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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, 2003
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 No. 1-16295
ENCORE ACQUISITION COMPANY
(Exact name of registrant as specified in its charter)
Delaware 75-2759650
- ------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
777 Main Street, Suite 1400, Ft. Worth, Texas 76102
- --------------------------------------------------- ------------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (817) 877-9955
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 / x / No / /
Number of shares of Common Stock outstanding as of May 2, 2003........30,208,215
ENCORE ACQUISITION COMPANY
INDEX
PART I. FINANCIAL INFORMATION
Page
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2003 and
December 31, 2002............................................ 3
Consolidated Statements of Operations for the three months
ended March 31, 2003 and 2002................................ 4
Consolidated Statements of Stockholders' Equity for the three
months ended March 31, 2003.................................. 5
Consolidated Statements of Cash Flows for the three
months ended March 31, 2003 and 2002......................... 6
Notes to Consolidated Financial Statements...................... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................. 11
Item 3. Quantitative and Qualitative Disclosures about Market
Risk............................................................ 15
Item 4. Controls and Procedures................................... 15
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.......................... 16
Signatures........................................................ 17
Certifications.................................................... 18
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ENCORE ACQUISITION COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands except share data)
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents................................ $ 8,366 $ 13,057
Accounts receivable (Net of allowance
of $0 and $7.0 million, respectively).................. 26,111 21,981
Deferred tax asset....................................... 3,930 4,833
Derivative assets........................................ 7,065 3,245
Other current assets..................................... 7,233 6,349
------------ ------------
Total current assets.............................. 52,705 49,465
------------ ------------
Properties and equipment, at cost -- successful efforts method:
Producing properties..................................... 608,533 581,012
Undeveloped properties................................... 1,227 1,168
Accumulated depletion, depreciation, and amortization.... (99,822) (94,356)
------------ ------------
509,938 487,824
------------ ------------
Other property and equipment............................. 3,475 3,680
Accumulated depreciation and amortization................ (2,078) (1,917)
------------ ------------
1,397 1,763
------------ ------------
Other assets 8,858 10,844
------------ ------------
Total assets...................................... $ 572,898 $ 549,896
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................... $ 7,003 $ 9,650
Derivative liabilities................................... 6,220 8,558
Other current liabilities................................ 21,799 18,768
------------ ------------
Total current liabilities......................... 35,022 36,976
------------ ------------
Derivative liabilities..................................... 1,397 2,998
Long-term debt............................................. 158,000 166,000
Future abandonment liability............................... 4,871 --
Deferred income taxes...................................... 57,349 47,656
------------ ------------
Total liabilities................................. 256,639 253,630
------------ ------------
Commitments and contingencies.............................. -- --
Stockholders' equity:
Preferred stock, $.01 par value, 5,000,000 shares
authorized, none issued and outstanding................ -- --
Common stock, $.01 par value, 60,000,000 authorized,
30,208,048 and 30,162,955 issued and outstanding....... 302 302
Additional paid-in capital............................... 251,795 251,231
Deferred compensation.................................... (2,082) (2,396)
Retained earnings........................................ 71,702 53,724
Accumulated other comprehensive income................... (5,458) (6,595)
------------ ------------
Total stockholders' equity........................ 316,259 296,266
------------ ------------
Total liabilities and stockholders' equity........ $ 572,898 $ 549,896
============ ============
The accompanying notes are an integral part of these consolidated financial statements.
3
ENCORE ACQUISITION COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share data)
THREE MONTHS ENDED
MARCH 31,
-----------------------
2003 2002
---------- --------
(unaudited)
Revenues:
Oil....................................................... $ 46,432 $ 26,686
Natural gas............................................... 9,355 5,611
---------- --------
Total revenues....................................... 55,787 32,297
Expenses:
Production--
Lease operations....................................... 8,953 6,817
Production, ad valorem, and severance taxes............ 6,169 3,013
General and administrative (excluding non-cash
stock based compensation).............................. 2,450 1,493
Non-cash stock based compensation......................... 145 --
Depletion, depreciation, and amortization................ 7,783 8,559
Derivative fair value gain................................ (1,260) (653)
Other operating........................................... 170 139
---------- --------
Total expenses....................................... 24,410 19,368
---------- --------
Operating income............................................ 31,377 12,929
Other income (expenses):
Interest.................................................. (4,171) (1,492)
Other..................................................... 47 30
---------- --------
Total other income (expenses)........................ (4,124) (1,462)
---------- --------
Income before income taxes and accounting change............ 27,253 11,467
Provision for income taxes - current........................ (767) (430)
Provision for income taxes - deferred....................... (9,371) (3,927)
---------- --------
Income before accounting change............................. 17,115 7,110
Cumulative effect of accounting change (net of
income taxes of $329 and $0, respectively)................ 863 --
---------- --------
Net income .......................................... $ 17,978 $ 7,110
========== ========
Income per common share before accounting change:
Basic..................................................... $ 0.57 $ 0.24
Diluted................................................... $ 0.57 $ 0.24
Net income per common share:
Basic..................................................... $ 0.60 $ 0.24
Diluted................................................... $ 0.59 $ 0.24
Weighted average common shares outstanding:.................
