependent upon the Company's future performance, which will be subject to general economic conditions and to financial, business and other factors affecting the operations of the Company, many of which are beyond its control. There can be no assurance that the Company's future performance will not be adversely affected by such economic conditions and financial, business and other factors. Administrative Services Agreement; Reliance on Torch The Company currently has nine employees. The Company is party to an administrative services agreement ("Administrative Services Agreement") with Torch, pursuant to which Torch performs certain administrative and technical functions for the Company, including financial, accounting, legal, geological, engineering and technical support. The Company believes that its relationship with Torch provides the Company with access to professional, technical and administrative personnel not otherwise available to a company of its size. Bellwether believes that if the Administrative Services Agreement were terminated Bellwether could, over time, hire experienced personnel and acquire the accounting and reporting systems and other assets 18 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES necessary to replace Torch. However, the unanticipated termination of the Administrative Services Agreement could have a material adverse effect upon the Company. The Administrative Services Agreement may be terminated by Bellwether upon one year's prior notice and may not be terminated by Torch prior to December 31, 1999. Conflicts of Interest Torch also renders administrative services to Nuevo Energy Company ("Nuevo"), a publicly traded independent oil and gas company and may manage or render management or administrative services for other energy companies in the future. These services may include the review and recommendation of potential acquisitions. It is possible that conflicts may occur between Nuevo and Bellwether in connection with possible acquisitions or otherwise in connection with the services rendered by Torch. Although the Administrative Services Agreement provides for procedures to reconcile conflicts of interest between Nuevo and the Company, no assurances can be made that such procedures will fully protect the Company from losses which may occur if a conflict between the Company and Nuevo arises. Estimates of Oil and Gas Reserves This document contains estimates of oil and gas reserves owned by the Company, and the future net cash flows attributable to those reserves. There are numerous uncertainties inherent in estimating quantities of proved reserves and cash flows attributable to such reserves, including factors beyond the control of the Company and the reserve engineers. Reserve engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact manner. The accuracy of an estimate of quantities of reserves, or of cash flows attributable to such reserves, is a function of the available data, assumptions regarding future oil and gas prices and expenditures for future development and exploitation activities, and of engineering and geological interpretation and judgment. Additionally, reserves and future cash flows may be subject to material downward or upward revisions based upon production history, development and exploitation activities and prices of oil and gas. Actual future production, revenue, taxes, development expenditures, operating expenses, quantities of recoverable reserves and the value of cash flows from such reserves may vary significantly from the assumptions and estimates set forth herein. In addition, reserve engineers may make different estimates of reserves and cash flows based on the same available data. In calculating reserves on an oil equivalent basis, gas was converted to oil equivalent at the ratio of six Mcf of gas to one Bbl of oil. While this ratio approximates the energy equivalency of gas to oil on a Btu basis, it may not represent the relative prices received by the Company on the sale of its oil and gas production. The estimated quantities of proved reserves and the discounted present value of future net cash flows attributable to estimated proved reserves set forth herein were prepared in accordance with the rules of the SEC, and are not intended to represent the fair market value of such reserves. 19 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES Hedging of Production Part of the Company's business strategy is to reduce its exposure to the volatility of oil and gas prices by hedging a portion of its production. In a typical hedge transaction, the Company will have the right to receive from the counterparty to the hedge, the excess of the fixed price specified in the hedge over a floating price based on a market index, multiplied by the quantity hedged. If the floating price exceeds the fixed price, the Company is required to pay the counterparty this difference multiplied by the quantity hedged. In such case, the Company is required to pay the difference regardless of whether the Company has sufficient production to cover the quantities specified in the hedge. Significant reductions in production at times when the floating price exceeds the fixed price could require the Company to make payments under the hedge agreements even though such payments are not offset by sales of production. Hedging will also prevent the Company from receiving the full advantage of increases in oil or gas prices above the fixed amount specified in the hedge. Operating Hazards, Offshore Operations and Uninsured Risks Bellwether's operations are subject to risks inherent in the oil and gas industry, such as blowouts, cratering, explosions, uncontrollable flows of oil, gas or well fluids, fires, pollution, earthquakes and environmental risks. These risks could result in substantial losses to the Company due to injury and loss of life, severe damage to and destruction of property and equipment, pollution and other environmental damage and suspension of operations. Moreover, a portion of the Company's operations are offshore and therefore are subject to a variety of operating risks peculiar to the marine environment, such as hurricanes or other adverse weather conditions, to more extensive governmental regulation, including regulations that may, in certain circumstances, impose strict liability for pollution damage, and to interruption or termination of operations by governmental authorities based on environmental or other considerations. The Company's operations could result in liability for personal injuries, property damage, oil spills, discharge of hazardous materials, remediation and clean-up costs and other environmental damages. The Company could be liable for environmental damages caused by previous property owners. As a result, substantial liabilities to third parties or governmental entities may be incurred, the payment of which could have a material adverse effect on the Company's financial condition and results of operations. The Company maintains insurance coverage for its operations, including limited coverage for sudden environmental damages, but does not believe that insurance coverage for environmental damages that occur over time is available at a reasonable cost. Moreover, the Company does not believe that insurance coverage for the full potential liability that could be caused by sudden environmental damages is available at a reasonable cost. Accordingly, the Company may be subject to liability or may lose substantial portions of its properties in the event of certain environmental damages. 20 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES Environmental and Other Regulation The Company's operations are subject to numerous laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. These laws and regulations require the acquisition of a permit before drilling commences, restrict the types, quantities and concentration of various substances that can be released into the environment in connection with drilling and production activities, limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas, and impose substantial liabilities for pollution resulting from the Company's operations. Moreover, the recent trend toward stricter standards in environmental legislation and regulation is likely to continue. For instance, legislation has been proposed in Congress from time to time that would reclassify certain oil and gas exploration and production wastes as "hazardous wastes" which would make the reclassified wastes subject to much more stringent handling, disposal and clean-up requirements. If such legislation were to be enacted, it could have a significant impact on the operating costs of the Company, as well as the oil and gas industry in general. Initiatives to further regulate the disposal of oil and gas wastes are also pending in certain states, and these various initiatives could have a similar impact on the Company. Management believes that the Company is in substantial compliance with current applicable environmental laws and regulations. The Oil Pollution Act of 1990 imposes a variety of regulations on "responsible parties" related to the prevention of oil spills. The implementation of new, or the modification of existing, environmental laws or regulations, including regulations promulgated pursuant to the Oil Pollution Act of 1990, could have a material adverse impact on the Company. Competition The Company operates in the highly competitive areas of oil and gas exploration, development and production. The Company's competitors include major integrated oil and gas companies and substantial independent energy companies, many of which possess greater financial and other resources than the Company. Shortages of Rigs, Equipment, Supplies and Personnel Currently, there is a general shortage of drilling rigs, equipment and supplies which the Company believes may intensify. The costs and delivery times of rigs, equipment and supplies are substantially greater than in prior periods and are currently escalating. Shortages of drilling rigs, equipment or supplies could delay and adversely affect the Company's exploration and development operations, which could have a material adverse effect on its financial condition and results of operation. The demand for, and wage rates of, qualified rig crews have begun to rise in the drilling industry in response to the increasing number of active rigs in service. Such shortages have in the past occurred in the industry in times of increasing demand for drilling services. If the number of active drilling rigs continues to increase, the oil and gas industry may experience 21 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES shortages of qualified personnel to operate drilling rigs, which could delay the Company's drilling operations and adversely effect the Company's financial condition and results of operations. ITEM 3. LEGAL PROCEEDINGS Cause No. C-4417-96-G; A.R. Guerra, et al. V. Eastern Exploration, Inc., et al.; In the 370th Judicial District Court of Hidalgo County, Texas On October 11, 1996, Plaintiffs filed suit in Hidalgo County, Texas, naming Eastern Exploration, Inc., ("Eastern"), Rebel Drilling, L.P., Southwest Gas Supply, Inc., and Bellwether Exploration Company (the "Company") as Defendants. Plaintiffs seek recovery of compensatory royalties in the amount of $3.3 million under the offset and compensatory royalty provisions of a 648-Acre Lease entered into between Plaintiffs, as Lessors, and Eastern, as Lessee, a lease in which the Company's predecessor, Hampton Resources Corporation, acquired a partial interest by assignment. Plaintiffs also included a separate claim for damages from an alleged breach of the bonus provisions of an entirely distinct and unrelated Top Lease Agreement. The Company believes that Plaintiffs claims for compensatory royalties under the 648-Acre Lease, and Plaintiffs' claims for recovery of damages for alleged breach of the bonus provisions of the Top Lease Agreement, are without merit, and the Company has filed a Motion for Summary Judgement with the Court seeking dismissal of the claims. The Company's Motion for Summary Judgement is pending. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS A Proxy statement was sent to all shareholders of record on October 10, 1997 for the following matters which were voted on at the Annual Meeting of Stockholders held on November 21, 1997: 1. To elect the nominees of the Board of Directors to serve until their successors are duly elected and qualified. The following sets forth the votes cast for each director:
DIRECTORS FOR WITHHOLD - -------------------------- --------------------- ------------------- J. P. Bryan 10,776,441 98,557 J. Darby Sere' 10,776,441 98,557 C. Barton Groves 10,775,641 99,357 Dr. Jack Birks 10,781,341 98,657 Vincent H. Buckley 10,781,341 98,657 Habib Kairouz 10,775,141 99,857 A. K. McLanahan 10,780,841 94,157 Townes G. Pressler 10,775,641 99,357 Charles C. Green, III 10,775,141 99,857
2. To consider and act upon a proposal to ratify and approve the Board of Directors' adoption of an amendment to increase the number of shares of the Company's Common Stock available for distribution under the Bellwether Exploration Company 1996 Stock Incentive Plan. There were 9,110,937 votes for the proposal, 1,740,106 against the proposal and 23,955 abstained. 3. To consider and act upon a proposal to ratify the appointment of KPMG Peat Marwick LLP as the independent auditors of the Company 22 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES for the period ending December 31, 1997. There were 10,841,978 votes cast for the proposal, 25,374 against the proposal and 7,646 abstained. No other matters were brought before the meeting. A copy of the Proxy Statement was filed with the Securities and Exchange Commission on October 22, 1997 and is incorporated herein by reference. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock is traded on the NASDAQ National Market (Symbol: BELW). There were approximately 1,095 stockholders of record as of March 20, 1998. The Company has not paid dividends on its common stock and does not anticipate the payment of cash dividends in the immediate future as it contemplates that cash flows will be used for continued growth in Company operations. In addition, certain covenants contained in the Company's financing arrangements restrict the payment of dividends (See Management's Discussion and Analysis of Financial Condition and Results of Operations - Financing Activities and Note 8 of the Notes to Consolidated Financial Statements). The following table sets forth the range of the high and low sales prices, as reported by the NASDAQ for Bellwether common stock for the periods indicated.
Sales Price ------------------- High Low ------ ----------- Quarter Ended: September 30, 1995 $ 6.25 $5.00 December 31, 1995 $ 6.13 $4.06 March 31, 1996 $ 7.00 $5.00 June 30, 1996 $ 8.00 $5.50 September 30, 1996 $ 6.88 $4.38 December 31, 1996 $ 9.00 $5.63 March 31, 1997 $11.50 $7.88 June 30, 1997 $10.25 $7.25 September 30, 1997 $15.38 $9.08 December 31, 1997 $14.88 $9.75
23 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES ITEM 6. SELECTED FINANCIAL DATA The following selected financial data with respect to the Company should be read in conjunction with the Consolidated Financial Statements and supplementary information included in Item 8 (amounts in thousands, except per share data).
