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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended March 31, 2004
or
[ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the Transition Period From ______ to ________
Commission file number 0-9498
MISSION RESOURCES CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 76-0437769
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
1331 Lamar, Suite 1455, Houston, Texas 77010-3039
(Address of principal executive offices) (ZIP Code)
(713) 495-3000
Registrant's telephone number, including area code
Not Applicable
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] NO [X]
As of April 30, 2004, 40,581,303 shares of common stock of Mission Resources
Corporation were outstanding.
MISSION RESOURCES CORPORATION
INDEX
PAGE #
------
PART I. FINANCIAL INFORMATION.................................................................... 1
ITEM 1. Financial Statements................................................................ 1
Consolidated Balance Sheets:
March 31, 2004 (Unaudited) and December 31, 2003.................. 1
Consolidated Statements of Operations (Unaudited):
Three months ended March 31, 2004 and 2003........................ 3
Consolidated Statements of Cash Flows (Unaudited):
Three months ended March 31, 2004 and 2003........................ 4
Notes to Consolidated Financial Statements (Unaudited)........................ 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................... 19
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 31
ITEM 4. Controls and Procedures............................................................. 32
PART II. OTHER INFORMATION........................................................................ 34
ITEM 1. Legal Proceedings................................................................... 34
ITEM 2. Change in Securities, Use of Proceeds and Issuer Purchases of Equity Securities..... 34
ITEM 3. Defaults Upon Senior Securities..................................................... 34
ITEM 4. Submission of Matters to a Vote of Security Holders................................. 34
ITEM 5. Other Information................................................................... 34
ITEM 6. Exhibits and Reports on Form 8-K.................................................... 34
-i-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MISSION RESOURCES CORPORATION
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
ASSETS
March 31, December 31,
2004 2003
------------ ------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents ........................................ $ 9,576 $ 2,234
Cash held for reinvestment ....................................... - 24,877
Accounts receivable .............................................. 5,799 6,327
Accrued revenues ................................................. 9,612 8,417
Prepaid expenses and other ....................................... 1,665 2,523
------------ ------------
Total current assets ........................................ 26,652 44,378
------------ ------------
PROPERTY AND EQUIPMENT, AT COST:
Oil and gas properties (full cost), including unproved properties
of $8,509 and $6,123 excluded from amortization as of March 31,
2004 and December 31, 2003, respectively ...................... 842,433 805,900
Asset retirement cost ............................................ 11,907 10,987
Accumulated depreciation, depletion and amortization ............. (527,361) (514,759)
------------ ------------
Net property, plant and equipment ........................... 326,979 302,128
------------ ------------
Leasehold, furniture and equipment ............................... 4,509 4,405
Accumulated depreciation ......................................... (2,248) (2,065)
------------ ------------
Net leasehold, furniture and equipment ...................... 2,261 2,340
------------ ------------
OTHER ASSETS ..................................................... 4,748 5,404
------------ ------------
$ 360,640 $ 354,250
============ ============
See accompanying notes to condensed consolidated financial statements
-1-
MISSION RESOURCES CORPORATION
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share information)
LIABILITIES AND STOCKHOLDERS' EQUITY
March 31, December 31,
2004 2003
------------ ------------
(Unaudited)
CURRENT LIABILITIES:
Accounts payable ............................................. $ 9,536 $ 8,864
Accrued liabilities .......................................... 12,600 9,131
Interest payable ............................................. 7,303 3,425
Commodity derivative liabilities ............................. 9,672 8,597
Asset retirement obligation .................................. 1,257 1,160
------------ ------------
Total current liabilities ............................... 40,368 31,177
LONG-TERM DEBT:
Term loan facility ........................................... 80,000 80,000
Senior subordinated notes due 2007 ........................... 87,426 117,426
Unamortized premium on issuance of senior subordinated
notes due 2007 ............................................ 734 1,070
------------ ------------
Total long-term debt .................................... 168,160 198,496
LONG-TERM LIABILITIES:
Commodity derivative liabilities, excluding current portion .. 1,500 80
Deferred income taxes ........................................ 16,676 17,270
Other liabilities ............................................ 130 130
Asset retirement obligation, excluding current portion ....... 31,517 32,157
------------ ------------
Total long-term liabilities ............................. 49,823 49,637
STOCKHOLDERS' EQUITY:
Preferred stock, $0.01 par value, 5,000,000 shares authorized,
none issued or outstanding at March 31, 2004 and
December 31, 2003 ....................................... -- --
Common stock, $0.01 par value, 60,000,000 shares authorized,
40,269,303 and 28,017,636 shares issued at March 31, 2004
and December 31, 2003, respectively ..................... 407 284
Additional paid-in capital ................................... 200,765 172,532
Retained deficit ............................................. (89,872) (90,232)
Treasury stock, at cost, 389,000 shares at March 31, 2004
and December 31, 2003 .................................. (1,937) (1,937)
Other comprehensive income (loss), net of taxes .............. (7,074) (5,707)
------------ ------------
Total stockholders' equity ............................. 102,289 74,940
------------ ------------
$ 360,640 $ 354,250
============ ============
See accompanying notes to condensed consolidated financial statements
-2-
MISSION RESOURCES CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(Amounts in thousands, except per share information)
Three Months Ended March 31,
----------------------------
2004 2003
------------ ------------
REVENUES:
Oil and gas revenues ................................. $ 28,796 $ 25,737
Gain on extinguishment of debt ....................... 1,425 22,375
Interest and other income (expense) .................. (810) 535
------------ ------------
29,411 48,647
COST AND EXPENSES:
Lease operating expenses ............................. 7,106 8,890
Transportation costs ................................. 25 90
Taxes other than income .............................. 1,694 2,693
Asset retirement obligation accretion expense ........ 271 345
Depreciation, depletion and amortization ............. 10,664 9,022
General and administrative expenses .................. 2,823 2,572
Interest expense ..................................... 6,262 6,027
------------ ------------
28,845 29,639
Income before income taxes and cumulative effect of
a change in accounting method ........................ 566 19,008
Provision for income taxes ................................. 206 6,653
------------ ------------
Income before cumulative effect of a change in
accounting method ...................................... 360 12,355
Cumulative effect of a change in accounting method,
net of deferred tax of $935 in 2003 .................. -- (1,736)
------------ ------------
Net income ................................................. $ 360 $ 10,619
============ ============
Income before cumulative effect of a change in
accounting method per share .......................... $ 0.01 $ 0.52
============ ============
Income before cumulative effect of a change in
accounting method per share-diluted .................. $ 0.01 $ 0.52
============ ============
Net income per share ....................................... $ 0.01 $ 0.45
============ ============
Net income per share -diluted .............................. $ 0.01 $ 0.45
============ ============
Weighted average common shares outstanding ................. 31,611 23,586
Weighted average common shares outstanding -diluted ........ 33,122 23,590
See accompanying notes to condensed consolidated financial statements
-3-
MISSION RESOURCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(Amounts in thousands)
Three Months Ended March 31,
----------------------------
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ..................................................... $ 360 $ 10,619
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation, depletion and amortization ............... 11,277 9,431
Loss (gain) on commodity hedges ........................ 423 (208)
Loss (gain) on interest rate swap ...................... -- (520)
Gain on extinguishment of debt ......................... (1,425) (22,375)
Cumulative effect of a change in accounting method,
net of deferred tax ................................ -- 1,736
Asset retirement obligation accretion expense .......... 271 345
Deferred income taxes .................................. 111 6,578
Other .................................................. 379 --
Change in assets and liabilities:
Accounts receivable and accrued revenue .................... (1,062) (2,367)
Accounts payable and accrued liabilities ................... 8,063 4,587
Other ...................................................... 296 (2,330)
------------ ------------
NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES ............ 18,693 5,496
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of oil and gas properties ...................... (27,090) (258)
Additions to oil and gas properties ........................ (10,717) (6,275)
Additions to leasehold, furniture and equipment ............ (104) (255)
Proceeds on sale of oil and gas properties, net ............ 2,119 3,564
------------ ------------
NET CASH FLOWS (USED IN) INVESTING ACTIVITIES .............. (35,792) (3,224)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings ................................... -- 80,000
Net proceeds from issuance of common stock ................. -- --
Repurchase of notes ........................................ -- (71,700)
Cash held for reinvestment ................................. 24,877 --
Financing costs ............................................ (436) (3,912)
------------ ------------
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES ............ 24,441 4,388
Net increase in cash and cash equivalents ....................... 7,342 6,660
Cash and cash equivalents at beginning of period ................ 2,234 11,347
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ...................... $ 9,576 $ 18,007
============ ============
See accompanying notes to condensed consolidated financial statements
-4-
MISSION RESOURCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
(Amounts in thousands)
Three Months Ended March 31,
----------------------------
2004 2003
------------ ------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest .............................................. $ 1,770 $ 5,534
Income taxes paid (received) .......................... $ 84 $ (525)
See accompanying notes to condensed consolidated financial statements
-5-
MISSION RESOURCES CORPORATION
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited consolidated financial statements have
been prepared in accordance with instructions to Form 10-Q and, therefore,
do not include all disclosures required by accounting principles generally
accepted in the United States of America. However, in the opinion of
management, these statements include all adjustments, which are of a
normal recurring nature, necessary to present fairly the Company's
financial position at March 31, 2004, and the results of operations and
changes in cash flows for the periods ended March 31, 2004 and 2003.
Interim period results are not necessarily indicative of results of
operations or cash flows for a full year. These financial statements
should be read in conjunction with the consolidated financial statements
and notes to the consolidated financial statements in the Mission
Resources Corporation (the "Company" or "Mission") Annual Report on Form
10-K for the year ended December 31, 2003.
Principles of Consolidation
The consolidated financial statements include the accounts of
Mission Resources Corporation and its wholly owned subsidiaries. Mission
owns a 26.6% interest in the White Shoal Pipeline Corporation that is
accounted for using the equity method. Mission's investment of
approximately $377,000 at March 31, 2004 is included in the other assets
line of the Balance Sheet. At March 31, 2004, Mission had not received any
distributions from White Shoal Pipeline Corporation.
Oil and Gas Property Accounting
The Company uses the full cost method of accounting for its
investment in oil and gas properties. Under this method of accounting, all
costs of acquisition, exploration and development of oil and gas reserves
(including such costs as leasehold acquisition costs, geological
expenditure, dry hole costs, tangible and intangible development costs and
direct internal costs) are capitalized as the cost of oil and gas
properties when incurred. 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 charges to operations were required during
the three-month periods ending March 31, 2004 or 2003.
Joint Interest Billings
Joint interest receivables are recorded at the invoiced amount and
typically do not bear interest. The Company reviews collectibility of such
receivables monthly. Balances over ninety days past due and exceeding
$30,000 are reviewed individually for collectibility. Account balances are
charged against earnings when the Company determines potential for
recovery is remote. During the quarter ended March 31, 2004, approximately
$395,000 of such receivables were charged against earnings. The income
reduction is included in the interest and other income line of the
Consolidated Statement of Operations. The Company does not have any
off-balance sheet credit exposure related to its customers.