Basic..................................................... 30,037 30,030
Diluted................................................... 30,221 30,052
The accompanying notes are an integral part of these consolidated financial statements.
4
ENCORE ACQUISITION COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
MARCH 31, 2003
(in thousands)
(unaudited)
Accumulated
Additional Other Total
Common Paid-In Deferred Retained Comprehensive Stockholders'
Stock Capital Compensation Earnings Income Equity
------ ---------- ------------ -------- ------------- ------------
Balance at December 31, 2002...... $ 302 $ 251,231 $ (2,396) $ 53,724 $ (6,595) $ 296,266
Exercise of stock options.......... -- 733 -- -- -- 733
Deferred compensation:
Amortization of expense......... -- -- 145 -- -- 145
Other changes................... -- (169) 169 -- -- --
Components of comprehensive income:
Net income...................... -- -- -- 17,978 -- 17,978
Change in deferred hedge loss
(net of income taxes of $697). -- -- -- -- 1,137 1,137
----------
Total comprehensive income 19,115
--------- --------- ------------ ---------- ------------ ----------
Balance at March 31, 2003......... $ 302 $ 251,795 $ (2,082) $ 71,702 $ (5,458) $ 316,259
========= ========= ============ ========== ============ ==========
The accompanying notes are an integral part of these consolidated financial statements.
5
ENCORE ACQUISITION COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
THREE MONTHS ENDED
MARCH 31,
----------------------
2003 2002
--------- ---------
(unaudited)
Operating activities
Net income................................................... $ 17,978 $ 7,110
Adjustments to reconcile net income to net
cash provided by operating activities:
Depletion, depreciation, and amortization.................. 7,783 8,559
Deferred taxes............................................. 9,371 3,927
Non-cash stock based compensation.......................... 145 --
Cumulative change in accounting principle.................. (863) --
Derivative fair value gain................................. (613) (653)
Other non-cash items....................................... 1,891 (470)
Loss on disposition of assets.............................. 124 147
Changes in operating assets and liabilities:
Accounts receivable...................................... (4,130) (3,228)
Other current assets..................................... (1,328) (700)
Other assets............................................. (112) 4,855
Accounts payable and other current liabilities........... (4,538) (2,303)
--------- ---------
Cash provided by operating activities........................ 25,708 17,244
Investing activities
Proceeds from disposition of assets........................ 395 35
Purchases of other property and equipment.................. (36) (323)
Acquisition of oil and gas properties...................... (60) (50,438)
Development of oil and gas properties...................... (23,431) (20,357)
--------- ---------
Cash used by investing activities............................ (23,132) (71,083)
Financing activities
Proceeds from long-term debt............................... 15,000 76,000
Payments on long-term debt................................. (23,000) (21,000)
Payments on note payable................................... -- (1,107)
Exercise of stock options.................................. 733 --
--------- ---------
Cash provided (used) by financing activities................. (7,267) 53,893
Increase (decrease) in cash and cash equivalents............. (4,691) 54
Cash and cash equivalents, beginning of period............... 13,057 115
--------- ---------
Cash and cash equivalents, end of period..................... $ 8,366 $ 169
========= =========
The accompanying notes are an integral part of these consolidated financial statements.
6
ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. FORMATION OF ENCORE
Encore Acquisition Company ("Encore"), a Delaware corporation, is an
independent (non-integrated) oil and natural gas company in the United States.
We were organized in April 1998 and are engaged in the acquisition, development,
exploitation and production of North American oil and natural gas reserves. Our
oil and natural gas reserves are concentrated in fields located in the Williston
Basin of Montana and North Dakota, the Permian Basin of Texas and New Mexico,
the Anadarko Basin of Oklahoma, the Powder River Basin of Montana, and the
Paradox Basin of Utah.
2. BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited consolidated
financial statements of Encore include all adjustments necessary to present
fairly our financial position as of March 31, 2003 and results of operations and
cash flows for the three months ended March 31, 2003 and 2002. All adjustments
are of a recurring nature. These interim results are not necessarily indicative
of results for an entire year.
Certain disclosures have been condensed or omitted from these consolidated
financial statements pursuant to the rules and regulations of the Securities and
Exchange Commission. Therefore, these financial statements should be read in
conjunction with the Company's 2002 consolidated financial statements and
related notes thereto included in the Company's Annual Report filed on Form
10-K.
