ITEM 1. BUSINESS
OVERVIEW
Titan Exploration, Inc. (the "Company") is an independent energy company engaged in the exploration, development and acquisition of oil and gas properties. Since its inception in March 1995, the Company has experienced significant growth in reserves, production and cash flow by acquiring and exploiting producing properties primarily in the Permian Basin of west Texas and southeastern New Mexico, the Gulf Coast region and the Gulf of Mexico.
In December 1995, the Company acquired a concentrated group of Permian Basin producing oil and gas properties from a large independent company for approximately $40.6 million (the "1995 Acquisition"). On October 31, 1996, the Company acquired additional Permian Basin producing properties from a major integrated company for approximately $135.7 million (the "1996 Acquisition"). In December 1996, the Company completed an initial public offering of 14,391,500 shares of Common Stock of the Company at $11.00 per share, resulting in net proceeds of $147.2 million. The shares are traded on the Nasdaq National Market under the symbol "TEXP." The proceeds were used to repay bank debt.
In December 1997, the Company issued 5,486,734 shares of Common Stock in connection with its acquisition of all of the issued and outstanding shares of common stock of Offshore Energy Development Corporation ("OEDC"), an independent energy company that focuses on the acquisition, exploration, development and production of natural gas and on natural gas gathering, processing and marketing activities (the "OEDC Acquisition"). OEDC's integrated operations are conducted in the Gulf of Mexico, where OEDC has interests in 24 lease blocks, all of which are operated by OEDC.
In December 1997, the Company issued 899,965 shares of Common Stock in connection with its acquisition of all of the issued and outstanding units of membership interests in Carrollton Resources, L.L.C., a small independent energy company engaged in the exploration, development and acquisition of onshore oil and gas properties located primarily in the Gulf Coast region (the "Carrollton Acquisition").
In December 1997, the Company completed the acquisition of certain oil and gas producing properties from Pioneer Natural Resources USA, Inc., a wholly-owned subsidiary of Pioneer Natural Resources Company ("Pioneer"), for approximately $54.4 million (the "Pioneer Acquisition").
As of December 31, 1997, the Company had estimated net proved reserves of approximately 30.3 MMBbls of oil and 345.4 Bcf of natural gas, or an aggregate of 527.0 Bcfe with a PV-10 of $435 million. Approximately 68% of these reserves were classified as proved developed. The Company acquired, explored for and developed its reserves for an average reserve replacement cost of approximately $.65 per Mcfe from inception of the Company through December 31, 1997.
The Company prefers to acquire properties over which it can exercise operating control. The Company operated 797 gross productive wells (710 net productive wells) at December 31, 1997, and these operated properties represented approximately 84% of its proved developed producing PV-10 and 82% of the Company's PV-10 attributable to proved reserves at December 31, 1997. The Company's emphasis on controlling the operation of its properties enables the Company to better manage expenses, capital allocation and other aspects of development and exploration.
The Company's proved oil and gas properties are located in approximately 100 fields in the Permian Basin and in 24 lease blocks in the Gulf of Mexico and, to a lesser extent, in North and South Louisiana. Approximately 61% of the Company's PV-10 of total proved reserves is concentrated in 12 principal fields located in the Permian Basin. The
Permian Basin is characterized by complex geology with numerous known producing horizons and provides significant opportunities to increase reserves, production and ultimate recoveries through development, exploratory and horizontal drilling, recompletions, secondary and tertiary recovery methods, and use of 3-D seismic and other advanced technologies.
The Company's strategy is to grow reserves, production and net income per share through (i) the acquisition of producing properties that provide development and exploratory drilling potential, (ii) the exploitation and development of its reserve base, (iii) the exploration for oil and gas reserves and (iv) the implementation and maintenance of a low operating and overhead cost structure.
The Company was formed in 1996 for the purpose of becoming the holding company for Titan Resources, L.P. ("TRLP") pursuant to the terms of an exchange agreement dated September 30, 1996. TRLP was formed in March 1995 and grew primarily through acquisitions of oil and gas properties and the exploitation of those properties. Under the exchange agreement, effective September 30, 1996, (i) the limited partners of TRLP transferred all their limited partnership interests to the Company in exchange for an aggregate of 19,318,199 shares of Common Stock, and (ii) the shareholders of Titan Resources I, Inc., a Texas corporation that is the general partner of TRLP, transferred all the issued and outstanding stock of that corporation to the Company in exchange for an aggregate of 231,814 shares of Common Stock. These transactions are referred to as the "Conversion." As a result of the Conversion, Titan Exploration, Inc. owns, directly or indirectly, all the partnership interests in TRLP and conducts its active business operations through TRLP. References to the "Company" are to Titan Exploration, Inc. and its predecessors and subsidiaries, including TRLP.
The Company is incorporated in the State of Delaware, its principal executive offices are located at 500 West Texas, Suite 500, Midland, Texas 79701, and its telephone number is 915/498-8600.
ACQUISITIONS
The Company regularly pursues and evaluates acquisition opportunities (including opportunities to acquire oil and gas properties or related assets or entities owning oil and gas properties or related assets and opportunities to engage in mergers, consolidations or other business combinations with entities owning oil and gas properties or related assets) and at any given time may be in various stages of evaluating these opportunities. These stages may take the form of internal financial and oil and gas property analysis, preliminary due diligence, the submission of an indication of interest, preliminary negotiations, negotiation of a letter of intent, or negotiation of a definitive agreement. While the Company is currently evaluating a number of potential acquisition opportunities (some of which would be material in size to the Company), it has not signed a letter of intent with respect to any material acquisition and currently has no assurance of completing any particular material acquisition or of entering into negotiations with respect to any particular material acquisition.
OIL AND GAS MARKETING AND MAJOR CUSTOMERS
The revenues generated by the Company's operations are highly dependent upon the prices of, and demand for, oil and gas. The price received by the Company for its oil and gas production depends on numerous factors beyond the Company's control, including seasonality, the condition of the United States and world economy, particularly the manufacturing sector, foreign imports, political and economic conditions in other oil-producing and gas-producing countries, the actions of OPEC and domestic government regulation, legislation and policies. Decreases in the prices of oil and natural gas could have a material adverse effect on the carrying value of the Company's proved reserves and the Company's revenues, profitability and cash flow. Although the Company is not currently experiencing any significant involuntary curtailment of its oil or gas production, market, economic and regulatory factors may in the future materially affect the Company's ability to sell its oil or gas production.
For the year ended December 31, 1997, sales to Enron Corp., and its subsidiaries and affiliates, and Western Gas Resources, Inc. were approximately 36% and 12% of the Company's oil and gas revenues, respectively.
Due to the availability of other markets and pipeline connections, the Company does not believe that the loss of any single crude oil or gas customer would have a material adverse effect on the Company's results of operations.
COMPETITION
The oil and gas industry is highly competitive. The Company encounters competition from other oil and gas companies in all areas of its operations, including the acquisition of producing properties. The Company's competitors include major integrated oil and gas companies and numerous independent oil and gas companies, individuals and drilling and income programs. Many of its competitors are large, well established companies with substantially larger operating staffs and greater capital resources than the Company and which, in many instances, have been engaged in the energy business for a much longer time than the Company. Such companies may be able to pay more for productive oil and gas properties and exploratory prospects and to define, evaluate, bid for and purchase a greater number of properties and prospects than the Company's financial or human resources permit. The Company's ability to acquire additional properties and to discover reserves in the future will be dependent upon its ability to evaluate and select suitable properties and to consummate transactions in a highly competitive environment.
OPERATING HAZARDS AND UNINSURED RISKS
Drilling activities are subject to many risks, including the risk that no commercially productive reservoirs will be encountered. There can be no assurance that new wells drilled by the Company will be productive or that the Company will recover all or any portion of its investment. Drilling for oil and gas may involve unprofitable efforts, not only from dry wells, but from wells that are productive but do not produce sufficient net revenues to return a profit after drilling, operating and other costs. The cost of drilling, completing and operating wells is often uncertain. The Company's drilling operations may be curtailed, delayed or canceled as a result of numerous factors, many of which are beyond the Company's control, including title problems, weather conditions, mechanical problems, compliance with governmental requirements and shortages or delays in the delivery of equipment and services. The Company's future drilling activities may not be successful and, if unsuccessful, such failure may have a material adverse effect on the Company's future results of operations and financial condition.
In addition, the Company's use of 3-D seismic requires greater pre-drilling expenditures than traditional drilling strategies. Although the Company believes that its use of 3-D seismic will increase the probability of success of its exploratory wells and should reduce average finding costs through the elimination of prospects that might otherwise be drilled solely on the basis of 2-D seismic data and other traditional methods, unsuccessful wells are likely to occur. There can be no assurance that the Company's drilling program will be successful or that unsuccessful drilling efforts will not have a material adverse effect on the Company. Although the Company has identified numerous potential drilling locations, there can be no assurance that they will ever be drilled or that oil or gas will be produced from them.
The Company's operations are subject to hazards and risks inherent in drilling for and producing and transporting oil and gas, such as fires, natural disasters, explosions, encountering formations with abnormal pressures, blowouts, cratering, pipeline ruptures and spills, any of which can result in the loss of hydrocarbons, environmental pollution, personal injury claims and other damage to properties of the Company and others. The Company's offshore operations are also subject to the additional hazards of marine operations such as severe weather, capsizing and collision.
The Company expects to drill a number of deep vertical and horizontal wells in the future. The Company's deep and/or horizontal drilling activities involve greater risk of mechanical problems than other drilling operations. These wells may be significantly more expensive to drill than those drilled to date.
The Company maintains insurance against some, but not all, of the risks described above. The Company may elect to self-insure in circumstances in which management believes that the cost of insurance, although available, is excessive relative to the risks presented. The occurrence of an event that is not covered, or not fully covered, by insurance could have a material adverse effect on the Company's financial condition and results of operations.
EMPLOYEES
As of December 31, 1997, the Company had 94 full-time employees, none of whom is represented by a labor union. Included in the total were 29 administrative employees located in the Company's office in Midland, Texas, eight of whom are involved in the management of the Company. The Company considers its relations with its employees to be good.
OTHER FACILITIES
The Company currently leases approximately 44,270 square feet of office space in Midland, Texas, where its principal offices are located. This office lease is with an affiliate of Jack Hightower. The Company's principal offices are leased through March 15, 2002. The Company currently leases approximately 8,433 and 3,420 square feet of office space in The Woodlands, Texas and Baton Rouge, Louisiana, respectively, where division offices are located.
TITLE TO PROPERTIES
The Company received title opinions relating to properties representing 80% of the PV-10 of the 1995 Acquisition, 90% of the PV-10 of the 1996 Acquisition and 54% of the PV-10 of the Pioneer Acquisition. The Company's land department and contract land professionals have reviewed title records of substantially all its producing properties. The title investigation performed by the Company prior to acquiring undeveloped properties is thorough but less rigorous than that conducted prior to drilling, consistent with industry standards. The Company believes it has satisfactory title to all of its producing properties in accordance with standards generally accepted in the oil and gas industry. The Company's properties are subject to customary royalty interests, liens incident to operating agreements, liens for current taxes and other burdens which the Company believes do not materially interfere with the use of or affect the value of such properties. The Company's Credit Agreement is secured by a first lien on properties that represented at least 80% of the value of the Company's proved oil and gas properties (based on PV-10 as of December 31, 1997). Presently, the Company keeps in force its leaseholds for 37% of its net acreage by virtue of production on that acreage in paying quantities. The remaining acreage is held by lease rentals and similar provisions and requires production in paying quantities prior to expiration of various time periods to avoid lease termination.
GOVERNMENTAL REGULATION
The Company's oil and gas exploration, production and related operations are subject to extensive rules and regulations promulgated by federal and state agencies. Failure to comply with such rules and regulations can result in substantial penalties. The regulatory burden on the oil and gas industry increases the Company's cost of doing business and affects its profitability. Although the Company believes it is in substantial compliance with all applicable laws and regulations, because such rules and regulations are frequently amended or reinterpreted, the Company is unable to predict the future cost or impact of complying with such laws. Significant expenditures may be required to comply with governmental laws and regulations and may have a material adverse effect on the Company's financial condition and results of operations.
Such regulation requires permits for drilling operations, drilling bonds and reports concerning operations and imposes other requirements relating to the exploration and production of oil and gas. Such state and federal agencies have statutes or regulations addressing conservation matters, including provisions for the unitization or pooling of oil and gas properties, the establishment of maximum rates of production from wells, and the regulation of spacing, plugging and abandonment of such wells.