From time to time, certain other receivables are created and may be
significant. At March 31, 2004, the Company has recorded a receivable of
approximately $2.45 million from its insurance carrier, representing
repair costs incurred as a direct result of hurricane Lili in 2002. This
amount will be received in May 2004.
-6-
MISSION RESOURCES CORPORATION
Royalties Payable
Included in the accrued liabilities line of the Consolidated Balance
Sheet is approximately $2.3 million of royalties which are awaiting
completion of an initial title opinion. As soon as the operator of the
well completes the title opinion, Mission will be required to make
payment. This liability will increase in size as the well produces until
the title opinion is completed. Typically, royalties are paid within one
to two months after the production is sold.
Comprehensive Income
Comprehensive income includes all changes in a company's equity
except those resulting from investments by owners and distributions to
owners. The Company's total comprehensive income for the three months
ended March 31, 2004 and 2003 was as follows (in thousands):
Three Months Ended
March 31,
--------------------
2004 2003
-------- --------
Net income (loss) .......................................... $ 360 $ 10,619
Hedge accounting for derivative instruments, net of tax .... (1,367) (1,888)
-------- --------
Comprehensive income (loss) ................................ $ (1,007) $ 8,731
======== ========
The accumulated balance of other comprehensive loss related to hedge
accounting is as follows (in thousands):
Balance at December 31, 2003 ..................... $ (5,707)
Net losses on cash flow hedges ................... 2,795
Reclassification adjustments ..................... (4,867)
Tax effect on hedging activity ................... 705
--------
Balance at March 31, 2004 ........................ $ (7,074)
========
Stock-Based Employee Compensation Plans
At March 31, 2004, the Company has three stock-based employee
compensation plans: the 1994 Stock Incentive Plan, the 1996 Stock
Incentive Plan and the 2004 Stock Incentive Plan. The 2004 Plan was
approved by the Board of Directors on March 4, 2004 and is subject to
approval by vote of the Company's stockholders at the May 19, 2004
stockholders' meeting. The Company accounts for those plans under the
recognition and measurement principles of APB Opinion No. 25, Accounting
or Stock Issued to Employees, and related Interpretations. No stock-based
employee compensation cost is reflected in net income for options granted
under those plans when the exercise price of the option is equal to the
market value of the underlying common stock on the date of the grant.
The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of Financial Accounting Standards Board ("FASB") Statement No.
123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
-7-
MISSION RESOURCES CORPORATION
Three Months Ended
-----------------------------------
March 31, 2004(1) March 31, 2003
----------------- --------------
Net income (in thousands)
As reported ............. $ 360 $ 10,619
Pro forma ............... $ 360 $ 10,582
Earnings per share
As reported ............. $ 0.01 $ 0.45
Pro forma ............... $ 0.01 $ 0.45
Diluted earnings per share
As reported ............. $ 0.01 $ 0.45
Pro forma ............... $ 0.01 $ 0.45
- ------------------
(1) No stock options were issued in this quarter.
Recently Adopted Pronouncements
At the March 17-18, 2004 FASB Emerging Issues Task Force ("EITF")
meeting, the EITF reached a consensus on EITF Issue No. 04-2 "Whether
Mineral Rights are Tangible or Intangible Assets," that mineral rights, as
defined in the issue are tangible assets. There is an inconsistency
between this consensus that mineral rights are tangible assets and the
characterization of mineral interests as intangible assets in SFAS No. 141
and SFAS No. 142. A FASB Staff Position ("FSP") was issued on April 30,
2004 to amend SFAS No. 141 and SFAS No. 142 to address that inconsistency.
The FSP has no impact on the Company's historical or prospective treatment
of mineral rights costs.
SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity was issued in May 2003.
SFAS No. 150 provides guidance on how to classify and measure certain
financial instruments with characteristics of both liabilities and equity.
Many of these instruments were previously classified as equity. This
statement is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. The statement requires
cumulative effect transition for financial instruments existing at
adoption date. None of the Company's financial instruments were impacted
by this statement.
SFAS No. 149, Amendment of Statement 133 on Derivative Instruments
and Hedging Activities was issued in April 2003. This statement amends and
clarifies the accounting and reporting for derivative instruments,
including embedded derivatives, and for hedging activities under SFAS No.
133. SFAS No. 149 amends SFAS No. 133 to reflect the decisions made as
part of the Derivatives Implementation Group (DIG) and in other FASB
projects or deliberations. SFAS 149 is effective for contracts entered
into or modified after June 30, 2003, and for hedging relationships
designated after June 30, 2003. The Company has addressed the pertinent
DIG interpretations as they were issued.
The FASB issued Interpretation No. 46 (R), Consolidation of Variable
Interest Entities, an interpretation of APB No. 51, in January 2003. This
interpretation addresses the consolidation by business enterprises of
variable interest entities as defined in the interpretation. The
interpretation applies immediately to variable interest entities created
after January 31, 2003, and to variable interests in variable interest
entities obtained after January 31, 2003. The Company does not own an
interest in any variable interest entities; therefore, this interpretation
does not have a material effect on its financial statements. The
provisions of this interpretation will be applied in the future should
Mission acquire or establish a variable interest entity.
-8-
MISSION RESOURCES CORPORATION
Asset Retirement Obligations
In July 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations, which provided accounting requirements for
retirement obligations associated with tangible long-lived assets. SFAS
No. 143 requires that the Company record a liability for the fair value of
its asset retirement obligation, primarily comprised of its plugging and
abandonment liabilities, in the period in which it is incurred if a
reasonable estimate of fair value can be made. The liability is accreted
at the end of each period through charges to operating expense. The amount
of the asset retirement obligation is added to the carrying amount of the
asset and this additional carrying amount is depreciated over the life of
the asset. If the obligation is settled for other than the carrying amount
of the liability, the Company will recognize a gain or loss on settlement.
The Company adopted the provisions of SFAS No. 143 with a
calculation effective January 1, 2003. The Company's assets are primarily
working interests in producing oil and gas properties and related support
facilities. The life of these assets is generally determined by the
estimation of the quantity of oil or gas reserves available for production
and the amount of time such production should require. The cost of
retiring such assets, the asset retirement obligation, is typically
referred to as abandonment costs. The Company hired independent engineers
to provide estimates of current abandonment costs on all its properties,
applied valuation techniques appropriate under SFAS No. 143, and recorded
a net initial asset retirement obligation of $44.3 million on its Balance
Sheet. An asset retirement cost of $14.4 million was simultaneously
capitalized in the oil and gas properties section of the Balance Sheet.
The adoption of SFAS No. 143 was accounted for as a change in accounting
principle. A $2.7 million charge, net of $935,000 in deferred tax, was
recorded to income as a cumulative effect of the change in accounting
principle.
The following table shows changes in the asset retirement obligation
that have occurred in the first quarter of 2004.
Quarter Ended
Asset Retirement Obligation March 31, 2004
- ---------------------------------------- --------------
(in thousands)
December 31, 2003 balance .............. $ 33,317
Liabilities incurred ................... 1,298
Liabilities settled .................... (2,112)
Accretion expense ...................... 271
--------------
Ending balance ......................... 32,774
--------------
Less: current portion ................. 1,257
--------------
Long-term portion ...................... $ 31,517
==============
Reclassifications
Certain reclassifications of prior period statements have been made
to conform with current reporting practices.
Use of Estimates
In order to prepare these financial statements in conformity with
accounting principles generally accepted in the United States, management
of the Company has made a number of estimates and assumptions relating to
the reporting of assets and liabilities, the disclosure of
-9-
MISSION RESOURCES CORPORATION
contingent assets and liabilities, and reserve information. Actual results
could differ from those estimates.
2. STOCKHOLDERS' EQUITY
On February 25, 2004, the Company acquired $15 million of its 10
7/8% senior subordinated notes due 2007 from Stellar Funding, Ltd. in
exchange for 6.25 million shares of the Company's common stock. On March
15, 2004, the Company acquired an additional $15 million of its 10 7/8%
senior subordinated notes due 2007 from Harbert Distressed Investment
Master Fund, Ltd. in exchange for 6.0 million shares of the Company's
common stock.
The following represents a reconciliation of the numerator and
denominator of the basic earnings per share computation to the numerator
and denominator of the diluted earnings per share computation for the
three-month periods ended March 31, 2004 and 2003. Additionally,
potentially dilutive options and warrants that are not in the money are
excluded from the computation of diluted earnings per share. For the
three-month periods ended March 31, 2004 and 2003, the potentially
dilutive options and warrants excluded represented 1.1 million and 3.2
million shares, respectively.
SFAS No. 128 reconciliation (amounts in thousands except per share
amounts):
For the Three Months Ended For the Three Months Ended
March 31, 2004 March 31, 2003
---------------------------------------- --------------------------------------
Income Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- ------------ ------------ ------------- ---------
INCOME PER COMMON SHARE:
Income available to common stockholders ..... $ 360 31,611 $ 0.01 $ 10,619 23,586 $ 0.45
============ =========
EFFECT OF DILUTIVE SECURITIES:
Options and warrants ........................ -- 1,511 -- 4
----------- ------------- ------------ -------------
INCOME PER COMMON SHARE-DILUTED:
Income available to common
stockholders and assumed conversions......... $ 360 33,122 $ 0.01 $ 10,619 23,590 $ 0.45
=========== ============= ============ ============ ============= =========
As of March 31, 2004 and 2003, respectively, Mission held in
treasury 389,000 and 311,000 shares of its common stock that had been
acquired at an aggregate price of $1.9 million. These treasury shares are
reported at cost as a reduction to Stockholders' Equity.
In September 1997, the Company adopted a shareholder rights plan to
protect its shareholders from coercive or unfair takeover tactics. Under
the plan, each outstanding share of the Company's common stock and each
share of subsequently issued common stock has attached to it one right.
The rights become exercisable if a person or group acquires or announces
an intention to acquire beneficial ownership of 15% or more of the
outstanding shares of common stock without the prior consent of the
Company. When the rights become exercisable, each holder of a right will
have the right to receive, upon exercise, a number of shares of the
Company's common stock having a market price of two times the exercise
price of the right. The Company may redeem the rights for $0.01 per right
at any time before they become
-10-
MISSION RESOURCES CORPORATION
exercisable without shareholder approval. The rights will expire on
September 26, 2007, subject to earlier redemption by the Board of
Directors of the Company.
3. LONG TERM DEBT
On April 8, 2004, the Company closed several transactions
effectively refinancing all of its long term debt. See footnote 7,
"Subsequent Events" for details of those transactions. The discussion
below addresses the Company's long term debt as it existed on March 31,
2004.
Senior Subordinated Notes
In April 1997, the Company issued $100.0 million of 10 7/8% senior
subordinated notes due 2007. On May 29, 2001, the Company issued an
additional $125.0 million of senior subordinated notes due 2007 with
identical terms to the notes issued in April 1997 (collectively the "10
7/8% Notes") at a premium of $1.9 million. The premium is amortized as a
reduction of interest expense over the life of the 10 7/8% Notes so that
the effective interest rate on the additional 10 7/8% Notes is 10.5%. The
premium is shown separately on the Balance Sheet. Interest on the 10 7/8%
Notes is payable semi-annually on April 1 and October 1.