(Unaudited) Six Month Six Month Transition Period Period Ended Ended Dec. 31, Dec. 31, Fiscal Years Ended June 30, --------- ------- ---------------------------------------------------------- 1997 1996 1997(1) 1996 1995(2) 1994(3) 1993 --------- ------- -------- ------- -------- -------- ------- Gas revenues........... $ 26,755 $ 6,759 $ 24,202 $ 9,856 $ 4,864 $ 2,620 $ 1,807 Oil revenues........... 17,408 3,087 14,865 5,810 3,643 1,086 1,708 Gas plant and gas gathering revenues, net.................. 804 2,052 3,330 3,534 4,627 2,917 23 Interest and other income.............. 609 54 363 116 97 63 116 --------- ------- -------- ------- -------- -------- ------- Total revenues....... 45,576 11,952 42,760 19,316 13,231 6,686 3,654 Production expenses... 13,836 3,061 11,437 5,317 2,856 1,294 1,273 General and administrative expenses............ 3,748 1,452 4,042 3,013 2,739 1,234 787 Depreciation, depletion and amortization........ 16,352 4,167 15,574 8,148 5,269 2,489 1,455 Interest expense...... 5,978 520 4,477 1,657 1,245 721 77 Provision for income taxes............... 2,114 1,018 2,585 46 9 --- 21 Other expenses........ --- --- --- 153 172 134 --- --------- ------- -------- ------- -------- -------- ------- Total expenses....... 42,028 10,218 38,115 18,334 12,290 5,872 3,613 --------- ------- -------- ------- -------- -------- ------- Net income............ $ 3,548 $ 1,734 $ 4,645 $ 982 $ 941 $ 814 $ 41 ========= ======= ======== ======= ======== ======== ======= Earnings per common share............... $ 0.26 $ 0.19 $ 0.46 $ 0.11 $ 0.12 $ 0.35 $ 0.02 Earnings per common share- diluted...... $ 0.25 $ 0.19 $ 0.45 $ 0.11 $ 0.12 $ 0.33 $ 0.02 Working capital....... $ 13,964 $ 4,357 $ 22,783 $ 5,168 $ (1,246) $ (249) $ 415 Long-term debt, net of current maturities $ 100,000 $11,000 $115,300 $13,048 $ 18,525 $ 12,797 $ 1,000 Stockholders equity... $ 91,669 $48,751 $ 87,924 $46,597 $ 45,447 $ 18,372 $10,770 Total assets.......... $ 214,757 $68,982 $222,648 $67,225 $ 74,650 $ 35,870 $12,480
________________ (1) Includes operations of the Partnership Transactions beginning April 1, 1997. (2) Reflects operations from Odyssey and Hampton mergers beginning August 1994 and February 1995, respectively. (3) Includes operations of the gas plant and Associated Gas Resources Inc. from dates of acquisition in July and December 1993, respectively. 24 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Bellwether is an independent energy company primarily engaged in the acquisition, exploitation, development and exploration of oil and gas properties. The Company has grown and diversified its operations primarily through acquisitions and the subsequent development of the acquired properties. The Company's results of operations have been significantly affected by its success in acquiring oil and gas properties and its ability to maintain or increase production through its exploitation activities. In April 1997, the Company purchased oil and gas properties and $13.9 million of working capital from affiliates of Torch for an adjusted purchase price at closing of $145.2 million, including a contingent payment of $3.4 million, the amount of which was based on 1997 gas prices. The acquisition was recorded effective April 1, 1997 and the operations of the Company include the Partnership Transactions from that date. The Partnership Transactions were financed with $34.1 million of net proceeds of a Common Stock offering, $97.0 million net proceeds of 10 7/8% Senior Subordinated Notes due 2007 (the "Offerings") and borrowings under a new credit facility ("New Credit Facility"). In addition, Torch was issued 150,000 shares of the Company's common stock and a warrant to purchase 100,000 shares at $9.90 per share for advisory services rendered the Partnership Transactions. The warrant and shares were valued at $1.5 million and recorded as a cost of the Partnership Transactions. On February 28, 1995, Bellwether acquired Hampton Resources Corporation ("Hampton") by merger for $17.0 million in cash and approximately 1.0 million shares of Common Stock. In August 1994, Bellwether acquired, by merger, certain of the assets, liabilities and properties of Odyssey Partners, Ltd. ("Odyssey"), in exchange for 0.9 million shares of Common Stock and $5.6 million in cash. In order to facilitate greater comparability with its peer group by the financial community, the Company changed its fiscal year to align with the calendar year, beginning January 1, 1998. The six-month transition period of July 1, 1997 through December 31, 1997 ("transition period") precedes the start of the new fiscal year. The unaudited financial information for the six months ended December 31, 1996 ("prior period") is presented for comparative purposes and includes any adjustments (consisting of normal, recurring adjustments) which are, in the opinion of management, necessary for fair presentation. The Company uses the full cost method of accounting for its investment in oil and gas properties. Under the full cost method of accounting, all costs of acquisition, exploration and development of oil and gas reserves are capitalized in a "full cost pool" as incurred. Oil and gas properties in the pool, plus estimated future expenditures to develop proved reserves and future abandonment, site reclamation and dismantlement costs, are depleted and charged to operations using the unit of production method based on the ratio of current production to total proved recoverable oil and gas reserves. To the extent that such capitalized costs (net of depreciation, depletion and amortization) exceed the discounted future net revenues on an after-tax basis of estimated proved oil and gas reserves, such excess costs are charged to operations. Once incurred, the writedown of oil and gas properties is not reversible at a later date even if 25 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES oil and gas prices increase. Sharp declines in oil and gas prices may cause companies who report on the full cost method, such as Bellwether, to write down their oil and gas properties, thereby decreasing earnings during such period. The Company periodically uses derivative financial instruments to manage oil and gas price risk. Settlements of gains and losses on price swap contracts are generally based upon the difference between the contract price and the average closing NYMEX or other floating index price and are reported as a component of oil and gas revenue. Gains or losses attributable to the termination of swap contracts are deferred and recognized in revenue when the hedged oil and gas is sold. Financing Activities The Company's outstanding indebtedness totals $100 million at December 31, 1997; all 10 7/8% Senior Subordinated Notes due in 2007. In April 1997, the Company entered into a senior revolving unsecured credit facility in an amount up to $90.0 million, with a current borrowing base of $75.0 million, and a maturity date of March 31, 2002. Bellwether may elect an interest rate based either on a margin plus London Interbank Offered Rate ("LIBOR") or the higher of the prime rate or the sum of 1/2 of 1% plus the Federal Funds Rate. For LIBOR borrowings, the interest rate will vary from LIBOR plus 0.875% to LIBOR plus 1.25% based upon the borrowing base usage. In connection with the acquisition of oil and gas properties, $33.3 million was drawn under this facility, including $22.0 million to retire indebtedness previously outstanding. As of December 31, 1997, no amounts were outstanding under the Senior Credit Facility. The Senior Credit Facility contains various covenants including certain required financial measurements for current ratio, consolidated tangible net worth and interest coverage ratio. In addition, the Senior Credit Facility includes certain limitations on restricted payments, dividends, incurrence of additional funded indebtedness and asset sales. In October 1996, the Company entered into a syndicated credit facility in an amount up to $50.0 million with an initial borrowing base of $27.0 million, to be re-determined semi-annually. This credit facility was unsecured and was retired in April 1997. In February 1995, the Company entered into a credit facility with a commercial bank providing an initial borrowing base of $29.8 million. The borrowings under the credit facility were secured by the Company's interest in oil and gas properties, a gathering system and two gas plants. The Credit Facility was retired in October 1996. In April 1997, the Company issued $100.0 million of 10 7/8% senior subordinated notes ("Notes") that mature April 1, 2007. Interest on the Notes is payable semi-annually on April 1 and October 1 commencing on October 1, 1997. The Notes contain certain covenants, including limitations on indebtedness by subsidiaries, dividends and other payment restrictions affecting restricted subsidiaries, issuance and sales of restricted subsidiary stock, dispositions of proceeds of asset sales and restrictions on mergers, and consolidations or sales of assets. In April 1997, the Company issued 4.4 million common shares in a public offering. The net proceeds of the offering were $34.1 million. 26 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES The net proceeds from the issuance of the Notes and the common stock and advances under the Senior Credit Facility of $33.3 million were used to finance the acquisition of oil and gas properties in the amount of $145.2 million, including $13.9 million in working capital, and to retire $22.0 million of the Company's existing debt. Liquidity and Capital Resources The Company's principal sources of capital for the last three years and for the six month transition period have been the sale of Notes, borrowings under bank credit facilities, the public sale of common stock and cash flow from operations. The Company sold $100 million in Notes in fiscal 1997. Borrowings from banks were $1.5 million, $57.3 million and $26.8 million for the transition period 1997 and fiscal years ended June 30, 1997 and 1995, respectively. The Company issued 4.4 million shares of common stock in a public offering in April 1997 for net proceeds of $34.1 million and 3.4 million shares in a public offering in fiscal 1995 for net proceeds of $17.2 million. Cash flow from operations before change in assets and liabilities totaled $21.8 million, $23.3 million, $9.1 million and $6.4 million for the transition period 1997 and fiscal years 1997, 1996 and 1995, respectively. The increase in cash flow from operations before changes in assets and liabilities resulted primarily from acquisitions made since 1994. In addition, during March 1996, the Company agreed to assume the purchase obligation under a gas contract in the West Monroe field in Louisiana in exchange for a cash payment of $9.9 million. In a series of transactions from May through December 1997, the Company divested non-core assets representing approximately 10% of its estimated net proved reserves for $24.3 million. The Company's primary uses of capital have been to fund acquisitions and to fund its exploration and development projects. Acquisitions, net of working capital acquired, totaled $5.5 million, $140 million and $38.3 million for transition period 1997, fiscal 1997 and fiscal 1995, respectively. The Company's expenditures for exploration and development of its oil and gas properties totaled $13.7 million, $15.6 million, $6.4 million and $3.4 million for the transition period ended December 31, 1997 and the fiscal years ended June 30, 1997, 1996 and 1995, respectively. Outlook The Company has adopted a $42 million capital budget for the year ending December 31, 1998 primarily for development and exploratory drilling activities. The Company believes its working capital and net cash flows provided by operating activities are sufficient to meet these capital commitments. Additionally, the Company currently has a $75.0 million borrowing base under its Senior Credit Facility with no outstanding borrowings at December 31, 1997. The Company is reviewing several acquisitions, any one of which could materially exceed the planned capital expenditure levels. It is anticipated that such acquisitions, if consummated, would be funded through additional borrowings and/or the issuance of securities. Currently, there is a general shortage of drilling rigs, equipment and supplies which the Company believes may intensify. The costs and delivery times of rigs, equipment and supplies are substantially greater than in prior periods and are currently escalating. Shortages of drilling rigs, equipment or supplies could delay and adversely affect the Company's exploration and development 27 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES operations, which could have a material adverse effect on its financial condition and results of operation. The demand for, and wage rates of, qualified rig crews have begun to rise in the drilling industry in response to the increasing number of active rigs in service. Such shortages have in the past occurred in the industry in times of increasing demand for drilling services. If the number of active drilling rigs continues to increase, the oil and gas industry may experience shortages of qualified personnel to operate drilling rigs, which could delay the Company's drilling operations and adversely effect the Company's financial condition and results of operations. The Company's results of operations and cash flow are affected by changing oil and gas prices. Increases in oil and gas prices often result in increased drilling activity, which in turn increases the demand for and cost of exploration and development. Thus, increased prices may generate increased revenue without necessarily increasing profitability. These industry market conditions have been far more significant determinants of Company earnings than have macroeconomic factors such as inflation, which has had only minimal impact of Company activities in recent years. While it is impossible to predict the precise effect of changing prices and inflation on future Company operations, the short-lived nature of the Company's gas reserves makes it more possible to match development costs with predictable revenue streams than would long-lived reserves. No assurance can be given as to the Company's future success at reducing the impact of price changes in the Company's operation results. World crude prices have declined significantly, although world production is operating at 97% of capacity. The primary reasons for this decline are 1) increased Organization of Petroleum Exporting Countries ("OPEC") production, 2) increased non-OPEC production, 3) decreased demand due to Southeast Asia economic collapse and 4) decreased demand resulting from a mild winter in the Northern Hemisphere. West Texas Intermediate (NYMEX) has declined by 31% from the 1997 average and heavy crude postings in California have declined by 53% from the 1997 average. During the first quarter of 1998, California has been impacted more than the rest of the United States by refining turnarounds and the Southeast Asia economy. At this time the Company does not feel a write-down in the book value of capitalized costs of oil and gas properties will be necessary at the end of the first quarter of 1998; however, if oil prices continue this decline a write-down may be necessary in future periods. The Company's technical services provider, Torch, plans to upgrade all major financial and administrative systems to ensure that such systems are Year 2000 compliant. The Year 2000 problem results from data storage of date information truncating to two places, i.e. 1998 stored as 98. Currently all programs storing year information as such recognize the year 2000 as 00 (or 1900). Torch is approaching the Year 2000 project in three steps: 1) awareness and assessment, 2) conversion or implementation and 3) validation and testing. Management does not believe that costs incurred to address the Year 2000 issue with respect to its financial and administrative systems will have a material impact on the Company's future financial results or operations. At this time, the Company is uncertain as to the impact that the Year 2000 issue will have on its operational information systems and as to how the Company will be indirectly affected by the impact that the Year 2000 issue will have on the companies with which it conducts business. 28 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES RESULTS OF OPERATIONS For comparability with annual periods, amounts discussed in this section regarding the six month transition period 1997 have been annualized. These amounts are only estimates and may not be indicative of twelve month's operating results. The table below recaps the major components of financial and operating performance to be discussed (amounts in thousands):
Annualized (1) Transition Fiscal Fiscal Fiscal Period 1997 1997 1996 1995 ----------------------- --------------- --------------- --------------- Oil and gas revenues $88,326 $39,067 $15,666 $ 8,507 Gas plant revenues,net 1,608 3,330 2,577 2,674 Gas gathering revenue, net --- --- 957 1,953 Interest and other 1,218 363 116 97 ----------------------- --------------- --------------- --------------- Total revenue 91,152 42,760 19,316 13,231 Production expenses 27,672 11,437 5,317 2,856 Depreciation,depletion and amortization 32,704 15,574 8,148 5,269 General and administrative expenses 7,496 4,042 3,013 2,739 Income taxes and other 4,228 2,585 199 181 Interest expense 11,956 4,477 1,657 1,245 ----------------------- --------------- --------------- --------------- Net income $ 7,096 $ 4,645 $ 982 $ 941 ======================= =============== =============== =============== Production Oil and condensate(MBBLS) 2,108 854 334 216 Natural gas (MMCF) 22,386 10,552 5,099 2,932 Oil equivalent (MBBLS) 5,839 2,613 1,184 705 Average sales price (2) Oil and condensate (per barrel) $ 16.34 $ 17.41 $ 17.81 $ 16.89 Natural gas (per MCF) $ 2.55 $ 2.29 $ 2.02 $ 1.66 Average unit production costs per equivalent barrel (6 MCF equal 1 barrel) $ 4.74 $ 4.38 $ 4.49 $ 4.05 Average unit general and administrative expense per equivalent barrel (3) $ 1.28 $ 1.38 $ 2.04 $ 2.49 Average unit depletion rate per equivalent barrel(4) $ 5.42 $ 5.62 $ 5.86 $ 5.52 _________
(1) Annualized amounts were computed by multiplying Transition Period 1997 components by 2 (2) Average sales price is exclusive of the effect of natural gas and crude oil price hedges (3) Exclusive of general and administrative expenses allocated to gas plants and gas gathering facilities (4) Exclusive of depreciation on gas plants 29 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES Operations of the gas plant and the gathering system are summarized as follows:
Annualized Transition Period Fiscal Fiscal Fiscal 1997 1997 1996 1995 ------------------- -------- -------- ------- Plant product sales volume (MBBLS).... 218 319 321 382 Average product sales price per barrel.............................. $14.45 $16.77 $13.01 $11.96 Gathering system throughput (MMCF per day)................................ --- --- 4.0(1) 4.1