The Federal Energy Regulatory Commission ("FERC") regulates interstate natural gas transportation rates and service conditions, which affect the marketing of gas produced by the Company, as well as the revenues received by the Company for sales of such production. Since the mid-1980s, FERC has issued a series of orders, culminating in Order Nos. 636, 636-A and 636-B ("Order 636"), that have significantly altered the marketing and transportation of gas. Order 636 mandated a fundamental restructuring of interstate pipeline sales and transportation service, including the unbundling by interstate pipelines of the sale, transportation, storage and other components of the city-gate sales services such pipelines previously performed. One of FERC's purposes in issuing the orders is to increase competition within all phases of the gas industry. The United States Court of Appeals for the District of Columbia Circuit largely upheld Order 636, and the Supreme Court has declined to hear the appeal. Generally, Order 636 has eliminated or substantially reduced the interstate pipelines' traditional role as wholesalers of natural gas, and has substantially increased competition and volatility in natural gas markets.
The price the Company receives from the sale of oil and natural gas liquids is affected by, among other things, the cost of transporting products to market. Effective January 1, 1995, FERC implemented regulations establishing an indexing system for transportation rates for oil pipelines, which, generally, would index such rates to inflation, subject
to certain conditions and limitations. The Company is not able to predict with certainty the effect, if any, of these regulations on its operations. However, the regulations may increase transportation costs or reduce wellhead prices for oil and natural gas liquids.
ENVIRONMENTAL MATTERS
The Company's operations and properties are subject to extensive and changing federal, state and local laws and regulations relating to environmental protection, including the generation, storage, handling, emission, transportation and discharge of materials into the environment, and relating to safety and health. The recent trend in environmental legislation and regulation generally is toward stricter standards, and this trend will likely continue. These laws and regulations may require the acquisition of a permit or other authorization before construction or drilling commences and for certain other activities; limit or prohibit construction, drilling and other activities on certain lands lying within wilderness and other protected areas; and impose substantial liabilities for pollution resulting from the Company's operations. The permits required for various of the Company's operations are subject to revocation, modification and renewal by issuing authorities. Governmental authorities have the power to enforce compliance with their regulations, and violators are subject to fines or injunction, or both. In the opinion of management, the Company is in substantial compliance with current applicable environmental laws and regulations, and the Company has no material commitments for capital expenditures to comply with existing environmental requirements. Nevertheless, changes in existing environmental laws and regulations or in interpretations thereof could have a significant material impact on the Company, as well as the oil and gas industry in general. CERCLA and comparable state statutes impose strict, joint and several liability on owners and operators of sites and on persons who disposed of or arranged for the disposal of "hazardous substances" found at such sites. It is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. RCRA and comparable state statutes govern the disposal of "solid waste" and "hazardous waste" and authorize the imposition of substantial fines and penalties for noncompliance. Although CERCLA currently excludes petroleum from its definition of "hazardous substance," state laws affecting the Company's operations impose clean-up liability relating to petroleum and petroleum related products. In addition, although RCRA classifies certain oil field wastes as "nonhazardous," such exploration and production wastes could be reclassified as hazardous wastes thereby making such wastes subject to more stringent handling and disposal requirements.
Federal regulations require certain owners or operators of facilities that store or otherwise handle oil, such as the Company, to prepare and implement spill prevention, control countermeasure and response plans relating to the possible discharge of oil into surface waters. The Oil Pollution Act of 1990, as amended ("OPA"), contains numerous requirements relating to the prevention of and response to oil spills into waters of the United States. For onshore facilities that may affect waters of the United States, the OPA requires an operator to demonstrate $10 million in financial responsibility. In addition, the OPA currently requires persons responsible for "offshore facilities" to establish $150 million in financial responsibility to cover environmental cleanup and restoration costs likely to be incurred in connection with an oil spill in the waters of the United States. On September 10, 1996, Congress passed legislation that would lower the financial responsibility requirement under OPA to $35 million, subject to increase to $150 million if a formal risk assessment indicates the increase is warranted. The impact of any legislation is not expected to be any more burdensome to the Company than it will be to other similarly situated companies involved in oil and gas exploration and production.
OPA imposes a variety of additional requirements on "responsible parties" for vessels or oil and gas facilities related to the prevention of oil spills and liability for damages resulting from such spills in waters of the United States. The "responsible parties" include the owner or operator of an onshore facility, pipeline, or vessel or the lessee or permittee of the area in which an offshore facility is located. OPA assigns liability to each responsible party for oil spill removal costs and a variety of public and private damages from oil spills. While liability limits apply in some circumstances, a party cannot take advantage of liability limits if the spill is caused by gross negligence or willful misconduct or resulted from violation of a federal safety, construction or operating regulation. If a party fails to report a spill or to cooperate fully in the cleanup, liability limits likewise do not apply. OPA establishes a liability limit for offshore facilities (including pipelines) of all removal costs plus $75 million. Few defenses exist to the liability for oil spills imposed by OPA. OPA also imposes other requirements on facility operators, such as the preparation of an oil spill contingency plan. Failure to comply with ongoing requirements or inadequate cooperation in a spill event may subject a responsible party to civil or criminal enforcement actions.
In addition, the OCSLA authorizes regulations relating to safety and environmental protection applicable to lessees and permittees operating in the OCS. Specific design and operational standards may apply to OCS vessels, rigs, platforms, pipelines, vehicles and structures. Violations of lease conditions or regulations issued pursuant to OCSLA can result in substantial civil and criminal penalties, as well as potential court injunctions curtailing operations and the cancellation of leases. Such enforcement liabilities can result from either governmental or private prosecution.
The Federal Water Pollution Control Act ("FWPCA") imposes restrictions and strict controls regarding the discharge of produced waters and other oil and gas wastes into navigable waters. Permits must be obtained to discharge pollutants into state and federal waters. The FWPCA and analogous state laws provide for civil, criminal and administrative penalties for any unauthorized discharges of oil and other hazardous substances in reportable quantities and, along with the OPA, may impose substantial potential liability for the costs of removal, remediation and damages. State water discharge regulations and the federal (NPDES) permits prohibit or are expected to prohibit within the next year the discharge of produced water and sand, and some other substances related to the oil and gas industry, into coastal waters. Although the costs to comply with zero discharge mandates under federal or state law may be significant, the entire industry will experience similar costs and the Company believes that these costs will not have a material adverse impact on the Company's financial conditions and operations. Some oil and gas exploration and production facilities are required to obtain permits for their storm water discharges. Costs may be incurred in connection with treatment of wastewater or developing storm water pollution prevention plans.
Regulations are currently being developed under federal and state laws concerning oil pollution prevention and other matters that may impose additional regulatory burdens on the Company. In addition, the Clean Water Act and analogous state laws require permits to be obtained to authorize discharge into surface waters or to construct facilities in wetland areas. With respect to certain of its operations, the Company is required to maintain such permits or meet general permit requirements. The EPA recently adopted regulations concerning discharges of storm water runoff. This program requires covered facilities to obtain individual permits, participate in a group or seek coverage under an EPA general permit. The Company believes that it will be able to obtain, or be included under, such permits, where necessary, and to make minor modifications to existing facilities and operations that would not have a material effect on the Company.
The implementation of new, or the modification of existing, laws or regulations could have a material adverse effect on the Company. The discharge of oil, gas or other pollutants into the air, soil or water may give rise to significant liabilities on the part of the Company to the government and third parties and may require the Company to incur substantial costs of remediation. Moreover, the Company has agreed to indemnify sellers of producing properties purchased in each of its substantial acquisitions against environmental claims associated with such properties. No assurance can be given that existing environmental laws or regulations, as currently interpreted or reinterpreted in the future, or future laws or regulations will not materially adversely affect the Company's results of operations and financial condition or that material indemnity claims will not arise against the Company with respect to properties acquired by the Company.
The Company has acquired leasehold interests in numerous properties that for many years have produced oil and gas. Although the previous owners of these interests may have used operating and disposal practices that were standard in the industry at the time, hydrocarbons or other wastes may have been disposed of or released on or under the properties. In addition, some of the Company's properties are operated by third parties over whom the Company has no control. Notwithstanding the Company's lack of control over properties operated by others, the failure of the operator to comply with applicable environmental regulations may, in certain circumstances, materially adversely impact the Company.
ABANDONMENT COSTS
The Company is responsible for payment of plugging and abandonment costs on the oil and gas properties pro rata to its working interest. Based on its experience, with the exception of its offshore oil and gas properties, the Company anticipates that the ultimate aggregate salvage value of lease and well equipment located on its properties will exceed the costs of abandoning such properties. There can be no assurance, however, that the Company will be successful in avoiding additional expenses in connection with the abandonment of any of its properties. In addition, abandonment costs and their timing may change due to many factors including actual production results, inflation rates and changes in environmental laws and regulations.
ITEM 2.
ITEM 2. PROPERTIES
OIL AND NATURAL GAS RESERVES
The following table summarizes the estimates of the Company's historical net proved reserves as of December 31, 1997 and 1996, and the present values attributable to these reserves at such dates. The reserve and present value data of the Company were prepared by the Company's independent petroleum consultants.
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(a) The present value of future net revenue attributable to the Company's reserves was prepared using prices in effect at the end of the respective periods presented, discounted at 10% per annum on a pre-tax basis. These amounts reflect the effects of the Company's hedging activities.
(b) The Standardized Measure of Discounted Future Net Cash Flows prepared by the Company represents the present value of future net revenues after income taxes discounted at 10%. These amounts reflect the effects of the Company's hedging activities.
In accordance with applicable requirements of the Commission, estimates of the Company's proved reserves and future net revenues are made using sales prices estimated to be in effect as of the date of such reserve estimates and are held constant throughout the life of the properties (except to the extent a contract specifically provides for escalation). The average realized prices for the Company's reserves as of December 31, 1997 were $16.11 per Bbl of oil and $1.83 per Mcf of natural gas, compared to average realized prices for the Company's reserves as of December 31, 1996 of $25.09 per Bbl of oil and $2.70 per Mcf of natural gas.
Estimated quantities of proved reserves and future net revenues therefrom are affected by natural gas prices, which have fluctuated widely in recent years. There are numerous uncertainties inherent in estimating oil and gas reserves and their estimated values, including many factors beyond the control of the producer. The reserve data set forth in this report represents only estimates. Reservoir engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact manner. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. As a result, estimates of different engineers, including those used by the Company, may vary. In addition, estimates of reserves are subject to revision based upon actual production, results of future development and exploration activities, prevailing oil and gas prices, operating costs and other factors, which revisions may be material. Accordingly, reserve estimates are often different from the quantities of oil and gas that are ultimately recovered and are highly dependent upon the accuracy of the assumptions upon which they are based. The Company's estimated proved reserves have not been filed with or included in reports to any federal agency.
Estimates with respect to proved reserves that may be developed and produced in the future are often based upon volumetric calculations and upon analogy to similar types of reserves rather than actual production history. Estimates based on these methods are generally less reliable than those based on actual production history. Subsequent evaluation
of the same reserves based upon production history will result in variations, which may be substantial, in the estimated reserves.
PRODUCTIVE WELLS AND ACREAGE
Productive Wells
The following table sets forth the Company's productive wells as of December 31, 1997:
ACTUAL -------------- GROSS NET ------ ----- Oil................................................... 2,138 767 Gas................................................... 392 115 ------ ----- Total Productive Wells............................. 2,530 882 ====== =====
Productive wells consist of producing wells and wells capable of production, including gas wells awaiting pipeline connections. Wells that are completed in more than one producing horizon are counted as one well.
Acreage Data
Undeveloped acreage includes leased acres on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil and gas, regardless of whether or not such acreage contains proved reserves. A gross acre is an acre in which an interest is owned. A net acre is deemed to exist when the sum of fractional ownership interests in gross acres equals one. The number of net acres is the sum of the fractional interests owned in gross acres expressed as whole numbers and fractions thereof. The following table sets forth the approximate developed and undeveloped acreage in which the Company held a leasehold mineral or other interest as of December 31, 1997.
DEVELOPED ACRES UNDEVELOPED ACRES TOTAL ACRES ---------------- ----------------- ---------------- GROSS NET GROSS NET GROSS NET ------- ------- -------- ------- ------- ------- Total............ 270,662 124,468 427,773 208,645 698,435 333,113
DRILLING ACTIVITIES
The following table sets forth the drilling activity of the Company on its properties for the years ended December 31, 1997 and 1996 and for the period from March 31, 1995 (inception) through December 31, 1995.
YEAR ENDED DECEMBER 31, ------------------------ PERIOD ENDED 1997 1996 DECEMBER 31, 1995 ----------- ---------- ----------------- GROSS NET GROSS NET GROSS NET ----- ---- ----- --- --------- ------ Exploratory Wells Productive....... 2.0 1.0 - - 1.0 0.5 Nonproductive.... 2.0 1.8 1.0 0.2 2.0 1.3 ---- ---- --- --- --- --- Total.......... 4.0 2.8 1.0 0.2 3.0 1.8 ==== ==== === === === === Development Wells Productive....... 48.0 17.2 7.0 3.9 - - Nonproductive.... 6.0 4.5 1.0 0.2 - - ---- ---- --- --- --- --- Total.......... 54.0 21.7 8.0 4.1 - - ==== ==== === === === ===
NET PRODUCTION, UNIT PRICES AND COSTS
The following table presents certain information with respect to oil and gas production, prices and costs attributable to all oil and gas property interests owned by the Company for the years ended December 31, 1997 and 1996 and for the period from March 31, 1995 (inception) through December 31, 1995.