On March 28, 2003, the Company acquired, in a private transaction
with various funds affiliated with Farallon Capital Management, LLC,
approximately $97.6 million in principal amount of the 10 7/8% Notes for
approximately $71.7 million, plus accrued interest. Immediately after the
consummation of the transaction, Mission had $127.4 million in principal
amount of 10 7/8% Notes outstanding. Including costs of the transaction
and the removal of $2.2 million of previously deferred financing costs
related to the acquired 10 7/8% Notes, the Company recognized a $22.4
million gain on the extinguishment of the 10 7/8% Notes.
In December 2003, February 2004 and March 2004, the Company, in
three private transactions, acquired $40.0 million aggregate principal
amount of the 10 7/8% Notes in exchange for an aggregate of 16.75 million
shares of its common stock as summarized below.
Net Gain on
Extiguishment
Principal Common of 10 7/8%
Date Note Holder Value Shares Notes
- ------------- --------------------------- --------------- ------------- -------------
December 2003 FTVIPT - Franklin $10 million 4.50 million $1.1 million
Income Securities
Fund and Franklin Custodian
Funds - Income Series
February 2004 Stellar Funding, Ltd. $15 million 6.25 million $0.5 million
March 2004 Harbert Distressed $15 million 6.00 million $0.9 million
Investment Master Fund,
Ltd.
-11-
MISSION RESOURCES CORPORATION
Credit Facility
The Company was party to a $150.0 million credit facility with a
syndicate of lenders. The credit facility was a revolving facility,
expiring May 16, 2004, which allowed Mission to borrow, repay and
re-borrow under the facility from time to time. The total amount which
might be borrowed under the facility was limited by the borrowing base
periodically set by the lenders based on Mission's oil and gas reserves
and other factors deemed relevant by the lenders. The facility was re-paid
in full and retired on March 28, 2003.
On March 28, 2003, simultaneously with the acquisition of $97.6
million in principal amount of the 10 7/8% Notes, the Company amended and
restated its credit facility with new lenders, led by Farallon Energy
Lending, LLC. The entire $947,000 of deferred financing costs relating to
the previously existing facility was charged to earnings as a reduction in
the gain on extinguishment of debt. Under the amended and restated secured
credit agreement (the "Facility"), the Company borrowed $80.0 million
pursuant to term loans (the "Term Loan Facility"), the proceeds of which
were used to acquire approximately $97.6 million face amount of 10 7/8%
Notes, to pay accrued interest on the 10 7/8% Notes purchased, and to pay
closing costs. On June 16, 2003, the Company amended the Facility to add a
revolving credit facility of up to $12.5 million (the "Revolver
Facility"), including a letter of credit sub-facility (the "Sub-Facility")
of up to $3.0 million. The Facility, which includes the Term Loan Facility
and the Revolver Facility, was secured by a lien on substantially all of
the Company's property and the property of all of the Company's
subsidiaries, including a lien on at least 90% of their respective oil and
gas properties and a pledge of the capital stock of all the subsidiaries.
As of March 31, 2004, the Company had no amounts outstanding under the
Revolver Facility, but had issued a $100,000 letter of credit under the
Sub-Facility. As of March 31, 2004, the Company was in compliance with the
covenants of the Facility.
4. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company produces and sells crude oil, natural gas and natural
gas liquids. As a result, its operating results can be significantly
affected by fluctuations in commodity prices caused by changing market
forces. The Company periodically seeks to reduce its exposure to price
volatility by hedging a portion of its production through swaps, options
and other commodity derivative instruments. A combination of options,
structured as a collar, is the Company's preferred hedge instrument
because there are no up-front costs and protection is given against low
prices. Such hedges assure that Mission receives NYMEX prices no lower
than the price floor and no higher than the price ceiling. The Company has
also entered into some commodity swaps that fix the NYMEX price to be
received. Hedging activities decreased revenues by $2.8 million and $6.1
million for the three-month periods ended March 31, 2004 and 2003,
respectively.
The Company's 12-month average realized price, excluding hedges, for
natural gas per MCF was $0.10 less than the NYMEX MMBTU price. The
Company's 12-month average realized price, excluding hedges, for oil was
$0.92 per BBL less than NYMEX. Realized prices differ from NYMEX as a
result of factors such as the location of the property, the heating
content of natural gas and the quality of oil. The gas differential stated
above excludes the impact the Mist field gas production that is sold at an
annually fixed price.
The Company has elected to designate all hedges by applying the
interpretations from the FASB's Derivative Implementation Group issue G-20
("DIG G-20"). By using the DIG G-20 approach, because the Company's
collars and swaps meet specific criteria, the time value
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MISSION RESOURCES CORPORATION
component is included in the hedge relationship and is recorded to other
comprehensive income ("OCI") rather than to income, which reduces earnings
variability.
Should ineffectiveness occur for reasons other than time, that
ineffectiveness is recognized currently and is reported in the interest
and other income line of the Consolidated Statement of Operations. The
Company has acquired software specifically designed to make the complex
calculations required by SFAS No. 133, including calculating
ineffectiveness. The Company recognized a loss of approximately $423,000
in the first quarter of 2004 related to ineffectiveness of its cash flow
hedges. As the existing hedges settle over the next two years, gains or
losses in OCI will be reclassified to earnings. The amount expected to be
reclassified over the next twelve months will be a $6.3 million loss.
The following tables detail the cash flow commodity hedges that were
in place at March 31, 2004.
OIL HEDGES
NYMEX NYMEX
BBLS PRICE PRICE
PERIOD PER DAY TOTAL BBLS TYPE FLOOR/SWAP AVG. CEILING AVG.
- ---------------- ------- ---------- ------ --------------- ------------
Second Qtr. 2004 2,500 227,500 Swap $24.67 N/A
Third Qtr. 2004 2,500 230,000 Swap $24.30 N/A
Fourth Qtr. 2004 2,500 230,000 Swap $23.97 N/A
First Qtr. 2005 2,000 180,000 Collar $27.14 $30.19
Second Qtr. 2005 1,500 136,500 Collar $26.33 $28.79
Third Qtr. 2005 1,500 138,000 Collar $26.17 $27.90
Fourth Qtr. 2005 1,500 138,000 Collar $26.00 $27.33
First Qtr. 2006 250 22,500 Collar $26.46 $30.90
Second Qtr. 2006 250 22,750 Collar $26.29 $30.75
Third Qtr. 2006 250 23,000 Collar $26.24 $30.51
Fourth Qtr. 2006 250 23,000 Collar $26.03 $30.15
GAS HEDGES
NYMEX NYMEX
MMBTU PRICE FLOOR PRICE CEILING
PERIOD PER DAY TOTAL MMBTU TYPE AVG. AVG.
- ---------------- ------- ----------- ------ ----------- -------------
Second Qtr. 2004 14,000 1,274,000 Collar $4.43 $5.10
Third Qtr. 2004 14,000 1,288,000 Collar $4.43 $4.99
Fourth Qtr. 2004 14,000 1,288,000 Collar $4.48 $5.31
First Qtr. 2005 5,000 450,000 Collar $4.65 $6.93
Second Qtr. 2005 5,000 455,000 Collar $4.45 $5.39
Third Qtr. 2005 5,000 460,000 Collar $4.45 $5.35
Fourth Qtr. 2005 5,000 460,000 Collar $4.45 $5.76
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MISSION RESOURCES CORPORATION
The Company may also enter into financial instruments such as
interest rate swaps to manage the impact of interest rates. Effective
September 22, 1998, the Company entered into an eight and one-half year
interest rate swap agreement with a notional value of $80.0 million. Under
the agreement, Mission received a fixed interest rate and paid a floating
interest rate. The Company paid $1.3 million to the counter party in
February 2003 to cancel the swap.
5. INCOME TAXES
The provision for federal and state income taxes for the three
months ended March 31, 2004 was based upon a 36.5% effective tax rate. In
assessing the realizability of the deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the recognition of future taxable
income during the periods in which those temporary differences are
available. Based upon projections for future state taxable income,
management believes it is more likely than not that the Company will not
realize its entire deferred tax asset related to state income taxes. In
addition, management believes it is more likely than not that the Company
will not realize its deferred tax asset related to the impairment of the
interest in Carpatsky. Accordingly, a valuation allowance has been
recorded in the amount of $5.1 million and $5.3 million for the quarters
ending March 31, 2004 and 2003, respectively.
On December 17, 2003, the Company issued 4.5 million shares of
common stock in exchange for the surrender of $10 million of the 10 7/8%
Notes. As a result of this transaction, management believes that the
Company has experienced an "ownership change" as defined in Section 382 of
the Internal Revenue Code, which could result in the imposition of
significant limitations on the future use of the Company's existing net
operating loss and tax credit carryforwards in the future. As of March 31,
2004, management believes that the limitations imposed by Section 382 will
not result in the Company being unable to fully utilize it's net operating
loss and tax credit carryforwards to offset future taxable income and
related tax liabilities.
6. GUARANTEES
In 1993 and 1996 the Company entered into agreements with surety
companies and with Torch Energy Advisors Incorporated ("Torch") and Nuevo
Energy Company ("Nuevo") whereby the surety companies agreed to issue such
bonds to the Company, Torch and/or Nuevo. However, Torch, Nuevo and the
Company agreed to be jointly and severally liable to the surety company
for any liabilities arising under any bonds issued to the Company, Torch
and/or Nuevo. The amount of bonds presently issued to Torch and Nuevo
pursuant to these agreements is approximately $0.4 million and $34.8
million respectively. The Company has notified the sureties that it will
not be responsible for any new bonds issued to Torch or Nuevo. However,
the sureties are permitted under these agreements to seek reimbursement
from the Company, as well and from Torch and Nuevo, if the surety makes
any payments under the bonds issued to Torch and Nuevo.
The Company's subsidiaries, Mission E&P Limited Partnership, Mission
Holding LLC and Black Hawk Oil Company were guarantors under the Revolver
Facility, the Term Loan Facility and the indenture for the 10 7/8% Notes.
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MISSION RESOURCES CORPORATION
7. SUBSEQUENT EVENTS
Property Acquisitions
On April 13, 2004, the Company acquired an additional 14% working
interest in the Jalmat field in Lea County, New Mexico for $3.6 million
cash, before customary adjustments. The additional working interest, which
was acquired from 13 separate sellers, includes approximately 4.7 BCF
equivalent of proved reserves and approximately 750 Mcf equivalent per day
of production. After completion of this transaction Mission owns
approximately a 94.5% operated working interest in the Jalmat field.
Refinancing
On April 8, 2004, Mission issued new senior notes, redeemed its
existing senior subordinated notes, and replaced both the Revolver
Facility and the Term Loan Facility. Those transactions and the details of
the resulting debt are discussed below.
9 7/8% Notes
On April 8, 2004, Mission issued $130 million of its 9 7/8% Notes
which are guaranteed on an unsubordinated, unsecured basis by all of its
current subsidiaries. Interest on the notes is payable semi-annually, on
each April 1 and October 1, commencing on October 1, 2004.