Employee stock options and restricted stock awards are accounted for at
intrinsic value under the provisions of Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25"). Accordingly, no
compensation expense is recorded for stock options that are granted to employees
or non-employee directors with an exercise price equal to or above the common
stock price on the grant date. If compensation expense for the stock based
awards had been determined using the fair value method proscribed in Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation", the Company's net income and net income per share would have been
adjusted to the pro forma amounts indicated below (in thousands, except per
share amounts):
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, MARCH 31,
2003 2002
------------ ------------
As Reported:
Net income ........................... $ 17,978 $ 7,110
Basic net income per common share..... 0.60 0.24
Diluted net income per common share... 0.59 0.24
Non-cash stock based compensation..... 145 --
Pro Forma:
Net income ........................... $ 17,646 $ 6,788
Basic net income per common share..... 0.59 0.23
Diluted net income per common share... 0.58 0.23
Non-cash stock based compensation..... 477 322
3. NEW ACCOUNTING STANDARDS
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"), which the
Company adopted as of January 1, 2003. This statement requires us to record a
liability in the period in which an asset retirement obligation ("ARO") is
incurred, in an amount equal to the discounted estimated fair value of the
obligation. Also, upon initial recognition of the liability, we must capitalize
additional asset cost equal to the amount of the liability. Thereafter, each
quarter, this liability is accreted up to the final cost.
The adoption of SFAS 143 on January 1, 2003 resulted in a cumulative effect
adjustment to record (i) a $4.0 million increase in the carrying values of
proved properties, (ii) a $2.1 million decrease in accumulated depletion,
depreciation, and amortization, and (iii) a
7
$5.2 million increase in other non-current liabilities, and (iv) a gain of $0.9
million, net of tax, as a cumulative effect of accounting change.
The following table shows pro forma net income and basic and diluted
earnings per share as if the Company had adopted SFAS 143 as of January 1, 2002
(in thousands, except per share amounts):
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, MARCH 31,
2003 2002
------------ ------------
As Reported:
Net income ............................ $ 17,978 $ 7,110
Basic net income per common share...... 0.60 0.24
Diluted net income per common share.... 0.59 0.24
Pro Forma:
Net income ............................ $ 17,115 $ 7,480
Basic net income per common share...... 0.57 0.25
Diluted net income per common share.... 0.57 0.25
The Company's primary asset retirement obligations relate to future plugging
and abandonment expenses on our oil and natural gas properties and related
facilities disposal. As of March 31, 2003, the Company had $2.5 million held in
an escrow account from which funds are released only for reimbursement of
plugging and abandonment expenses on our Bell Creek property. This amount is
included in `Other assets' in the consolidated balance sheet. The following
table summarizes the changes in the Company's total estimated liability from the
amount recorded upon adoption of SFAS 143 on January 1, 2003 though March 31,
2003 (in thousands):
THREE MONTHS
ENDED
MARCH 31,
2003
------------
Beginning future abandonment liability... $ 4,791
Accretion expense...................... 64
Additional liabilities incurred........ 16
------------
Ending future abandonment liability...... $ 4,871
============
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections".
Under Statement 4, all gains and losses from extinguishment of debt were
required to be aggregated and, if material, classified as an extraordinary item,
net of related income tax effect. This Statement eliminates Statement 4 and,
thus, the exception to applying Opinion 30 to all gains and losses related to
extinguishments of debt. As a result, gains and losses from extinguishment of
debt should be classified as extraordinary items only if they meet the criteria
in Opinion 30. Applying the provisions of Opinion 30 will distinguish
transactions that are part of an entity's recurring operations from those that
are unusual or infrequent or that meet the criteria for classification as an
extraordinary item. This statement is effective for Encore beginning January 1,
2003. Thus, we will reclassify the extraordinary loss on extinguishment of debt
recorded in the second quarter of 2002 to operating income in all future
filings.
4. EARNINGS PER SHARE (EPS)
The following table sets forth basic and diluted EPS computations for the
three months ended March 31 (in thousands, except per share amounts):
THREE MONTHS ENDED
MARCH 31,
2003 2002
----------- -----------
NUMERATOR:
Income before accounting change........................... $ 17,115 $ 7,110
=========== ===========
Net income ............................................... $ 17,978 $ 7,110
=========== ===========
DENOMINATOR:
Denominator for basic earnings per share -
weighted average shares outstanding..................... 30,037 30,030
Effect of dilutive securities........................... 184 22
----------- -----------
Denominator for diluted earnings per share................ 30,221 30,052
=========== ===========
8
Basic income per common share before
accounting change........................ $ 0.57 $ 0.24
Cumulative effect of accounting
change, net of tax....................... 0.03 --
----------- -----------
Basic income per common share after
accounting change........................ $ 0.60 $ 0.24
=========== ===========
Diluted income per common share before
accounting change........................ $ 0.57 $ 0.24
Cumulative effect of accounting change,
net of tax............................... 0.02 --
----------- -----------
Diluted income per common share after
accounting change........................ $ 0.59 $ 0.24
=========== ===========
For the quarters ended March 31, 2003 and 2002, outstanding employee stock
options of 240,000 and 500,000, respectively, were excluded from the calculation
of diluted earnings per share because their effect would have been antidilutive.
5. DERIVATIVE FINANCIAL INSTRUMENTS
During the quarter ended March 31, 2003, current derivative assets increased
$3.8 million and long-term derivative assets decreased $1.9 million, while
current derivative liabilities decreased $2.3 million and long-term derivative
liabilities decreased $1.6 million. These changes were due primarily to the
increased value of two of our 2003 basis swaps and a decrease in the forward
strip prices on certain oil contracts offset by an increase in the forward strip
prices on all of our gas contracts. Also, during the quarter we recorded a $1.3
million derivative fair value gain, which was primarily due to changes in the
forward LIBOR curve which caused the fair value of our interest rate swaps to
increase. As our interest rate swaps do not qualify for hedge accounting, they
are marked to market through 'Derivative fair value gain' on the consolidated
statement of operations.