___________ (1) Represents operations from July 1995 through February 1996. Subsequent to February 1996, the Company ceased recognition of such operations following the Company's assumption of a gas purchase contract and receipt of $9.9 million. (See Note 2 of Notes to Consolidated Financial Statements). Annualized Transition Period 1997 Compared with Fiscal 1997: Oil and gas revenues were $88.3 million for the annualized transition period 1997, an increase of 126% over the fiscal year ended June 30, 1997. This increase is due to a full year of production from the Partnership Transaction which closed in the fourth quarter of fiscal 1997. Annualized production on a BOE basis increased 124% to 5,839 equivalent barrels in the transition period compared to 2,613 equivalent barrels of production in fiscal 1997. During the period, the volatility of oil and gas prices also directly impacted revenues. Most significantly, natural gas prices increased in the transition period 1997 to $2.55 per Mcf from $2.29 per Mcf in fiscal 1997. During the transition period 1997 and fiscal 1997, the Company utilized various hedging transactions to manage a portion of the risks associated with natural gas and crude oil price volatility. As a result of these hedges, oil and gas revenues were reduced by $1.6 million in the transition period 1997 and by $18,000 in fiscal 1997. Gas plant revenues were $4.1 million in the annualized transition period 1997, a decrease of 39% from fiscal 1997 gas plant revenues. The decrease, prior to annualization, was due to a 10 day shut-down of the plant in September to install an amine unit and a two week shut-down in December to repair the insulation in the incinerator. Gas plant throughput is currently back to 10 MMCFD and no material future shut-downs are anticipated. Also, contributing to the decline in the annualized transition period 1997 gas plant revenues was a 14% decline from fiscal 1997 in plant liquids prices. Annualized gas plant expenses were $2.5 million in the transition period 1997 as compared to $3.3 million during fiscal 1997. The decrease in expenses is attributable to the plant shut-downs. Production expenses for the annualized transition period 1997 were $27.7 million, an increase of 142% over the fiscal 1997 amount. Primarily, the increase is due to inclusion of the Partnership Transaction for all of transition 1997, while fiscal 1997 amounts reflect only one quarter for the Partnership Transaction. In addition, production expenses for the annualized transition period increased to $4.74 per equivalent barrel versus $4.38 per equivalent barrel in fiscal 1997. The increase in the per unit rate results from the suspension of production, but not production expenses, at the Point 30 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES Pedernales field for most of the last quarter of the transition period and from out of period expenses recorded within the annualized 1997 transition period. Depreciation, depletion and amortization for the annualized transition period 1997 increased 110% to $32.7 million. Increased production due to the Partnership Transaction, partially offset by a $.20 decrease in the depletion rate, in transition period 1997 caused the variance to fiscal 1997 depreciation, depletion and amortization. General and administrative expenses increased from $4.0 million in fiscal 1997 to $7.5 million in annualized transition period 1997. The increase is primarily due to increased management fees resulting from the Partnership Transaction. Management fees are based on the Company's net assets and operating cash flows. Annualized interest expense increased 167% to $12 million from $4.5 million in fiscal 1997. The increase is primarily due to interest attributable to the $100 million of 10 7/8% Senior Subordinated Notes issued April 1997. Fiscal 1997 Compared to Fiscal 1996: Oil and gas revenues were $39.1 million in fiscal 1997, an increase of 149% over the fiscal year ended June 30, 1996. This increase is largely attributable to a 120.6% increase in equivalent production in 1997 resulting primarily from the Partnership Transaction. In addition, natural gas prices increased 13% to $2.29 per Mcf in fiscal 1997 as compared to $2.02 per Mcf in fiscal 1996. As a result of natural gas and crude oil hedging activities, oil and gas revenues were reduced by $18,000 in fiscal 1997 and by $560,000 in fiscal 1996. Gas plant revenues were $6.7 million in fiscal 1997, an increase of 26% over prior year revenues of $5.3 million. Contributing to this increase were increases in plant liquid prices of 29% over the prior year. There were no gas gathering revenues in fiscal 1997 due to the Company's agreement in February 1996 to assume payment obligations under a gas purchase contract and its decision to cease recognition of income from gas gathering operations. Production expenses for fiscal 1997 totaled $11.4 million, as compared to $5.3 million in fiscal 1996. The 115% increase in production expenses in fiscal 1997 was attributable to increased production from the Partnership Transaction. Depreciation, depletion and amortization increased 93% to $15.6 million in fiscal 1997 versus $8.1 million in fiscal 1996. Such increase was attributable to higher production from the Partnership Transaction, offset by a 4% decrease in the depletion rate per net equivalent barrel as a result of the Partnership Transaction. General and administrative expenses increased in 1997 to $4.0 million from $3.0 million in fiscal 1996. The absolute increase is attributable to the increased management fee resulting from the April 1997 Partnership 31 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES Transaction. General and administrative expenses on an equivalent basis actually decreased from $2.04 per equivalent barrel in fiscal 1996 to $1.38 per equivalent barrel in fiscal 1997. Interest expense increased 170% to $4.5 million in fiscal 1997 from $1.7 million in fiscal 1996. The increase is due to the Company issuing $100 million of 10 7/8% Senior Subordinated Notes in April 1997. Fiscal 1996 Compared to Fiscal 1995: Oil and gas revenues for fiscal 1996 were $15.7 million, or 85% higher than fiscal 1995 oil and gas revenues of $8.5 million. Higher equivalent production of 68% in 1996 was principally responsible for the increase. The increased production was attributable to the Company's mergers with Odyssey and Hampton completed during fiscal 1995. Volatility of oil and gas prices also directly impacted revenues. Crude oil prices increased 5% to 17.81 per barrel in fiscal 1996 compared to $16.89 per barrel in fiscal 1995. Natural gas prices increased 22% to $2.02 per Mcf in fiscal 1996 compared to $1.66 per Mcf in fiscal 1995. Gas plant revenues were $5.3 million in fiscal 1996, or 7% lower than fiscal 1995 revenues of $5.7 million due primarily to decreased throughput, partially offset by a 7% increase in natural gas liquids prices. Gas plant expenses were $2.8 million or 7% lower in fiscal 1996 than in fiscal 1995 as a result of decreased throughput, offset partially by higher costs for natural gas. Gas gathering revenues decreased to $3.4 million in fiscal 1996, or 32% under fiscal 1995 revenues of $5.0 million due to the Company's agreement in February 1996 to assume payment obligations under a gas purchase contract and its decision to cease recognition of income from gas gathering operations. Gas gathering expenses in fiscal 1996 of $2.4 million were 23% under the prior year total of $3.1 million, due to the Company's agreement in February 1996 to assume payment obligations under a gas purchase contract and its decision to cease gas gathering operations. The 86% increase in production expenses in fiscal 1996 over fiscal 1995 was attributable to the Odyssey and Hampton mergers. Such mergers were included in operations for only ten and four months, respectively, in fiscal 1995. Depreciation, depletion and amortization increased in fiscal 1996 to $8.1 million from $5.3 million in fiscal 1995 as a result of increased production from the Odyssey and Hampton mergers mentioned above. In addition, the rate increased $.34 to $5.86 per BOE for fiscal 1996. Net Income Annualized net income of $7.1 million was generated in transition 1997 as compared to $4.6 million, $1 million, and $.9 million in fiscal 1997, 1996, and 1995, respectively. 32 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES Other Matters Dividends At present, there is no plan to pay dividends on common stock. Certain restrictions contained in the Company's loan agreements limit the amount of dividends which may be declared. The Company maintains a policy of reinvesting its discretionary cash flows for the continued growth in Company operations. Gas Balancing Positions It is customary in the industry for various working interest partners to sell more or less than their entitled share of natural gas. The Company uses the sales method of accounting for gas imbalances. Under this method, gas sales are recorded when revenue checks are received or are receivable on the accrual basis. The settlement or disposition of gas balancing positions as of December 31, 1997 is not anticipated to adversely impact the financial condition of the Company. Derivative Financial Instruments The Company periodically uses derivative financial instruments to manage oil and gas price risk. At December 31, 1997, the Company has entered into a contract to hedge 1,000 barrels of crude oil per day at a Nymex price of $21.80 per barrel for January through March 1998. Financial Accounting Standards Board Statement No. 128 Effective December 1997, the Company adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 introduces the concept of basic earnings per share, which represents net income divided by the weighted average common shares outstanding without the dilutive effects of common stock equivalents (options, warrants, etc.). Additionally, SFAS No. 128 replaces fully diluted EPS with diluted EPS. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The Company's dilutive securities include stock options and warrants. The assumed conversion of these securities is anti-dilutive for a period if the option or warrant exercise price exceeds the average market price for the periods. SFAS No. 128 also requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. The Company's reconciliation is included in Note 6 of Notes to Consolidated Financial Statements. In accordance with SFAS No. 128, the Company retroactively restated all prior period EPS data (including interim EPS) included in these financial statements and footnotes. The retroactive impact of adopting SFAS 128 is immaterial. Financial Accounting Standards Board Statement No. 130 In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"), which establishes standards for reporting and display of comprehensive income and its components. The components of comprehensive 33 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES income refer to revenues, expenses, gains and losses that are excluded from net income under current accounting standards, including unrecognized foreign currency translation items, minimum pension liability adjustments and unrealized gains and losses on certain investments in debt and equity securities. SFAS 130 requires that all items that are recognized under accounting standards as components of comprehensive income be reported in a financial statement displayed in equal prominence with other financial statements; the total of other comprehensive income for a period is required to be transferred to a component of equity that is separately displayed in a statement of financial position at the end of an accounting period. SFAS 130 is effective for both interim and annual periods beginning after December 15, 1997, at which time the Company will adopt the provisions. Financial Accounting Standards Board Statement No. 131 In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes standards for the manner in which public enterprises are to report information about operating segments in annual financial statements and requires the reporting of selected information about operating segments in interim financial reports issued to shareholders. SFAS 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. SFAS 131 is effective for periods beginning after December 15, 1997, at which time the Company will adopt the provisions. The Company does not expect SFAS 131 to have a material effect on its reported results. 34 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
PAGE NUMBER ------ Independent Auditors' Report......................................... 36 Financial Statements: Consolidated Balance Sheets as of December 31, 1997, June 30, 1997 and 1996............................................. 37 Consolidated Statements of Operations for the Periods Ended December 31, 1997, December 31, 1996 (unaudited), June 30, 1997, 1996 and 1995...................................................... 39 Consolidated Statements of Changes in Stockholders' Equity for the Periods Ended December 31, 1997, June 30, 1997, 1996 and 1995...... 40 Consolidated Statements of Cash Flows for the Periods Ended December 31, 1997, June 30, 1997, 1996 and 1995.................... 41 Notes to Consolidated Financial Statements.......................... 43
35 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders of Bellwether Exploration Company and Subsidiaries: We have audited the accompanying consolidated balance sheets of Bellwether Exploration Company and subsidiaries as of December 31, 1997 and June 30, 1997 and 1996, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the six month period ended December 31, 1997 and for each of the years in the three year period ended June 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Bellwether Exploration Company and subsidiaries as of December 31, 1997 and June 30, 1997 and 1996, and the results of their operations and their cash flows for the period ended December 31, 1997 and each of the years in the three year period ended June 30, 1997, in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP Houston, Texas February 24, 1998 36 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS (Amounts in thousands)
DECEMBER 31, JUNE 30, JUNE 30, 1997 1997 1996 ---------------------- -------------------- -------------------- CURRENT ASSETS: Cash and cash equivalents....................... $ 2,699 $ 15,341 $ 783 Accounts receivable and accrued revenues..................................... 18,293 16,795 5,990 Accounts receivable related parties............ 4,645 1,836 1,417 Prepaid expenses................................ 3,240 1,759 314 ---------------------- -------------------- -------------------- Total current assets........................ 28,877 35,731 8,504 ---------------------- -------------------- -------------------- PROPERTY, PLANT AND EQUIPMENT, AT COST: Oil and gas properties (full cost) method) including Unproved properties of $6,469, $4,500, and $13,453 excluded from amortization as of December 31, 1997 and June 30, 1997 and 1996, 250,227 233,175 76,043 respectively................................. Gas plant facilities............................ 16,717 12,924 12,840 ---------------------- -------------------- -------------------- 266,944 246,099 88,883 Less accumulated depreciation, depletion and amortization................... (86,811) (65,097) (30,748) ---------------------- -------------------- -------------------- 180,133 181,002 58,135 ---------------------- -------------------- -------------------- OTHER ASSETS.................................... 5,747 5,915 586 ---------------------- -------------------- -------------------- $214,757 $222,648 $ 67,225 ====================== ==================== ====================
See Notes to Consolidated Financial Statements. 37 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY (Amounts in thousands, except share information)
DECEMBER 31, June 30, June 30, 1997 1997 1996 ---------------------- --------------------- --------------------- CURRENT LIABILITIES: Accounts payable and accrued liabilities................................... $ 14,241 $ 12,739 $ 2,634 Accounts payable related parties................ 672 209 702 ------------------- --------------------- --------------------- Total current liabilities................... 14,913 12,948 3,336 ------------------- --------------------- --------------------- LONG-TERM DEBT................................... 100,000 115,300 13,048 DEFERRED INCOME TAXES............................ 7,106 5,521 2,861 OTHER LIABILITIES................................ 1,069 955 1,383 CONTINGENCIES.................................... --- --- --- STOCKHOLDERS' EQUITY: Preferred stock, $0.01 par value, 1,000,000 shares authorized, none issued or outstanding......................... --- --- --- Common stock, $0.01 par value, 30,000,000 shares authorized, 13,891,465, 13,844,965 and 9,075,479 shares issued and outstanding at December 31, 1997 and at June 30, 1997 and 1996, respectively.................................. 139 139 91 Additional paid-in capital....................... 78,470 78,273 41,639 Retained earnings................................ 13,060 9,512 4,867 ------------------- --------------------- --------------------- Total stockholders' equity....................... 91,669 87,924 46,597 ------------------- --------------------- --------------------- $214,757 $222,648 $67,225 =================== ===================== =====================
See Notes to Consolidated Financial Statements. 38 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands, except per share data)
Six Month (Unaudited) Transition Six Month Period Ended Period Ended December 31, December 31, Fiscal Year Ended June 30, -------------------- ------------- --------------------------------- 1997 1996 1997 1996 1995 -------------------- -------------- ----------- --------- --------- REVENUES: Gas revenues.................... $26,755 $ 6,759 $24,202 $ 9,856 $ 4,864 Oil revenues.................... 17,408 3,087 14,865 5,810 3,643 Gas plant revenues, net......... 804 2,052 3,330 2,577 2,674 Gas gathering revenues, net..... --- --- --- 957 1,953 Interest and other income....... 609 54 363 116 97 -------------------- -------------- ----------- --------- --------- 45,576 11,952 42,760 19,316 13,231 -------------------- -------------- ----------- --------- --------- COSTS AND EXPENSES: Production expenses............. 13,836 3,061 11,437 5,317 2,856 General and administrative expenses.................... 3,748 1,452 4,042 3,013 2,739 Depreciation, depletion and amortization.................. 16,352 4,167 15,574 8,148 5,269 Interest expense................ 5,978 520 4,477 1,657 1,245 Other expenses.................. --- --- --- 153 --- -------------------- -------------- ----------- --------- --------- 39,914 9,200 35,530 18,288 12,109 -------------------- -------------- ----------- --------- --------- Income before income taxes and minority interest......... 5,662 2,752 7,230 1,028 1,122 Provision for income taxes........ 2,114 1,018 2,585 46 9 Minority interest in gas plant ventures.................... --- --- --- --- 172 -------------------- -------------- ----------- --------- --------- Net income........................ $ 3,548 $ 1,734 $ 4,645 $ 982 $ 941 ==================== ============== =========== ========= ========= Net income per share.............. $0.26 $0.19 $0.46 $0.11 $0.12 ==================== ============== =========== ========= ========= Net income per share-diluted diluted.......................... $0.25 $0.19 $0.45 $0.11 $0.12 ==================== ============== =========== ========= ========= Weighted average common shares outstanding primary........ 13,876 9,118 10,201 9,052 7,716 ==================== ============== =========== ========= ========= Weighted average common shares outstanding diluted........ 14,446 9,139 10,261 9,114 7,734 ==================== ============== =========== ========= =========
See Notes to Consolidated Financial Statements. 39 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Amounts in thousands)