A portion of the net proceeds from the offering of the 9 7/8% Notes
is to be used to redeem, on May 10, 2004, the $87.4 million aggregate
principal amount of the 10 7/8% Notes that remain outstanding. On April 8,
2004, the remainder of the net proceeds from the offering of the 9 7/8%
Notes, together with $21.5 million that was advanced under the new senior
secured revolving credit facility (as described below) and $25.0 million
that was borrowed under the new second lien term loan (as described
below), was used to completely discharge all of the Company's outstanding
indebtedness under its prior Facility.
At any time on or after April 9, 2005 and prior to April 9, 2008,
the Company may redeem up to 35% of the aggregate original principal
amount of the 9 7/8% Notes, using the net proceeds of equity offerings, at
a redemption price equal to 109.875% of the principal amount of the 9 7/8%
Notes, plus accrued and unpaid interest. On or after April 9, 2008, the
Company may redeem all or a portion of the 9 7/8% Notes at the redemption
prices (expressed as percentages of principal amount) set forth below plus
accrued and unpaid interest, if redeemed during the twelve-month period
beginning on April 9 of the years indicated below:
YEAR PERCENTAGE
---- ----------
2008.............................. 104.93750%
2009.............................. 102.46875%
2010.............................. 100.00000%
If the Company experiences specific kinds of change of control, it
may be required to purchase all or part of the 9 7/8% Notes at a price
equal to 101% of the principal amount together with accrued and unpaid
interest.
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MISSION RESOURCES CORPORATION
The 9 7/8 Notes contain covenants that, subject to certain
exceptions and qualifications, limit the Company's ability and the ability
of certain its subsidiaries to:
- incur additional indebtedness or issue certain types of
preferred stock or redeemable stock;
- transfer or sell assets;
- enter into sale and leaseback transactions;
- pay dividends or make other distributions on stock, redeem stock
or redeem subordinated debt;
- enter into transactions with affiliates;
- create liens on its assets;
- guarantee other indebtedness;
- enter into agreements that restrict dividends from subsidiaries;
- make investments;
- sell capital stock of subsidiaries; and
- merge or consolidate.
Standard and Poor's and Moody's publish debt ratings for the 9 7/8%
Notes. Their ratings consider a number of items including the Company's
debt levels, planned asset sales, near-term and long-term production
growth opportunities, capital allocation challenges and commodity price
levels. At April 8, 2004, Mission's Standard & Poor's rating on the 9 7/8%
Notes was "CCC" and its Moody's rating was "Caa2." A decline in credit
ratings will not create a default or other unfavorable change in the 9
7/8% Notes.
Senior Secured Revolving Credit Facility
On April 8, 2004, the Company entered into a new senior secured
revolving credit facility with a syndicate of lenders led by Wells Fargo
Bank, N.A. The facility, which matures on April 8, 2007, is secured by a
first priority mortgage and security interest in at least 85% of its oil
and gas properties, all of the ownership interests of all of its
subsidiaries, and its equipment, accounts receivable, inventory, contract
rights, general intangibles and other assets. The facility is also
guaranteed by all of the Company's subsidiaries.
Availability under the facility, which includes a $3 million
subfacility for standby letters of credit, is subject to a borrowing base
that is determined at the sole discretion of the facility lenders. The
initial borrowing base of the facility was $50 million, of which $30
million was available for general corporate purposes and $20 million was
available for the acquisition of oil and gas properties approved by the
lenders. The borrowing base will be redetermined on each April 1 and
October 1, beginning October 1, 2004. Mission and the lenders each have
the option to request one unscheduled interim redetermination between
scheduled redetermination dates. On April 8, 2004, the Company was
advanced $21.5 million under the facility, which amount, together with a
portion of the net proceeds from the offering of the 9 7/8% Notes and
$25.0 million that was borrowed under the new second lien term loan (as
described below), was used to completely discharge all of the Company's
outstanding indebtedness under its prior Facility.
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MISSION RESOURCES CORPORATION
Advances under the facility bear interest, at the Company's option,
at either (i) a margin (which varies from 25.0 basis points to 125.0 basis
points based upon utilization of the borrowing base) over the base rate,
which is the higher of (a) Wells Fargo's prime rate in effect on that day,
and (b) the federal funds rate in effect on that day as announced by the
Federal Reserve Bank of New York, plus 0.5%; or (ii) a margin (which
varies from 175.0 basis points to 275.0 basis points based upon
utilization of the borrowing base) over LIBOR. The Company is allowed to
prepay any base rate or LIBOR loan without penalty, provided that each
prepayment is at least $1 million and multiples of $500,000 in excess
thereof, plus accrued and unpaid interest.
Standby letters of credit may be issued under the letter of credit
subfacility. Mission is required to pay, with respect to each issued
letter of credit, (i) a per annum letter of credit fee equal to the LIBOR
margin then in effect multiplied by the face amount of such letter of
credit plus (ii) a fronting fee, which the higher of $500 or 12.5 basis
points to the issuer of the letters of credit.
The facility requires the Company to hedge forward, on a rolling
12-month basis, 50% of proved producing volumes projected to be produced
over the following 12 months. The Company is also required to hedge
forward, on a rolling 12-month basis, 25% of proved producing production
volumes projected to be produced over the succeeding 12-month period. Any
time that Mission has borrowings under the facility in excess of 70% of
the borrowing base available for general corporate purposes, the agent
under the facility may require Mission to hedge a percentage of projected
production volumes on terms acceptable to the agent.
The facility also contains the following restrictions on hedging
arrangements and interest rate agreements: (i) the hedge provider must be
a lender under the facility or an unsecured counterparty acceptable to the
agent under the facility; and (ii) total notional volume must be not more
than 75% of scheduled proved producing net production quantities in any
period or, with respect to interest rate agreements, notional principal
amount must not exceed 75% of outstanding loans, including future
reductions in the borrowing base.
The facility contains the following covenants which are considered
important in operating Mission:
- The Company is required to maintain a current ratio of
consolidated current assets (as defined in the facility) to
consolidated current liabilities (as defined in the facility) of
not less than 1.0 to 1.0;
- The Company is required to maintain (on an annualized basis
until the passing of four fiscal quarters and thereafter on a
rolling four quarter basis) an interest coverage ratio (as
defined in the facility) of no less than (i) 2.50 for June 30,
2004 through December 31, 2004, (ii) 2.75 for March 31, 2005
through June 30, 2005, and (iii) 3.0 for September 30, 2005 and
thereafter;
- The Company is required to maintain (on an annualized basis
until the passing of four fiscal quarters and thereafter on a
rolling four quarter basis) a leverage ratio (as defined in the
facility) of no more than (i) 3.75 for June 30, 2004 through
September 30, 2004, and (ii) 3.5 for December 31, 2004 and
thereafter; and
- The Company is required to maintain a tangible net worth (as
defined in the facility) of not less than 85% of tangible net
worth at March 31, 2004, plus 50% of
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MISSION RESOURCES CORPORATION
positive net income after tax distributions, plus 100% of equity
offerings after March 31, 2004, excluding any asset impairment
charges.
The facility also includes restrictions with respect to changes in
the nature of the Company's business; sale of all or a substantial or
material part of its assets; mergers, acquisitions, reorganizations and
recapitalizations; liens; guarantees; debt; leases; dividends and other
distributions; investments; debt prepayments; sale-leasebacks; capital
expenditures; lease expenditures; and transactions with affiliates.
Second Lien Term Loan
On April 8, 2004, Mission entered into a new second lien term loan
with a syndicate of lenders arranged by Guggenheim Corporate Funding, LLC.
The loan, which matures on April 8, 2008, is secured by a second priority
security interest in the assets securing the senior secured revolving
credit facility. The facility is also guaranteed by all of Mission's
subsidiaries. On April 8, 2004, the Company borrowed the $25.0 million
under the loan, which amount, together with a portion of the net proceeds
from the offering of the 9 7/8% Notes and $21.5 million that was borrowed
under the senior secured revolving credit facility (as described above),
was used to completely discharge all of the outstanding indebtedness under
the prior Facility.
The loan accrues interest in each monthly interest period at the
rate of 30-day LIBOR plus 525 basis points per annum, payable monthly in
cash. The Company may prepay the loan at any time after the date six
months and one day after April 8, 2004 in whole or in part in multiples of
$1 million at the prices (expressed as percentages of principal amount)
set forth below, plus accrued and unpaid interest, if prepaid during each
successive 12-month period beginning on April 9 of each year indicated
below:
YEAR PREMIUM
---- -------
2004 102%
2005 101%
2006 to maturity 100%
provided, however, that no prepayment shall be made prior to the date six
months and one day after April 8, 2004.
The loan contains covenants that are no more restrictive than those
contained in the senior secured revolving credit facility.
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MISSION RESOURCES CORPORATION
ITEM 2. MANAGEMENTS' DISCUSSION & ANALYSIS AND RESULTS OF OPERATIONS
Mission is an independent oil and gas exploration and production company.
We drill for, acquire, develop and produce natural gas and crude oil. Our
property portfolio is comprised of long-lived, low-risk assets, like those in
the Permian Basin, and multi-reservoir, high-productivity assets found along the
Gulf Coast and in the Gulf of Mexico. Our operational focus remains on
efficient, well managed upstream natural gas and crude oil exploration and
production. We will continue to pursue complementary acquisitions when the
appropriate opportunities present themselves.
RESULTS OF OPERATIONS
The following table sets forth certain operating information for the Company for
the periods presented:
Three Months Ended March 31, Change
---------------------------- ------------------------
2004 2003 Amount Percent
------------ ------------ ---------- ----------
Production:
Oil and condensate (MBBLs) .................... 401 561 (160) (29%)
Natural gas (MMCF) ............................ 3,216 2,337 879 38%
MMCFE ......................................... 5,622 5,703 (81) (1%)
Average sales price including the effect of hedges:
Oil and condensate (per BBL) .................. $ 27.54 $ 24.75 2.79 11%
Natural gas (per MCF) ........................ $ 5.52 $ 5.07 0.45 9%
Average sales price excluding the effect of hedges:
Oil and condensate (per BBL) .................. $ 34.25 $ 30.68 3.57 12%
Natural gas (per MCF) ......................... $ 5.55 $ 6.26 (0.71) (11%)
Average costs per unit of production (per MCFE):
Lease operating expenses ...................... $ 1.26 $ 1.56 (0.30) (19%)
General and administrative expense ............ $ 0.50 $ 0.45 0.05 11%
Depreciation, depletion and amortization ...... $ 1.86 $ 1.56 0.30 19%
THREE MONTHS ENDED MARCH 31, 2004 AND 2003
NET INCOME
Net income for the three months ended March 31, 2004 was $360,000 or $0.01
per share. Net income for the three months ended March 31, 2003 was $10.6
million or $0.45 per share. The $22.4 million gain ($14.5 million net of tax)
from the repurchase of the 10 7/8% Notes was the primary reason for the net
income in the first quarter of 2003.
