PETROQUEST ENERGY INC - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

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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: June 30, 2002
[ ] 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: 019020

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PETROQUEST ENERGY, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 72-1440714
(State of Incorporation) (I.R.S. Employer Identification No.)

400 E. KALISTE SALOOM RD., SUITE 6000
LAFAYETTE, LOUISIANA 70508
(Address of principal executive offices) (Zip code)

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Registrant's telephone number, including area code: (337) 232-7028

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
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As of July 31, 2002, there were 37,852,394 shares of the registrant's
common stock, par value $.001 per share, outstanding.

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PETROQUEST ENERGY, INC.

Table of Contents

2

PETROQUEST ENERGY, INC.
Consolidated Balance Sheets
(Amounts in Thousands)

See accompanying Notes to Consolidated Financial Statements.

3

PETROQUEST ENERGY, INC.
Consolidated Statements of Operations
(unaudited)
(Amounts in Thousands, Except Per Share Data)

See accompanying Notes to Consolidated Financial Statements.

4

PETROQUEST ENERGY, INC.
Consolidated Statements of Cash Flows
(unaudited)
(Amounts in Thousands)

See accompanying Notes to Consolidated Financial Statements.

5

PETROQUEST ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 BASIS OF PRESENTATION

The consolidated financial information for the three- and six-month periods
ended June 30, 2002 and 2001, respectively, have been prepared by the Company
and was not audited by its independent public accountants. In the opinion of
management, all normal and recurring adjustments have been made to present
fairly the financial position, results of operations, and cash flows of the
Company at June 30, 2002 and for all reported periods. Results of operations for
the interim periods presented are not necessarily indicative of the operating
results for the full year or any future periods.

Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States have been condensed or omitted. These consolidated
financial statements should be read in conjunction with the financial statements
and related notes thereto included in the Company's Annual Report on Form 10-K
for the year ended December 31, 2001.

Unless the context otherwise indicates, any references in this Quarterly Report
on Form 10-Q to "PetroQuest" or the "Company" refer to PetroQuest Energy, Inc.
(Delaware) and its wholly-owned consolidated subsidiaries, PetroQuest Energy,
L.L.C. (a single member Louisiana limited liability company) and PetroQuest Oil
& Gas, L.L.C. (a single member Louisiana limited liability company).

Certain reclassifications of prior year amounts have been made to conform with
the current year presentation.

NOTE 2 EARNINGS PER SHARE

Basic earnings or loss per common share was computed by dividing net income or
loss by the weighted average number of shares of common stock outstanding during
the relevant periods. Diluted earnings or loss per common share is determined on
a weighted average basis using common shares issued and outstanding adjusted for
the effect of stock options considered common stock equivalents computed using
the treasury stock method. For purposes of computing earnings per share in a
loss period, common stock equivalents have been excluded from the computation of
weighted average common shares outstanding because their effect is antidilutive.

For the six months ended June 30, 2002, 3,476,749 of the Company's options and
warrants were not included in the computation of diluted loss per share because
the effect of the assumed exercise of these stock options as of the beginning of
the year would have an antidilutive effect. Options to purchase 160,000 shares
of common stock were outstanding during the three-month period ended June 30,
2002, but were not included in the computation of diluted earnings per share
because the options' exercise prices were greater than the average market prices
of the common shares during the periods. These options' exercise prices were
between $6.25-$7.65 and expire in 2011. Options to purchase 80,000 and 192,500
shares of common stock were outstanding during the three- and six-month periods
ended June 30, 2001, respectively, but were not included in the computation of
diluted earnings per share because the options' exercise prices were greater
than the average market prices of the common shares during the periods. These
options' exercise prices were $7.65 and between $5.89-$7.65, respectively, and
expire in 2011.

NOTE 3 LONG-TERM DEBT

PetroQuest and our subsidiary PetroQuest Energy, L.L.C. (the "Borrower") have a
$100 million revolving credit facility with Hibernia National Bank, Royal Bank
of Canada and Union Bank of California, N.A. which permits the Borrower to
borrow amounts from time to time based on its available borrowing base as
determined in the credit facility. The credit facility is secured by a mortgage
on substantially all of the Borrower's oil and gas properties, a pledge of the
membership interest of the Borrower and PetroQuest's corporate guarantee of the
indebtedness of the Borrower. The borrowing base under this credit facility is
based upon the valuation on March 31 and September 30 of the Borrower's
mortgaged properties, projected oil and gas prices, and any other factors deemed
relevant by the lenders. The Company or the lenders may also request additional
borrowing base redeterminations. On April 30, 2002, the borrowing base under the
credit facility was adjusted to $27 million and is subject to quarterly
reductions of $5 million commencing on July 31, 2002.