For the quarter ended March 31, 2003, we had total comprehensive income of
$19.1 million, while net income totaled $18.0 million. The difference between
net income and total comprehensive income is due to a $1.1 million decrease in
our deferred hedging loss in 'Accumulated Other Comprehensive Income' from $6.6
million at December 31, 2002 to $5.5 million at March 31, 2003. For the quarter
ended March 31, 2002, we had a total comprehensive loss of $0.7 million, while
net income totaled $7.1 million. The difference between net income and total
comprehensive income is due to a $7.8 million decrease in deferred hedging
gain/loss.
The following tables summarize our open commodity hedging positions as of
March 31, 2003:
OIL HEDGES AT MARCH 31, 2003
DAILY FLOOR DAILY CAP DAILY SWAP
FLOOR VOLUME PRICE CAP VOLUME PRICE SWAP VOLUME PRICE
PERIOD (BBL) (PER BBL) (BBL) (PER BBL) (BBL) (PER BBL)
------ ------------ --------- ---------- --------- ----------- ---------
Apr - June 2003 12,000 $ 21.25 7,500 $ 26.93 1,000 $ 24.50
July - Dec 2003 9,500 $ 21.05 7,000 $ 27.14 -- $ --
Jan - June 2004 4,500 $ 21.00 4,500 $ 27.94 -- $ --
July - Dec 2004 500 $ 21.00 500 $ 26.00 -- $ --
In addition to the amounts noted in the table above, as of March 31, 2003,
we had one short oil put contract in place covering 500 Bbls per day at a strike
price of $17.00 which does not qualify for hedge accounting. Accordingly, this
contract is marked to market through earnings each period. We also have several
basis swaps outstanding. The following table summarizes our open basis swap
positions:
DAILY
PERIOD VOLUME (BBLS) ENCORE PAYS ENCORE RECEIVES
------ ------------- ----------- ---------------
Apr - Dec 2003 3,000 Platts WTS + $1.87 NYMEX WTI
Apr - June 2003 3,000 P-Plus $4.76
May 2003 1,000 P-Plus $4.91
Apr - Dec 2003 2,000 Platts Mars Platts WTI - $3.95
May - Dec 2003 1,000 Platts Mars Platts WTI - $4.03
NATURAL GAS HEDGES AT MARCH 31, 2003
DAILY FLOOR DAILY CAP DAILY SWAP
FLOOR VOLUME PRICE CAP VOLUME PRICE SWAP VOLUME PRICE
PERIOD (MCF) (PER MCF) (MCF) (PER MCF) (MCF) (PER MCF)
- -------------- ------------ --------- ---------- --------- ----------- ---------
Jan - Dec 2003 7,500 $ 3.17 2,500 $ 6.83 2,500 $ 3.69
Apr - Dec 2004 5,000 $ 3.25 5,000 $ 6.10 -- $ --
9
The actual gains or losses we realize from our hedge transactions may vary
significantly from the amounts recorded in the March 31, 2003 balance sheet due
to fluctuation of prices in the commodities markets and/or fluctuations in the
floating LIBOR interest rate.
INTEREST RATE DERIVATIVES
In conjunction with the sale of its $150 million 8 3/8% Senior Subordinated
Notes ("Notes") on June 25, 2002, the Company repaid all amounts outstanding
under its previous credit facility on June 25, 2002, and terminated the facility
on that date. At the time, the Company had three interest rate swaps
outstanding, with a notional amount of $30 million each, which swapped LIBOR
based floating rates for fixed rates. According to the provisions of SFAS 133,
these no longer qualified for hedge accounting. The unrealized loss of $3.8
million through June 25, 2002, which was recognized in accumulated other
comprehensive income, is being amortized to interest expense over the original
life of the swaps. We increased interest expense by $654,000 in the first
quarter of 2003 related to the amortization of this unrealized loss.
At the end of 2002, the Company had outstanding two of the interest rate
swap contracts with a notional amount of $30 million each whereby we paid a
fixed rate and received LIBOR and one interest rate swap contract whereby we pay
LIBOR + 3.89% and receive 8.375% on a $80 million notional amount. During
January 2003, we cash settled the two $30 million floating for fixed swap
contracts at a cost of $4.3 million. This resulted in a gain of $647,000
recorded in `Derivative fair value gain' on the consolidated statement of
operations. The following table summarizes the Company's only remaining interest
rate swap contract at March 31, 2003:
ENCORE
REMAINING TERM NOTIONAL AMOUNT ENCORE PAYS RECEIVES
-------------- --------------- ----------- --------
Apr 2003 - June 2005 $80,000,000 LIBOR + 3.89% 8.375%
6. ENRON SETTLEMENT
On December 2, 2001, Enron Corp. and certain subsidiaries, including Enron
North America Corp. ("Enron"), each filed voluntary petitions for relief under
Chapter 11 of Title 11 of the United States Bankruptcy Code. Prior to this date,
the Company had entered into oil and natural gas hedging contracts with Enron,
which were terminated as of December 12, 2001. According to the terms of the
contract, Enron was then liable to the Company for the mark-to-market value of
all contracts outstanding on that date, which totaled $6.6 million.