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MISSION RESOURCES CORPORATION
OIL AND GAS REVENUES
Oil revenues for the three months ended March 31, 2004 were $11.0 million,
as compared to $13.9 million for the respective period in 2003. Oil production
decreased 29% from 561,000 barrels in the three-month period ended March 31,
2003 to 401,000 barrels for the same period of 2004. Our sales of oil properties
during 2003 account for most of the production decrease. Realized oil prices
averaged $27.54 per barrel in the three-month period ended March 31, 2004, as
compared to $24.75 per barrel in the three-month period ended March 31, 2003.
Gas revenues increased 50% from $11.8 million reported for the quarter
ended March 31, 2003 to $17.8 million for the quarter ended March 31, 2004. Gas
production was up 38% compared to the same quarter of 2003 with 3,216 MMCF and
2,337 MMCF for the three-month periods ended March 31, 2004 and 2003,
respectively. The acquisition of the Jalmat field, a New Mexico gas field, in
January 2004 combined with the results of successful development drilling at
South Marsh Island and in South Louisiana, account for most of the production
increase. Realized gas prices averaged $5.52 per MCF, or 9% higher, in the
three-month period ended March 31, 2004 as compared to $5.07 per MCF in the
comparable period of 2003.
The realized prices discussed above include the impact of oil and gas
hedges. A decrease of $2.8 million related to hedging activity was reflected in
oil and gas revenues for the three months ended March 31, 2004, while a decrease
in oil and gas revenues of $6.1 million was reflected for the same period of
2003.
EXTINGUISHMENT OF DEBT
On March 28, 2003, Mission acquired approximately $97.6 million in
principal amount of its 10 7/8 Notes for approximately $71.7 million, plus
accrued interest. The difference between the principal amount of the 10 7/8
Notes retired and the amount paid to purchase the 10 7/8 Notes is recorded as a
gain on the extinguishment of debt. The costs of the transaction and the removal
of the amount of previously deferred subordinated debt financing costs related
to the retired 10 7/8 Notes were subtracted from the gain resulting in the $22.4
million gain ($14.5 million net of tax) on extinguishment of debt.
In February and March 2004, an additional $30.0 million in principal
amount of the 10 7/8 Notes were retired at a net gain of $1.4 million ($905,000
net of tax) on extinguishment of debt.
INTEREST AND OTHER INCOME (LOSS)
Interest and other income was a loss of $810,000 for the three months
ended March 31, 2004 and was a gain of $535,000 for the three months ended March
31, 2003. Activity for 2003 includes approximately $289,000 of equity in the
earnings of White Shoal Pipeline Corporation. Mission owns a 26.6% interest in
this corporation, which operates in the Gulf of Mexico. In the first quarter of
2004, bad debt expense of approximately $395,000 related to joint interest
receivables was recognized and hedge ineffectiveness was a $423,000 loss.
LEASE OPERATING EXPENSES
Lease operating expense decreased from $8.9 million in the three months
ended March 31, 2003 to $7.1 million for the same period of 2004. This decline
of approximately 20% is primarily related to our 2003 sales of high cost
properties and the subsequent redeployment of proceeds into lower cost gas
properties. Lease operating expenses decreased approximately 19% on a per MCFE
basis between the periods to $1.26 per MCFE.
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MISSION RESOURCES CORPORATION
TAXES OTHER THAN INCOME
The table below details the components of taxes other than income and
their respective changes between the periods (dollars in thousands).
Three Months Ended March 31, Change
---------------------------- ------------------------
2004 2003 Amount Percent
------------ ------------ ---------- ----------
Production taxes ............. $ 1,145 $ 1,368 $ (223) (16%)
Property taxes ............... 442 1,205 (763) (63%)
Other taxes .................. 107 120 (13) (11%)
------------ ------------ ----------
Taxes other than income ...... $ 1,694 $ 2,693 $ (999)
============ ============ ==========
Taxes other than income decreased from $2.7 million in the three months
ended March 31, 2003 to $1.7 million for the same period of 2004. Production
taxes are included in this total. Production taxes can be a function of revenue
or of production, depending upon the state. There is no production tax on
offshore federal properties. In 2004, Mission filed for production tax refunds
over three years of production from the Porters Creek field in Texas, reducing
reported taxes by approximately $220,000 in the first quarter of 2004. In
addition, our property taxes are also lower because we sold many Texas
properties late in 2003 and replaced them with properties in New Mexico, which
has lower property tax rates than Texas.
DEPRECIATION, DEPLETION AND AMORTIZATION
Depreciation, depletion and amortization ("DD&A") was $10.7 million for
the three months ended March 31, 2004 and $9.0 million for the three months
ended March 31, 2003. DD&A per MCFE has increased from $1.56 per MCFE in the
first quarter of 2003 to $1.87 per MCFE in the first quarter of 2004. The
increase in DD&A on a per MCFE basis reflects the impact of decreases in
reserves due to property sales in 2003.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses ("G&A") were $2.8 million in the
three-month period ended March 31, 2004 and were $2.6 million in the three-month
period ended March 31, 2003. The first quarter of 2003 included increased
expenses that would not be required in future quarters such as additional audit
fees related to the first time audit of functions that were previously
outsourced and legal costs related to settled litigation and new corporate
governance requirements. We also performed an extensive review of our land
records in preparation of implementing a new land system. While those same costs
were not incurred in 2004, salaries increased with the insourcing of the
operations function in February 2003. As an outsourced function this management
fee was reflected as lease operating expense and with the insourcing of the
function some positions are now reflected as G&A. Other costs such as insurance
premiums, investor relations and public accounting fees have also increased.
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MISSION RESOURCES CORPORATION
INTEREST EXPENSE
Interest expense increased 4% to $6.3 million for the three months ended
March 31, 2004 from $6.0 million in the year ended March 31, 2003. The following
table details the components of interest and their respective changes between
the periods (dollars in thousands).
Three Months Ended March 31, Change
---------------------------- ------------------------
2004 2003 Amount Percent
------------ ------------ ---------- ----------
Interest rate swap (gain) loss $ -- $ (570) $ 570 100%
Interest on 10 7/8% Notes,
net of amortized premium 2,889 5,975 (3,086) (52%)
Amortization of financing costs 685 479 206 43%
Interest on credit facility 2,574 79 2,495 3158%
Other 114 64 50 78%
------------ ------------ ----------
Reported interest expense $ 6,262 $ 6,027 $ 235
============ ============ ==========
The interest rate swap was cancelled in February 2003 and was not
replaced. Throughout 2003 and early 2004, we repurchased approximately $137.6
million in 10 7/8% Notes resulting in a 52% reduction in interest paid. A term
loan of $80 million was used to fund a portion of the 10 7/8% Notes repurchases
resulting in a $2.5 million increase in credit facility interest paid.
INCOME TAXES
The provision for federal and state income taxes for the three months
ended March 31, 2004 was based upon a 36.5% effective tax rate. The $5.1 million
valuation allowance on deferred taxes applicable at December 31, 2003 remains
unchanged at March 31, 2004. In assessing the realizability of the deferred tax
assets, management considers whether it is more likely than not that some
portion or all of the deferred tax assets will be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences become
deductible. Based upon the projection for future state taxable income,
management believes it is more likely than not that the Company will not realize
its deferred tax asset related to state income taxes.
FINANCIAL CONDITION
CAPITAL STRUCTURE
In 2002, management began evaluating various alternatives to improve
Mission's financial position. In 2003 and the first quarter of 2004, the
following steps were taken to enhance our financial condition:
- The March 2003 repurchase of approximately $97.6 million of 10 7/8%
Notes financed with a $80.0 million term loan facility.
- The establishment of a new revolving credit facility in June 2003,
making $12.5 million available for short-term borrowings.
- The issuance of 4.5 million shares of common stock in exchange for $10
million of the 10 7/8% Notes in December 2003.
- The issuance of 12.25 million shares of common stock in exchange for
$30 million of the 10 7/8% Notes in two transactions in February and
March 2004.
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MISSION RESOURCES CORPORATION
Our outstanding indebtedness totaled $168.2 million at March 31, 2004. The
nature of our indebtedness at of March 31, 2004 and 2003 is summarized on the
table below (amounts in thousands).
March 31,
--------------------
2004 2003
-------- --------
Revolving credit facility (1) .......... $ -- $ --
Term loan facility ..................... 80,000 80,000
10 7/8% Notes .......................... 87,426 117,426
Unamortized premium on 107/8% Notes .... 734 1,070
-------- --------
Total debt ............................. $168,160 $198,426
======== ========
- ------------------
(1) The revolving credit facility did not exist at March 31, 2003. The
borrowing base was $12.5 million at March 31, 2004.
At March 31, 2004, our capital structure was highly leveraged, which could
have limited our financial flexibility. In particular, we were required to pay
approximately $20 million of interest annually on our long term debt, which
limited the amount of cash available for exploration and development of oil and
gas properties. We took the following steps on April 8, 2004 to further enhance
our financial position:
- The issuance of $130 million of the 9 7/8% Notes, and the simultaneous
establishment of a new senior secured revolving credit facility and a
new second lien term loan.
- The redemption of the remaining $87.4 million aggregate principal
amount of the 10 7/8% Notes using a portion of the proceeds from the
issuance of the 9 7/8% Notes.
- The repayment in full of the prior Facility using the remaining
portion of the proceeds from the issuance of the 9 7/8% Notes,
together with $21.5 million that was advanced under the new senior
secured revolving credit Facility and $25 million that was borrowed
under the new second lien term loan.
After the April 8, 2004 transactions, our outstanding debt was reduced to
$176.5 million and our estimated annual cash interest payments were reduced to
approximately $15.4 million. The nature of our indebtedness as of April 8, 2004
is summarized in the table below (amounts in thousands):
April 8, 2004
-------------
9 7/8% Notes............................................... $ 130,000
Second lien term loan facility............................. 25,000
Senior secured revolving credit facility(1)................ 21,500
-------------
Total debt................................................. $ 176,500
=============
(1) $28.5 million was available for additional borrowings under this
facility.
Further details of these transactions and the resulting obligations may be found
at footnote 7, "Subsequent Events" beginning on page 15.
-23-
MISSION RESOURCES CORPORATION
LIQUIDITY AND CAPITAL RESOURCES
Mission's principal sources of capital for the last three years have been
cash flow from operations, debt sources such as the issuance of bonds or credit
facility borrowings, issuances of common stock, and the sale of oil and gas
properties. Our primary uses of capital have been the funding of exploration and
development projects, property acquisitions and the refinancing of long term
debt.
At March 31, 2004, we had negative working capital of $13.7 million
compared to a positive working capital of $13.2 million at December 31 2003.
Cash held for reinvestment in oil and gas properties of approximately $24.9
million was included in the December 31, 2003 working capital. When this cash
balance, which was used to acquire the Jalmat field in January 2004, is
excluded, our working capital at December 31, 2003 would be a negative $11.7
million. The decrease in working capital over the first three months of 2004 can
primarily be attributed to changes in our commodity derivative liabilities, cash
balances, accrued interest payable and accrued liabilities.