- ---------------------- (a) Reflects results of hedging activities in 1997 and 1996. (b) Includes approximately $.09 and $.22 per Mcfe of production costs primarily attributable to necessary rework operations on the 1995 Acquisition and the 1996 Acquisition for the years ended December 31, 1997 and 1996, respectively.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The following is a brief description of certain litigation to which the Company is subject, as a result of assuming the obligations of OEDC. The Company believes it has meritorious defenses to the claims and intends to vigorously defend against such claims. The Company does not believe that it has a probable and estimable loss with respect to any such litigation in excess of currently provided reserves, if any. If such loss becomes probable and estimable, the amount of any recorded liability could have a material adverse effect on the Company's (i) results of operations for the period in which such liability is recorded, (ii) consolidated financial position as a whole and (iii) liquidity and capital resources. However, the Company does not expect that any such liability will have a material adverse effect on its consolidated financial position as a whole or on its liquidity or capital resources. Due to uncertainties inherent in litigation, no assurance can be given to the ultimate outcome of these matters.
OEDC and certain of its officers and directors, as well as Natural Gas Partners, L.P. ("NGP"), the managing underwriters of OEDC's initial public offering and an analyst from each of the managing underwriters, have been named as defendants in a suit styled Eric Barron and Edward C. Allen, On Behalf of Themselves and all Others Similarly Situated, v. David B. Strassner, Douglas H. Kiesewetter, David R. Albin, Natural Gas Partners, L.P., David Garcia, John J. Myers, Offshore Energy Development Corporation, Morgan Keegan & Company, Inc. and Principal Securities, Inc., which was filed October 20, 1997, in the Texas State District Court of Harris County, Texas, 270th Judicial District. The defendants removed plaintiffs' claims to federal court in the United States Southern District of Texas. Plaintiffs have sought to have the case remanded to the state court. As of March 15, 1998, the federal judge had not decided whether to deny plaintiffs' request for remand. The suit seeks class certification on behalf of certain holders of common stock of OEDC, excluding the defendants and holders related to or affiliated with the defendants. The suit alleges generally that the defendants wrongfully made false or misleading statements or omissions relating to OEDC's business and
prospects in the course of OEDC's initial public offering and subsequent thereto. The suit seeks rescission of sales of common stock of OEDC and unspecified monetary damages, including punitive damages.
OEDC and certain of its officers and directors, as well as NGP, have also been named as defendants in a suit styled John W. Robertson, et al. v. David B. Strassner, Douglas H. Kiesewetter, David R. Albin, Natural Gas Partners, L.P. and Offshore Energy Development Corporation, which was filed February 6, 1998, in the United States Southern District of Texas, Houston Division. This suit mirrors the allegations of the foregoing matter, but adds request for relief under federal securities laws. It, too, seeks certification of a class of certain purchasers of common stock of OEDC. The suit seeks compensatory damages, including rescissory damages, where applicable.
The Company is seeking to consolidate both of these lawsuits, as the Company believes the claims are connected. Plaintiffs in both lawsuits are represented by the same lawyers.
The Company is involved in other various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations or liquidity.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) A special meeting of the stockholders of the Company was held in Midland, Texas, at 10:00 a.m., local time, on December 12, 1997.
(b) The meeting did not involve the election of directors.
(c) A total of 33,945,798 shares of common stock of the Company were outstanding and entitled to vote at the meeting. Stockholders voted on a proposal to approve the Amended and Restated Agreement and Plan of Merger dated November 6, 1997 among the Company, a subsidiary of the Company and OEDC. The results of the voting were as follows:
BROKER FOR AGAINST ABSTAIN NONVOTES ------------ -------- ------- ---------- 30,834,030 11,150 9,800 --
(d) Inapplicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to Instruction 3 to Item 401(b) of the Regulation S-K and General Instruction G(3) to Form 10-K, the following information is included in Part I of this report.
The following table sets forth certain information concerning the executive officers of the Company as of December 31, 1997:
NAME AGE POSITION ---- --- --------
Jack D. Hightower.. 49 President and Chief Executive Officer George G. Staley... 63 Executive Vice President, Exploration Rodney L. Woodard.. 42 Vice President, Engineering Thomas H. Moore.... 53 Vice President, Business Development Dan P. Colwell..... 53 Vice President, Land William K. White... 55 Vice President, Finance and Chief Financial Officer John L. Benfatti... 52 Vice President, Accounting and Controller Susan D. Rowland... 37 Vice President, Administration and Corporate Secretary
Set forth below is a description of the backgrounds of each executive officer of the Company, including employment history for at least the last five years.
Jack D. Hightower has served as President, Chief Executive Officer and Chairman of the Board of Directors of the Company since he founded the Company in March 1995. Prior to forming the Company, from 1986 to January 1996, Mr. Hightower served as Chairman of the Board and Chief Executive Officer of United Oil Services, Inc., a complete oil field service company serving customers in the Permian Basin. From 1978 to 1995, Mr. Hightower served as Chairman of the Board and President of Amber Energy, Inc., a company formed to identify oil and gas exploration prospects. From 1991 to 1994, Mr. Hightower served as Chairman of the Board, Chief Executive Officer and President of Enertex, Inc., which served as the operator of record for several oil and gas properties involving Mr. Hightower and other nonoperators, including Selma International Investment Limited. Since 1990, Mr. Hightower has served on the Board of Directors of Texas Commerce Bank, N.A., Midland.
George G. Staley has served as Executive Vice President, Exploration and Director of the Company since its formation. From 1975 until 1995, Mr. Staley served as President and Chief Executive Officer of Staley Gas Co., Inc. and Staley Operating Co., which are oil and gas exploration and operating companies.
Rodney L. Woodard has served as Vice President, Engineering for the Company since its formation. From 1985 to 1995, Mr. Woodard served as Vice President of Selma International Investment Limited.
Thomas H. Moore has served as Vice President, Business Development of the Company since its formation. From 1992 to 1995, Mr. Moore served as Managing Partner of Magnum Energy Corporation, L.L.C. From 1991 until 1992, Mr. Moore served as Executive Vice President -- Exploration and Production, Chief Operating Officer and Director of Clayton Williams Energy, Inc. From 1985 to 1991, Mr. Moore served as President, Chief Operating Officer and Director of Clayton W. Williams, Jr. Inc.
Dan P. Colwell has served as Vice President, Land for the Company since its formation. From 1993 to 1995, Mr. Colwell served as Vice President of Land for Enertex, Inc. Mr. Colwell was employed by ARCO as Director of Business Development from 1991 to 1993 and Area Land Manager from 1987 to 1991.
William K. White has served as Vice President, Finance and Chief Financial Officer of the Company since September 1996. From 1994 to September 1996, Mr. White was Senior Vice President of the Energy Investment Group of Trust Company of The West. From 1991 to 1994, Mr. White was President of the Odessa Associates, a private firm engaged in the practice of providing financial consulting services to the oil and gas industry.
John L. Benfatti has served as Vice President, Accounting and Controller of the Company since its formation. From 1980 to 1995, Mr. Benfatti served as Controller and Treasurer of Staley Gas Co., Inc.
Susan D. Rowland has served as Vice President, Administration and Corporate Secretary of the Company since its formation. From 1986 to 1996, Ms. Rowland served as a corporate officer and administrative manager of a number of companies, including Amber Energy, Inc., Enertex, Inc., Haley Properties, Inc. and United Oil Services, Inc.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been publicly traded on the Nasdaq National Market under the symbol "TEXP" since the Company's initial public offering effective December 16, 1996. The following table summarizes the high and low last reported sales prices on Nasdaq for each quarterly period since the Company's initial public offering:
COMMON STOCK ---------------- HIGH LOW ------- ------- Fourth Quarter (from December 16, 1996).. $ 12.75 $11.25
First Quarter............................ $ 14.75 $8.125 Second Quarter.............. ............ 12.125 6.75 Third Quarter............................ 13.00 9.50 Fourth Quarter........................... 13.875 8.875
As of March 10, 1998, the Company had 166 registered stockholders and estimates that there were more than 2,000 stockholders (including brokerage firms and other nominees) of the Company's Common Stock.
No dividends have been declared or paid on the Company's Common Stock to date. The Company intends to retain all future earnings for the development of its business.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with "Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company is an independent energy company engaged in the exploration, development and acquisition of oil and gas properties. The Company's strategy is to grow reserves, production and net income per share through (i) the acquisition of producing properties that provide significant development and exploratory drilling potential, (ii) the exploitation and development of its reserve base, (iii) the exploration for oil and gas reserves, (iv) a low operating and overhead structure, and (v) acquiring companies which provide the previously mentioned opportunities. The Company has grown rapidly through the acquisition and exploitation of oil and gas properties, consummating the 1995 Acquisition for a purchase price of approximately $40.6 million, the 1996 Acquisition for approximately $135.7 million and the Pioneer Acquisition for approximately $54.4 million. In addition, the Company issued 5,486,734 shares and 899,965 shares of the Company's common stock in connection with the OEDC acquisition and the Carrollton acquisition, respectively.
The Company's growth from acquisitions has impacted its financial results in a number of ways. Acquired properties may not have received focused attention prior to sale. After acquisition, certain of these properties required extensive maintenance, workovers, recompletions and other remedial activity that while not constituting capital expenditures may initially increase lease operating expenses. The Company may dispose of certain of the properties it determines are outside the Company's strategic focus. The increased production and revenue resulting from the rapid growth of the Company has required it to recruit and develop operating, accounting and administrative personnel compatible with its increased size. As a result, the Company has incurred and anticipates future increases in its general and administrative expense levels. The Company believes that with its current inventory of drilling locations and the anticipated additional staff it will be well positioned to follow a more balanced program of exploration and exploitation activities to complement its acquisition efforts.
Titan uses the successful efforts method of accounting for its oil and gas producing activities. Costs to acquire mineral interests in oil and gas properties, to drill
and equip exploratory wells that result in proved reserves, and to drill and equip development wells are capitalized. Costs to drill exploratory wells that do not result in proved reserves, and geological and geophysical costs are expensed. Costs of significant nonproducing properties, wells in the process of being drilled and significant development projects are excluded from depletion until such time as the related project is developed and proved reserves are established or impairment is determined.
The Company's predecessor was classified as a partnership for federal income tax purposes. Therefore, no income taxes were paid by the Company prior to the Conversion. Future tax amounts, if any, will be dependent upon several factors, including, but not limited to, the Company's results of operations.
IMPACT OF DECLINING CRUDE OIL PRICES
During the quarter ended December 31, 1997, the posted price of West Texas intermediate crude oil (the "West Texas Crude Oil Price") fell from prices in excess of $20 per barrel to prices of less than $17 per barrel. From December 31, 1997 through March 10, 1998, the West Texas Crude Oil Price ranged from $15.50 to $12.00 per barrel. This decline in prices is thought to be caused primarily by an oversupply of crude oil inventory created, in part, by an unusually warm winter in the United States and Europe, an announced increase in crude oil production quotas for OPEC countries and a possible decline in demand in certain Asian markets.
If such a decline in the West Texas Crude Oil Price worsens or persists for a protracted period, it could adversely affect the Company's revenues, net income and cash flows from operations. Also, if these prices maintain their present level for an extended time period or decline further the Company may delay or postpone certain of its capital projects.
If the posted price for West Texas Crude Oil Price remains at current levels or continues to decline, the Company would expect that it may be required to record an additional impairment of its oil and gas properties in 1998. The extent of an impairment, if any, cannot be determined.
YEAR 2000 ISSUES
The Company has reviewed the effect of the year 2000 issues relating to its information systems. The Company has determined that the year 2000 issues directly related to its information systems will not have a material impact on its business, operations nor its financial position. However, the Company cannot determine what effect, if any, the year 2000 issues affecting its vendors, customers, other businesses and the numerous local, state, federal and other U.S. and foreign governmental entities with which it conducts business or which it is regulated or governed or taxed will have on its business or financial position.
OPERATING DATA
The following sets forth the Company's historical operating data for the periods indicated:
- ----------------------- (a) Reflects results of hedging activities.
RESULTS OF OPERATIONS
The financial statements of the Company, which began operations on March 31, 1995, include the results of the years ended December 31, 1997 and 1996, and the nine months ended December 31, 1995. As a result of the Company's limited operating history and rapid growth, its financial statements are not readily comparable and may not be indicative of future results. The OEDC Acquisition, the Carrollton Acquisition and the Pioneer Acquisition did not contribute to the 1997 operating results of the Company as the transactions did not close until the end of December 1997.