Additionally, Enron failed to make timely payment of $0.4 million in 2001 hedge
settlements. Due to the uncertainty of future collection of any or all of the
amounts owed to us by Enron, the Company fully reserved this receivable at
December 31, 2001. During the first quarter of 2003, due to continued
uncertainty of any ultimate collection and continuing legal fees, the Company
sold its entire Enron receivable to a third party for $490,000. As the
receivable was fully reserved, this amount was recorded as a gain in the first
quarter 2003 and included in `Other operating' in the consolidated statement of
operations. The Company no longer has any claims outstanding with Enron and
accordingly has eliminated its previously recorded $7 million receivable and
related allowance for doubtful accounts from the accompanying consolidated
balance sheet.
7. FINANCIAL STATEMENTS OF SUBSIDIARY GUARANTORS
All of the Company's subsidiaries are currently subsidiary guarantors of the
Notes. Since (i) each subsidiary guarantor is 100% owned by the Company, (ii)
the Company has no assets or operations that are independent of its
subsidiaries, (iii) the subsidiary guarantees are full and unconditional and
joint and several and (iv) all of the Company's subsidiaries are subsidiary
guarantors, the Company has not included the financial statements of each
subsidiary in this report. The subsidiary guarantors may without restriction
transfer funds to the Company in the form of cash dividends, loans and advances.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This document contains forward-looking statements that involve risks and
uncertainties that are made pursuant to the Safe Harbor Provisions of the
Private Securities Litigation Reform Act of 1995. Actual results may differ
materially from those anticipated in our forward-looking statements due to many
factors, including, but not limited to, those set forth under "SPECIAL NOTE
REGARDING FORWARD-LOOKING STATEMENTS" contained in Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations, in
Encore's 2002 Annual Report filed on Form 10-K. The following discussion should
be read in conjunction with the consolidated financial statements and notes
thereto included in this document and Encore's 2002 Form 10-K.
DESCRIPTION OF CRITICAL ACCOUNTING POLICIES
The information included in "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Description of Critical
Accounting Policies" in Encore's 2002 Annual Report filed on Form 10-K is
incorporated herein by reference. There have been no material changes to our
accounting policies during the current quarter with the exception of the
adoption of SFAS 143 discussed in Note 3 to the accompanying financial
statements.
RESULTS OF OPERATIONS
The following table sets forth operating information of Encore for the
periods presented:
THREE MONTHS ENDED
MARCH 31,
-------------------- INCREASE
2003 2002 (DECREASE)
---- ---- ---------
Operating Results (in thousands):
Oil and natural gas revenues.................. $ 55,787 $ 32,297 $ 23,490
Lease operations.............................. 8,953 6,817 2,136
Production, ad valorem and severance taxes.... 6,169 3,013 3,156
Daily production:
Oil volumes (Bbls)............................ 18,509 15,500 3,009
Natural gas volumes (Mcf)..................... 21,475 23,967 (2,492)
Combined volumes (BOE)........................ 22,088 19,494 2,594
Average prices (net of hedging):
Oil (per Bbl)................................. $ 27.87 $ 19.13 $ 8.74
Natural gas (per Mcf)......................... 4.84 2.60 2.24
Combined volumes (per BOE).................... 28.06 18.41 9.65
Average costs (per BOE):
Lease operations.............................. $ 4.50 $ 3.89 $ 0.61
Production, ad valorem and severance taxes.... 3.10 1.72 1.38
G&A (excluding non-cash stock based
compensation)............................... 1.23 0.85 0.38
DD&A.......................................... 3.92 4.88 (0.96)
11
COMPARISON OF QUARTER ENDED MARCH 31, 2003 TO QUARTER ENDED MARCH 31, 2002
Set forth below is our comparison of operations during the first quarter of
2003 with the first quarter of 2002.