The size of our current liability related to commodity derivatives has
increased as commodity prices increased, contributing to the working capital
reduction. The hedge liability represents the amount by which actual commodity
prices exceed the price caps on our hedges. Should commodity prices decrease,
the liability will decline and the premium over the hedge prices that we will
realize on unhedged production will also reduce. Since hedges are settled out of
the receipts from the sale of production, we anticipate having adequate cash
inflows to settle any hedge payments when they come due while maintaining
revenue near the hedge price.
Our cash balance increased by approximately $7.3 million from December 31,
2003 to March 31, 2004. This increase in our cash balance was partially offset
by increases in accrued interest payable and accrued liabilities. Because
interest on our 10 7/8% Notes is due on April 1st, our March 31st cash balance
is greater than or equal to our upcoming interest payment. Two components of
accrued liabilities account for most of the increase in accrued liabilities,
royalties payable and accrued capital expenditures. The increase in royalties
payable included approximately $2.3 million of royalties that are awaiting
completion of an initial title opinion by the operator of the well before
Mission will be required to make payment. This payable will increase in size as
the well produces each month until paid. The increase in accrued capital
expenditures results from increased exploratory and development activities in
the first quarter of 2004.
After considering the impact of these working capital changes and our
forecasts of future results of operations, we believe that cash flows from
operating activities combined with our ability to control the timing of
substantially all of our future exploration and development requirements will
provide us with the flexibility and liquidity to meet our planned capital
requirements for 2004. In addition, our revolving credit facility has $8.5
million available for general corporate purposes, including exploratory and
developmental drilling, and $20.0 million available for acquisitions of oil and
gas properties as of April 8, 2004.
CASH FLOWS
Net cash flow provided by operations was $18.7 million for the three month
period ending March 2004 and net cash flow provided by operations was $5.5
million for the three month period ending March 31, 2003. The period-to-period
increase in cash flow is primarily caused by significantly higher gas prices,
reduced operating costs and reductions in cash interest expense.
-24-
MISSION RESOURCES CORPORATION
Net cash used in investing activities for the three-month periods ending
March 31, 2004 and 2003 was $35.8 million and $3.2 million, respectively. We
spent $27.1 million to acquire oil and gas properties in the three-month period
ended March 31, 2004, compared to approximately $258,000 for the same period of
2003. We invested $10.7 million in exploration and development of oil and gas
properties for the three-month period ended March 31, 2004 compared to $6.3
million for the same period of 2003. Proceeds from property sales were $2.1
million and $3.6 million for the three-month periods ending March 31, 2004 and
2003, respectively.
Net cash provided by financing activities was $24.4 million and $4.4
million in the first quarters of 2004 and 2003, respectively, however financing
activities differed greatly between the periods. This reflects the use of $24.9
million of cash held for reinvestment to acquire the Jalmat field in January
2004.
A capital budget of $34.0 million was adopted for the year 2004, with
approximately 60% for development, 20% for exploration and 20% for seismic, land
or corporate assets. The budget did not include an estimate for costs of major
acquisitions. Based upon the level of funding needed for development, the level
of exploratory spending could be modified to meet the budget in total. This
capital budget represents the largest planned use of our available operating
cash flow. Should cash flows from operations exceed budgeted levels, we plan to
spend 50% of any excess over $34 million on capital projects with the remaining
portion to be used to reduce long-term debt. We believe that cash flows from
operating activities combined with our ability to control the timing of
substantially all of our future exploration and development requirements will
provide us with the flexibility and liquidity to meet our planned capital
requirements for 2004. Our intent is to apply less than our discretionary cash
flow to capital projects in 2004; therefore, the budget could be modified
throughout the year to the extent that we can control the timing of capital
expenditures. Natural gas and oil prices, the timing of our drilling program and
drilling results have a significant impact on the cash flows available for
capital expenditures and our ability to borrow and raise additional capital.
Lower prices may also reduce the amount of natural gas and oil that we can
economically produce. Lower prices and/or lower production may decrease revenues
and cash flows, thus reducing the amount of financial resources available to
meet our capital requirements.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
Mission is required to make future payments under contractual obligations.
Mission has also made various commitments in the future should certain events
occur or conditions exist. As a result of the Jalmat field acquisition in
January 2004 and the debt for equity swaps in February and March 2004, our
contractual obligations and commercial commitments changed. Additionally, on
April 8, 2004, we substantially refinanced all Mission's existing debt;
therefore, the following tables reflect future estimated payments related to
Mission's obligations and commitments after the April 8th transactions (amounts
in thousands):
Contractual Cash Obligations: Total 2004** 2005 2006 2007 2008 Thereafter
- ----------------------------------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Long Term Debt* ................... $ 313,677 $ 103,441 $ 12,838 $ 12,838 $ 12,838 $ 12,838 $ 158,884
Term Loan ......................... 109,428 82,076 1,588 1,588 1,588 22,588 --
Operating Leases .................. 2,253 866 709 677 1 -- --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total Contractual Obligations ..... $ 425,358 $ 186,383 $ 15,135 $ 15,103 $ 14,427 $ 35,426 $ 158,884
========== ========== ========== ========== ========== ========== ==========
- -----------------
* Includes principal of $130 million on the scheduled for repayment in 2011 and
bond interest accrued monthly and payable April 1st and October 1st of each year
at 9 7/8% .
** Long Term Debt and Term Loan activity includes the redemption of $87.4
million of 10 7/8% Notes scheduled for May 2004 and the repayment of the $80.0
million term loan is April 2004.
-25-
MISSION RESOURCES CORPORATION
Commercial Commitments: Total 2004 2005 2006 2007 2008 Thereafter
- ----------------------------------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Credit Facility ................... $ 23,748 $ 49 $ 733 $ 733 $ 22,233 $ -- $ --
Other Commercial
Commitments ................. 4,980 4,071 336 262 173 138 --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total Commercial
Commitments ................. $ 28,728 $ 4,120 $ 1,069 $ 995 $ 22,406 $ 138 $ --
========== ========== ========== ========== ========== ========== ==========
SUBSEQUENT EVENTS
On April 13, 2004, we acquired approximately 14% additional working
interest in the Jalmat Field in Lea County, New Mexico for $3.6 million cash,
before customary adjustments. The additional working interest, which was
acquired from 13 separate sellers, includes approximately 4.7 BCF equivalent of
proved reserves and approximately 750 Mcf equivalent per day of production.
After completion of this transaction,Mission owns an approximately 94.5%
operated working interest in the Jalmat field.
On April 8, 2004, we issued the 9 7/8% Notes, notified our existing 10
7/8% Note holders that such notes will be redeemed on May 10, 2004 and replaced
our prior Facility as discussed in footnote 7, "Subsequent Events" on page 15.
CRITICAL ACCOUNTING POLICIES
In response to SEC Release No. 33-8040, "Cautionary Advice Regarding
Disclosure About Critical Accounting Policies," we identified those policies of
particular importance to the portrayal of our financial position and results of
operations and those policies that require our management to apply significant
judgment. We believe these critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
FULL COST METHOD OF ACCOUNTING FOR OIL AND GAS ASSETS
We use the full cost method of accounting for investments 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 as incurred
into a "full cost pool". Under the full cost method, a portion of
employee-related costs may be capitalized in the full cost pool if they are
directly identified with acquisition, exploration and development activities.
Generally, salaries and benefits are allocated based upon time spent on
projects. Amounts capitalized can be significant when exploration and major
development activities increase.
We deplete the capitalized costs in the full cost pool, plus estimated
future expenditures to develop reserves, on a prospective basis using the units
of production method based upon the ratio of current production to total proved
reserves. Depreciation, depletion and amortization is a significant component of
our net income. Proportionally, it represented 37% and 35% of our total oil and
gas revenues in the quarters ended March 31, 2004 and 2003, respectively. Any
reduction in proved reserves without a corresponding reduction in capitalized
costs will increase the depletion rate. If, during 2004, our reserves increase
by 10%, our depletion per MCFE would decrease approximately $0.17, or 9%;
however, a 10% decrease in reserves would have an 11% impact, increasing
depletion per MCFE by approximately $0.20.
-26-
MISSION RESOURCES CORPORATION
Both the volume of proved reserves and the estimated future expenditures
used for the depletion calculation are obtained from the reserve estimates
prepared by independent reserve engineers. These reserve estimates rely upon
both the engineers' quantitative and subjective analysis of various data, such
as engineering data, production trends and forecasts, estimated future spending
and the timing of spending. Finally, estimated production costs and commodity
prices are added to the assessment in order to determine whether the estimated
reserves have any value. Reserves that cannot be produced and sold at a profit
are not included in the estimated total proved reserves; therefore the quantity
of reserves can increase or decrease as oil and gas prices change. See "Risk
Factors: Risks Related to Our Business, Industry and Strategy" in our Annual
Report on Form 10-K filed for the fiscal year ended December 31, 2003 for
general cautions concerning the reliability of reserve and future net revenue
estimates by reserve engineers.
The full cost method requires a quarterly calculation of a limitation on
capitalized costs, often referred to as a full cost ceiling calculation. The
ceiling is the discounted present value of our estimated total proved reserves
adjusted for taxes, using a 10% discount rate. To the extent that our
capitalized costs (net of depreciation, depletion, amortization, and deferred
taxes) exceed the ceiling, the excess must be written off to expense. Once
incurred, this impairment of oil and gas properties is not reversible at a later
date even if oil and gas prices increase. No such impairment was required in the
quarters ended March 31, 2004 and 2003.
While the difficulty in estimating proved reserves could cause the
likelihood of a ceiling impairment to be difficult to predict, the impact of
changes in oil and gas prices is most significant. In general, the ceiling is
lower when prices are lower. Oil and gas prices at the end of the period are
applied to the estimated reserves, then costs are deducted to arrive at future
net revenues, which are then discounted at 10% to arrive at the discounted
present value of proved reserves. Additionally, we adjust the estimated future
revenues for the impact of our existing cash flow commodity hedges. The ceiling
calculation dictates that prices and costs in effect as of the last day of the
period are generally held constant indefinitely. Therefore, the future net
revenues associated with the estimated proved reserves are not based on
Mission's assessment of future prices or costs, but rather are based on prices
and costs in effect as of the end the period.
Because the ceiling calculation dictates that prices in effect as of the
last day of the period be held constant, the resulting value is rarely
indicative of the true fair value of our reserves. Oil and natural gas prices
have historically been variable and, on any particular day at the end of a
period, can be either substantially higher or lower than our long-term price
forecast, which we feel is more indicative of our reserve value. You should not
view full cost ceiling impairments caused by fluctuating prices, as opposed to
reductions in reserve volumes, as an absolute indicator of a reduction in the
ultimate value of our reserves.
Oil and gas prices used in the ceiling calculation at March 31, 2004 were
$35.70 per barrel and $5.42 per MMBTU. A significant reduction in these prices
at a future measurement date could trigger a full cost ceiling impairment. As an
illustration, had oil and gas prices at March 31, 2004 been 10% lower, we would
have been 68% closer to a ceiling impairment. Our hedging program would serve to
mitigate some of the impact of any price decline. If our hedges were excluded
from the ceiling calculation, we would have been 58% closer to a ceiling
impairment.