Year Ended December 31, 1997
For the year ended December 31, 1997, the Company's revenues from the sale of oil and gas (excluding the effects of hedging activities) were $34.6 million and $38.7 million, respectively. During the year, the Company produced 1,880 MBbls of oil and 22,104 MMcf of gas, with total oil and gas production of 33,385 MMcfe. The revenues and production are primarily attributable to the 1995 Acquisition, the 1996 Acquisition, and the continued exploitation of the Company's proved properties.
As a result of hedging activities in the year ended December 31, 1997, oil revenues were increased $551,000 ($.29 per Bbl) and gas revenues were reduced $62,000 ($.003 per Mcf) for a total increase of $489,000.
Oil and gas production costs, including production taxes, were $21.8 million ($.65 per Mcfe) for the year ended December 31, 1997. These costs included $2.8 million ($.09 per Mcfe) of rework expenses primarily related to the 1995 Acquisition and 1996 Acquisition.
Exploration and abandonment costs were $3.1 million for the year ended December 31,1997. The costs primarily relate to $1.4 million for the acquisition of seismic data and $1.1 million related to unsuccessful exploratory projects.
General and administrative expenses were $5.4 million ($.16 per Mcfe) for the year ended December 31, 1997. The Company expects its 1998 general and administrative expenses to increase primarily as the result of the OEDC Acquisition and Carrollton Acquisition.
For the year ended December 1997, depletion, depreciation and amortization expense was $20.0 million ($.60 per Mcfe). This represents a full year of depletion relating to production for the 1996 Acquisition and depletion related to the exploitation and development expenditures.
For the year ended December 31, 1997, the Company recognized a pretax impairment related to its long-lived assets of approximately $69 million. The impairment is primarily the result of (i) significantly lower commodity prices as compared to the economics on which the Company acquired certain properties and (ii) downward adjustments of initially expected reserves on acquired and developed properties.
Interest expense was $1,524,000 for the year ended December 31, 1997. The interest expense was attributable to bank financing incurred to fund capital expenditures.
Year Ended December 31, 1996
For the year ended December 31, 1996, the Company's revenues from the sale of oil and gas (excluding the effects of hedging activities) were $15.1 million and $11.1 million, respectively. Of total gross oil and gas revenues, $16.2 million and $9.5 million are attributable to the 1995 Acquisition and the 1996 Acquisition, respectively. During the year, the Company produced 714 MBbls of oil (514 MBbls attributable to the 1995 Acquisition and 186 MBbls attributable to the 1996 Acquisition) and 5,787 MMcf of gas (3,401 MMcf attributable to the 1995 Acquisition and 2,124 MMcf attributable to the 1996 Acquisition), with total oil and gas production of 10,071 MMcfe. The revenues and production are primarily attributable to the 1995 Acquisition since the 1996 Acquisition did not close until October 31, 1996.
As a result of hedging activities in the year ended December 31, 1996, oil revenues were reduced $1.5 million ($2.10 per Bbl) and gas revenues were reduced $995,000 ($.17 per Mcf) for a total reduction of $2,495,000.
Oil and gas production costs, including production taxes, were $9.2 million ($.91 per Mcfe) for the year ended December 31, 1996. These costs included $2.2 million ($.22 per Mcfe) of rework expenses of which $945,000 were attributable to the 1995 Acquisition and $1.2 million were attributable to the 1996 Acquisition.
Exploration and abandonment costs were $184,000 for the year ended December 31, 1996.
General and administrative expenses were $2.3 million ($.23 per Mcfe) for the year ended December 31, 1996.
For the year ended December 31, 1996, depletion, depreciation and amortization expense was $5.8 million ($.57 per Mcfe). This represents a full year of depletion, depreciation and amortization relating to production for the 1995 Acquisition and two months of depletion, depreciation and amortization relating to production for the 1996 Acquisition.
Interest expense was $2,965,000 for the year ended December 31, 1996. The interest expense was attributable to bank financing incurred primarily to fund the 1995 Acquisition and the 1996 Acquisition.
Nine Months Ended December 31, 1995
For the nine months ended December 31, 1995, the Company's revenues from the sale of oil and gas were $504,000 and $239,000, respectively. During the period, the Company produced 30 MBbls of oil and 245 MMcf of gas, for a total production of 425 MMcfe. The revenues and production are primarily attributable to the 1995 Acquisition which was consummated December 11, 1995.
Oil and gas production costs including production taxes, were $304,000 ($.72 per Mcfe) for the nine months ended December 31, 1995.
Exploration and abandonment costs were $490,000 for the nine months ended December 31, 1995.
General and administrative expenses were $1.5 million ($3.64 per Mcfe) for the nine months ended December 31, 1995.
For the nine months ended December 31, 1995, depletion, depreciation and amortization expense was $299,000 ($.70 per Mcfe).
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of capital have been its initial capitalization, private equity sales, bank financing, cash flow from operations and the Company's initial public offering. The 1995 Acquisition was funded with cash from the Company's initial capitalization, additional private equity sales and bank financing. The 1996 Acquisition was principally funded with bank financing, which was repaid with the proceeds from the Company's initial public offering. The OEDC Acquisition and the Carrollton Acquisition were completed by issuing Common Stock in exchange for the equity interest in each entity. The Pioneer Acquisition was funded with bank financing.
The Company requires capital primarily for the exploration, development and acquisition of oil and gas properties, the repayment of indebtedness and general working capital needs.
Net Cash Provided by Operating Activities. Net cash provided by operating activities, before changes in operating assets and liabilities, was $43.3 million for the year ended December 31, 1997, compared to $9.8 million for the year ended December 31,1996. The increase was primarily attributable to the cash flow generated by the 1996 Acquisition and from continued exploitation of the Company's proved properties.
Capital Expenditures. Apart from the Company's expenditure for the Pioneer Acquisition, the Company budgeted for 1997 approximately $27 million for the drilling and recompletion of oil and gas wells and workover projects on its proved properties and approximately $25.2 million for expenditures for geological and geophysical costs, drilling costs and lease acquisition costs on the Company's unproved properties.
Cash expenditures for additions to oil gas properties were $57.6 million for the year ended December 31, 1997. This includes $11.7 million for the acquisition of oil and gas leases and $45.9 million for development and exploratory drilling.
The Company requires capital primarily for the exploration, development and acquisition of oil and gas properties, the repayment of indebtedness and general working capital needs.
The following table sets forth costs incurred by the Company in its exploration, development and acquisition activities during the periods indicated.
Nine Months Ended Year Ended December 31, December 31, ----------------------- ----------------- 1997 1996 1995 ----------- ---------- ----------------- Development costs.... $ 44,896 $ 12,468 $ 1,580 Exploration costs.... 2,856 129 448 Acquisition costs: Unproved properties.. 24,532 802 1,040 Proved properties.... 100,871 139,110 40,873 -------- -------- ------- Total................ $173,155 $152,509 $43,941 ======== ======== =======
For 1998, the Company expects to spend (i) approximately $25.1 million to drill proved undeveloped properties, (ii) approximately $3.6 million on probable projects, (iii) approximately $9.6 million to explore unproven locations, (iv) approxmiately $15.3 million on development projects following successful exploratory efforts, (v) approximately $10.4 million to acquire additional acreage and seismic, (vi) $16.0 million to fund development of pipeline and processing project investments and (vii) $3.8 million on other items. The final determination with respect to the drilling of any well, including those currently budgeted, will depend on a number of factors, including (i) the results of exploration efforts and the review and analysis of the seismic data, (ii) the availability of sufficient capital resources by the Company and other participants for drilling prospects, (iii) economic and industry conditions at the time of drilling, including prevailing and anticipated prices for natural gas and oil and the availability and costs of drilling rigs and crews, (iv) the financial resources and results of the Company, and (v) the availability of leases on reasonable terms and permitting for the potential drilling location. There can be no assurance that the budgeted wells will encounter, if drilled, recompleted or worked over reservoirs of commercial quantities of natural gas or oil.
While the Company regularly engages in discussions relating to potential acquisitions of oil and gas properties, the Company has no present agreement, commitment or understanding with respect to any such acquisition, other than the acquisition of oil and gas properties and interests in its normal course business. Any future acquisitions may require additional financing and will be dependent upon financing which may be required in the future to fund the Company's acquisition and drilling programs.
Capital Resources. The Company's primary capital resources are net cash provided by operating activities and the availability under the Credit Agreement, of which $80.6 million was available at December 31, 1997. The Pioneer Acquisition of $54.4 million was funded with proceeds from the Credit Agreement.
Credit Agreement. The Credit Agreement established a four year revolving credit facility, up to the maximum amount of $250 million, subject to a borrowing base to be redetermined semi-annually by the lenders based on certain proved oil and gas reserves and other assets of the Company. The borrowing base at December 31, 1997 was $165 million. To the extent that the borrowing base is less than the aggregate principal amount of all outstanding loans and letters of credit under the Credit Agreement, such deficiency must be cured by the Company ratably within 180 days, by either prepaying a portion of the outstanding amounts under the Credit Agreement or pledging additional collateral to the lenders. A portion of the credit facility is available for the issuance of up to $15.0 million of letters of credit, of which $275,000 was outstanding at December 31, 1997. All outstanding amounts under the Credit Agreement are due and payable in full on January 1, 2001. The Company's outstanding long-term debt under the Credit Agreement was $84.1 million on December 31, 1997.
At the Company's option, borrowings under the Credit Agreement bear interest at either the "Base Rate" (i.e., the higher of the applicable prime commercial lending rate, or the federal funds rate plus .5% per annum) or the Eurodollar rate, plus 1% to 1.50% per annum, depending on the level of the Company's aggregate outstanding borrowings. In addition, the Company is committed to pay quarterly in arrears a fee of .30% to .375% of the unused borrowing base.
The Credit Agreement contains certain covenants and restrictions that are customary in the oil and gas industry. In addition, the line of credit is secured by substantially all of the Company's oil and gas properties.
Liquidity and Working Capital. At December 31, 1997, the Company had $1.6 million of cash and cash equivalents as compared to $6.3 million at December 31, 1996. The Company's ratio of current assets to current liabilities was 1.00 at December 31, 1997, compared to 2.03 at December 31, 1996. Due principally to a reduction in cash as a result of an intentional change in the way the Company manages its operating accounts, the Company's working capital decreased $8.1 million from $8.1 million at December 31, 1996 to $28,000 at December 31, 1997.
Unsecured Credit Agreement. In April 1997, the Company entered into a credit agreement (the "Unsecured Credit Agreement") with Texas Commerce Bank National Association (the "Bank"), which establishes a revolving credit facility, up to the maximum of $5 million. All outstanding amounts pursuant to the Unsecured Credit Agreement are due and payable in full on or before December 31, 1999. Proceeds of the Unsecured Credit Agreement are utilized to fund
short-term needs (less than thirty days). The Company had no outstanding debt under the Unsecured Credit Agreement at December 31, 1997.
The interest rate of amounts outstanding under the Unsecured Credit Agreement is at a rate determined by agreement between the Company and the Bank. The rate shall not exceed the maximum interest rate permitted under applicable laws. Interest rates generally are the bank's cost of funds plus 1% per annum.
OTHER MATTERS
Stock Options and Compensation Expense
In connection with the Conversion, the Company issued options to purchase 3,631,350 shares of Common Stock to certain of its officers and employees in substitution for options issued by Titan Resources, L.P. Of the options issued by the partnership approximately 93% were issued on March 31, 1995, the date of inception, and approximately 7% were issued as of September 30, 1996. The options issued by the Company have an exercise price of $2.08 per share. Options to purchase 1,991,627 shares of Common Stock are currently vested and an additional 1,208,557 and 426,881 shares will vest on March 31 of each of 1998 and 1999, respectively. Based in part on selling prices of interests in the partnership in December 1995 and September 1996, the Company expected to record a noncash compensation expense of approximately $421,000 per month for a period of 39 months beginning in October of 1996 to reflect the estimated value of the revised option plan on September 30, 1996. Noncash compensation expense recorded for the years ended December 31, 1997 and 1996 was $5,053,000 and $1,839,000, respectively, and $576,000 for the period ended December 31, 1995. During the years ended December 31, 1997 and 1996 the Company issued additional stock options of 259,000 and 85,000, respectively, for which no deferred compensation was recorded as these options had no implicit value when issued.
Hedging Activities
The Company uses swap agreements and other financial instruments in an attempt to reduce the risk of fluctuating oil and gas prices and interest rates. The Company is party to various agreements with numerous counterparties for purposes of utilizing financial instruments, of which the Company assesses the creditworthiness of its counterparties. Among other counterparties, the Company has utilized Enron Capital & Trade Resources Corp. (an affiliate of a significant stockholder of the Company) as a counterparty. Settlement of gains or losses on the hedging transactions was generally based on the difference between the contract price and a formula using New York Mercantile Exchange ("NYMEX") or other major indices related prices and was reported as a component of oil and gas revenues as the associated production occurs. The Company, at December 31, 1997, had entered into hedging transactions with respect to approximately 6,196 MMcfe of its 1998 estimated production. Subsequent to December 31, 1997 and through March 10, 1998, the Company has entered into additional hedging transactions, relating to its 1998 estimated production, of approximately 4,265 MMcfe at prices ranging from $2.08 to $2.35 per Mcf. See "Risk Factors-Risk of Hedging Activities."