REVENUES AND PRODUCTION. Oil and natural gas revenues of Encore for the
first quarter of 2003 increased as compared to 2002 by $23.5 million, from $32.3
million to $55.8 million. The following table illustrates the primary components
of oil and natural gas revenue for the quarters ended March 31, 2003 and 2002,
as well as each quarter's respective oil and natural gas volumes (in thousands,
except per unit amounts):
THREE MONTHS ENDED MARCH 31,
2003 2002 DIFFERENCE
-------------------- -------------------- --------------------
REVENUES: Revenue $/Unit Revenue $/Unit Revenue $/Unit
--------- ------ --------- ------ --------- ------
Oil wellhead.............. $ 52,214 $ 31.34 $ 26,215 $ 18.79 $ 25,999 $ 12.55
Oil hedges................ (5,882) (3.53) (235) (0.17) (5,647) (3.36)
Enron hedges.............. 100 0.06 706 0.51 (606) (0.45)
--------- -------- --------- -------- -------- --------
Total Oil Revenues... $ 46,432 $ 27.87 $ 26,686 $ 19.13 $ 19,746 $ 8.74
========= ======== ========= ======== ======== ========
Natural gas wellhead...... $ 10,312 $ 5.34 $ 4,761 $ 2.21 $ 5,551 $ 3.13
Gas hedges................ (962) (0.50) 452 0.21 (1,414) (0.71)
Enron hedges.............. 5 -- 398 0.18 (393) (0.18)
--------- -------- --------- -------- -------- --------
Total Gas Revenues... $ 9,355 $ 4.84 $ 5,611 $ 2.60 $ 3,744 $ 2.24
========= ======== ========= ======== ======== ========
NYMEX NYMEX NYMEX
OTHER DATA: Production $/Unit Production $/Unit Production $/Unit
---------- ------ ---------- -------- ---------- --------
Oil (Bbls)................ 1,666 $ 33.86 1,395 $ 21.64 271 $ 12.22
Gas (Mcf)................. 1,933 5.91 2,157 2.49 (224) 3.42
Total oil revenues increased $19.7 million from the first quarter of 2002 to
the first quarter of 2003. This is primarily due to the 67% increase in wellhead
price received over the same period last year. This increase follows general
market conditions during which the average NYMEX price increased from $21.64 to
$33.86 per barrel. Oil volumes also increased, from 1,395 MBbls in the first
three months of 2002 to 1,666 MBbls for the same period of 2003. This was the
result of the Company's successful development drilling program and the Paradox
Basin acquisition completed in the third quarter of 2002. The increase in
wellhead oil revenues was partially offset by an increase in payments made for
hedging, which increased $5.6 million. The increase in hedging payments resulted
from the increase in the average NYMEX price for oil.
Natural gas revenues increased $3.7 million due to a $3.13 per Mcf increase
in the wellhead price received, which was partially offset by a 224 MMcf
decrease in production, as well as net hedging payments in the first quarter of
2003 versus net hedging receipts in the first quarter of 2002. The wellhead
price increase is consistent with overall market conditions, which are reflected
in an increase in the NYMEX price from $2.49 to $5.91 per Mcf over the same
period last year. The decrease in production is due to natural decline in our
Crockett County properties. The $1.4 million unfavorable change in hedge
settlements is a result of the increase in gas prices from the first quarter of
2002 to the first quarter of 2003.
LEASE OPERATIONS. Encore's lease operations expense for the first quarter of
2003 increased as compared to the first quarter of 2002 by $2.1 million. The
increase in lease operations expense is primarily attributable to increased
production in 2003 and increased expense per BOE. On a per BOE basis, lease
operations expense increased from $3.89 to $4.50 due to production from the
Paradox Basin properties, which have higher per BOE operating costs than the
Company's historical average per BOE lease operations expense, as well as higher
electricity costs on our Permian and CCA properties. This increase was lower
than expected, however, due to higher production volumes and a reduced level of
maintenance in the CCA.
PRODUCTION, AD VALOREM, AND SEVERANCE TAXES. Production, ad valorem, and
severance taxes for the first quarter of 2003 increased as compared to the first
quarter of 2002 by approximately $3.2 million, from $3.0 million to $6.2
million. The increase in production, ad valorem, and severance taxes was a
result of the substantially higher commodity prices in the first quarter of 2003
as compared to the first quarter of 2002. As a percent of oil and natural gas
revenues (excluding the effects of hedges), production, ad valorem and severance
taxes increased slightly, up to 9.9% from 9.7% in the first quarter of 2002. The
effect of hedges are excluded from oil and natural gas revenues in the
calculation of the previous percentages because this more closely reflects the
method used to calculate actual production, ad valorem, and severance taxes paid
to taxing authorities.
12
DEPLETION, DEPRECIATION, AND AMORTIZATION (DD&A) EXPENSE. DD&A expense for
the first quarter of 2003 decreased by $0.8 million as compared to the first
quarter of 2002, reflecting a decrease in our DD&A rate. The DD&A rate in the
first quarter of 2003 of $3.92 per BOE represents a decrease of $0.96 per BOE
from the $4.88 per BOE recorded in the first quarter of 2002. The decrease is a
result of an increase in reserves and the adoption of SFAS 143 on January 1,
2003 (see Note 3). Historically, consistent with industry practice, the Company
assumed salvage value would be offset by plugging and abandonment expenses.
However, upon the adoption of SFAS 143, the Company began subtracting the
estimated salvage value of its equipment from its depreciable base in its DD&A
calculation, thus lowering its per BOE rate.
GENERAL AND ADMINISTRATIVE (G&A) EXPENSE. G&A expense increased $1.0 million
in the first quarter of 2003 as compared to the first quarter of 2002, from $1.5
million to $2.5 million (excluding non-cash stock based compensation of $0.1
million in the first quarter of 2003). The rise in G&A was a result of increased
staffing levels and non-recurring consulting services. On a per BOE basis, G&A
increased to $1.23 in the first quarter of 2003 from $0.85 during the first
quarter of 2002.