6

Outstanding balances on the revolving credit facility bear interest at either
the prime rate (plus 0.375% per year whenever the borrowing base usage under the
credit facility is greater than or equal to 90%) or the Eurodollar rate plus a
margin (based on a sliding scale of 1.625% to 2.375% depending on borrowing base
usage). The credit facility also allows the Company to use up to $10 million of
the borrowing base for letters of credit for fees of 2% per annum. At June 30,
2002, the Company had $9 million of borrowings and a $2.6 million letter of
credit issued pursuant to the credit facility.

The credit facility contains covenants and restrictions common to borrowings of
this type, including maintenance of certain financial ratios. The Company was in
compliance with all of its covenants at June 30, 2002. The credit facility
matures on June 30, 2004.

During the fourth quarter of 2001, the Company entered into three $5 million
interest rate swaps covering its floating rate debt. The swaps which are for
one, two and three year periods have fixed interest rates of 2.78%, 2.78%-4.56%
and 3.05%-5.665%, respectively. The swaps are stated at their fair value and are
marked-to-market through other income in the Company's income statement. At June
30, 2002, the Company recognized a liability of $301,000 related to these
derivative instruments.

NOTE 4 NEW ACCOUNTING STANDARDS

In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143, "Accounting for Asset Retirement
Obligations," which requires recording the fair value of a liability for an
asset retirement obligation in the period incurred. The standard is effective
for fiscal years beginning after June 15, 2002, with earlier application
permitted. The Company expects to adopt this standard effective January 1, 2003.
The Company has not completed an evaluation of the impact of this new standard.

NOTE 5 EQUITY

Other Comprehensive Income

The following table presents a recap of the Company's comprehensive income for
the three- and six-month periods ended June 30, 2002 and 2001 (in thousands):

The Company accounts for derivatives in accordance with Statement of Financial
Accounting Standards No. 133, as amended (SFAS 133). When the conditions
specified in SFAS 133 are met, the Company may designate these derivatives as
hedges. As of June 30, 2002, the Company had no open commodity hedging
contracts.

Unearned Deferred Compensation

In April 2001, the original owners, (the "Original Owners") of American Explorer
L.L.C. entered into an agreement with an officer of the Company whereby the
Original Owners granted to the officer an option to acquire, at a fixed price,
certain of the shares the Original Owners were issued in the September 1, 1998
merger and reorganization (the "Merger"). As the fixed price of the April grant
was below the market price as of the date of grant, the Company is recognizing
non-cash compensation expense over the three-year vesting period of the option.
In addition, the Original Owners granted to the officer an interest in a portion
of the 1,667,001 shares of common stock issuable pursuant to the Contingent
Stock Issue Rights (the "CSIRs") issued to the Original Owners in the Merger, if
any,

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that might be issued. This agreement is similar to agreements previously entered
into with two other officers of the Company. Non-cash compensation expense is
being recognized for the common stock issuable pursuant to the CSIRs granted to
the three officers over the three-year vesting period based on the fair value of
the common stock issuable pursuant to the CSIRs in May 2001, when the common
stock issuable pursuant to the CSIRs was issued to the Original Owners. The
Company has recorded the effects of the transactions as deferred compensation
until fully amortized. The Company recorded non-cash compensation expense of
$86,000 and $172,000 during the quarter and six months ended June 30, 2002,
respectively, which is included in general and administrative expense. The
Company recorded non-cash compensation expense of $180,000 during the quarter
and six months ended June 30, 2001.

Public Offering

During February and March 2002, the Company completed the offering of 5,193,600
shares of its common stock. The shares were sold to the public for $4.40 per
share. After underwriting discounts, the Company realized proceeds of
approximately $21.9 million.

NOTE 6 DISPOSITION OF PROPERTY

On March 1, 2002, the Company closed the sale of its interest in Valentine Field
for $18.6 million. The transaction had an effective date of January 1, 2002. At
December 31, 2001, the Company's independent reservoir engineering firm
attributed 7.3 Bcfe of proved reserves net to the Company's interest in this
field. Consistent with the full cost method of accounting, the Company did not
recognize any gain or loss as a result of this sale. The proceeds were treated
as a reduction of the full cost pool through an increase in accumulated
depreciation, depletion and amortization.

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ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

PetroQuest Energy, Inc. is an independent oil and gas company engaged in the
exploration, development, acquisition and operation of oil and gas properties
onshore and offshore in the Gulf Coast Region. The Company and its predecessors
have been active in this area since 1986, which gives the Company extensive
geophysical, technical and operational expertise in this area.