Crude Oil. The Company reports average oil prices per Bbl including the net effect of oil hedges. During the year ended December 31, 1997, the Company reported average oil prices of $18.67 per Bbl, while realizing average prices, excluding hedging results, of $18.38 per Bbl. The Company recorded net increases to oil revenues of $551,000 ($.29 per Bbl) for the year ended December 31, 1997, as a result of its commodity hedges.
During the year ended December 31, 1996, the Company reported average oil prices of $19.16 per Bbl, while realizing average prices, excluding hedging results, of $21.26 per Bbl. The Company recorded a reduction to oil revenues of $1.5 million ($2.10 per Bbl) for the year ended December 31, 1996, as a result of its commodity hedges.
Natural Gas. The Company reports average gas prices per Mcf including the net effect of gas hedges. During the year ended December 31, 1997, the Company reported average gas prices of $1.75 per Mcf. The Company recorded a reduction of $62,000 to gas revenues, which had no significant effect on the average gas price, for the year ended December 31, 1997, as a result of its commodity hedges.
During the year ended December 31, 1996, the Company reported average gas prices of $1.75 per Mcf, while realizing average prices, excluding hedging results, of $1.92 per Mcf. The Company recorded net decreases to gas revenues of $995,000 ($.17 per Mcf) for the year ended December 31, 1996, as a result of its commodity hedges.
Natural Gas Balancing
In the natural gas industry, various working interest partners produce more or less than their entitlement share of natural gas from time to time. The Company's net overproduced position at December 31, 1997 was 32,863 Mcf. Under terms of typical natural gas balancing agreements, the underproduced party can take a certain percentage, typically 25% to 50% of the overproduced party's entitled share of gas sales in future months, to eliminate such imbalances. During the make-up period, the overproduced party's cash flow will be adversely affected. The Company recognizes revenue and imbalance obligations under the entitlements method of accounting, which means that the Company recognizes the revenue to which it is entitled and records a liability with respect to the value of the overproduced gas.
Environmental and Other Laws and Regulations
The Company's business is subject to certain federal, state and local laws and regulations relating to the exploration for and the development, production and transportation of oil and gas, as well as environmental and safety matters. Many of these laws and regulations have become more stringent in recent years, often imposing greater liability on a larger number of potentially responsible parties. Although the Company believes it is in substantial compliance with all applicable laws and regulations, the requirements imposed by such laws and regulations are frequently changed and subject to interpretation, and the Company is unable to predict the ultimate cost of compliance with these requirements or their effect on its operations. The Company has no material commitments for capital expenditures to comply with existing environmental requirements.
Nevertheless, changes in existing environmental laws or in interpretations thereof could have a significant adverse impact on the operating costs of the Company, as well as the oil and gas industry in general. See "Risk Factors- Compliance with Environmental Regulations," "Business and Properties- Environmental Matters" and "Business and Properties-Abandonment Costs."
Recently Issued Accounting Standards
In June 1997, FASB issued FAS No. 130, "Reporting Comprehensive Income" which requires that all items required to be recognized under accounting standards as components of comprehensive income be reported as a part of the basic financial statements. FAS No. 130 is effective for both interim and annual periods beginning after December 15, 1997. The Company plans to adopt FAS No. 130 for the period ended March 31, 1998 and does not expect FAS No. 130 to have a material effect on reported results.
In June 1997, FASB issued FAS No. 131, "Disclosures about Segments of Enterprise and Related Information" which established standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. FAS No. 131 is effective for financial statements for periods beginning after December 15, 1997 but the statement need not be applied to interim financial statements in the initial year of application. Titan does not expect FAS No. 131 to materially affect its reporting practices.
CAUTIONARY STATEMENTS FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company or its representatives may make forward looking statements, oral or written, including statements in this report, press releases, public and private forums and filings with the SEC, regarding estimated future net revenues from oil and natural gas reserves and the present value thereof, planned capital expenditures (including the amount and nature thereof), increases in oil and gas production, the number of wells the Company anticipates drilling through 1998 in connection with its capital expenditure plans and the Company's financial position, business strategy and other plans and objectives for future operations. Although the Company believes that the expectations reflected in these forward
looking statements are reasonable, there can be no assurance that the actual results or developments anticipated by the Company will be realized or, even if substantially realized, that they will have the expected effects on its business or operations. Among the factors that could cause actual results to differ materially from the Company's expectations are general economic conditions, inherent uncertainties in interpreting engineering data, operating hazards, delays or cancellations of drilling operations for a variety of reasons, competition, fluctuations in oil and gas prices, the ability of the Company to successfully integrate the business and operations of acquired companies, government regulations and other factors including but not limited to those set forth among the risk factors noted below or in the description of the Company's business in Item 1 of this report. All subsequent oral and written forward looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by these factors. The Company assumes no obligation to update any of these statements.
RISK FACTORS
Volatility of Oil and Gas Prices. The Company's revenues, operating results and future rate of growth are highly dependent upon the prices received for the Company's oil and gas. Historically, the markets for oil and gas have been volatile and may continue to be volatile in the future. Revenues generated from the oil and gas operations of the Company will be highly dependent on the future prices of oil and gas. Various factors beyond the control of the Company will affect prices of oil and gas, including but not limited to the worldwide and domestic supplies of oil and gas, the ability of the members of the Organization of Petroleum Exporting Countries to agree to and maintain oil price and production controls, political instability or armed conflict in oil-producing regions, the price and level of foreign imports, the level of consumer demand, the price and availability of alternative fuels, the availability of pipeline capacity, weather conditions, domestic and foreign governmental regulations and taxes and the overall economic environment. On March 10, 1998, the posted price for West Texas Intermediate Crude was $12.00 per Bbl, as posted by the Company's major purchaser. On December 31, 1997, the posted price for West Texas Intermediate Crude was $15.50 per Bbl, as posted by the Company's major purchaser. The Company is unable to predict the long-term effects of these and other conditions on the prices of oil. Moreover, it is possible that prices for any oil the Company produces will be lower than current prices received by the Company. Historically, the market for natural gas has been volatile and is likely to continue to be volatile in the future. Prices for natural gas are subject to wide fluctuation in response to market uncertainty, changes in supply and demand and a variety of additional factors, all of which are beyond the Company's control. On March 10, 1998, estimated natural gas prices received by the Company at the wellhead averaged $1.52 per Mcf. On December 31, 1997, natural gas prices received by the Company at the wellhead averaged $1.84 per Mcf. Lower oil and gas prices may reduce the amount of oil and gas the Company can produce economically. Any significant decline in the price of oil or gas would adversely affect the Company's revenues and operating income and may require a reduction in the carrying value of the Company's oil and gas properties.
Uncertainty of Reserve Information and Future Net Revenue Estimates. There are numerous uncertainties inherent in estimating quantities of proved reserves and their values, including many factors beyond the Company's control. The reserve information set forth in this report represents estimates only. Although the Company believes such estimates to be reasonable, reserve estimates are imprecise and should be expected to change as additional information becomes available.
Estimates of oil and gas reserves, by necessity, are projections based on engineering data, and there are uncertainties inherent in the interpretation of such data as well as the projection of future rates of production and the timing of development expenditures. Reserve engineering is a subjective process of estimating underground accumulations of oil and gas that are difficult to measure. The accuracy of any reserve estimate is a function of the quality of available data, engineering and geological interpretation and judgment. Estimates of economically recoverable oil and gas reserves and of future net cash flows necessarily depend upon a number of variable factors and assumptions, such as historical production from the area compared with production from other producing areas, the assumed effects of regulations by governmental agencies and assumptions concerning future oil and gas prices, future operating costs, severance and excise taxes, development costs and workover and remedial costs, all of which may in fact vary considerably from actual results. For these reasons, estimates of the economically recoverable quantities of oil and gas attributable to any particular group of properties, classifications of such reserves based on risk of recovery and estimates of the future net cash flows expected therefrom may vary substantially. Moreover, there can be no assurance that the Company's reserves will ultimately be produced or that the Company's proved undeveloped reserves will be developed within the periods anticipated. Any significant variance in the assumptions could materially affect the estimated quantity
and value of the Company's reserves. Actual production, revenues and expenditures with respect to the Company's reserves will likely vary from estimates, and such variances may be material.
The PV-10 referred to in this report should not be construed as the current market value of the estimated oil and gas reserves attributable to the Company's properties. In accordance with applicable requirements, the estimated discounted future net cash flows from proved reserves are generally based on prices and costs as of the date of the estimate, whereas actual future prices and costs may be materially higher or lower. Actual future net cash flows also will be affected by factors such as the amount and timing of actual production, supply and demand for oil and gas, curtailments or increases in consumption by gas purchasers and changes in governmental regulations or taxation. The timing of actual future net cash flows from proved reserves, and thus their actual present value, will be affected by the timing of both the production and the incurrence of expenses in connection with development and production of oil and gas properties. In addition, the 10% discount factor, which is required to be used to calculate discounted future net cash flows for reporting purposes, is not necessarily the most appropriate discount factor based on interest rates in effect from time to time and risks associated with the Company or the oil and gas industry in general.
Limited Operating History; Rapid Growth. The Company, which began operations in March 1995, has a brief operating history upon which the Company's stockholders may base their evaluation of the Company's performance. As a result of its brief operating history and rapid growth, the operating results from the Company's historical periods are not readily comparable and may not be indicative of future results. There can be no assurance that the Company will continue to experience growth in, or maintain its current level of, revenues, oil and gas reserves or production.
The Company's rapid growth has placed significant demands on its administrative, operational and financial resources. Any future growth of the Company's oil and gas reserves, production and operations would place significant further demands on the Company's financial, operational and administrative resources. The Company's future performance and profitability will depend in part on its ability to successfully integrate the administrative and financial functions of acquired properties and companies into the Company's operations, to hire additional personnel and to implement necessary enhancements to its management systems to respond to changes in its business. There can be no assurance that the Company will be successful in these efforts. The inability of the Company to integrate acquired properties and companies, to hire additional personnel or to enhance its management systems could have a material adverse effect on the Company's results of operations.
Substantial Capital Requirements. The Company makes, and will continue to make, substantial capital expenditures for the exploration, development, acquisition and production of its oil and gas reserves. The Company intends to finance such capital expenditures primarily with funds provided by operations and borrowings under its $250 million Credit Agreement, which currently has a borrowing base of $165 million, against which $92.6 million had been drawn as of March 10, 1998. In 1995, the Company spent approximately $40.6 million on its first large property acquisition, in 1996, approximately $135.7 million on its second large property acquisition, and in 1997, approximately $54.4 million on its third large property acquisition. In 1997, the Company issued (i) 5,486,734 shares of Common Stock in connection with the acquisition of OEDC, which focuses on the exploration, development and production of natural gas and on natural gas gathering, processing and marketing activities, primarily in the Gulf of Mexico, and (ii) 899,965 shares of Common Stock in connection with the acquisition of Carrollton Resources, L.L.C., a small independent energy company engaged in the exploration and development of onshore oil and gas properties located primarily in the Gulf Coast region. The Company's direct capital expenditures for oil and gas producing activities, excluding property acquisitions, were $46.1 million and $12.6 million for the years ended December 31, 1997 and 1996, respectively, and $2.0 million for the nine months ended December 31, 1995.
If revenues decrease as a result of lower oil or gas prices or otherwise, the Company may have limited ability to expend the capital necessary to replace its reserves or to maintain production at current levels, resulting in a decrease in production over time. If the Company's cash flow from operations and availability under the Credit Agreement are not sufficient to satisfy its capital expenditure requirements, there can be no assurance that additional debt or equity financing will be available to meet these requirements.
Reserve Replacement Risk. The Company's future success depends upon its ability to find, develop or acquire additional oil and gas reserves that are economically recoverable. The proved reserves of the Company will generally decline as reserves are depleted, except to the extent that the Company conducts successful exploration or development activities or acquires properties containing proved reserves, or both. In order to increase reserves and production, the Company must continue its development and exploration drilling and recompletion programs or undertake other replacement activities. The Company's current strategy includes increasing its reserve base through acquisitions of producing properties, continued exploitation of its existing properties and exploration of new and existing properties. There can be no assurance, however, that the Company's planned development and exploration projects and acquisition activities will result in significant additional reserves or that the Company will have continuing success drilling productive wells at low finding and development costs. Furthermore, while the Company's revenues may increase if prevailing oil and gas prices increase significantly, the Company's finding costs for additional reserves could also increase.