INTEREST EXPENSE. Interest expense for the quarter ended March 31, 2003 was
$4.2 million compared to $1.5 million for the quarter ended March 31, 2002. The
increase in interest expense is due to higher debt levels, a higher interest
rate on our Notes as compared to our previous credit facility, and higher
expense due to hedges. Interest expense related to hedges for the three months
ended March 31, 2003 reflected in the table below represents the amortization of
a mark-to-market loss on our interest rate hedges recorded in conjunction with
the issuance of the Notes in the second quarter of 2002 (See Note 5). The
weighted average interest rate, including hedges, for the first quarter of 2003
was 10.2% compared to 4.7% for the first quarter of 2002.
THREE MONTHS ENDED MARCH 31,
(IN THOUSANDS) 2003 2002 DIFFERENCE
---- ---- ----------
Credit facility.................. $ 102 $ 985 $ (883)
8 3/8% notes due 2012............ 3,141 -- 3,141
Interest rate hedges............. 654 458 196
Banking fees and other........... 274 49 225
---------- ---------- -----------
Total.................. $ 4,171 $ 1,492 $ 2,679
========== ========== ===========
LIQUIDITY AND CAPITAL RESOURCES
Principal uses of capital have been for the acquisition and development of
oil and natural gas properties.
Cash Flow
During the quarter ended March 31, 2003, net cash provided by operations was
$25.7 million, an increase of $8.5 million compared to the quarter ended March
31, 2002. This increase is a result of higher oil and natural gas prices and
higher oil production. Cash used by investing activities decreased from $71.1
million to $23.1 million over the same period, primarily due to the Central
Permian acquisition in the first quarter of 2002 with no similar acquisition in
the first quarter of 2003. Cash used by financing activities was $7.3 million in
the first three months of 2003, as compared to cash provided by financing
activities of $53.9 million in the first three months of 2002. The decrease is
primarily attributable to borrowings used to fund the Central Permian
acquisition in 2002, while high commodity prices allowed us to repay $8.0
million under our credit facility during the first quarter of 2003.
Capitalization
At March 31, 2003, Encore had total assets of $572.9 million. Total
capitalization was $474.3 million, of which 66.7% was represented by
stockholders' equity and 33.3% by debt. The following table details the
components of the Company's total capitalization at March 31, 2003 (in
thousands):
MARCH 31,
2003
---------
Long-term debt.................... $ 158,000
Total stockholder's equity........ 316,259
----------
Total capitalization.............. $ 474,259
==========
Debt Maturities
13
Of our $158.0 million debt balance at March 31, 2003, $150.0 represents our
Notes maturing on June 15, 2012. The remaining $8.0 million is outstanding under
our revolving credit facility, from which the total amount available to us is
$220.0. The maturity date of the facility is June 25, 2006.
Future Capital Requirements
In April 2003, the Board of Directors approved an increase to Encore's 2003
capital budget in the amount of $20.0 million to begin the second phase of the
high-pressure air injection ("HPAI") tertiary recovery project in the CCA. This,
when added to the previously announced $105.0 million capital budget, will give
the Company a capital budget of $125.0 million for 2003.
We anticipate that our capital expenditures will total approximately $30.0
million for the second quarter of 2003. The level of these and other future
expenditures and the amount of funds devoted to any particular activity may
increase or decrease significantly, depending on available opportunities and
market conditions. We plan to finance our ongoing development and acquisition
expenditures using internally generated cash flow, available cash, and our
existing credit facility.
The Company believes that its capital resources from internally generated
cash flows and funds available under the credit facility are adequate to meet
the requirements of its business through 2004. Based on our anticipated capital
investment programs, we expect to invest our internally generated cash flow to
replace production volumes and enhance our waterflood programs. Additional
capital may be required to pursue acquisitions and longer-term capital projects,
such as our HPAI program, to increase our reserve base. Substantially all of
these expenditures are discretionary and will be undertaken only if funds are
available and the projected rates of return are satisfactory. Future cash flows
are subject to a number of variables, including the level of oil and natural gas
production volumes and prices. Operations and other capital resources may not
provide cash in sufficient amounts to maintain planned levels of capital
expenditures.
The following table illustrates the Company's contractual obligations
outstanding at March 31, 2003 (in thousands):
PAYMENTS DUE BY PERIOD
CONTRACTUAL OBLIGATIONS TOTAL 2003 2004 - 2005 2006 - 2007 THEREAFTER
- ------------------------ ----- --------- ----------- ----------- ----------
8 3/8% Notes.............. $ 150,000 $ -- $ -- $ -- $ 150,000
Revolving Credit Facility.. 8,000 -- -- 8,000 --
Operating Leases........... 3,561 719 1,938 691 213
---------- --------- ---------- ---------- ----------
Totals..................... $ 161,561 $ 719 $ 1,938 $ 8,691 $ 150,213
========== ========= ========== ========== ==========
INFLATION AND CHANGES IN PRICES
While the general level of inflation affects certain of our costs, factors
unique to the petroleum industry result in independent price fluctuations.