The Company's business strategy is to increase production, cash flow and
reserves through exploration, development and acquisition of properties located
in the Gulf Coast Region. At June 30, 2002, the Company operated approximately
95% of all of its proved reserves. For the six months ended June 30, 2002,
approximately 39% of the Company's equivalent production was oil and 61% was
natural gas.

RESULTS OF OPERATIONS

The following table (unaudited) sets forth certain operating information with
respect to our oil and gas operations for the periods noted:

Net income totaled $255,000 and $3,854,000 for the quarters ended June 30, 2002
and 2001, respectively. Net loss and income totaled $109,000 and $7,995,000 for
the six-month periods ended June 30, 2002 and 2001, respectively. The results
are attributable to the following components:

PRODUCTION. Oil production in 2002 decreased and increased 4% and 24% over the
second quarter and six months ended June 30, 2001, respectively. Natural gas
production in 2002 increased 3% and 41% over the second quarter and six months
ended June 30, 2001, respectively. On an Mcfe basis, production for the second
quarter and six months remained flat and increased 34% over the same periods in
2001, respectively. The increase in production volumes for the six months ended
June 30, 2002, as compared to 2001, was primarily due to our 77% drilling
success rate during 2001. The decrease in production in the quarter ended June
30, 2002 as compared to the quarter ended March 31, 2002 was due to weather,
third party pipeline mechanical problems, unscheduled repairs and maintenance,
and certain well performance at the Ship Shoal 72 and Turtle Bayou fields.

PRICES. Average oil prices per Bbl for the second quarter and six months ended
June 30, 2002 were $25.51 and $23.01, respectively, as compared to $26.90 and
$27.32, respectively, for the same periods in 2001. Average gas prices per Mcf
were $3.03 and $2.67, respectively, for the second quarter and six months ended
June 30, 2002, as compared to $4.60 and $5.57, respectively, for the same
periods in 2001. Stated on a Mcfe basis, unit prices

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received during the second quarter and six months of 2002 were 22% and 39%
lower, respectively, than the prices received during the comparable 2001
periods.

REVENUE. Oil and gas sales during the second quarter and six months ended June
30, 2002 decreased to $11,357,000 and $21,866,000, respectively, as compared to
sales of $14,590,000 and $26,935,000, respectively for the same periods in 2001.
The decrease in commodity prices, partially offset by a growth in production
volumes, resulted in a decrease in revenue.

EXPENSES. Lease operating expenses for the second quarter and six months ended
June 30, 2002 increased to $2,404,000 and $4,752,000, respectively, as compared
to $1,908,000 and $3,156,000, respectively, for the second quarter and six
months ended June 30, 2001. On a Mcfe basis, lease operating expenses for the
second quarter and six months ended June 30, 2002 increased to $0.75 and $0.68,
respectively, as compared to $0.59 and $0.60, respectively, for the same periods
in 2001. The increases during the second quarter and six months ended June 30,
2002, as compared to the same periods in 2001 are primarily due to an increase
in the repairs and maintenance at the Ship Shoal 72 Field.

General and administrative expenses during the second quarter and six months
ended June 30, 2002 totaled $1,542,000 and $2,743,000, respectively, as compared
to expenses of $1,255,000 and $1,916,000, respectively, during the 2001 periods.
The Company capitalized $1,043,000 and $1,968,000, respectively, of general and
administrative costs during the quarter and six months ended June 30, 2002 as
compared to $614,000 and $1,236,000, respectively in the comparable 2001
periods. The increase in general and administrative expenses is primarily due to
an increase in staffing levels related to the generation of prospects,
exploration for oil and gas reserves and operation of properties. Additionally,
we have recognized $86,000 and $172,000, respectively, of non-cash compensation
expense during the quarter and six months ended June 30, 2002. We recorded
non-cash compensation expense of $180,000 during the quarter and six months
ended June 30, 2001.

Depreciation, depletion and amortization ("DD&A") expense for the three- and
six-month periods ended June 30, 2002 increased 37% and 68%, respectively, from
the 2001 periods. On a Mcfe basis, which reflects the changes in production, the
DD&A rate for the second quarter of 2002 was $2.06 per Mcfe as compared to $1.51
per Mcfe for the same period in 2001. The DD&A rate for the six months ended
June 30, 2002 was $1.96 per Mcfe compared to $1.57 per Mcfe for the same period
in 2001. The increase in 2002 as compared to 2001 is due primarily to the
significant capital and future development costs related to our offshore
projects, as well as drilling costs in excess of previous estimates during the
previous twelve months.