Drilling and Operating Risks. Drilling activities are subject to many risks, including well blow outs, cratering, uncontrollable flows of oil, natural gas or well fluids, fires, formations with abnormal pressures, pollution, releases of toxic gases and other environmental hazards and risks, any of which could result in substantial losses to the Company. The Company's offshore operations are also subject to the additional hazards of marine operations such as severe weather, capsizing and collision. In addition, the Company incurs the risk that no commercially productive reservoirs will be encountered through its drilling operations. There can be no assurance that new wells drilled by the Company will be productive or that the Company will recover all or any portion of its investment in wells drilled. Drilling for oil and gas may involve unprofitable efforts, not only from dry wells, but from wells that are productive but do not produce net reserves to return a profit after drilling, operating and other costs. The cost of drilling, completing and operating wells is often uncertain. The Company's drilling operations may be curtailed, delayed or canceled as a result of numerous factors, many of which are beyond its control, including economic conditions, mechanical problems, title problems, weather conditions, compliance with governmental requirements and shortages and delays in the delivery of equipment and services.
Acquisition Risks. The Company's rapid growth since its inception in March 1995 has been largely the result of acquisitions of producing properties. The Company expects to continue to evaluate and pursue acquisition opportunities available on terms management considers favorable to the Company. The successful acquisition of producing properties involves an assessment of recoverable reserves, future oil and gas prices, operating costs, potential environmental and other liabilities and other factors beyond the Company's control. This assessment is necessarily inexact and its accuracy is inherently uncertain. In connection with such an assessment of the subject properties, the Company performs a review it believes to be generally consistent with industry practices. This review, however, will not reveal all existing or potential problems, nor will it permit a buyer to become sufficiently familiar with the properties to assess fully their deficiencies and capabilities. Inspections may not be performed on every well, and structural and environmental problems are not necessarily observable even when an inspection is undertaken. The Company generally assumes preclosing liabilities, including environmental liabilities, and generally acquires interests in the properties on an "as is" basis. With respect to its acquisitions to date, the Company has no material commitments for capital expenditures to comply with existing environmental requirements. There can be no assurance that the Company's acquisitions will be successful. Any unsuccessful acquisition could have a material adverse effect on the Company.
Risk of Hedging Activities. The Company's use of energy swap arrangements and other financial instruments to reduce its sensitivity to oil and gas price volatility is subject to a number of risks. If the Company's reserves are not produced at the rates estimated by the Company due to inaccuracies in the reserve estimation process, operational difficulties or regulatory limitations, the Company would be required to satisfy obligations it may have under fixed price sales and hedging contracts on potentially unfavorable terms without the ability to hedge that risk through sales of comparable quantities of its own production. Further, the terms under which the Company enters into fixed price sales and hedging contracts are based on assumptions and estimates of numerous factors such as cost of production and pipeline and other transportation costs to delivery points. Substantial variations between the assumptions and estimates used by the Company and actual results experienced could materially adversely affect the Company's anticipated profit margins and its ability to manage the risk associated with fluctuations in oil and gas prices. Additionally, fixed price sales and hedging contracts limit the benefits the Company will realize if actual prices rise above the contract prices. In addition, fixed price sales and hedging contracts are subject to the risk that the counter-party may prove unable or unwilling to perform its obligations under such contracts. Any significant nonperformance could have a material adverse
financial effect on the Company. As of December 31, 1997, 6,196 MMcfe of the Company's 1998 production was subject to hedging contracts.
Marketability of Production. The marketability of the Company's production depends in part upon the availability, proximity and capacity of natural gas gathering systems, pipelines and processing facilities. Most of the Company's natural gas is delivered through gas gathering systems and gas pipelines that are not owned by the Company. Federal and state regulation of oil and gas production and transportation, tax and energy policies, changes in supply and demand and general economic conditions all could adversely affect the Company's ability to produce and market its oil and gas. Any dramatic change in market factors could have a material adverse effect on the Company.
Compliance with Environmental Regulations. The Company's operations are subject to complex and constantly changing environmental laws and regulations adopted by federal, state and local governmental authorities. The implementation of new, or the modification of existing, laws or regulations could have a material adverse affect on the Company. Discharge of oil, gas or other pollutants into the air, soil or water may give rise to significant liabilities on the part of the Company to the government and third parties and may require the Company to incur substantial costs of remediation. Moreover, the Company has agreed to indemnify sellers of producing properties purchased in each of its substantial acquisitions against environmental claims associated with such properties. No assurance can be given that existing environmental laws or regulations, as currently interpreted or reinterpreted in the future, or future laws or regulations will not materially adversely affect the results of operations or financial condition of Company or that material indemnity claims will not arise against the Company with respect to properties acquired by it.
Dependance on Key Personnel. The Company's success has been and will continue to be highly dependent on Jack Hightower, its Chairman of the Board and Chief Executive Officer, and a limited number of other senior management personnel. Loss of the services of Mr. Hightower or any of those other individuals could have a material adverse effect on the Company's operations. The Company maintains a $3.0 million key man life insurance policy on the life of Mr. Hightower, but no other senior management personnel. In addition, as a result of the Company's acquisitions, the Company has significantly increased its number of employees and employed 94 employees at December 31, 1997. As the Company increases its workforce, it will face competition for such personnel from other companies. There can be no assurance that the Company will be successful in hiring or retaining key personnel. The Company's failure to hire additional personnel or retain its key personnel could have a material adverse effect on the Company.
Competition. The Company operates in the highly competitive areas of oil and gas exploration, development, acquisition and production with other companies, many of which have substantially larger financial resources, staffs and facilities. In seeking to acquire desirable producing properties or new leases for future exploration and in marketing its oil and gas production, the Company faces intense competition from both major and independent oil and gas companies. Many of these competitors have financial and other resources substantially in excess of those available to the Company. This highly competitive environment could have a material adverse affect on the Company.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements required by this item are included on the pages immediately following the Index to Consolidated Financial Statements appearing on page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference to information under the caption "Proposal 1 - Election of Directors" and to the information under the caption "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the Company's definitive Proxy Statement (the "1998 Proxy Statement") for its annual meeting of stockholders to be held on or about May 28, 1998. The 1998 Proxy Statement will be filed with the Securities and Exchange Commission (the "Commission") not later than 120 days subsequent to December 31, 1997.
Pursuant to Item 401(b) of Regulation S-K, the information required by this item with respect to executive officers of the Company is set forth in Part I of this report.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the 1998 Proxy Statement, which will be filed with the Commission not later than 120 days subsequent to December 31, 1997.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated herein by reference to the 1998 Proxy Statement, which will be filed with the Commission not later than 120 days subsequent to December 31, 1997.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTION
The information required by this item is incorporated herein by reference to the 1998 Proxy Statement, which will be filed with the Commission not later than 120 days subsequent to December 31, 1997.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Consolidated Financial Statements:
See Index to Consolidated Financial Statements on page.
2. Financial Statement Schedules:
See Index to Consolidated Financial Statements on page.
3. Exhibits: The following documents are filed as exhibits to this report:
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - -------
2.1 -- Exchange Agreement and Plan of Reorganization (filed as Exhibit 2.1 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
2.2 -- Amended and Restated Agreement and Plan of Merger, dated as of November 6, 1997, among Titan Exploration, Inc., Titan Offshore, Inc. and Offshore Energy Development Corporation (included as Appendix I to the Joint Proxy Statement/Prospectus forming a part of the Company's Registration Statement on S-4, Registration No. 333- 40215, and incorporated herein by reference).
2.3 -- Agreement and Plan of Merger, dated as of November 4, 1997, among Titan Exploration, Inc., Titan Bayou Bengal Holdings, Inc. and Carrollton Resources, L.L.C. (filed as Exhibit 2.3 to the Company's Registration Statement on S-4 Registration No. 333-40215 incorporated herein by reference).
3.1 -- Certificate of Incorporation (filed as Exhibit 3.1 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
3.1.1 -- Certificate of Amendment of Certificate of Incorporation (filed as Exhibit 3.1.1 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
3.2 -- Bylaws (filed as Exhibit 3.2 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.1 -- Agreement of Limited Partnership, dated March 31, 1995, between Titan Resources I, Inc., as general partner, and Natural Gas Partners, L.P., Natural Gas Partners II, L.P. and Jack Hightower, as limited partners (filed as Exhibit 10.1 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.1.1 -- Amendment No. 1 to the Agreement of Limited Partnership of Titan Resources, L.P., dated December 11, 1995, by and among Titan Resources I, Inc., as the general partner, and a Majority Interest of the Limited Partners (filed as Exhibit 10.1.1 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.1.2 -- Amendment No. 2 to the Agreement of Limited Partnership of Titan Resources, L.P., dated September 27, 1996, by and among Titan Resources I, Inc., as the general partner, and a Majority Interest of the Limited Partners (filed as Exhibit 10.1.2 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.1.3 -- Amendment No. 3 to the Agreement of Limited Partnership of Titan Resources, L.P., dated September 30, 1996, by and among Titan Resources I, Inc., as the general partner, and a Majority Interest of the Limited Partners (filed as Exhibit 10.1.3 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.2 -- Amended and Restated Voting and Shareholders Agreement, dated December 11, 1995, by and among Titan Resources I, Inc., Jack Hightower, Natural Gas Partners, L.P., Natural Gas Partners II, L.P., Joint Energy Development Investments Limited Partnership and First Union Corporation (filed as Exhibit 10.2 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.3 -- Amended and Restated Registration Rights Agreement, dated September 30, 1996, by and among Titan Exploration, Inc., Jack Hightower, Natural Gas Partners, L.P., Natural Gas Partners II, L.P., Joint Energy Development Investments Limited Partnership, First Union Corporation and Selma International Investment Limited (filed as Exhibit 10.3 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.4 -- Financial Advisory Services Contract, dated March 31, 1995, by and between Titan Resources, L.P. and Natural Gas Partners, L.P. and Natural Gas Partners II, L.P. (filed as Exhibit 10.4 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference).
10.4.1 -- First Amendment to Financial Advisory Services Contract, dated December 11, 1995, between Titan Resources, L.P., Natural Gas Partners, L.P. and Natural Gas Partners II, L.P. (filed as Exhibit 10.4.1 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - -------
10.5 -- Employment Agreement, dated September 30, 1996, by and between Titan Exploration, Inc., Titan Resources I, Inc. and Jack Hightower (filed as Exhibit 10.5 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.6.1 -- Form of Confidentiality and Non-compete Agreement among Titan Resources, L.P., Titan Resources I, Inc. and certain of the Registrant's executive officers (filed as Exhibit 10.6.1 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference).
10.6.2 -- Form of Confidentiality and Non-compete Agreement among the Registrant, Titan Resources I, Inc. and certain of the Registrant's executive officers (filed as Exhibit 10.6.2 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.7 -- Titan Resources, L.P. Option Plan (filed as Exhibit 10.7 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference).
10.7.1 -- Form of Option Agreement (A Option) (filed as Exhibit 10.7.1 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference).
10.7.2 -- Form of Option Agreement (B Option) (filed as Exhibit 10.7.2 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference).
10.7.3 -- Form of Option Agreement (C Option) (filed as Exhibit 10.7.3 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference).
10.7.4 -- Form of Option Agreement (D Option) (filed as Exhibit 10.7.4 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference).
10.8 -- Titan Exploration, Inc., Option Plan (filed as Exhibit 10.8 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference).
10.8.1 -- Form of Option Agreement (A Option) (filed as Exhibit 10.8.1 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference).
10.8.2 -- Form of Option Agreement (B Option) (filed as Exhibit 10.8.2 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference).
10.8.3 -- Form of Option Agreement (C Option) (filed as Exhibit 10.8.3 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference).
10.8.4 -- Form of Option Agreement (D Option) (filed as Exhibit 10.8.4 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference).
10.9 -- 1996 Incentive Plan (filed as Exhibit 10.9 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.10 -- Stock and Unit Purchase Agreement, dated December 11, 1995, by and among Joint Energy Development Investments Limited Partnership, Titan Resources I, Inc. and Titan Resources, L.P. (filed as Exhibit 10.10 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.10.1 -- Designation Agreement, dated December 11, 1995, by and between Titan Resources, L.P. and Joint Energy Development Investments Limited Partnership (filed as Exhibit 10.10.1 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.11 -- Stock and Unit Purchase Agreement, dated December 11, 1995, by and among First Union Corporation, Titan Resources I, Inc. and Titan Resources, L.P. (filed as Exhibit 10.11 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - -------
10.11.1 -- Designation Agreement, dated December 11, 1995, by and between Titan Resources, L.P. and First Union Corporation (filed as Exhibit 10.11.1 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.12 -- Advisory Services Contract, dated December 11, 1995, between Titan Resources, L.P. and ECT Securities Corp. (filed as Exhibit 10.12 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.13 -- Amended and Restated Credit Agreement, dated October 31, 1996, among Titan Resources, L.P. and Texas Commerce Bank National Association, as Agent, and Financial Institutions now or hereafter parties hereto (filed as Exhibit 10.13 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.14 -- Agreement of Sale and Purchase, dated April 19, 1995, between Enertex, Inc. and Titan Resources, L.P. (filed as Exhibit 10.14 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.15 -- Agreement of Sale and Purchase, dated April 19, 1995, between Staley Gas Co., Inc. and Titan Resources, L.P. (filed as Exhibit 10.15 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.16 -- Administrative Services Contract, dated March 31, 1995, between Staley Operating Co. and Titan Resources, L.P. (filed as Exhibit 10.16 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.17 -- Services Agreement, dated April 1, 1995, between Titan Resources I, Inc. and Titan Resources, L.P. (filed as Exhibit 10.17 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference).