COMMON STOCK PREFERRED STOCK ADDITIONAL TREASURY STOCK --------------- --------------- PAID-IN RETAINED --------------- SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS SHARES AMOUNT TOTAL ------ ------ ------ ------ ---------- -------- ------ ------ ------- Balance June 30, 1994.... 3,737 $ 37 --- --- $15,490 $ 2,944 15 $(99) $18,372 Shares issued in public stock offering.......... 3,400 34 --- --- 17,204 --- --- --- 17,238 Cancellation of treasury stock.......... (15) --- --- --- --- --- (15) 99 99 Shares issued in merger with Odyssey Partners, Ltd..................... 917 9 --- --- 3,944 --- --- --- 3,953 Shares issued in merger with Hampton Resources Corporation... 1,006 10 --- --- 4,834 --- --- --- 4,844 Net earnings............. --- --- --- --- --- 941 --- --- 941 ------ ------ ------ ------ ---------- -------- ------ ------ ------- Balance June 30, 1995.... 9,045 90 --- --- 41,472 3,885 --- --- 45,447 Stock options exercised............... 30 1 --- --- 167 --- --- --- 168 Net earnings............. --- --- --- --- --- 982 --- --- 982 ------ ------ ------ ------ ---------- -------- ------ ------ ------- Balance June 30, 1996.... 9,075 91 --- --- 41,639 4,867 --- --- 46,597 Shares issued in public stock offering, net of offering costs.......... 4,687 47 --- --- 36,169 --- --- --- 36,216 Stock options exercised............... 83 1 --- --- 465 --- --- --- 466 Net earnings............. --- --- --- --- --- 4,645 --- --- 4,645 ------ ------ ------ ------ ---------- -------- ------ ------ ------- Balance June 30, 1997.... 13,845 139 --- --- 78,273 9,512 --- --- 87,924 Offering costs........... --- --- --- --- (96) --- --- --- (96) Stock options exercised............... 47 --- --- --- 293 --- --- --- 293 Net earnings............. --- --- --- --- --- 3,548 --- --- 3,548 ------ ------ ------ ------ ---------- -------- ------ ------ ------- Balance December 31, 1997...... 13,892 $139 --- --- $78,470 $13,060 --- $--- $91,669 ====== ====== ====== ====== ========== ======== ====== ====== =======
See Notes to Consolidated Financial Statements. 40 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in Thousands)
Six Month Transition Period Ended December 31, Fiscal Years Ended June 30, ------------------------- ------------------------------------ 1997 1997 1996 1995 ------------------------- ------------ ------------ -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income............................................... $ 3,548 $ 4,645 $ 982 $ 941 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion and amortization......................................... 16,708 16,044 8,273 5,382 Minority interest in gas plant ventures............................................. --- --- --- 120 Deferred taxes......................................... 1,585 2,562 (183) --- ------------------------- ------------ ------------ -------- 21,841 23,251 9,072 6,443 Change in assets and liabilities, net of acquisition effects: Accounts receivable and accrued revenues............................................. (1,498) 2,941 (668) 1,548 Prepaid expenses....................................... (1,481) (638) 25 117 Accounts payable and accrued expenses.................. 1,502 4,438 84 (2,047) Due (to) from affiliates............................... (2,346) 5,738 (791) (633) Other.................................................. (57) (6,447) (237) (145) ------------------------- ------------ ------------ -------- NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES............................................. 17,961 29,283 7,485 5,283 ------------------------- ------------ ------------ -------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisitions of oil and gas properties, including working capital of $13,914 and $5,816 in fiscal years ended June 30, 1997 and June 30, 1995, respectively - Partnership Transactions............................ --- (147,909) --- --- - Odyssey Petroleum................................... --- --- --- (5,374) - Hampton Resources................................... --- --- --- (18,168) - Other acquisitions.................................. (5,486) (2,005) --- --- Additions to oil and gas properties...................... (13,727) (20,811) (6,934) (3,497) Proceeds from sales of properties........................ 5,362 18,775 644 265 Additions to gas plant facilities........................ (1,632) (84) (44) (87) Proceeds from gas contract assignment.................... --- --- 9,875 --- Other.................................................... (17) (88) 1 (428) ------------------------- ------------ ------------ -------- NET CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES................................... (15,500) (152,122) 3,542 (27,289) ========================= ============ ============ ========
See Notes to Consolidated Financial Statements. 41 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (Amounts in Thousands)
Six Month Transition Period Ended December 31, Fiscal Year Ended June 30, ------------- ------------------------------------------------------ 1997 1997 1996 1995 ------------- -------------- ---------- ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from borrowings....................... $ 1,500 $157,300 $ --- $ 26,773 Net proceeds from issuance of common stock........................................ 197 35,145 168 17,238 Payments of long-term debt..................... (16,800) (55,048) (11,500) (22,369) ------------- -------------- ---------- ------------ NET CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES......................... (15,103) 137,397 (11,332) 21,642 ------------- -------------- ---------- ------------ Net increase (decrease) in cash and cash equivalents............................. (12,642) 14,558 (305) (364) Cash and cash equivalents at beginning of period.................................... 15,341 783 1,088 1,452 ------------- -------------- ---------- ------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD.................................... $ 2,699 $ 15,341 $ 783 1,088 ============= ============== ========== ============
See Notes to Consolidated Financial Statements. 42 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION Bellwether Exploration Company ("the Company") was formed as a Delaware corporation in 1994 to succeed to the business and properties of its predecessor company pursuant to a merger, the primary purpose of which was to change the predecessor company's state of incorporation from Colorado to Delaware. The predecessor company was formed in 1980 from the consolidation of the business and properties of related oil and gas limited partnerships. References to Bellwether or the Company include the predecessor company, unless the context requires otherwise. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The consolidated financial statements include the accounts of Bellwether Exploration Company and its wholly-owned subsidiaries. Snyder Gas Plant Venture and NGL/Torch Gas Plant Venture and their 11.98% and 35.78% investments in the Snyder and Diamond M-Sharon Ridge Gas Plants have been pro rata consolidated. All significant intercompany accounts and transactions have been eliminated in consolidation. Fiscal Year Change In order to facilitate greater comparability with its peer group by the financial community, the Company changed its fiscal year to align with the calendar year, beginning January 1, 1998. The six-month transition period of July 1, 1997 through December 31, 1997 ("transition period") precedes the start of the new fiscal year. The unaudited financial information for the six months ended December 31, 1996 ("prior period") is presented for comparative purposes and includes any adjustments (consisting of normal, recurring adjustments) which are, in the opinion of management, necessary for fair presentation. Oil and Gas Properties The Company utilizes the full cost method to account for its investment in oil and gas properties. Under this method, all costs of acquisition, exploration and development of oil and gas reserves (including such costs as leasehold acquisition costs, geological expenditures, dry hole costs and tangible and intangible development costs and direct internal costs) are capitalized as incurred. The cost of oil and gas properties, the estimated future expenditures to develop proved reserves, and estimated future abandonment, site remediation and dismantlement costs are depleted and charged to operations using the unit-of-production method based on the ratio of current production to proved oil and gas reserves as estimated by 43 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS independent engineering consultants. Costs directly associated with the acquisition and evaluation of unproved properties are excluded from the amortization computation until it is determined whether or not proved reserves can be assigned to the properties or whether impairment has occurred. Depletion expense per equivalent barrel of production was approximately $5.42 in transition period 1997, $5.62 in fiscal 1997, $5.86 in fiscal 1996 and $5.52 in fiscal 1995. Dispositions of oil and gas properties are recorded as adjustments to capitalized costs, with no gain or loss recognized unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and gas. To the extent that capitalized costs of oil and gas properties, net of accumulated depreciation, depletion and amortization, exceed the discounted future net revenues of proved oil and gas reserves net of deferred taxes, such excess capitalized costs would be charged to operations. No such write-down in book value was required at December 1997, June 1997, 1996 or 1995. Any reference to oil and gas reserve information in the Notes to Consolidated Financial Statements is unaudited. Gas Plants and Gas Gathering System Gas plant facilities include the costs to acquire certain gas plants and to secure rights-of-way. Capitalized costs associated with gas plants facilities are amortized primarily over the estimated useful lives of the various components of the facilities utilizing the straight-line method. The estimated useful lives of such assets range from four to fifteen years. The Company's gas gathering subsidiary and certain third parties were the beneficiaries of an agreement whereby another party had an obligation to purchase, until May 31, 1999, the gas produced by the Company and such third parties from the West Monroe field in Union Parish, Louisiana at a price of $4.50 per MMBTU. Bellwether owned a large majority of the gas produced and sold pursuant to the Purchase Agreement. In March 1996, in exchange for Bellwether's agreement to assume the purchase obligations under the gas purchase contract, Bellwether was paid $9.9 million. As a result of this transaction, the Company has written off the remaining book value of the gas gathering system and has recorded a liability to cover the estimated future losses under the contract. Gas gathering operations of the subsidiary and payments to third parties are charged to the liability as incurred. From the proceeds, $9.5 million was paid on the Company's credit facility. Gas Imbalances The Company uses the sales method of accounting for gas imbalances. Under this method, gas sales are recorded when revenue checks are received or are receivable on the accrual basis. The Company had a net imbalance liability, at fair value of $1.7 million 44 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS and $1.6 million at December 31, 1997 and June 30, 1997, respectively. The Company's net imbalance was immaterial at June 30, 1996 and 1995. Financial Accounting Standards Board Statement No. 121 In March 1995, the Financial Accounting Standards Board ("FASB") issued Statement No. 121 ("SFAS 121") "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of". SFAS 121 is effective beginning July 1, 1996 and establishes guidelines for determining and measuring asset impairment and the required timing of asset impairment evaluations. The impact of implementing SFAS 121 was immaterial. Financial Accounting Standards Board Statement No. 123 In October 1995, the FASB issued Statement No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation" which is effective for the Company beginning July 1, 1996. SFAS 123 permits, but does not require, a fair-value-based method of accounting for employee stock option plans which results in compensation expense being recognized in the results of operations when stock options are granted. The Company plans to continue to use the current intrinsic-value-based method of accounting for such plans where no compensation expense is recognized. However, as required by SFAS 123, the Company has provided pro forma disclosure of net income and earnings per share in the notes to the consolidated financial statements as if the fair-value-based method of accounting had been applied. Financial Accounting Standards Board Statement No. 128 Effective December 1997, the Company retroactively adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 introduces the concept of basic earnings per share, which represents net income divided by the weighted average common shares outstanding without the dilutive effects of common stock equivalents (options, warrants, etc.) Additionally, SFAS No. 128 replaces fully diluted EPS with diluted EPS. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The Company's dilutive securities include stock options and warrants. The assumed conversion of these securities is anti-dilutive for a period if the option or warrant exercise price exceeds the average market price for the periods. SFAS No. 128 also requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. The Company's reconciliation is included in Note 6. In accordance with SFAS No. 128, the Company retroactively restated all prior period EPS data (including interim EPS) included in these financial statements and footnotes. The impact of adopting SFAS 128 is immaterial. 45 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Natural Gas and Crude Oil Hedging Commodity derivatives utilized as hedges include swap contracts. In order to qualify as a hedge, price movements in the underlying commodity derivative must be sufficiently correlated with the hedged commodity. When a commodity derivative ceases to qualify as a hedge, the change in its fair value is recognized in income currently. Settlement of gains and losses on price swap contracts are realized monthly, generally based upon the difference between the contract price and the average closing New York Mercantile Exchange ("NYMEX") price and are reported as a component of oil and gas revenues and operating cash flows in the period realized. Gains and losses attributable to the termination of a swap contract are deferred on the balance sheet and recognized in revenue when the hedged crude oil and natural gas is sold. There were no such deferred gains or losses at December 31, 1997 or at June 30, 1997, 1996 or 1995. Oil and gas revenues were decreased by $1.6 million in the six month transition period ended December 1997, and by $18,000 and $0.6 million in the fiscal years ended June 1997 and 1996, as a result of such hedging activity. There was no hedging in 1995. Income Taxes Deferred taxes are accounted for under the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. The effect on deferred taxes of a change in tax rates is recognized in income in the period the change occurs. Statements of Cash Flows For cash flow presentation purposes, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Interest paid in cash for the six month transition period ended December 31, 1997, and the fiscal years ended June 30, 1997, 1996 and 1995, was $5.4 million, $1.5 million, $1.6 million and $1.2 million, respectively. Income taxes paid in cash for the transition period ended December 31, 1997 and the fiscal years ended June 30, 1997, 1996, and 1995 were $41,000, $198,000, $126,000, and $9,000, respectively. A portion of the purchase price of the Partnership Transactions included the issuance to Torch, as consideration for advisory services, 150,000 shares of the Company's common stock valued at $1.2 million and a warrant to purchase 100,000 shares of common stock at $9.90 per share valued at $300,000. During 1995, a portion of the consideration for the merger of Odyssey Partners, Ltd. and Hampton Resources Corporation, collectively ("the Mergers"), was the assumption of debt of $1.4 million and $4.1 million, 46 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS respectively. Additionally, common stock with a value of $4.0 million and $4.8 million, respectively, was issued in the Mergers. Use of estimates Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities as well as reserve information which affects the depletion calculation and the computation of the full cost ceiling limitation to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from these estimates. Reclassifications Certain reclassifications of prior period statements have been made to conform with current reporting practices. 3. ACQUISITIONS AND MERGERS During the last three fiscal years, the Company has completed the following mergers and acquisitions, all of which were recorded using the purchase method of accounting: In April 1997, the Company closed acquisitions of oil and gas properties, totaling $145.2 million including working capital of $13.9 million, from certain partnerships and other entities managed or sponsored by Torch Energy Advisors Incorporated ("Torch"). The acquisitions were financed by the sale of 4.4 million shares of common stock, the sale of $100.0 million of 10-7/8% senior subordinated notes due in 2007 and the use of $33.3 million of a new $90.0 million senior unsecured credit facility (including the repayment of $22.0 million on a then existing credit facility). On February 28, 1995 the Company acquired Hampton in exchange for $17.0 million in cash and 1,006,458 shares of the Company's common stock. The Company had paid previous to the merger $2.7 million to acquire common and preferred stock of Hampton and incurred $1.4 million in expenses in arranging the merger. The total cost of the Hampton acquisition was $25.9 million, consisting of $21.1 million in cash and $4.8 million in common stock. Hampton was an energy company engaged in the exploration, acquisition and production of oil and natural gas, primarily in the onshore Gulf Coast region and offshore in Texas state waters. On August 26, 1994 the Company acquired Odyssey in exchange for $5.6 million in cash (funded from a common stock offering which closed on the same date) and 916,665 shares of the Company's common stock, for a total cost of $9.6 million. Odyssey is an exploration company which assembles, exploits and operates oil and gas properties using state-of-the-art 3-D seismic and computer-aided exploration technology. 47 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Odyssey's primary areas of operation have been the onshore Gulf Coast region and the Permian Basin area of West Texas and Southeast New Mexico. The following table presents the unaudited pro forma results of operations as if the Partnership Transactions had all occurred on July 1, 1995 and July 1, 1996. The Partnership Transactions were accounted for as purchases, and their results of operations are included in the Company's results of operations from the date of acquisition. The Company's pro forma results are based on assumptions and estimates and are not necessarily indicative of the Company's results of operations had the transaction occurred as of July 1, 1995 or 1996, or those in the future (in thousands, except earnings per share).