-27-
MISSION RESOURCES CORPORATION
DERIVATIVE INSTRUMENTS ACCOUNTING
All of our commodity derivative instruments represent hedges of the price
of future oil and natural gas production. We estimate the fair values of our
hedges at the end of each reporting period. The estimated fair values of our
commodity derivative instruments are recorded in the consolidated Balance Sheet
as assets or liabilities as appropriate.
For effective hedges, we record the change in the fair value of the hedge
instruments to other comprehensive income, a component of stockholders' equity,
until the hedged oil or natural gas quantities are produced. Any ineffectiveness
in our hedges, which could represent either gains or losses, is reported when
calculated at the end of each accounting period as part of the interest and
other income line of the Statement of Operations
Estimating the fair values of commodity hedge derivatives requires complex
calculations, including the use of a discounted cash flow technique and our
subjective judgment in selecting an appropriate discount rate. In addition, the
calculation uses future NYMEX prices, which although posted for trading
purposes, are merely the market consensus of forecast price trends. The results
of our fair value calculation cannot be expected to represent exactly the fair
value of our commodity hedges. We currently use a software product from an
outside vendor to calculate the fair value of our hedges. This vendor provides
the necessary NYMEX futures prices and the calculated volatility in those prices
to us daily. The software is programmed to apply a consistent discounted cash
flow technique, using these variables and a discount rate derived from
prevailing interest rates. This software is successfully used by several of our
peers. Its methods are in compliance with the requirements of SFAS No. 133 and
have been reviewed by a national accounting firm. In order to minimize the
impact on managements' estimates on our ineffectiveness calculation, we began
using this same software to calculate any ineffectiveness in our hedge
relationships. The software facilitates the complex calculations and uses
current prices downloaded to the database, but the results are nevertheless
estimates. The most significant estimate used in the ineffectiveness calculation
is our estimate of future prices. We use the forward price curves posted for
each of our contract prices.
REVENUE RECOGNITION
Mission records revenues from sales of crude oil and natural gas when
delivery to the customer has occurred and title has transferred. This occurs
when production has been delivered to a pipeline or a tanker lifting has
occurred. We may share ownership with other producers in certain properties. In
this case, we use the sales method to account for sales of production. It is
customary in the industry for various working interest partners to sell more or
less than their entitled share of natural gas production, creating gas
imbalances. Under the sales method, gas sales are recorded when revenue checks
are received or are receivable on the accrual basis. Typically no provision is
made on the Balance Sheet to account for potential amounts due to or from
Mission related to gas imbalances. If the gas reserves attributable to a
property have depleted to the point that there are insufficient reserves to
satisfy existing imbalance positions, a liability or a receivable, as
appropriate, should be recorded equal to the net value of the imbalance. As of
March 31, 2004, the Company had recorded a net liability of approximately
$895,000, representing approximately 382,000 MCF at an average price of $2.34
per MCF, related to imbalances on properties at or nearing depletion. The net
liability accrued as of March 31, 2003, was $454,000 representing 266,000 MCF at
an average price of $1.71 per MCF. We value gas imbalances using the price at
which the imbalance originated, if required by the gas balancing agreement, or
we use the current price where there is no gas balancing agreement available.
Reserve changes on any fields that have imbalances could change this liability.
We do not anticipate the settlement of gas imbalances to adversely impact our
financial condition in the future. Settlements are typically negotiated, so the
per MCF price for which imbalances are settled could differ among wells and even
among owners in one well. Exclusive of the liability recorded for properties at
or nearing depletion (see discussion above), the Company's unrecorded imbalance,
valued at current prices would be a $2.1 million liability.
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MISSION RESOURCES CORPORATION
ASSET RETIREMENT, IMPAIRMENT OR DISPOSAL
We adopted SFAS No. 143, "Accounting for Asset Retirement Obligations"
effective January 1, 2003. Previously our estimate of future plugging and
abandonment and dismantlement costs was charged to income by being included in
the capitalized costs that we depleted using the unit of production method. SFAS
No. 143 requires us to record a liability for the fair value of our estimated
asset retirement obligation, primarily comprised of our plugging and abandonment
liabilities, in the period in which it is incurred. Upon initial implementation,
we estimate asset retirement costs for all of our assets as of such date,
inflation adjust those costs to the forecast abandonment date, discount that
amount back to the date we acquired the asset and record an asset retirement
liability in that amount with a corresponding addition to our asset value. Then
we must compute all depletion previously taken on future plugging and
abandonment costs, and reverse that depletion. Finally, we must accrete the
liability to present day. Any income effect of this initial implementation is
reflected as a change in accounting method on our Statement of Operations.
After initial implementation, we reduce the liability as abandonment costs
are incurred. We will accrete the liability quarterly using the period and
effective interest rates determined at implementation. As new wells are drilled
or purchased their initial asset retirement cost and liability will be
calculated and recorded. Should either the estimated life or the estimated
abandonment costs of a property change upon our quarterly review, a new
calculation is performed using the same methodology of taking the abandonment
cost and inflating it forward to its abandonment date and then discounting it
back to the present using our risk-adjusted rate. The carrying value of the
asset retirement obligation is adjusted to the newly calculated value, with a
corresponding offsetting adjustment to the asset retirement cost; therefore,
abandonment costs will almost always approximate the estimate. We have developed
a process through which to track and monitor the obligations for each asset
following implementation of SFAS No. 143.
When wells are sold the related liability and asset costs are removed from
the Balance Sheet. Any difference between the two remains in the full cost pool.
SFAS No. 143 does not specifically address the proper accounting to be applied
by a full cost method company when properties are sold. A May 23, 2003 letter to
the FASB and the SEC from a group of concerned companies makes inquiries and
outlines possible alternatives, including our current treatment. Should a
clarification be issued, there is a chance that Mission's treatment will be
required to change and the entire $3.5 million credit that is in our full cost
pool for 2003 and 2004 activities might be reclassified into income.
As with previously discussed estimates, the estimation of our initial
liability and its subsequent remeasurements is dependent upon many variables. We
attempt to limit the impact of management's judgment on these variables by using
the input of qualified third parties when possible. We engaged an independent
engineering firm to evaluate our properties annually and to provide us with
estimates of abandonment costs. We used the remaining estimated useful life from
the yearend reserve reports by Netherland, Sewell & Associates, Inc. in
estimating when abandonment could be expected for each property. The resulting
estimate, after application of a discount factor and some significant
calculations, could differ from actual results, despite all our efforts to make
the most accurate estimation possible.
INCOME TAXES
Mission has accumulated substantial income tax deductions that have not
yet been used to reduce cash income taxes actually paid with the filing of our
income tax returns. These accumulated deductions are commonly referred to as
"net operating loss carryforwards" or "NOLs".
Our NOLs are, subject to a number of restrictions, available to reduce
cash taxes that may become owed in future years. In accordance with the
accounting for income taxes under SFAS No. 109, we record a deferred tax asset
and a reduction of our tax expense for our NOLs. If we estimate that
-29-
MISSION RESOURCES CORPORATION
some or all of our NOLs are more likely than not going to expire or otherwise
not be utilized to reduce future tax, we record a valuation allowance to remove
the benefit of those NOLs from our financial statements
One of the restrictions on the future use of NOLs is contained in Section
382 of the Internal Revenue Code. In general, Section 382 provides that the
amount of existing NOLs that may be used to offset future taxable income after
the occurrence of an "ownership change" (as defined solely for Section 382
purposes) is limited to an amount that is determined, in part, by the fair
market value of the enterprise at the time the ownership change occurred. The
fair market value of the enterprise's individual assets and the timing in which
the value of those assets are realized are also factors that impact the amount
of NOLs available under Section 382 ("382 Limitation").
As a result of our issuance of common stock in exchange for the retirement
of a portion of our 10 7/8% senior subordinated notes in December 2003, we
experienced an "ownership change" as defined under Section 382. Consequently, we
have included the estimated impact that a 382 Limitation may have upon the
future availability of our NOLs as part of our evaluation under SFAS 109.
Consistent with previously described estimates, the initial estimation of
the future benefit of our NOLs is dependent upon many variables and is subject
to change. Management's judgment on these variables is based upon the input of
qualified third parties when possible. We have used information derived from the
public equity markets as well as data provided by an independent engineering
firm to assist us with determining fair market values. We have engaged an
international independent public accounting firm to assist us in applying the
numerous and complicated tax law requirements. However, despite our attempt to
make the most accurate estimates possible, the ultimate utilization of our NOLs
is highly dependent upon our actual production and the realization of taxable
income in future periods.
FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q 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, as
amended ("Exchange Act"). All statements other than statements of historical
fact are forward-looking statements. Forward-looking statements are subject to
certain risks, trends and uncertainties that could cause actual results to
differ materially from those projected. Among those risks, trends and
uncertainties are our estimate of the sufficiency of existing capital sources,
our highly leveraged capital structure, our ability to raise additional capital
to fund cash requirements for future operations, the uncertainties involved in
estimating quantities of proved oil and natural gas reserves, in prospect
development and property acquisitions and in projecting future rates of
production, the timing of development expenditures and drilling of wells, and
the operating hazards attendant to the oil and gas business. Although we believe
that in making such forward-looking statements our expectations are based upon
reasonable assumptions, such statements may be influenced by factors that could
cause actual outcomes and results to be materially different from those
projected. We cannot assure you that the assumptions upon which these statements
are based will prove to have been correct.
-30-
MISSION RESOURCES CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Mission is exposed to market risk, including adverse changes in commodity prices
and interest rate.
COMMODITY PRICE RISK
Mission produces and sells crude oil, natural gas and natural gas liquids.
As a result, our operating results can be significantly affected by fluctuations
in commodity prices caused by changing market forces. We periodically seek to
reduce our exposure to price volatility by hedging a portion of production
through swaps, options and other commodity derivative instruments. A combination
of options, structured as a collar, is our preferred hedge instrument because
there are no up-front costs and protection is given against low prices. These
collars assure that the NYMEX prices we receive on the hedged production will be
no lower than the price floor and no higher than the price ceiling. The oil
hedges that are swaps fix the price to be received.
Our 12-month average realized price, excluding hedges, for natural gas per
MCF was $0.10 less than the NYMEX MMBTU price. Our 12-month average realized
price, excluding hedges, for oil was $0.92 per BBL less than NYMEX. Realized
prices differ from NYMEX as a result of factors such as the location of the
property, the heating content of natural gas and the quality of oil. The gas
differential stated above excludes the impact the Mist field gas production that
is sold at an annually fixed price.
By removing the price volatility from hedged volumes of oil and natural
gas production, we have mitigated, but not eliminated, the potential negative
effect of declining prices on our operating cash flow. The potential for
increased operating cash flow due to increasing prices has also been reduced. If
all our commodity hedges were to settle at March 31, 2004 prices, our cash flows
would decrease by $14.6 million; however the actual settlement of our hedges
will increase or decrease cash flows over the period of the hedges at varying
prices.
As of May 10, 2004, Mission had the following hedges in place:
OIL HEDGES
NYMEX NYMEX
PRICE PRICE
BBLS FLOOR/SWAP CEILING
PERIOD PER DAY TOTAL BBLS TYPE AVG. AVG.