Historically, significant fluctuations have occurred in oil and natural gas
prices. In addition, changing prices often cause costs of equipment and supplies
to vary as industry activity levels increase and decrease to reflect perceptions
of future price levels. Although it is difficult to estimate future prices of
oil and natural gas, price fluctuations have had, and will continue to have, a
material effect on us.
The following table indicates the average oil and natural gas prices
received for the quarter ended March 31, 2003 and 2002. Average equivalent
prices for 2003 and 2002 were decreased by $3.39 and increased by $0.75 per BOE,
respectively, as a result of our hedging activities (including amortization of
the gain on our discontinued Enron hedges). Average prices per equivalent barrel
indicate the composite impact of changes in oil and natural gas prices. Natural
gas production is converted to oil equivalents at the conversion rate of six Mcf
per Bbl.
OIL NATURAL GAS EQUIV. OIL
(PER BBL) (PER MCF) (PER BOE)
--------- --------- ---------
NET PRICE REALIZATION WITH HEDGES
Quarter ended March 31, 2003.......... $ 27.87 $ 4.84 $ 28.06
Quarter ended March 31, 2002.......... 19.13 2.60 18.40
NET PRICE REALIZATION WITHOUT HEDGES
Quarter ended March 31, 2003.......... $ 31.34 $ 5.34 $ 31.45
Quarter ended March 31, 2002.......... 18.79 2.21 17.65
14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information included in "Quantitative and Qualitative Disclosures About
Market Risk" in Encore's 2002 Annual Report filed on Form 10-K is incorporated
herein by reference. Such information includes a description of Encore's
potential exposure to market risks, including commodity price risk and interest
rate risk. Encore's open commodity positions as of March 31, 2003 are presented
in Note 5 to the accompanying financial statements. The fair value of our open
commodity and interest rate hedges is ($0.5) million as of March 31, 2003.
Subsequent to the first quarter of 2003, we entered into additional oil
hedges. Through May 2, 2003, we entered into floors covering 2,000 Bbls per day
at an average strike price of $21.75 for the first six months of 2004.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Within 90 days prior
to the filing date of this Report, the Company's principal executive officer
("CEO") and principal financial officer ("CFO") carried out an evaluation of the
effectiveness of the Company's disclosure controls and procedures. Based on
those evaluations, the Company's CEO and CFO believe (i) that the Company's
disclosure controls and procedures are designed to ensure that information
required to be disclosed by the Company 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 the Company's management,
including the CEO and CFO, as appropriate to allow timely decisions regarding
required disclosure; and (ii) that the Company's disclosure controls and
procedures are effective.
(b) Changes in internal controls. There have been no significant changes in
the Company's internal controls or in other factors that could significantly
affect the Company's internal controls subsequent to the evaluation referred to
in Item 4. (a), above, nor have there been any corrective actions with regard to
significant deficiencies or material weaknesses.
15
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
3.1 Second Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the fiscal quarter ended September 30,
2001, filed with the SEC on November 7, 2001).
3.2 Second Amended and Restated Bylaws of the Company (incorporated by
reference to the Company's Quarterly Report on Form 10-Q for the
fiscal quarter ended September 30, 2001, filed with the SEC on
November 7, 2001).
**10.1 Employee Severance Protection Plan
**10.2 Form of Restricted Stock Award - Executive
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
** Management compensatory plan or contract
Reports on Form 8-K
During the three months ended March 31, 2003, the Company filed with
the SEC current reports on Form 8-K on February 3, February 13, and March 27.
The Company's February 3, 2003 Form 8-K included as an exhibit a press
release announcing year end 2002 reserves, production, and finding and
development costs.
The Company's February 13, 2003 Form 8-K included as an exhibit a press
release announcing full year and fourth quarter 2002 results.
The Company's March 27, 2003 Form 8-K filing includes as an exhibit a press
release announcing resignation of Gene R. Carlson, Executive Vice President and
Chief Operating Officer.
16
SIGNATURES
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.
ENCORE ACQUISITION COMPANY
Date: May 7, 2003 By: /s/ Morris B. Smith
--------------------------------------
Morris B. Smith
Chief Financial Officer, Treasurer,
Executive Vice President,
Secretary and Principal Financial Officer
Date: May 7, 2003 By: /s/ Robert C. Reeves
--------------------------------------
Robert C. Reeves
Vice President, Controller and Principal
Accounting Officer
17
CERTIFICATIONS
I, I. Jon Brumley, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Encore Acquisition
Company:
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of circumstances under which such statements were
made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 7, 2003 By: /s/ I. Jon Brumley
--------------------------------------
I. Jon Brumley
Chairman and Chief Executive Officer
18
I, Morris B. Smith, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Encore Acquisition
Company:
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of circumstances under which such statements were
made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 7, 2003 By: /s/ Morris B. Smith
--------------------------------------
Morris B. Smith
Chief Financial Officer, Treasurer,
Executive Vice President and Secretary
19
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
10.1 Employee Severance Protection Plan
10.2 Form of Restricted Stock Award - Executive
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
20