(Unaudited) --------------------------------------------- Six Month Prior Period Ended December 31, Fiscal Year Ended June 30, 1996 1997 1996 ---------------- ------------- ------------ Revenues....................... $63,311 $120,384 $140,969 Expenses....................... 47,689 90,024 104,629 ---------------- ------------- ------------ Earnings before income taxes................. 15,622 30,360 36,340 Income taxes................... 5,780 11,143 13,112 ---------------- ------------- ------------ Net earnings................... $ 9,842 $ 19,217 $ 23,228 ================ ============= ============ Net earnings per common share................ $ 0.71 $ 1.40 $ 1.68 ================ ============= ============ Net earnings per common share - diluted..................... $ 0.71 $ 1.38 $ 1.68 ================ ============= ============
48 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. GUARANTOR FINANCIAL STATEMENTS Consolidating financial statements of the Company and the Guarantor Subsidiaries, (Odyssey Petroleum Company, Black Hawk Oil Company, and 1989-I TEAI Limited Partnership), as guarantors of the Company's 10-7/8% Senior Subordinate Notes due 2007 are presented as follows (See Note 8): CONDENSED CONSOLIDATING BALANCE SHEETS UNAUDITED AS OF DECEMBER 31, 1997 (IN THOUSANDS)
GUARANTOR NONGUARANTOR BELLWETHER SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------- -------------- --------------- --------------- ------------- Current assets $ 20,135 $ 2,409 $ 1,688 $ 4,645 $ 28,877 Property, plant and equipment, net 160,988 15,139 23,174 (19,168) 180,133 Other assets 48,751 495 33 (43,532) 5,747 --------------- -------------- --------------- --------------- ------------- Total assets $229,874 $18,043 $24,895 $(58,055) $214,757 =============== ============== =============== =============== ============= Current liabilities $ 9,851 $ 4,715 $(4,273) $ 4,620 $ 14,913 Long-term debt 100,000 --- --- --- 100,000 Deferred taxes 6,606 363 137 --- 7,106 Other long-term liabilities 1,488 --- --- (419) 1,069 Stockholders' equity (deficit) 111,929 12,965 29,031 (62,256) 91,669 --------------- -------------- --------------- --------------- ------------- Total liabilities and stockholders' equity (deficit) $229,874 $18,043 $24,895 $(58,055) $214,757 =============== ============== =============== =============== =============
CONDENSED CONSOLIDATING INCOME STATEMENTS UNAUDITED FOR THE SIX MONTHS ENDED DECEMBER 31, 1997 (IN THOUSANDS)
GUARANTOR NONGUARANTOR BELLWETHER SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------- -------------- --------------- --------------- ------------- Revenues $32,858 $ 6,704 $5,446 $ 568 $45,576 Expenses 19,462 16,233 4,927 (708) 39,914 Net earnings (loss) before income taxes 13,396 (9,529) 519 1,276 5,662 Income taxes 1,988 (11) 137 --- 2,114 --------------- -------------- --------------- --------------- ------------- Net earnings (loss) $11,408 $(9,518) $ 382 $1,276 $ 3,548 =============== ============== =============== =============== =============
49 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS UNAUDITED FOR THE SIX MONTHS ENDED DECEMBER 31, 1997 (IN THOUSANDS)
GUARANTOR NONGUARANTOR BELLWETHER SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------- -------------- --------------- --------------- ------------- Cash flows from operating ACTIVITIES Net income (loss) $ 11,408 $(9,518) $ 382 $ 1,276 $ 3,548 Non-cash adjustments (531) 16,896 1,928 --- 18,293 Changes in assets and liabilities (5,581) 2,058 (801) 444 (3,880) --------------- -------------- --------------- --------------- ------------- Net cash provided by operating activities 5,296 9,436 1,509 1,720 17,961 --------------- -------------- --------------- --------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to oil and gas properties and facilities (8,444) (9,454) (1,244) (1,720) (20,862) Proceeds from sales of properties 4,349 199 814 --- 5,362 --------------- -------------- --------------- --------------- ------------- Net cash used in investing activities (4,095) (9,255) (430) (1,720) (15,500) --------------- -------------- --------------- --------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from borrowings 1,500 --- --- --- 1,500 Payments of long-term debt (16,800) --- --- --- (16,800) Net proceeds from issuance of common stock 197 --- --- --- 197 --------------- -------------- --------------- --------------- ------------- Net cash provided by financing activities (15,103) --- --- --- (15,103) --------------- -------------- --------------- --------------- ------------- Net increase (decrease) in cash and cash equivalents (13,902) 181 1,079 --- (12,642) Cash and cash equivalents at beginning of year 15,170 160 11 --- 15,341 --------------- -------------- --------------- --------------- ------------- Cash and cash equivalents at end of year $ 1,268 $ 341 $ 1,090 $ --- $ 2,699 =============== ============== =============== =============== =============
50 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONDENSED CONSOLIDATING BALANCE SHEETS UNAUDITED AS OF JUNE 30, 1997 (IN THOUSANDS)
GUARANTOR NONGUARANTOR BELLWETHER SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------- -------------- -------------- ---------------- ------------- Current assets $ 30,446 $ 2,069 $ 1,380 $ 1,836 $ 35,731 Property, plant and equipment, net 158,407 20,800 25,087 (23,292) 181,002 Other assets 20,780 346 39 (15,250) 5,915 --------------- -------------- -------------- ---------------- ------------- Total assets $209,633 $23,215 $26,506 $(36,706) $222,648 =============== ============== ============== ================ ============= Current liabilities $ 12,003 $ 2,383 $(3,927) $ 2,489 $ 12,948 Long-term debt 115,300 --- --- --- 115,300 Deferred taxes 5,127 363 31 --- 5,521 Other long-term liabilities 1,910 --- --- (955) 955 Stockholders' equity (deficit) 75,293 20,469 30,402 (38,240) 87,924 --------------- -------------- -------------- ---------------- ------------- Total liabilities and stockholders' equity (deficit) $209,633 $23,215 $26,506 $(36,706) $222,648 =============== ============== ============== ================ =============
CONDENSED CONSOLIDATING INCOME STATEMENTS UNAUDITED FOR THE YEAR ENDED JUNE 30, 1997 (IN THOUSANDS)
GUARANTOR NONGUARANTOR BELLWETHER SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------- -------------- -------------- ---------------- ------------- Revenues $32,539 $ 5,260 $5,966 $(1,005) $42,760 Expenses 26,153 6,979 3,762 (1,364) 35,530 --------------- -------------- -------------- ---------------- ------------- Net earnings (loss) before income taxes 6,386 (1,719) 2,204 359 7,230 Income taxes 2,610 (57) 8 24 2,585 --------------- -------------- -------------- ---------------- ------------- Net earnings (loss) $ 3,776 $(1,662) $2,196 $ 335 $ 4,645 =============== ============== ============== ================ =============
51 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS UNAUDITED For the Year Ended June 30, 1997 (IN THOUSANDS)
GUARANTOR NONGUARANTOR BELLWETHER SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------- --------------- --------------- ---------------- ------------- Cash flows from operating ACTIVITIES Net income (loss) $ 3,776 $(1,662) $ 2,196 $ 335 $ 4,645 Non-cash adjustments 12,527 4,732 1,565 (218) 18,606 Changes in assets and liabilities 6,064 2,400 (2,315) (117) 6,032 --------------- --------------- --------------- ---------------- ------------- Net cash provided by operating activities 22,367 5,470 1,446 --- 29,283 --------------- --------------- --------------- ---------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to oil and gas properties and facilities (12,083) (7,894) (1,006) --- (20,983) Acquisitions of oil and gas properties (149,914) --- --- --- (149,914) Proceeds from sales of properties 15,408 3,071 296 --- 18,775 --------------- --------------- --------------- ---------------- ------------- Net cash used in investing activities (146,589) (4,823) (710) --- (152,122) --------------- --------------- --------------- ---------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from borrowings 157,300 --- --- --- 157,300 Payments of long-term debt (55,048) --- --- --- (55,048) Net proceeds from issuance of common stock 35,145 --- --- --- 35,145 --------------- --------------- --------------- ---------------- ------------- Net cash provided by financing activities 137,397 --- --- --- 137,397 --------------- --------------- --------------- ---------------- ------------- Net increase (decrease) in cash and cash equivalents 13,175 647 736 --- 14,558 Cash and cash equivalents at beginning of year 588 191 4 --- 783 --------------- --------------- --------------- ---------------- ------------- Cash and cash equivalents at end of year $ 13,763 $ 838 $ 740 $ --- $ 15,341 =============== =============== =============== ================ =============
52 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONDENSED CONSOLIDATING BALANCE SHEETS UNAUDITED AS OF JUNE 30, 1996 (IN THOUSANDS)
GUARANTOR NONGUARANTOR BELLWETHER SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------- -------------- -------------- ---------------- ------------- Current assets $ 6,118 $ 887 $ 924 $ 575 $ 8,504 Property, plant and equipment, net 39,317 11,004 15,050 (7,236) 58,135 Other assets 29,872 25 37 (29,348) 586 --------------- -------------- -------------- ---------------- ------------- Total assets $75,307 $11,916 $16,011 $(36,009) $67,225 =============== ============== ============== ================ ============= Current liabilities $ 2,160 $ 1,044 $(1,207) $ 1,339 $ 3,336 Long-term debt 13,048 --- --- --- 13,048 Deferred taxes 5,096 407 --- (2,642) 2,861 Other long-term liabilities 2,115 --- --- (732) 1,383 Stockholders' equity (deficit) 52,888 10,465 17,218 (33,974) 46,597 --------------- -------------- -------------- ---------------- ------------- Total liabilities and stockholders' equity (deficit) $75,307 $11,916 $16,011 $(36,009) $67,225 =============== ============== ============== ================ =============
CONDENSED CONSOLIDATING INCOME STATEMENTS UNAUDITED FOR THE YEAR ENDED JUNE 30, 1996 (IN THOUSANDS)
GUARANTOR NONGUARANTOR BELLWETHER SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------- -------------- -------------- ---------------- ------------- Revenues $10,984 $3,600 $4,300 $ 432 $19,316 Expenses 11,187 2,830 3,486 785 18,288 --------------- -------------- -------------- ---------------- ------------- Net earnings (loss) before income taxes (203) 770 814 (353) 1,028 Income taxes (404) 285 141 24 46 --------------- -------------- -------------- ---------------- ------------- Net earnings (loss) $ 201 $ 485 $ 673 $(377) $ 982 =============== ============== ============== ================ =============
53 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS UNAUDITED For the Year Ended June 30, 1996 (IN THOUSANDS)
GUARANTOR NONGUARANTOR BELLWETHER SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ---------------- -------------- ---------------- -------------- -------------- Cash flows from operating ACTIVITIES Net income (loss) $ 201 $ 485 $ 673 $ (377) $ 982 Non-cash adjustments 4,851 1,506 1,314 419 8,090 Changes in assets and liabilities 896 (244) 159 (2,398) (1,587) ---------------- -------------- ---------------- -------------- -------------- Net cash provided by (used in)operating activities 5,948 1,747 2,146 (2,356) 7,485 ---------------- -------------- ---------------- -------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to oil and gas properties and facilities (5,597) (1,567) 187 --- (6,977) Acquisitions of oil and gas properties 644 --- --- --- 644 Proceeds from sales of properties 9,875 --- --- --- 9,875 ---------------- -------------- ---------------- -------------- -------------- Net cash used in investing activities 4,922 (1,567) 187 --- 3,542 ---------------- -------------- ---------------- -------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES: --- --- --- --- --- Proceeds from borrowings (11,500) --- --- --- (11,500) Payments of long-term debt --- --- (2,356) 2,356 --- Net proceeds from issuance of common stock 168 --- --- --- 168 ---------------- -------------- ---------------- -------------- -------------- Net cash provided by (used in) financing activities (11,332) --- (2,356) 2,356 (11,332) ---------------- -------------- ---------------- -------------- -------------- Net increase (decrease) in cash and cash equivalents (462) 180 (23) --- (305) Cash and cash equivalents at beginning of year 1,050 11 27 --- 1,088 ---------------- -------------- ---------------- -------------- -------------- Cash and cash equivalents at end of year $ 588 $ 191 $ 4 $ --- $ 783 ================ ============== ================ ============== ==============
54 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. RELATED PARTY TRANSACTIONS The Company is a party to an administrative services agreement which requires Torch to administer certain business activities of the Company for a monthly fee equal to the sum of one-twelfth of 2% of the average of the book value of the Company's total assets, excluding cash, plus 2% of annual operating cash flows (as defined) during the period in which the services are rendered plus reimbursement of certain costs incurred on behalf of the Company. The administrative services agreement, whose initial term ends December 31, 1999, renews automatically for successive one-year periods until terminated by either party in accordance with the applicable provisions of the agreement. For the periods ended December 31, 1997, and June 30, 1997, 1996 and 1995, related fees paid to Torch amounted to $2.4 million, $2.3 million, $1.5 million and $1.2 million, respectively. Additionally, in the ordinary course of business, the Company incurs intercompany balances resulting from the payment of costs and expenses by affiliated entities on behalf of the Company. Torch may charge interest on any unpaid balances not paid within 30 days, however, no such interest has been charged by Torch since the inception of the agreement. In April, 1997, Torch was issued 150,000 shares of the Company's common stock and a warrant to purchase 100,000 shares at $9.90 per share for advisory services rendered in connection with the Partnership Transactions. The Company's stock was valued at $1.2 million, and the warrant was valued at $300,000. In December 1993, Torch was issued a warrant to purchase 187,500 shares of the Company's common stock at a price of $6.40 per share for its advisory services in identifying and negotiating a merger; such warrants were exercised in connection with the Partnership Transactions with total proceeds to the Company of $684,000. Torch was also a selling partner in the Partnership Transactions through its ownership of general partnership and working interests in the partnerships programs. As a result, Torch was paid $18.4 million for such interests. Two of the Company's officers are officers of Torch and have an equity interest in Torch. A director of the Company holds significant options to purchase stock in Torch, which if exercised would constitute a substantial equity interest in Torch. Two of the directors of the Company were formerly officers of Odyssey. A subsidiary of Torch markets oil and natural gas production from certain oil and gas properties in which the Company owns an interest. The Company generally pays fees of 2% of revenues for such marketing services. Such charges were $757,000, $646,000, $114,000 and $12,000 in periods ended December 1997 and June 1997, 1996 and 1995, respectively. Costs of the evaluation of potential property acquisitions and due diligence conducted in conjunction with acquisitions closed are 55 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS incurred by Torch at the Company's request. The Company was charged $217,000, $650,000, $74,000, and $193,000 for these costs in periods ended December 1997 and June 1997, 1996, and 1995, respectively. Torch operates certain oil and gas interests owned by the Company. The Company is charged, on the same basis as other third parties, for all customary expenses and cost reimbursements associated with these activities. Operator's overhead charged for these activities for the periods ended December 31, 1997 and June 30, 1997, 1996 and 1995 was $698,000, $729,000, $367,000 and $164,000, respectively. Torch became the operator of the Snyder Gas Plant on December 1, 1993. In periods ended December 1997 and June 1997, 1996 and 1995, the fees paid by the Company to Torch were $42,000, $49,000, $83,000 and $71,000, respectively. 