10.18 -- Office Lease, dated April 10, 1997, between Fasken Center, Ltd. and Titan Exploration, Inc. (filed as Exhibit 10.17 to the Company's Registration Statement on Form S-4, Registration No. 333-40215 incorporated herein by reference).
10.19 -- Purchase and Sale Agreement, dated October 12, 1995, by and between Anadarko Petroleum Corporation and Titan Resources, L.P. (filed as Exhibit 10.19 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.20 -- Amendment No. 1 to Purchase and Sale Agreement, dated December 11, 1995, by and between Anadarko Petroleum Corporation and Titan Resources, L.P. (filed as Exhibit 10.20 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.21 -- Purchase and Sale Agreement, dated July 12, 1996, by and between Mobil Producing Texas & New Mexico Inc. and Titan Resources, L.P. (filed as Exhibit 10.21 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.22 -- Unit Purchase and Exchange Agreement, dated September 27, 1996, by and between Selma International Investment Limited and Titan Resources, L.P. (filed as Exhibit 10.22 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.23 -- Form of Indemnity Agreement between the Registrant and each of its executive officers (filed as Exhibit 10.23 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference).
10.24 -- Advisory Director Agreement, dated September 30, 1996, by and between Titan Exploration, Inc. and Joint Energy Development Investments Limited Partnership (filed as Exhibit 10.24 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference).
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - -------
10.25 -- First Amendment to Amended and Restated Credit Agreement, dated May 12, 1997, among Titan Resources, L.P., The Chase Manhattan Bank, as Administrative Agent, and Financial Institutions now or thereafter parties thereto (filed as Exhibit 10.13.1 to the Company's Form 10-Q for the quarterly period ended June 30, 1997 and incorporated herein by reference).
10.26 -- Form of Guaranty Agreement among The Chase Manhattan Bank, as Administrative Agent, Financial Institutions now or thereafter parties thereto and Titan Exploration, Inc., Titan Resources I, Inc. and Titan Resources Holdings, Inc. (filed as Exhibit 10.13.2 to the Company's Form 10-Q for the quarterly period ended June 30, 1997 and incorporated herein by reference).
10.27 -- Second Amendment to Amended and Restated Credit Agreement, dated August 12, 1997, effective as of April 1, 1997, by and among Titan Resources, L.P., The Chase Manhattan Bank, as Administrative Agent, and Financial Institutions now or thereafter parties thereto (filed as Exhibit 10.13.3 to the Company's Form 10-Q for the quarterly period ended September 30, 1997 and incorporated herein by reference).
10.28 -- Form of Stockholders Voting Agreement, dated November 6, 1997, between Titan Exploration, Inc. and the executive officers and directors of Offshore Energy Development Corporation (filed as Exhibit 10.24 to the Company's Registration Statement on S-4, Registration No. 333-40215, and incorporated herein by reference).
10.29 -- Stockholders Voting Agreement, dated November 6, 1997, between Titan Exploration, Inc. and Natural Gas Partners, L.P. (filed as Exhibit 10.25 to the Company's Registration Statement on S-4, Registration No. 333-40215, and incorporated herein by reference).
10.30 -- Master Promissory Note, dated March 6, 1997, between Titan Resources, L.P. and Texas Commerce Bank National Association (filed as Exhibit 10.25 to the Company's Form 10-Q for the quarterly period ended June 30, 1997 and incorporated herein by reference).
10.31 -- Letter Agreement, dated November 6, 1997, among Titan Exploration, Inc. and certain stockholders of Titan Exploration, Inc. (filed as Exhibit 10.29 to the Company's Registration Statement on S-4, Registration No. 333-40215, and incorporated herein by reference).
21 -- Subsidiaries of the Registrant.
27.1 -- Financial Data Schedule.
27.2 -- Restated Financial Data Schedule.
27.3 -- Restated Financial Data Schedule.
(b) The following reports on Form 8-K were filed by the Company during the last quarter of the period covered by this Annual Report on Form 10-K:
Form 8-K dated December 29, 1997 (Date of Event: December 12, 1997), which reported the consummation of the OEDC Acquisition, the Carrollton Acquisition and the Pioneer Acquisition.
GLOSSARY OF OIL AND GAS TERMS
The following are abbreviations and definitions of terms commonly used in the oil and gas industry and this report. Unless otherwise indicated in this report, natural gas volumes are stated at the legal pressure base of the state or area in which the reserves are located and at 60 degrees Fahrenheit and in most instances are rounded to the nearest major multiple. BOEs are determined using the ratio of six Mcf of natural gas to one Bbl of oil.
"Bbl" means a barrel of 42 U.S. gallons of oil.
"Bcf" means billion cubic feet of natural gas.
"Bcfe" means billion cubic feet equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of crude oil, condensate or natural gas liquids.
"BOE" means barrels of oil equivalent.
"Completion" means the installation of permanent equipment for the production of oil or gas.
"Development well" means a well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive.
"Exploratory well" means a well drilled to find and produce oil or gas in an unproved area, to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir, or to extend a known reservoir.
"Gross," when used with respect to acres or wells, refers to the total acres or wells in which the Company has a working interest.
"Horizontal drilling" means a drilling technique that permits the operator to contact and intersect a larger portion of the producing horizon than conventional vertical drilling techniques and can result in both increased production rates and greater ultimate recoveries of hydrocarbons.
"MBbls" means thousands of barrels of oil.
"Mcf" means thousand cubic feet of natural gas.
"Mcfe" means 1,000 cubic feet equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of crude oil, condensate or natural gas liquids.
"MMBbls" means millions of barrels of oil.
"MMBOE" means millions of barrels of oil equivalent on a 6:1 basis.
"MMcf" means million cubic feet of natural gas.
"MMcfe" means million cubic feet equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of crude oil, condensate or natural gas liquids.
"Net," when used with respect to acres or wells, refers to gross acres of wells multiplied, in each case, by the percentage working interest owned by the Company.
"Net production" means production that is owned by the Company less royalties and production due others.
"Oil" means crude oil or condensate.
"Operator" means the individual or company responsible for the exploration, development, and production of an oil or gas well or lease.
"Present Value of Future Revenues" or "PV-10" means the pretax present value of estimated future revenues to be generated from the production of proved reserves calculated in accordance with SEC guidelines, net of estimated production and future development costs, using prices and costs as of the date of estimation without future escalation, without giving effect to non-property related expenses such as general and administrative expenses, debt service and depreciation, depletion and amortization, and discounted using an annual discount rate of 10%.
"Proved developed reserves" means reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. Additional oil and gas expected to be obtained through the application of fluid injection or other improved recovery techniques for supplementing the natural forces and mechanisms of primary recovery will be included as "proved developed reserves" only after testing by a pilot project or after the operation of an installed program has confirmed through production response that increased recovery will be achieved.
"Proved reserves" means the estimated quantities of crude oil, natural gas, and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made. Prices include consideration of changes in existing prices provided only by contractual arrangements, but not on escalations based upon future conditions.
i. Reservoirs are considered proved if economic producibility is supported by either actual production or conclusive formation test. The area of a reservoir considered proved includes (A) that portion delineated by drilling and defined by gas-oil and/or oil-water contacts, if any; and (B) the immediately adjoining portions not yet drilled, but which can be reasonably judged as economically productive on the basis of available geological and engineering data. In the absence of information on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir.
ii. Reserves which can be produced economically through application of improved recovery techniques (such as fluid injection) are included in the "proved" classification when successful testing by a pilot project, or the operation of an installed program in the reservoir, provides support for the engineering analysis on which the project or program was based.
iii. Estimates of proved reserves do not include the following: (A) oil that may become available from known reservoirs but is classified separately as "indicated additional reserves"; (B) crude oil, natural gas, and natural gas liquids, the recovery of which is subject to reasonable doubt because of uncertainty as to geology, reservoir characteristics, or economic factors; (C) crude oil, natural gas, and natural gas liquids that may occur in undrilled prospects; and (D) crude oil, natural gas, and natural gas liquids that may be recovered from oil shales, coal, gilsonite and other such sources.
"Proved undeveloped reserves" means reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Reserves on undrilled acreage shall be limited to those drilling units offsetting productive units that are reasonably certain of production when drilled. Proved reserves for other undrilled units can be claimed only where it can be demonstrated with certainty that there is continuity of production from the existing productive formation. Under no circumstances should estimates for proved undeveloped reserves be attributable to any acreage for which an application of fluid injection or other improved recovery technique is contemplated, unless such techniques have been proved effective by actual tests in the area and in the same reservoir.
"Recompletion" means the completion for production of an existing well bore in another formation from that in which the well has been previously completed.
"Reserves" means proved reserves.
"Royalty" means an interest in an oil and gas lease that gives the owner of the interest the right to receive a portion of the production from the leased acreage (or of the proceeds of the sale thereof), but generally does not require the owner to pay any portion of the costs of drilling or operating the wells on the leased acreage. Royalties may be either landowner's royalties, which are reserved by the owner of the leased acreage at the time the lease is granted, or overriding royalties, which are usually reserved by an owner of the leasehold in connection with a transfer to a subsequent owner.
"3-D seismic" means seismic data that are acquired and processed to yield a three-dimensional picture of the subsurface.
"Tertiary recovery" means enhanced recovery methods for the production of oil or gas. Enhanced recovery of crude oil requires a means for displacing oil from the reservoir rock, modifying the properties of the fluids in the reservoir and/or the reservoir rock to cause movement of oil in an efficient manner, and providing the energy and drive mechanism to force its flow to a production well. The Company injects chemicals or energy as required for displacement and for the control of flow rate and flow pattern in the reservoir, and a fluid drive is provided to force the oil toward a production well.
"Working interest" means an interest in an oil and gas lease that gives the owner of the interest the right to drill for and produce oil and gas on the leased acreage and requires the owner to pay a share of the costs of drilling and production operations. The share of production to which a working interest owner is entitled will always be smaller than the share of costs that the working interest owner is required to bear, with the balance of the production accruing to the owners of royalties. For example, the owner of a 100% working interest in a lease burdened only by a landowner's royalty of 12.5% would be required to pay 100% of the costs of a well but would be entitled to retain 87.5% of the production.
"Workover" means operations on a producing well to restore or increase production.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, hereunder duly authorized, as of March 10, 1998.
TITAN EXPLORATION, INC.
Registrant
By: /s/ Jack Hightower ------------------------------------- Jack Hightower President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below as of March 10, 1998, by the following persons on behalf of the Registrant and in the capacity indicated.
/s/ Jack Hightower - ------------------------------------------------------------ Jack Hightower President, Chief Executive Officer and Chairman of the Board
/s/ George G. Staley - ------------------------------------------------------------ George G. Staley Executive Vice President, Exploration and Director
/s/ William K. White - ------------------------------------------------------------ William K. White Vice President, Finance and Chief Financial Officer
/s/ David R. Albin - ------------------------------------------------------------ David R. Albin Director
/s/ Kenneth A. Hersh - ------------------------------------------------------------ Kenneth A. Hersh Director
/s/ William J. Vaughn, Jr. - ------------------------------------------------------------ William J. Vaughn, Jr. Director
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Consolidated Financial Statements of Titan Exploration, Inc.
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1997 and 1996
Consolidated Statements of Operations for the years ended December 31, 1997 and 1996 and the period March 31, 1995 (date of inception) through December 31, 1995
Consolidated Statements of Stockholders' Equity and Predecessor Capital for the year ended December 31, 1997 and 1996 and the period March 31, 1995 (date of inception) through December 31, 1995
Consolidated Statements of Cash Flows for the year ended December 31, 1997 and 1996 and the period March 31, 1995 (date of inception) through December 31, 1995
Notes to Consolidated Financial Statements
All schedules are omitted, as the required information is inapplicable or the information is presented in the financial statements or related notes.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders Titan Exploration, Inc.
We have audited the consolidated financial statements of Titan Exploration, Inc. (the "Company") as listed in the accompanying index. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Titan Exploration, Inc. as of December 31, 1997 and 1996, and the results of their operations and their cash flows for the years ended December 31, 1997 and 1996 and the period from March 31, 1995 (date of inception) through December 31, 1995, in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Midland, Texas March 6, 1998
TITAN EXPLORATION, INC.