- ---------------- ------- ---------- ------ ---------- -------
Second Qtr. 2004 2,500 227,500 Swap $24.67 N/A
Third Qtr. 2004 2,500 230,000 Swap $24.30 N/A
Fourth Qtr. 2004 2,500 230,000 Swap $23.97 N/A
First Qtr. 2005 2,000 180,000 Collar $27.14 $30.19
Second Qtr. 2005 1,500 136,500 Collar $26.33 $28.79
Third Qtr. 2005 1,500 138,000 Collar $26.17 $27.90
Fourth Qtr. 2005 1,500 138,000 Collar $26.00 $27.33
First Qtr. 2006 250 22,500 Collar $26.46 $30.90
Second Qtr. 2006 250 22,750 Collar $26.29 $30.75
Third Qtr. 2006 250 23,000 Collar $26.24 $30.51
Fourth Qtr. 2006 250 23,000 Collar $26.03 $30.15
-31-
MISSION RESOURCES CORPORATION
GAS HEDGES
NYMEX NYMEX
MMBTU PRICE FLOOR PRICE CEILING
PERIOD PER DAY TOTAL MMBTU TYPE AVG. AVG.
- ---------------- ------- ----------- ------ ----------- -------------
Second Qtr. 2004 14,000 1,274,000 Collar $4.43 $5.10
Third Qtr. 2004 19,000 1,748,000 Collar $4.71 $5.65
Fourth Qtr. 2004 16,500 1,518,000 Collar $4.64 $5.73
First Qtr. 2005 11,000 990,000 Collar $4.83 $8.52
Second Qtr. 2005 6,000 546,000 Collar $4.54 $5.49
Third Qtr. 2005 6,000 552,000 Collar $4.54 $5.45
Fourth Qtr. 2005 6,000 552,000 Collar $4.54 $5.87
These commodity derivative agreements expose Mission to counter party
credit risk to the extent the counter party is unable to met its monthly
settlement commitment to Mission. Mission believes it selects creditworthy
counter parties to its hedge transactions. Each of Mission's counter parties
have long term senior unsecured debt ratings of at least A/A2 by Standard &
Poor's or Moody's.
INTEREST RATE RISK
Effective September 22, 1998, Mission entered into an eight and one-half
year interest rate swap agreement with a notional value of $80.0 million. Under
the agreement, Mission receives a fixed interest rate and pays a floating
interest rate, subject to a cap, based on the simple average of three foreign
LIBOR rates. Mission paid $1.3 million to the counter party in February 2003 to
cancel the swap. A $520,000 gain related to the change in the fair market value
of the swap from January 1, 2002 to the date of cancellation was recognized as a
reduction in interest expense during the quarter ended March 31, 2003.
Our new senior secured revolving credit facility has floating interest
rates and as such exposes us to interest rate risk. If interest rates were to
increase 10% over their April 8, 2004 levels, our annualized interest expense
would increase $260,000 or 1.7%. We have considered, but have not yet entered
into, any derivative transactions designed to mitigate interest rate risk.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report, Mission's principal
executive officer ("CEO") and principal financial officer ("CFO") carried out an
evaluation of the effectiveness of Mission's disclosure controls and procedures
pursuant to Rule 13a-15 of the Securities and Exchange Act of 1934. Based on
those evaluations, the CEO and CFO believe:
i. that Mission's disclosure controls and procedures are designed to
ensure that information required to be disclosed by Mission in the
reports it files under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms, and that such information is
accumulated and communicated to Mission's management, including the
CEO and CFO, as appropriate to allow timely decisions regarding
required disclosure; and
ii. that Mission's disclosure controls and procedures are effective.
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MISSION RESOURCES CORPORATION
CHANGES IN INTERNAL CONTROLS
There have been no significant changes in Mission's internal controls over
financial reporting during the period covered by this report that have
materially affected, or are reasonably likely to materially affect, Mission's
control over financial reporting.
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MISSION RESOURCES CORPORATION
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in litigation relating to claims arising out of
its operations in the normal course of business, including workmen's
compensation claims, tort claims and contractual disputes. Some of the existing
known claims against the Company are covered by insurance subject to the limits
of such policies and the payment of deductible amounts by the Company.
Management believes that the ultimate disposition of all uninsured or
unindemnified matters resulting from existing litigation will not have a
material adverse effect on the Company's business or financial position.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
On February 25, 2004, the Company acquired $15 million of the 10 7/8%
Notes from Stellar Funding, Ltd. in exchange for 6.25 million shares of the
Mission common stock. On March 15, 2004, the Company acquired an additional $15
million of the 10 7/8% Notes from Harbert Distressed Investment Master Fund,
Ltd. in exchange for 6 million shares of the Company's common stock. The shares
of common stock issued in the transactions were exempt from registration
pursuant to Section 3(a) (9) of the Securities Act of 1933, as amended, as they
were exchanged with our existing security holders exclusively and no commission
or remuneration was paid or given directly or indirectly for the exchange.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits.
The following exhibits are filed with this Form 10-Q and
they are identified by the number indicated.
4.1 Amendment to Rights Agreement dated as of February
25, 2004, by and between Mission Resources
Corporation and American Stock Transfer & Trust
Company (incorporated by reference to Exhibit 4.1 to
the Company's Current Report on Form 8-K filed on
February 26, 2004).
4.2 Amendment to Rights Agreement dated as of March 15,
2004, by and between Mission Resources Corporation
and American Stock Transfer & Trust Company
(incorporated by reference to Exhibit 4.1 to the
Company's Current Report on Form 8-K filed on March
15, 2004).
4.3 Registration Rights Agreement dated February 25,
2004, by and among Mission Resources Corporation and
Stellar Funding Ltd. (incorporated
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MISSION RESOURCES CORPORATION
by reference to Exhibit 99.3 to the Company's
Current Report on Form 8-K filed on February 26,
2004).
4.4 Registration Rights Agreement dated March 15, 2004,
by and among Mission Resources Corporation and
Harbert Distressed Investment Master Fund,
Ltd.(incorporated by reference to Exhibit 99.3 to
the Company's Current Report on Form 8-K filed on
March 15, 2004).
10.1 Purchase and Sale Agreement, dated as of February
25, 2004, by and between Mission Resources
Corporation and Stellar Funding Ltd. (incorporated
by reference to Exhibit 99.2 to the Company's
Current Report on Form 8-K filed on February 26,
2004).
10.2 Purchase and Sale Agreement, dated as of March 15,
2004, by and between Mission Resources Corporation
and Harbert Distressed Investment Master Fund, Ltd.
(incorporated by reference to Exhibit 99.2 to the
Company's Current Report on Form 8-K filed on March
15, 2004).
31.1* Certification of Chief Executive Officer pursuant to
Rule 13a-14(a) / Rule 15d-14(a), promulgated under
the Securities Exchange Act of 1934, as amended.
31.2* Certification of Chief Financial Officer pursuant to
Rule 13a-14(a) / Rule 15d-14(a), promulgated under
the Securities Exchange Act of 1934, as amended.
32.1* Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, of Chief Executive
Officer of the Company.
32.2* Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, of Chief Financial
Officer of the Company.
--------------
*Filed herewith.
b. Reports on Form 8-K.
(i) The Company filed a Current Report on Form 8-K on
January 15, 2004 regarding an agreement to acquire
an interest in the Jalmat field.
(ii) The Company filed a Current report on Form 8-K on
February 3, 2004 regarding the closing of the
acquisition of an interest in the Jalmat field.
(iii) The Company filed a Current Report on Form 8-K on
February 11, 2004 regarding its fourth quarter and
yearend 2003 results and quarterly conference call.
(iv) The Company filed a Current Report on Form 8-K on
February 26, 2004, regarding fourth quarter and
yearend 2003 results.
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MISSION RESOURCES CORPORATION
(v) The Company filed a Current Report on Form 8-K on
February 26, 2004 regarding an equity for debt swap
with Stellar Funding Ltd..
(vi) The Company filed a Current Report on Form 8-K on
March 16, 2004 regarding an equity for debt swap
with Harbert Distressed Master Fund, Ltd.
(vii) The Company filed a Current Report on Form 8-K on
March 16, 2004 regarding a prospective private
placement of senior notes.
(viii) The Company filed a Current Report on Form 8-K on
March 30, 2004 regarding commitment letters for a
new senior secured revolving credit facility and a
new second lien term loan.
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MISSION RESOURCES CORPORATION
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MISSION RESOURCES CORPORATION
-----------------------------------------
(Registrant)
Date: May 10, 2004 By: /s/ Robert L. Cavnar
-------------------------------------
Robert L. Cavnar
Chairman and Chief Executive Officer
Date: May 10, 2004 By: /s/ Richard W. Piacenti
-------------------------------------
Richard W. Piacenti
Executive Vice President and Chief
Financial Officer
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EXHIBIT INDEX
Exhibits.
The following exhibits are filed with this Form 10-Q and they are
identified by the number indicated.
4.1 Amendment to Rights Agreement dated as of February 25, 2004, by and
between Mission Resources Corporation and American Stock Transfer & Trust
Company (incorporated by reference to Exhibit 4.1 to the Company's Current
Report on Form 8-K filed on February 26, 2004).
4.2 Amendment to Rights Agreement dated as of March 15, 2004, by and between
Mission Resources Corporation and American Stock Transfer & Trust Company
(incorporated by reference to Exhibit 4.1 to the Company's Current Report
on Form 8-K filed on March 15, 2004).
4.3 Registration Rights Agreement dated February 25, 2004, by and among
Mission Resources Corporation and Stellar Funding Ltd. (incorporated by
reference to Exhibit 99.3 to the Company's Current Report on Form 8-K
filed on February 26, 2004).
4.4 Registration Rights Agreement dated March 15, 2004, by and among Mission
Resources Corporation and Harbert Distressed Investment Master Fund,
Ltd.(incorporated by reference to Exhibit 99.3 to the Company's Current
Report on Form 8-K filed on March 15, 2004).
10.1 Purchase and Sale Agreement, dated as of February 25, 2004, by and between
Mission Resources Corporation and Stellar Funding Ltd. (incorporated by
reference to Exhibit 99.2 to the Company's Current Report on Form 8-K
filed on February 26, 2004).
10.2 Purchase and Sale Agreement, dated as of March 15, 2004, by and between
Mission Resources Corporation and Harbert Distressed Investment Master
Fund, Ltd. (incorporated by reference to Exhibit 99.2 to the Company's
Current Report on Form 8-K filed on March 15, 2004).
31.1* Certification of Chief Executive Officer pursuant to Rule 13a-14(a) / Rule
15d-14(a), promulgated under the Securities Exchange Act of 1934, as
amended.
31.2* Certification of Chief Financial Officer pursuant to Rule 13a-14(a) / Rule
15d-14(a), promulgated under the Securities Exchange Act of 1934, as
amended.
32.1* Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, of Chief Executive Officer
of the Company.
32.2* Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, of Chief Financial Officer
of the Company.
- ---------------------
* Filed herewith.