6. STOCKHOLDERS' EQUITY Common and Preferred Stock The Certificate of Incorporation of the Company authorizes the issuance of up to 15,000,000 shares of common stock and 1,000,000 shares of preferred stock, the terms, preferences, rights and restrictions of which are established by the Board of Directors of the Company. Certain restrictions contained in the Company's loan agreements limit the amount of dividends which may be declared. There is no present plan to pay cash dividends on common stock as the Company intends to reinvest its cash flows for continued growth of the Company. In July, 1997 in a special meeting of Stockholders of the Company, the Company's Certificate of Incorporation was amended to increase the number of authorized shares of Common Stock from 15,000,000 to 30,000,000. On September 12, 1997, the Company authorized and declared a dividend of one preferred stock purchase right for each share of common stock, par value $.01 per share, of the Company. The dividend was payable on September 26, 1997 to the holders of record of Common Shares as of the close of business on such date. In April 1997, the Company issued 4.4 million shares of common stock for net proceeds to the Company of $34.1 million. Such proceeds were used in financing the Partnership Transactions. Also included in the April Offering were 719,264 shares sold by certain shareholders. Additional shares issued during fiscal 1997 included 125,000 shares issued upon exercise of a warrant and 150,000 shares issued to Torch for advisory services rendered in connection with the Partnership Transactions. In addition to stock options outstanding, the Company has 160,000 warrants outstanding at exercise prices ranging from $6.90 per share to 56 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS $9.90 per share. The expiration date for 100,000 warrants is April 2002, while the expiration date for the remaining 60,000 warrants is August 1999. During the first quarter of fiscal 1995, the Company consummated the sale of 3,650,000 shares of common stock. The net proceeds to the Company were $17.3 million which were used for the Odyssey and Hampton mergers and general corporate purposes. Of the shares sold, 3,400,000 were newly- issued by the Company and 250,000 were sold by certain stockholders. Earnings Per Share SFAS No. 128 (see Note 2) requires the reconciliation of the numerator (income) and denominator (shares) of the earnings per share computation to the numerator and denominator of the diluted earnings per share computation. The Company's reconciliation is as follows (amounts in thousands):
Six Month Transition Period Six Month Period Fiscal Year Ended June 30, Ended Ended --------------------------------------------------------------- December 31, 1997 December 31, 1996 1997 1996 1995 ---------------------------------------------------------------------------------------------------------- Income Shares Income Shares Income Shares Income Shares Income Shares ---------- -------- -------- --------- --------- -------- --------- -------- -------- ------- Net income $3,458 $1,734 $4,645 $982 $941 ------ ------ ------ ---- ---- Earnings per common share $3,458 13,876 $1,734 9,118 $4,645 10,201 $982 9,052 $941 7,716 Effect of Dilutive Securities: Options & Warrants --- 570 --- 21 --- 60 --- 62 --- 18 ------ ------ ------ ----- ------ ------ ---- ----- ---- ----- Earnings per common share-diluted $3,458 14,446 $1,734 9,139 $4,645 10,261 $982 9,114 $941 7,734 ====== ====== ====== ====== ====== ====== ==== ===== ==== =====
Stock Incentive Plans The Company has stock option plans that provide for granting of options for the purchase of common stock to directors, officers and key employees of the Company and Torch. These stock options may be granted subject to terms ranging from 6 to 10 years at a price equal to the fair market value of the stock at the date of grant. At December 31, 1997, options under the plans available for future grants were 421,000. 57 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A summary of activity in the stock option plans is set forth below:
Number Option Of shares Price Range ------------------------ ------------------------------ Balance at June 30, 1994................................. 471,325 $3.00 - $7.00 Granted................................................ 450,000 $5.56 - $5.94 ------------------------ ------------------------------ Balance at June 30, 1995................................. 921,325 $3.00 - $7.00 Granted................................................ 27,000 $4.375 - $6.38 Surrendered............................................ (10,000) $5.75 Exercised.............................................. (30,000) $5.625 ------------------------ ------------------------------ Balance at June 30, 1996................................. 908,325 $3.00 - $7.00 Granted................................................ 378,500 $6.25 - $10.19 Surrendered............................................ (12,000) $7.625 Exercised.............................................. (82,500) $5.625 - $5.75 ------------------------ ------------------------------ Balance at June 30, 1997................................. 1,192,325 $3.00 - $10.88 Granted................................................ 242,000 $10.31 - $12.38 Exercised.............................................. (46,500) $3.00 - $10.00 ------------------------ ------------------------------ Balance at December 31, 1997............................. 1,387,825 $3.00 - $12.38 ======================== ============================== Exercisable at December 31, 1997......................... 1,145,825 $3.00 - $12.38 ======================== ==============================
Detail of stock options outstanding and options exercisable at June 30, 1997 follows:
Outstanding Exercisable ---------------------------------------------------- ---------------------------------- Weighted Average Weighted Weighted Remaining Average Average Life Exercise Exercise Range of Exercise Prices Number (Years) Price Number Price - -------------------------------------------------------------------------------------------------------------------------------- 1988 Plan $3.00 to $ 7.00 131,325 0.74 $4.79 108,435 $4.78 1994 Plan $4.38 to $ 7.63 705,500 7.28 5.70 705,500 5.70 1996 Plan $6.25 to $12.38 355,500 9.41 7.76 276,500 7.25 ----------------- ----------------- Total 1,192,325 1,090,435 ================= =================
Detail of stock options outstanding and options exercisable at December 31, 1997 follows:
Outstanding Exercisable ---------------------------------------------------- ---------------------------------- Weighted Average Weighted Weighted Remaining Average Average Life Exercise Exercise Range of Exercise Prices Number (Years) Price Number Price - ------------------------------------------------------------------------------------------------------------------------------- 1988 Plan $3.00 to $ 7.00 121,325 0.23 $4.82 121,325 $4.82 1994 Plan $4.38 to $ 7.63 682,500 6.77 5.69 682,500 5.69 1996 Plan $6.25 to $12.38 584,000 9.30 9.31 342,000 7.83 ----------------- ----------------- Total 1,387,825 1,145,825 ================= =================
58 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The estimated weighted average fair value per share of options granted during transition 1997, fiscal 1997 and fiscal 1996 was $6.73, $3.26 and $2.39, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted- average assumptions: transition 1997, fiscal 1997 and fiscal 1996 expected stock price volatility of 40%; and risk free interest rate of 6% and an average expected option life of 5 years. Had compensation expense for stock-based compensation been determined based on the fair value at the date of grant, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below (in thousands except share information):
Six Month Transition Period Ended Fiscal Years Ended June 30, December 31, ---------------------------------------------- 1997 1997 1996 --------------------- ------------------- -------------------- Net income As Reported.................................. $3,548 $4,645 $ 982 Pro forma.................................... $2,524 $3,853 $ 921 Earnings per share As reported.................................. $ 0.26 $ 0.46 $0.11 Pro forma.................................... 0.18 0.38 0.10 Diluted earnings per share As reported.................................. $ 0.25 $ 0.45 $0.11 Pro forma.................................... 0.17 0.38 0.10
7. DERIVATIVE FINANCIAL INSTRUMENTS The Company periodically uses derivative financial instruments to manage oil and gas price risk; generally commodity price swap agreements which provide for the Company to receive or make counterparty payments on the differential between a fixed price and a variable indexed price for natural gas or crude oil. Gains and losses from these hedging activities are included in oil and gas sales at the time the related production is delivered. During the transition period the Company hedged an aggregate of 6,888 MMBTU of natural gas at an average Nymex quoted price of $2.25 per MMBTU, before transaction and transportation costs, and an aggregate of 67,900 barrels of crude oil at an average Nymex quoted price of $22.00 per barrel, before quality differentials and transportation costs. At December 31, 1997 the Company was a party to an oil price swap contract for January through March of 1998 for 90,000 barrels at a Nymex quoted price of $21.80 per barrel, before quality differentials and transportation costs. Hedging activities reduced revenues by $1.6 million, $18,000 and $.6 million for the transition period and for the years ended June 30, 1997 and 1996, respectively. There was no hedging in 1995. At December 31, 1997 the Company had no unrealized hedging gains or losses. These energy swap agreements expose the Company to counterparty credit risk to the extent the counterparty is unable to meet its monthly settlement commitment to the Company. 59 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DETERMINATION OF FAIR VALUES OF FINANCIAL INSTRUMENTS Fair value for cash, short-term investments, receivables and payables approximates carrying value. The following table details the carrying values and approximate fair values of the Company's other investments, derivative financial instruments and long-term debt at December 31, 1997, June 30, 1997 and 1996 (in thousands).
December 31, 1997 June 30, 1997 June 30, 1996 ----------------------------- ------------------------------- ------------------------------ Carrying Approximate Carrying Approximate Carrying Approximate Value Fair Value Value Fair Value Value Fair Value ------------ -------------- -------------- -------------- ------------- -------------- Liabilities/ (Assets): Swap Agreements $ --- $ (505) $ --- $ 994 $ --- $ 28 Long-term debt $100,000 $107,420 $115,300 $120,580 $13,048 $13,048 (See Note 8)
8. LONG-TERM DEBT -------------- Long-term debt is comprised of the following at December 31, 1997, June 30, 1997 and 1996 (in thousands):
December 31, June 30, June 30, ------------------- ------------------ ------------------ 1997 1997 1996 ------------------- ------------------ ------------------ Bank credit facility.................................... $ --- $ 15,300 $13,048 10-7/8% Senior Subordinated Notes....................... $100,000 $100,000 --- ------------------- ------------------ ------------------- Long-term debt.......................................... $100,000 $115,300 $13,048 =================== ================== ==================
Debt maturities by fiscal year are as follows (amounts in thousands): 1998 $ --- 1999 --- 2000 --- 2001 --- 2002 --- Thereafter 100,000 --------- $ 100,000 ========= On February 28, 1995, the Company entered into a credit facility ("Credit Facility") with a commercial bank providing an initial borrowing base of $29.8 million. The borrowings under the Credit Facility were secured by the Company's interests in oil and gas properties, a gathering system and two gas plants. The Credit Facility was retired in October 1996. 60 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In October 1996, the Company entered into a syndicated credit facility ("Syndicated Credit Facility") in an amount up to $50.0 million with an initial borrowing base of $27.0 million, to be re-determined semi-annually. At Bellwether's option, the interest rate varied, based upon borrowing base usage, from London Interbank Offered Rate ("LIBOR") plus 7/8% to LIBOR plus 1-1/4%, or the greater of the prime rate or Federal Funds rate plus 1/2%. The Syndicated Credit Facility was unsecured and was retired in April 1997. In April 1997, the Company entered into a senior revolving unsecured credit facility ("Senior Credit Facility") in an amount up to $90.0 million, with a borrowing base to be re-determined semi-annually, and a maturity date of March 31, 2002. On December 20, 1997 the borrowing base was re-determined to be $75.0 million. Bellwether may elect an interest rate based either on a margin plus LIBOR or the higher of the prime rate or the sum of 1/2 of 1% plus the Federal Funds Rate. For LIBOR borrowings, the interest rate will vary from LIBOR plus 0.875% to LIBOR plus 1.25% based upon borrowing base usage. In connection with the acquisition of oil and gas properties, $33.3 million was drawn under this facility, including $22 million used to retire outstandings under the Syndicated Credit facility. At December 31, 1997, there were no outstanding borrowings. The Senior Credit Facility contains various covenants including certain required financial measurements for a current ratio, consolidated tangible net worth and interest coverage ratio. In addition, the Senior Credit Facility includes certain limitations on restricted payments, dividends, incurrence of additional funded indebtedness and asset sales. In April 1997, the Company issued $100.0 million of 10-7/8% senior subordinated notes ("Notes") that mature April 1, 2007. Interest on the Notes is payable semi-annually on April 1 and October 1 commencing on October 1, 1997. The Notes will be redeemable, in whole or in part, at the option of the Company at any time on or after April 1, 2002 at 105.44% which decreases annually to 100.00% on April 1, 2005 and thereafter, plus accrued and unpaid interest. In the event of Change of Control of the Company, each holder of the Notes will have the right to require the Company to repurchase all or part of such holder's Notes at an offer price in cash equal to 101.0% of the aggregate principal amount thereof, plus accrued and unpaid interest to the date of purchase. The Notes are guaranteed by the Company and its wholly owned subsidiaries, Odyssey Petroleum Company, Black Hawk Oil Company and 1989-I TEAI Limited Partnership. The Notes contain certain covenants, including limitations on indebtedness, restricted payments, transactions with affiliates, liens, guarantees of indebtedness by subsidiaries, dividends and other payment restrictions affecting restricted subsidiaries, issuance and sales of restricted subsidiary stock, disposition of proceeds of asset sales, and restrictions on mergers, and consolidations or sales of assets. 61 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. INCOME TAXES (IN THOUSANDS) Income tax expense is summarized as follows:
Six Month Transition Period Ended December 31, Fiscal Year Ended June 30, ---------------------- ---------------------------------------------------------- 1997 1997 1996 1995 ---------------------- ----------------- ------------------ ---------------- Current Federal.............................. $ 400 $ (12) $ 126 $ 9 State................................ 129 35 103 --- Deferred - Federal and State........... 1,585 2,562 (183) --- ---------------------- ----------------- ------------------ ---------------- Total income tax expense............... $2,114 $2,585 $ 46 $ 9 ====================== ================= ================== ================
The tax effect of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 1997, June 30, 1997 and 1996 is as follows:
At December 31, At June 30, ----------------- -------------------------------------------- 1997 1997 1996 ----------------- ------------------ ------------------ Net operating loss carryforwards....................................... $ 7,858 $ 8,668 $ 8,922 Percentage depletion carryforwards....................................... 271 271 271 Alternative minimum tax credit carryforwards......................................... 513 114 126 ----------------- ------------------ ------------------ Total deferred income tax assets............................................. 8,642 9,053 9,319 ----------------- ------------------ ------------------ Plant, property and equipment......................... (12,106) (11,019) (8,840) State income taxes.................................... (748) (661) (446) ----------------- ------------------ ------------------ Total deferred income tax liabilities......................................... (12,854) (11,680) (8,840) ----------------- ------------------ ------------------ Valuation allowances.................................. (2,894) (2,894) (2,894) ----------------- ------------------ ------------------ Net deferred income tax liability........................................... $ (7,106) $ (5,521) (2,861) ================= ================== ==================
The Company files a consolidated federal income tax return. Deferred income taxes are provided for transactions which are recognized in different periods for financial and tax reporting purposes. Such temporary differences arise primarily from the deduction for tax purposes of certain oil and gas development costs which are capitalized for financial statement purposes. Management believes it is more likely 62 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS than not that the deferred tax assets, net of the valuation allowance, will be recovered. Total income tax differs from the amount computed by applying the Federal income tax rate to income before income taxes and minority interest. The reasons for the differences are as follows:
Six Month Transition Period Ended December 31, Fiscal Year Ended June 30, --------------- ---------------------------------------- 1997 1997 1996 1995 --------------- ------------ ---------- --------- Statutory Federal income tax rate................................................. 34.0% 34.0% 34.0% 34.0% Increase (Decrease) in tax rate resulting from: State income taxes, net of federal benefit.................................... 3.2% 1.3% 7.0% --- Non-deductible travel and entertainment...................................... .1% 0.5% 0.3% 1.2% Reduction of valuation allowance due to utilization of net operating loss carryforwards...................................... --- --- (36.8%) (34.4%) --------------- ------------ ---------- --------- 37.3% 35.8% 4.5% 0.8% =============== ============ ========== =========
The Company issued 3,400,000 shares of its common stock on July 20, 1994. As a result of the common stock issuance, the Company has undergone an ownership change. Therefore, the Company's ability to use its net operating loss ("NOL") carryforwards for federal income tax purposes is subject to significant restrictions. Section 382 of the Internal Revenue Code significantly limits the amount of NOL and investment tax credit carryforwards that are available to offset future taxable income and related tax liability when a change in ownership occurs after December 31, 1986. At December 31, 1997, the Company had net operating loss carryforwards of approximately $23.1 million which will expire in future years beginning in 1998. Due to provisions of Section 382, the Company is limited to approximately $4.6 million utilization of NOL per year. 63 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. CONTINGENCIES The Company has been named as a defendant in certain lawsuits incidental to its business. Management does not believe that the outcome of such litigation will have a material adverse impact on the Company. 12. SELECT QUARTERLY FINANCIAL DATA (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (Unaudited):
Quarter Ended -------------------------------------------------------------------- December March June September December 31, 1996 31, 1997 30, 1997 30, 1997 31, 1997 -------------------------------------------------------------------- Revenues $6,633 $7,294 $23,514 $21,177 $24,399 Operating income $1,771 $2,303 $ 2,175 $ 1,375 $ 4,287 Net income $1,116 $1,462 $ 1,449 $ 857 $ 2,691 Earnings per common share $ 0.12 $ 0.16 $ 0.11 $ 0.06 $ 0.19 Earnings per common shares diluted $ 0.12 $ 0.16 $ 0.11 $ 0.06 $ 0.19 -------------------------------------------------------------------- September December March June September 30, 1995 31,1995 31, 1996 30, 1996 30, 1996 -------------------------------------------------------------------- Revenues $4,221 $4,895 $ 4,887 $ 5,313 $ 5,319 Operating income $ 38 $ 95 $ 542 $ 353 $ 981 Net income (loss) $ 13 $ (12) $ 557 $ 424 $ 618 Earnings per common share $ -- $ -- $ 0.06 $ 0.05 $ 0.07 Earnings per common share diluted $ -- $ -- $ 0.06 $ 0.05 $ 0.06
13. SUPPLEMENTAL INFORMATION - (Unaudited) OIL AND GAS PRODUCING ACTIVITIES: Included herein is information with respect to oil and gas acquisition, exploration, development and production activities, which is based on estimates of year-end oil and gas reserve quantities and estimates of future development costs and production schedules. Reserve quantities and future production are based primarily upon reserve reports prepared by the independent petroleum engineering firms of Williamson Petroleum Consultants, Inc., for fiscal 1996 and 1995, R.T. Garcia & Co. Inc. for fiscal 1995, and Ryder Scott Company for fiscal 1997 and the transition period 1997. These estimates are inherently imprecise and subject to substantial revision. Estimates of future net cash flows from proved reserves of gas, oil, condensate and natural gas liquids were made in accordance with Statement of Financial Accounting Standards No. 69, "Disclosures about Oil and Gas Producing Activities." The estimates are based on prices at year-end. Estimated future cash inflows are reduced by estimated future 64 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS development and production costs based on year-end cost levels, assuming continuation of existing economic conditions, and by estimated future income tax expense. Tax expense is calculated by applying the existing statutory tax rates, including any known future changes, to the pre-tax net cash flows, less depreciation of the tax basis of the properties and depletion allowances applicable to the gas, oil, condensate and NGL production. Impact of net operating loss is considered in calculation of tax expense. The results of these disclosures should not be construed to represent the fair market value of the Company's oil and gas properties. A market value determination would include many additional factors including: (i) anticipated future increases or decreases in oil and gas prices and production and development costs; (ii) an allowance for return on investment; (iii) the value of additional reserves, not considered proved at the present, which may be recovered as a result of further exploration and development activities; and (iv) other business risks. Costs incurred (in thousands) The following table sets forth the costs incurred in property acquisition and development activities:
Six Month Transition Period Ended December 31, Fiscal Year Ended June 30, --------------------- ------------------------------------------------------- 1997 1997 1996 1995 --------------------- ----------------- ---------------- --------------- Property acquisition: Proved properties..................... $ 3,281 $138,984 $ 128 $25,072 Unproved properties................... 2,205 1,002 424 13,233 Exploration............................. 3,274 1,576 824 530 Development............................. 10,453 14,032 5,558 2,841 ------- -------- ------ ------- $19,213 $155,594 $6,934 $41,676 ======= ======== ======= =======
65 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Capitalized costs (in thousands) - ----------------- The following table sets forth the capitalized costs relating to oil and gas activities and the associated accumulated depreciation, depletion and amortization:
Six Month Transition Period Ended December 31, Fiscal Year Ended June 30, ----------------- ----------------------------------------------------------- 1997 1997 1996 1995 ----------------- --------------- ------------- ------------ Proved properties..................... $243,758 $228,675 $ 62,590 $ 56,300 Unproved properties................... 6,469 4,500 13,453 15,125 ------------ ------------- ----------- ----------- Total capitalized costs............... 250,227 233,175 76,043 71,425 Accumulated depreciation, depletion and amortization.......... (82,975) (61,783) (28,316) (20,983) ------------ ------------ ----------- ----------- Net capitalized costs................. $167,252 $171,392 $ 47,727 $ 50,442 ============ ============ =========== ===========
Results of operations for producing activities (in thousands):
Six Month Transition Period Ended December 31, Fiscal Year Ended June 30, ------------ ---------------------------------------------------------- 1997 1997 1996 (1) 1995 (1) -------------- -------------- --------------- -------------- Revenues from oil and gas producing activities..................... $44,163 $39,067 $15,666 $ 8,507 Production costs.......................... 13,836 11,437 5,317 2,856 Income tax................................ 5,379 4,529 -- -- Depreciation, depletion and amortization............................. 15,831 14,691 6,933 3,893 ------------ ----------- ------------ --------- Results of operations from producing activities (excluding corporate overhead and interest costs)............. $ 9,117 $ 8,410 $ 3,416 $ 1,758 ============ =========== ============ =========
_________ (1) Net operating loss carryfowards were sufficient to offset income. 66 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Per unit sales prices and costs: - -------------------------------
Six Month Transition Period Ended December 31, Fiscal Year Ended June 30, ------------ ---------------------------------------------------------- 1997 1997 1996 (1) 1995 (1) -------------- -------------- --------------- -------------- Average sales price: (1) Oil (per barrel)........................ $16.34 $17.41 $17.81 $16.89 Gas (per MCF)........................... $ 2.55 $ 2.29 $ 2.02 $ 1.66 Average production cost per equivalent barrel....................... $ 4.74 $ 4.38 $ 4.49 $ 4.05 Average unit depletion rate per equivalent barrel................... $ 5.42 $ 5.62 $ 5.86 $ 5.52
_________ (1) Average sales price is exclusive of the effect of natural gas and crude oil price swaps, which decreased revenues $1.6 million in transition period 1997 and $18,000 and $.6 million in fiscal years ended June 30, 1997 and 1996, respectively. 67 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Reserves - -------- The Company's estimated total proved and proved developed reserves of oil and gas are as follows:
Six Month Transition Period Ended Description December 31, 1997 - ---------------------------------------------------- -------------------------------------------------------------------- Oil NGL Gas (MBBL) (MBBL) (MMCF) -------------------- ------------------ ------------------ Proved reserves at beginning of period 12,007 4,023 127,940 Revisions of previous estimates 1,246 (1,417) 1,599 Extensions and discoveries 641 52 4,869 Production (967) (87) (11,193) Sales of reserves in-place (694) --- (642) Purchase of reserves in-place 5 --- 3,387 Reserves added in Merger --- --- --- -------------------- ------------------ ------------------ Proved reserves at end of period 12,238 2,571 125,960 ==================== ================== ================== Proved developed reserves - Beginning of period 10,162 3,705 117,914 ==================== ================== ================== End of period 11,153 2,460 119,270 ==================== ================== ==================
Fiscal Year Ended June 30, -------------------------------------------------------------------------- Description 1997 1996 1995 - -------------------------- -------------------------------------------------------------------------- Oil NGL Gas Oil Gas Oil Gas (MBBL) (MBBL) (MMCF) (MBBL) (MMCF) (MBBL) (MMCF) ------------ -------- ---------- -------- -------- --------- ------- Proved reserves at beginning of year 1,808 --- 33,194 2,597 30,159 393 10,671 Revisions of previous estimates (1,187) 2,435 (2,773) (534) 2,853 (61) (988) Extensions and discoveries 658 52 4,202 89 7,128 724 1,179 Production (854) --- (10,552) (334) (5,099) (216) (2,932) Sales of reserves in- place (1,260) --- (16,194) (14) (2,023) (1) (3) Purchase of reserves in-place 12,842 1,536 120,063 4 176 --- 163 Reserves added in Mergers --- --- --- --- --- 1,758 22,069 ------------ -------- ---------- -------- -------- --------- ------- Proved reserves at end of year 12,007 4,023 127,940 1,808 33,194 2,597 30,159 ============ ======== ========== ======== ======== ========= ======= Proved developed reserves- Beginning of year 1,494 --- 22,696 1,891 23,795 361 9,154 ============ ======== ========== ======== ======== ========= ======= End of year 10,162 3,705 117,914 1,494 22,696 1,891 23,795 ============ ======== ========== ======== ======== ========= =======
68 Discounted future net cash flows (in thousands) - -------------------------------- The standardized measure of discounted future net cash flows and changes therein related to proved oil and gas reserves are shown below:
June 30, December 31, ------------------------------------------- 1997 1997 1996 1995 ---------------- ------------- -------------- ---------- Future cash inflows.............................. $ 517,323 $ 529,928 $113,550 $ 96,738 Future production costs.......................... (191,988) (183,479) (33,117) (34,093) Future income taxes.............................. (48,594) (59,419) (11,095) --- Future development costs......................... (33,197) (32,237) (8,959) (7,738) ------------------ --------------- -------------- ----------- Future net cash flows............................ 243,544 254,793 60,379 54,907 10% discount factor.............................. (57,829) (67,300) (15,191) (17,616) ------------------ --------------- -------------- ----------- Standardized measure of discounted future net cash flows...................................... $ 185,715 $ 187,493 $ 45,188 $ 37,291 ================== =============== ============== ===========
The following are the principal sources of change in the standardized measure of discounted future net cash flows:
Six Month Transition Period Ended December 31, Fiscal Year Ended June 30, ------------------- ------------------------------------- 1997 1997 1996 1995 ------------------- ------------ ------------ --------- Standardized measure - beginning of year................ $187,493 $ 45,188 $ 37,291 $12,044 Sales, net of production costs.......................... (30,327) (27,630) (10,349) (5,651) Purchases of reserves in-place.......................... 4,117 151,836 246 162 Reserves added in Mergers............................... --- --- --- 34,039 Net change in prices and production costs............... (3,922) 22,599 11,458 (8,326) Net change in income taxes.............................. 8,706 (20,265) (2,958) --- Extensions, discoveries and improved recovery, net of future production and development costs..................................... 10,769 12,555 7,709 5,085 Changes in estimated future development costs................................................. (3,588) (3,034) 497 (3,148) Development costs incurred during the 6,662 9,124 883 629 period................................................ Revisions of quantity estimates......................... 569 27,102 (438) (4) Accretion of discount................................... 18,749 4,518 3,729 1,204 Sales of reserves in-place.............................. (4,602) (16,140) (1,614) (5) Changes in production rates and other................... (8,911) (18,360) (1,266) 1,262 -------------- ------------ ------------ --------- Standardized measure - end of year...................... $185,715 $187,493 $ 45,188 $37,291 ============== ============ ============ =========