Interest expense, net of amounts capitalized on unevaluated prospects, decreased
$500,000 and $756,000 during the second quarter and six months ended June 30,
2002, respectively, as compared to same periods in 2001. The decreases are the
result of a decrease in the average debt levels and interest rates during the
current year. We capitalized $144,000 and $308,000 of interest during the three
months ended June 30, 2002 and 2001, respectively, and $307,000 and $608,000
during the six months ended June 30, 2002 and 2001, respectively.

Income tax expense (benefit) of $137,000 and $(59,000) was recognized during the
second quarter and six months ended June 30, 2002, respectively, as compared to
$2,263,000 and $4,696,000 during the same periods of 2001. The decreases are the
result of a decrease in the operating profit during the current year. We provide
for income taxes at a statutory rate of 35%.

LIQUIDITY AND CAPITAL RESOURCES

We have financed our exploration and development activities to date principally
through cash flow from operations, bank borrowings, and private and public
offerings of our common stock. Net cash flow from operations before working
capital changes during the six-month periods ended June 30, 2002 decreased from
$21,618,000 in 2001 to $14,135,000 in 2002. This decrease is primarily a result
of decreases in commodity prices during 2002. These decreases in commodity
prices caused lower revenues and operating cash flows during the current year.
The working capital deficit (before considering debt) increased from $(10.4)
million at December 31, 2001 to $(12.4) million at June 30, 2002. The increase
in our working capital deficit is due to a decrease in our receivables as a
result of lower commodity prices and higher capital expenditures resulting from
increased drilling activity.

10

During February and March 2002, we completed the offering of 5,193,600 shares of
our common stock. The shares were sold to the public for $4.40 per share. After
underwriting discounts, we realized proceeds of approximately $21.9 million.

On March 1, 2002, we closed the sale of our interest in Valentine Field for
$18.6 million. The transaction had an effective date of January 1, 2002. At
December 31, 2001, our independent reservoir engineering firm attributed 7.3
Bcfe of proved reserves net to our interest in this field. Consistent with the
full cost method of accounting, we did not recognize any gain or loss as a
result of this sale. The proceeds were treated as a reduction of the full cost
pool.

PetroQuest and our subsidiary PetroQuest Energy, L.L.C. (the "Borrower") have a
$100 million revolving credit facility with Hibernia National Bank, Royal Bank
of Canada and Union Bank of California, N.A. which permits us to borrow amounts
from time to time based on our available borrowing base as determined in the
credit facility. The credit facility is secured by a mortgage on substantially
all of the Borrower's oil and gas properties, a pledge of the membership
interest of the Borrower and PetroQuest's corporate guarantee of the
indebtedness of the Borrower. The borrowing base under this credit facility is
based upon the valuation on March 31 and September 30 of the Borrower's
mortgaged properties, projected oil and gas prices, and any other factors deemed
relevant by the lenders. We or the lenders may also request additional borrowing
base redeterminations. On April 30, 2002, the borrowing base under the credit
facility was adjusted to $27 million and is subject to quarterly reductions of
$5 million commencing on July 31, 2002. Based on the results of our recently
drilled wells, we expect that our borrowing base will be adjusted upward at the
September 30, 2002 redetermination. As of August 2, 2002, the borrowing base
under the credit facility was $22 million.

Outstanding balances on the revolving credit facility bear interest at either
the prime rate (plus 0.375% per year whenever the borrowing base usage under the
credit facility is greater than or equal to 90%) or the Eurodollar rate plus a
margin (based on a sliding scale of 1.625% to 2.375% depending on borrowing base
usage). The credit facility also allows us to use up to $10 million of the
borrowing base for letters of credit for fees of 2% per annum. At June 30, 2002,
we had $9 million of borrowings and a $2.6 million letter of credit issued
pursuant to the credit facility.

The credit facility contains covenants and restrictions common to borrowings of
this type, including maintenance of certain financial ratios. We were in
compliance with all of our covenants at June 30, 2002. The credit facility
matures on June 30, 2004.

We have an exploration and development program budget for the year 2002 which
will require significant capital. Our budget for direct capital for new projects
in 2002 is approximately $45-50 million of which approximately $29 million has
been incurred as of June 30, 2002. Our management believes the cash flows from
operations and anticipated available borrowing capacity under our credit
facility will be sufficient to fund remaining planned 2002 exploration and
development activities. In the future, our exploration and development
activities could require additional financings, which may include sales of
additional equity or debt securities, additional bank borrowings, or joint
venture arrangements with industry partners. There can be no assurances that
such additional financings will be available on acceptable terms, if at all. If
we are unable to obtain additional financing, we could be forced to delay or
even abandon some of our exploration and development opportunities.

DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS

This Form 10-Q contains "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 (the
"Exchange Act"). All statements other than statements of historical facts
included in and incorporated by reference into this Form 10-Q are
forward-looking statements. These 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 the Company's estimate of the sufficiency of its existing
capital sources, its 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. In particular, careful consideration
should be given to cautionary statements made in the various reports the Company
has filed with the Securities and Exchange Commission. The Company undertakes no
duty to update or revise these forward-looking statements.

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When used in the Form 10-Q, the words, "expect," "anticipate," "intend," "plan,"
"believe," "seek," "estimate" and similar expressions are intended to identify
forward-looking statements, although not all forward-looking statements contain
these identifying words. Because these forward-looking statements involve risks
and uncertainties, actual results could differ materially from those expressed
or implied by these forward-looking statements for a number of important
reasons, including those discussed under "Management's Discussions and Analysis
of Financial Condition and Results of Operations" and elsewhere in this Form
10-Q.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company experiences market risks primarily in two areas: interest rates and
commodity prices. The Company believes that its business operations are not
exposed to significant market risks relating to foreign currency exchange risk.

The Company's revenues are derived from the sale of its crude oil and natural
gas production. Based on projected annual sales volumes for the remaining six
months of 2002, a 10% change in the prices the Company receives for its crude
oil and natural gas production would have an approximate $2.1 million impact on
the Company's revenues.

In a typical hedge transaction, the Company will have the right to receive from
the counterparts to the hedge, the excess of the fixed price specified in the
hedge over a floating price based on a market index, multiplied by the quantity
hedged. If the floating price exceeds the fixed price, the Company is required
to pay the counterparts this difference multiplied by the quantity hedged. The
Company is required to pay the difference between the floating price and the
fixed price (when the floating price exceeds the fixed price) regardless of
whether the Company has sufficient production to cover the quantities specified
in the hedge. Significant reductions in production at times when the floating
price exceeds the fixed price could require the Company to make payments under
the hedge agreements even though such payments are not offset by sales of
production. Hedging will also prevent the Company from receiving the full
advantage of increases in oil or gas prices above the fixed amount specified in
the hedge. The Company had no open commodity hedging contracts as of June 30,
2002.

During the fourth quarter of 2001, we entered into three $5 million interest
rate swaps covering our floating rate debt. The swaps which are for one, two and
three year periods have fixed interest rates of 2.78%, 2.78%-4.56% and
3.05%-5.665%, respectively. The swaps are stated at their fair value and are
marked-to-market through other income in our income statement. At June 30, 2002,
the Company recognized a liability of $301,000 related to these derivative
instruments.

The Company also evaluated the potential effect that reasonably possible near
term changes may have on the Company's credit facility. Debt outstanding under
the facility is subject to a floating interest rate and represents 100% of the
Company's total debt as of June 30, 2002. Based upon an analysis, utilizing the
actual interest rate in effect and balances outstanding as of June 30, 2002 and
assuming a 10% increase in interest rates and no changes in the amount of debt
outstanding, the potential effect on interest expense for the remaining six
months of 2002 is approximately $17,000.

PART II

Item 1. LEGAL PROCEEDINGS

NONE.

Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

NONE.

Item 3. DEFAULTS UPON SENIOR SECURITIES

NONE.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

12

On April 30, 2002, an annual meeting of stockholders of the Company was
held. The holders of 30,373,129 shares of Common Stock were present in person or
represented by proxy at the meeting. At the meeting, the stockholders elected
the following persons to serve as directors of the Company until the next annual
meeting of stockholders, or until their successors are duly elected and
qualified:

Item 5. OTHER INFORMATION

NONE.

Item 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits:

Exhibit 99.1, Certification Pursuant To 18 U.S.C. Section
1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act Of
2002

Exhibit 99.2, Certification Pursuant to 18 U.S.C. Section
1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002

(b) Reports on Form 8-K:

The Company filed a report on Form 8-K on April 8, 2002
relating to the move of its headquarters.

The Company filed a report on Form 8-K on May 1, 2002 relating
to first quarter 2002 results.

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SIGNATURE

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.

PETROQUEST ENERGY, INC.

Date: August 2, 2002 By: /s/ Michael O. Aldridge
-------------------- ---------------------------------
Michael O. Aldridge
Senior Vice President, Chief
Financial Officer and Treasurer
(Authorized Officer and Principal
Financial and Accounting Officer)

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INDEX TO EXHIBITS