The discounted future cash flows above were calculated using NYMEX equivalent prices of $18.32 and $19.80 per barrel and $2.58 and $2.35 per MMBTU, for December 31, 1997 and June 30, 1997, respectively, adjusted to the wellhead to reflect adjustments for transportation, quality and heating content. Oil prices have declined significantly since such time and gas prices have declined approximately 11% since year end 1997. 69 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On or about June 18, 1997 the Company replaced the firm of Deloitte and Touche LLP as its principal independent accountant and auditors to audit all the Company's financial statements with the firm of KPMG Peat Marwick LLP. The decision to make this change was influenced by the acquisition of Partnership properties and interests, which were previously audited by KPMG Peat Marwick LLP. The Company does not and has not during the past three years had disagreements with Deloitte and Touche LLP concerning their audit or application of accounting principles according to GAAP. PART III -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------ Incorporated by reference to the Proxy Statement for the 1997 Transition Period Annual Meeting of Shareholders to be held on May 22, 1998, pursuant to Regulation 14A. ITEM 11. EXECUTIVE COMPENSATION - -------------------------------- Incorporated by reference to the Proxy Statement for the 1997 Transition Period Annual Meeting of Shareholders to be held on May 22, 1998, pursuant to Regulation 14A. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------ Incorporated by reference to the Proxy Statement for the 1997 Transition Period Annual Meeting of Shareholders to be held on May 22, 1998, pursuant to Regulation 14A. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------------------------------------------------------- Incorporated by reference to the Proxy Statement for the 1997 Transition Period Annual Meeting of Shareholders to be held on May 22, 1998, pursuant to Regulation 14A. PART IV ------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - ------------------------------------------------------------------------- (a) 1. and 2. Financial Statements. See index to Consolidated Financial Statements and Supplemental Information in Item 8, which information is incorporated herein by reference. 3. Exhibits -------- 3.1 Certificate of Incorporation of Bellwether Exploration Company (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement No. 33-76570) 70 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES 3.2 Certificate of Amendment to Certificate of Incorporation (incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10- K for the fiscal year ended June 30, 1997) 3.3 Certificate of Designation, Preferences and Rights of Series A Preferred Stock (incorporated by reference to Exhibit 3.3 to the Company's report on Form 8-K dated September 19, 1997.) 3.4 By-laws of Bellwether Exploration Company (incorporated by reference to Exhibit 3.2 to the Company's Registration Statement No. 33-76570) 3.5 Amendment to Article II, Section 2.2 of Bellwether Exploration Company's Bylaws 3.6 Amendment to Bellwether Exploration Company's bylaws adopted on March 27, 1998. 4.1 Specimen Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form S-1, File No. 33- 76570) 4.2 The Company's 1996 Stock Incentive Plan (incorporated by reference to Exhibit 10.20 to the Company's Registration Statement on Form S-1, File No. 33-21813) 4.3 Indenture dated April 9, 1997 among the Company, a Subsidiary Guarantor and Bank of Montreal Trust Company (incorporated herein by reference to Exhibit 4.2 to the Company's Registration Statement on Form S-1, Registration No. 33-21813) 4.4 First Supplemental Indenture dated April 21, 1997 among the Company, Odyssey Petroleum Company, Black Hawk Oil Company, 1989-I TEAI Limited Partnership and Bank of Montreal Trust Company, as Trustee (incorporated by reference to Exhibit 99.2 on the Company's Form 8-K Current Report filed on April 23, 1997) 4.5 Shareholders Rights Agreement between the Company and American Stock Transfer & Trust Company (incorporated herein by reference to the Company's Registration Statement on Form 8-A as filed with the Securities and Exchange Commission on September 19, 1997) 4.6 Warrant to Torch Energy Dated April 9. 1997 (incorporated by reference to Exhibit 4.6 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1997) 10.1 1988 Non-qualified Stock Option Plan (incorporated by reference to Exhibit 10.37 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1988) 10.2 Stock Option Agreement dated March 25, 1988 between the Company and J. Darby Sere' (incorporated by reference to Exhibit 10.38 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1988) 71 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES 10.3 Administrative Services Agreement with Torch Energy Advisors Incorporated commencing January 1, 1994 (incorporated by reference to Exhibit 94-10-3 to the Company's Report on Form 10-Q for the quarter ended March 31, 1994) 10.4 Amended Joint Venture Agreement dated July 29, 1993 between the Company and NGL Associates (incorporated by reference to Exhibit 10.93.5 to the Company's Report on Form 10-K dated July 29, 1993) 10.5 Amended Joint Venture dated July 15, 1993 between Torch Energy Marketing, Inc. and NGL Associates (incorporated by reference to Exhibit 10.93.8 to the Company's report on Form 8-K dated December 31, 1993) 10.6 Registration Rights Agreement dated December 31, 1993 among the Company and the Stockholders of Associated Gas Resources, Inc. (incorporated by reference to Exhibit 10.1 to the Company's Registration Statement No. 33-76570) 10.7 1994 Stock Incentive Plan (incorporated by reference to Exhibit 10.9 to the Company's Registration Statement No. 33-76570) 10.8 Amendment dated March 14, 1994 to the Amended Joint Venture Agreement dated as of July 29, 1993 between the Company and NGL Associates (incorporated by reference to Exhibit 10.11 to the Company's Registration Statement No. 33-76570) 10.9 Amendment dated March 14, 1994 to the Amended Joint Venture Agreement dated as of July 15, 1993 between Torch Energy Marketing, Inc. and NGL Associates (incorporated by reference to Exhibit 10.12 to the Company's Registration Statement No. 33-76570) 10.10 Registration Rights Agreement among the Company, Allstate Insurance Company and the former owners of Odyssey Partners, Ltd. (incorporated by reference to Exhibit 10.4 to the Company's Registration Statement No. 33-76570) 10.11 Assignment of gas purchase contract from Texas Gas Transmission Corporation to Bellwether (incorporated by reference to Exhibit 96-1 0-4 to the Company's Report on Form 10-Q for the quarter ended March 31, 1997) 10.12 Credit Agreement among Bellwether Exploration Company as borrower and The Chase Manhattan Bank as agent(incorporated by reference to Exhibit 10.1 to the Company's Report on Form 10-Q for the quarter ended September 30, 1996) 10.13 Acquisition Agreement dated March 31, 1997 among Bellwether Exploration Company, Program Acquisition Company and the other parties thereto. (incorporated by reference to Exhibit 2.2 of the Company's Registration Statement on Form S-1 (Registration No. 333- 21813) filed on April 3, 1997) 72 BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES 10.14 Credit Agreement dated April 21, 1997 among the Company, Odyssey Petroleum Company, Black Hawk Oil Company, 1989-I TEAI Limited Partnership, Morgan Guarantee Trust Company of New York, as administrative Agent, and certain banking institutions (incorporated by reference to the Company's Form 8-K Current Report as filed with the Commission on April 23, 1997) 10.15 Purchase and Sale Agreement dated June 9, 1997 among Bellwether Exploration Company, Black Hawk Oil Company, 1988-II TEAI Limited Partnership, 1989-I TEAI Limited Partnership, TEAI Oil and Gas Company, and the other parties thereto as Sellers, and Jay Resources Corporation as Buyer (incorporated by reference to Exhibit 10.18 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1997). 16.1 Letter from predecessor auditors regarding change in certifying accountant (incorporated by reference to Exhibit 16-1 to the Company's Form 8K/A-1 dated July 8, 1997) 21.1 Subsidiaries of Bellwether Exploration Company - Included herewith. 23 Consents of experts: 23.1 Consent of Williamson Petroleum Consultants, Inc. 23.2 Consent of R.T. Garcia & Co. Inc. 23.3 Consent of Ryder Scott Company 23.4 Consent of KPMG Peat Marwick LLP 27 Financial Data Schedule 73 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Company and in the capacities and on the dates indicated. BELLWETHER EXPLORATION COMPANY /s/ J. DARBY SERE' ------------------ J. Darby Sere' Chairman of Board of Directors and Chief Executive Officer Dated March 27, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Company and in the capacities and on the dates indicated.
SIGNATURES TITLE DATE /s/ J. DARBY SERE' Chairman of Board of March 27, 1998 - -------------------------------------------- Directors and Chief J. Darby Sere' Executive Officer /s/ C. BARTON GROVES Senior Vice President March 27, 1998 - -------------------------------------------- and Director C. Barton Groves /s/ WILLIAM C. RANKIN Senior Vice President March 27, 1998 - -------------------------------------------- and Chief Financial William C. Rankin Officer /s/ DR. JACK BIRKS Director March 27, 1998 - -------------------------------------------- Dr. Jack Birks /s/ J.P. BRYAN Director March 27, 1998 - -------------------------------------------- J.P. Bryan /s/ VINCENT H. BUCKLEY Director March 27, 1998 - -------------------------------------------- Vincent H. Buckley /s/ CHARLES C. GREEN Director March 27, 1998 - -------------------------------------------- Charles C. Green /s/ HABIB KAIROUZ Director March 27, 1998 - -------------------------------------------- Habib Kairouz /s/ A. K. MCLANAHAN Director March 27, 1998 - -------------------------------------------- A. K. McLanahan /s/ TOWNES G. PRESSLER Director March 27, 1998 - -------------------------------------------- Townes G. Pressler
74 EX-3.5 2 AMENDMENT TO ARTICLE II EXHIBIT 3.5 BELLWETHER EXPLORATION COMPANY MINUTES OF THE MEETING OF THE BOARD OF DIRECTORS HELD AT THE HOUSTON CENTER CLUB 1100 CAROLINE HOUSTON, TEXAS 77010 FRIDAY, NOVEMBER 21, 1997 Present: Mr. J. Darby Sere (in the chair) Mr. Vincent H. Buckley Mr. A. K. McLanahan Mr. C. Barton Groves Mr. Habib Kairouz Dr. Jack Birks Mr. Townes G. Pressler Absent: Mr. J. P. Bryan Mr. Charles C. Green, III In Attendance: Mr. William C. Rankin Mr. Michael B. Smith Ms. Mary Lou Fry The Board was presented with a proposal to amend the Bylaws of the Company effective November 21, 1997. Upon motion duly made and seconded, it was unanimously, RESOLVED, that Article II, Section 2.2 of the Company's Bylaws shall be and hereby is amended in its entirety to read as follows: Section 2. Annual meeting of stockholders, commencing with the year 1998, shall be held at a time and date designated at the discretion of the Board of Directors, said time and date to be stated within the notice of the meeting, at which they shall elect by a plurality vote a board of directors, and transact such other business as may properly be brought before the meeting. EX-3.6 3 AMENDMENT TO BYLAWS Exhibit 3.6 The following amendments were adopted at the Board Meeting on March 27, 1998: SPECIAL MEETING BYLAW Section 2.5 of the Bylaws shall be amended as follows: Special meeting of the stockholders for any purpose or purposes, unless otherwise prescribed by statute or by the certificate of incorporation, may be called by the Chairman of the Board or by a majority vote of the Board of Directors. ADVANCE NOTICE BYLAW Section 2.11 shall be added to the Bylaws as follows: A nomination shall be accepted, and votes cast for a proposed nominee shall be counted by the inspectors of election, only if the Secretary of the Company has received at least 90 days prior to the meeting a statement over the signature of the proposed nominee that he consents to being the nominee and, if elected intends to serve as a director. Such statement shall also contain the Bellwether stock ownership of the proposed nominee, occupations and business history for the previous five years, other directorships and all other information required by the federal proxy rules in effect at the time the proposed nominee submits said statement. EX-21.1 4 SUBSIDIARIES OF BELLWETHER Exhibit 21.1 Subsidiaries of Bellwether Exploration Company State of Incorporation ------------- Bellwether Exploration Company Delaware Snyder Gas Plant Venture Texas West Monroe Gas Gathering Corporation Louisiana NGL-Torch Gas Plant Venture Texas Odyssey Petroleum Company Delaware Black Hawk Oil Company Delaware TEAI Oil & Gas Company Delaware 1989-I TEAI Limited Partnership Texas 1988-II TEAI Limited Partnership Texas TEAI VIII-A Limited Partnership Texas EX-23.1 5 CONSENT OF WILLIAMSON PETROLEUM EXHIBIT 23.1 [Letterhead of Williamson Petroleum Consultants, Inc. appears here] CONSENT OF WILLIAMSON PETROLEUM CONSULTANTS, INC. As independent oil and gas consultants, Williamson Petroleum Consultants, Inc. hereby consents to (a) the use of our reserve reports entitled "Evaluation of Oil and Gas Reserves to the Interests of Bellwether Exploration Company in Certain Properties, Effective June 30, 1996, for Disclosure to the Securities and Exchange Commission, Williamson Project 6.8369" dated August 20, 1996 and "Evaluation of Oil and Gas Reserves to the Interests of Bellwether Exploration Company in Certain Properties, Effective June 30, 1995, for Disclosure to the Securities and Exchange Commission, Williamson Project 5.8286" dated August 30, 1995 and (b) all references to our firm included in or made a part of the Bellwether Exploration Company Annual Report on Form 10-K to be filed with the Securities and Exchange Commission on or about March 27, 1998. /s/ Williamson Petroleum Consultants, Inc. ------------------------------------------- WILLIAMSON PETROLEUM CONSULTANTS, INC. Houston, Texas March 23, 1998 [Address of Williamson Petroleum Consultants, Inc. appears here] EX-23.2 6 CONSENT OF R.T. GARCIA EXHIBIT 23.2 [Letterhead of R. T. Garcia & Co., Inc. appears here] March 5, 1998 We do hereby grant consent to Bellwether Exploration Company for the reference to, or the inclusion of, our Reserve Report for Associated Gas Resources, Inc. for the fiscal year ending June 30th, 1995, in the Bellwether Exploration Company Form 10-K annual report. R. T. GARCIA & CO., INC. /s/ Raymond T. Garcia ------------------------------ Raymond T. Garcia, P.E. President [Address of R.T. Garcia & Co. Inc. appears here] EX-23.3 7 CONSENT OF RYDER SCOTT EXHIBIT 23.3 [Letterhead of Ryder Scott Company appears here] CONSENT OF INDEPENDENT PETROLEUM ENGINEERS We hereby consent to the use of this Annual Report on Form 10-K of our reserve reports dated September 25, 1997 and February 18, 1998 relating to the oil and gas reserves of Bellwether Exploration Company at July 1, 1997 and January 1, 1998, respectively. We also consent to the references to us under the heading "Supplemental Information" in the Notes to the Consolidated Financial Statements of Bellwether Exploration Company in such report. /s/ Ryder Scott Company Petroleum Engineers -------------------------------------------- RYDER SCOTT COMPANY PETROLEUM ENGINEERS Houston, Texas March 6, 1998 [Address of Ryder Scott Company appears here] EX-23.4 8 CONSENT OF KPMG PEAT MARWICK Exhibit 23.4 Independent Accountants' Consent - -------------------------------- The Board of Directors Bellwether Exploration Company: We consent to incorporation by reference in the registration statement (No. 33-91320) on Form S-8, registration statement (No. 33-91326) on Form S-8, registration statement (No. 333-27707) on Form S-8 and registration statement (No. 333-16231) on Form S-8 of Bellwether Exploration Company of our report dated February 24, 1998, relating to the consolidated balance sheets of Bellwether Exploration Company and subsidiaries as of December 31, 1997 and June 30, 1997 and 1996, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the six month period ended December 31, 1997 and for each of the years in the three year period ended June 30, 1997, which report appears in the December 31, 1997 annual report on Form 10-K of Bellwether Exploration Company. /s/ KPMG Peat Marwick LLP Houston, Texas March 27, 1998 EX-27 9 FINANCIAL DATA SCHEDULE
5 1,000 6-MOS DEC-31-1997 JUL-01-1997 DEC-31-1997 2,699 0 22,938 0 0 28,877 266,944 (86,811) 214,757 14,913 100,000 0 0 139 91,530 214,757 44,163 45,576 30,188 39,914 3,748 0 5,978 5,662 2,114 3,548 0 0 0 3,548 $0.26 $0.25
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