Consolidated Balance Sheets (in thousands, except share data)
See accompanying notes to consolidated financial statements.
TITAN EXPLORATION, INC.
Consolidated Statements of Operations (in thousands, except share and per share data)
See accompanying notes to consolidated financial statements.
TITAN EXPLORATION, INC.
Consolidated Statements of Stockholders' Equity and Predecessor Capital (in thousands)
See accompanying notes to consolidated financial statements.
TITAN EXPLORATION, INC.
Consolidated Statements of Cash Flows (in thousands)
See accompanying notes to consolidated financial statements.
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
December 31, 1997, 1996 and 1995
(1) ORGANIZATION AND NATURE OF OPERATIONS
Titan Exploration, Inc. (the "Company") a Delaware corporation, was organized on September 27, 1996 and began operations on September 30, 1996 with the combination, pursuant to the terms of an Exchange Agreement and Plan of Reorganization (the "Exchange Agreement"), of Titan Resources I, Inc. (the "General Partner"), a Texas corporation, and Titan Resources, L.P. (the "Partnership"). Under the exchange agreement, the limited partners of the Partnership transferred all of their limited partnership interests to the Company in exchange for 19,318,199 shares of common stock, and the shareholders of the General Partner transferred all of the issued and outstanding stock of that corporation to the Company in exchange for an aggregate of 231,814 shares of common stock. These transactions are referred to as the "Conversion."
Prior to the Conversion, the Company had no issued or outstanding shares of common stock and there was no public market for the General Partner's common stock. All shares of the Company issued in the Conversion were issued to the shareholders of the General Partner or to the limited partners of the Partnership. The combination of the Company, the General Partner and the Partnership is treated as a combination of entities under common control because of the 100% commonality of control between the Company subsequent to the Conversion and the Partnership prior to the Conversion. All partners of the Partnership were party to the exchange of shares in the Conversion. Consequently, the accompanying consolidated financial statements have given effect to the Conversion as if it were a pooling of interests. Revenues and costs arising from transactions between the two predecessor entities (the General Partner and the Partnership) have been eliminated. The following table sets forth revenues and net income with respect to the two predecessor entities (in thousands):
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements (Continued)
The Company is an independent energy company engaged primarily in the exploration, development and acquisition of oil and gas properties. Since its inception in March 1995, the Company has experienced significant growth, primarily through the acquisition of companies and oil and gas properties and the exploitation of these properties in the Permian Basin region of west Texas and southeastern New Mexico, Gulf Coast region and the Gulf of Mexico.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Investments in corporate joint ventures and partnerships where the Company has ownership interest of less than 50% are accounted for on the equity method. All investments with an ownership interest of less than 20% and no significant control are accounted for on the cost method. All material intercompany accounts and transactions have been eliminated in the consolidation.
Use of Estimates in the Preparation of Financial Statements
Preparation of the accompanying consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all demand deposits, money market accounts and certificates of deposit purchased with an original maturity of three months or less to be cash equivalents.
Inventories
Inventories consist of lease and well equipment not currently being used in production and are accounted for at the lower of cost (first-in, first-out) or market.
Oil and Gas Properties
The Company utilizes the successful efforts method of accounting for its oil and gas properties. Under this method of accounting, all costs associated with productive wells and nonproductive development wells are capitalized. Exploration costs are capitalized pending determination of whether proved reserves have been found. If no proved reserves are found, previously capitalized exploration costs are charged to expense.
Costs of significant nonproducing properties, wells in the process of being drilled and development projects are excluded from depletion until such time as the related project is developed and proved reserves are established or impairment is determined. The Company capitalizes interest on expenditures for significant development projects until such time as significant operations commence.
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements (Continued)
Capitalized costs of individual properties abandoned or retired are charged to accumulated depletion, depreciation and amortization. Sales proceeds from sales of individual properties are credited to property costs. No gain or loss is recognized until the entire amortization base is sold or abandoned.
Other property and equipment are recorded at cost. Major renewals and betterments are capitalized while the costs of repairs and maintenance are charged to operating expenses in the period incurred. With respect to dispositions of assets other than oil and gas properties, the cost of assets retired or otherwise disposed of, and the applicable accumulated depreciation are removed from the accounts, and the resulting gains or losses, if any, are reflected in operations.
Depletion, Depreciation and Amortization
Provision for depletion of oil and gas properties is calculated using the unit-of-production method on the basis of an aggregation of properties with a common geologic structural feature or stratigraphic condition, typically a field or reservoir. In addition, estimated costs of future dismantlement, restoration and abandonment, if any, are accrued as a part of depletion, depreciation and amortization expense on a unit of production basis; actual costs are charged to the accrual. Other property and equipment is depreciated using the straight- line method over the estimated useful lives of the assets. Organization costs are amortized over five years, while loan costs are amortized over the life of the related loan.
Impairment of Long-Lived Assets
The Company follows the provisions of Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("FAS 121"). Consequently, the Company reviews its long-lived assets to be held and used, including oil and gas properties accounted for under the successful efforts method of accounting and other identifiable intangible assets, whenever events or circumstances indicate that the carrying value of those assets may not be recoverable. An impairment loss is indicated if the sum of the expected future cash flows, on a depletable unit basis, is less than the carrying amount of such assets. In this circumstance, the Company recognizes an impairment loss for the amount by which the carrying amount of the asset exceeds the fair value of the asset.
The Company accounts for long-lived assets to be disposed of at the lower of their carrying amount or fair value less cost to sell once management has committed to a plan to dispose of the assets.
Net Income (Loss) per Common Share
In 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings per Share" ("FAS 128"). FAS 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods have been presented, and when appropriate, restated to conform to the FAS 128 requirements. For the periods prior to the Offering, the weighted average shares outstanding attributable to predecessor capital are the shares issued to the predecessor members upon Conversion.
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements (Continued)
Income Taxes
The Company follows the provisions of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("FAS 109"). Under the asset and liability method of FAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under FAS 109, the effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date.
Upon Conversion, the Company recorded the tax effect of the differences between the book and tax basis of its assets and liabilities as a deferred tax liability and a corresponding charge to deferred income tax expense.
Environmental
The Company is subject to extensive federal, state and local environmental laws and regulations. These laws, which are constantly changing, regulate the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed or capitalized depending on their future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures of a noncapital nature are recorded when environmental assessment and/or remediation is probable, and the costs can be reasonably estimated.
Revenue Recognition
The Company uses the sales method of accounting for crude oil revenues. Under this method, revenues are recognized based on actual volumes of oil sold to purchasers.
The Company uses the entitlements method of accounting for natural gas revenues. Under this method, revenues are recognized based on the Company's proportionate share of actual sales of natural gas. Natural gas revenues would not have been significantly altered in any period had the sales method of recognizing natural gas revenues been utilized. The Company has a net asset of approximately $318,000 recorded in other assets and a net liability of approximately $508,000 in other liabilities at December 31, 1997 and December 31, 1996, respectively, associated with gas balancing recorded.
The Company recognizes marketing revenue net of the cost of gas and third- party delivery fees as service is provided.
Stock-based Compensation
The Company accounts for employee stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Accordingly, the Company has only adopted the disclosure provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). See Note 13 for the pro forma disclosures of compensation expense determined under the fair-value provisions of FAS 123.
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements (Continued)
Treasury Stock
Treasury stock purchases are recorded at cost. Upon reissuance, the cost of treasury shares held is reduced by the average purchase price per share of the aggregate treasury shares held.
Commodity Hedging
The financial instruments that the Company accounts for as hedging contracts must meet the following criteria: the underlying asset or liability must expose the Company to price or interest rate risk that is not offset in another asset or liability, the hedging contract must reduce that price or interest rate risk at the inception of the contract and throughout the contract period, and the instrument must be designated as a hedge. In order to qualify as a hedge, there must be clear correlation between changes in the fair value of the financial instrument and the fair value of the underlying asset or liability such that changes in the market value of the financial instrument will be offset by the effect of price or interest rate changes on the exposed items.
The Company periodically enters into commodity derivative contracts in order to hedge the effect of price changes on commodities the Company produces and sells. Gains and losses on contracts that are designed to hedge commodities are included in income recognized from the sale of those commodities. Gains and losses on derivative contracts which do not qualify as hedges are recognized in each period based on the market value of the related instrument.
Interest Rate Swap Agreements
The Company enters into interest rate swap agreements to effectively convert a portion of its floating-rate borrowings into fixed rate obligations. The interest rate differential to be received or paid is recognized over the lives of the agreements as an adjustment to interest expense. At December 31, 1997, the Company was not subject to any interest rate swap agreements.
Reclassifications
Certain reclassifications have been made to the 1995 and 1996 amounts to conform to the 1997 presentation.
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements (Continued)
(3) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair values of the Company's financial instruments (in thousands):
Cash and cash equivalents, restricted cash, accounts receivable, other current assets, accounts payable and other current liabilities. The carrying amounts approximate fair value due to the short maturity of these instruments.
Restricted investments. The fair value of noncurrent investments is based on quoted market prices.
Debt. The carrying amount of long-term debt approximates fair value because the Company's current borrowing rate does not materially differ from market rates for similar bank borrowings.
Commodity price hedges. The fair market values of commodity derivative instruments are estimated based upon the current market price of the respective commodities at the date of valuation. It represents the amount which the Company would be required to pay or able to receive based upon the differential between a fixed and a variable commodity price as specified in the hedge contracts.
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements (Continued)
(4) DEBT
Debt consists of the following (in thousands):
December 31, -------------------------- 1997 1996 ------- ------ Line of credit $84,100 $6,500 Unsecured line of credit - - Other 1,350 - ------- ------ $85,450 $6,500 ======= ====== Line of Credit
On October 31, 1996, the Company entered into a credit agreement (the "Credit Agreement") with Chase Securities, Inc. which establishes a four year revolving credit facility, up to the maximum amount of $250 million subject to a borrowing base. All amounts outstanding are due and payable in full by January 1, 2001. The borrowing base, which was $165 million at December 31, 1997, is subject to redetermination semiannually by the lenders based on certain proved oil and gas reserves and other assets of the Company with the next redetermination date scheduled for April 1, 1998.
The Credit Agreement, which is secured by the Company's proved oil and gas reserves, is subject to mandatory prepayments. To the extent that the borrowing base is less than the aggregate principal amount of all outstanding loans and letters of credit under the Credit Agreement, such deficiency must be cured by the Company within 180 days, by either prepaying a portion of the outstanding amounts or pledging additional collateral. Commitment fees are due quarterly and range from .300% to .375% per annum on the difference between the commitment and the average daily amount outstanding.
At the Company's option, borrowings under the Credit Agreement bear interest at either (i) the "Base Rate" (i.e. the higher of the agent's prime commercial lending rate, or the federal funds rate plus 0.5% per annum), or (ii) the Eurodollar rate plus a margin ranging from 1% to 1.50% per annum, which margin increases as the level of the Company's aggregate outstanding borrowings under the Credit Agreement increases. The interest rates in effect at December 31, 1997 ranged from 6.97% to 8.50%.
The credit agreement contains various restrictive covenants and compliance requirements, which include (1) limiting the incurrence of additional indebtedness, (2) restrictions as to merger, sale or transfer of assets and transactions with affiliates without the lenders' consent, and (3) prohibition of any return of capital payments or distributions to any of its partners other than for taxes due as a result of their partnership interest.
Unsecured Credit Agreement
In April 1997, the Company entered into a credit agreement, as amended, (the "Unsecured Credit Agreement") with Texas Commerce Bank National Association (the "Bank"), an affiliate of Chase Securities, Inc., which establishes a revolving credit facility, up to the maximum of $5 million. All outstanding amounts pursuant to the Unsecured Credit Agreement are due and payable in full on or before December 31, 1999. The interest rate of each loan under the Unsecured Credit Agreement is at a rate determined by agreement between the Company and
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements (Continued)
the Bank. The rate shall not exceed the maximum interest rate permitted under applicable laws. Interest rates generally are at the bank's cost of funds plus 1% per annum.
Maturities of debt are as follows (in thousands):
1997 $ - 1998 - 1999 - 2000 - 2001 85,450
(5) ACQUISITIONS
On December 12,1997, the Company completed the acquisitions of all the outstanding stock of Offshore Energy Development Corporation ("OEDC") and Carrollton Resources, L.L.C. ("Carrollton"). The acquisitions were made by the issuance of 5,486,734 and 899,965 shares of the Company's common stock to the stockholders of OEDC and Carrollton, respectively. The results of operations of OEDC and Carrollton from the closing date are not included in the Company's 1997 results of operations as the acquisitions closed in late December 1997, and the amounts are not material.
The acquisitions, accounted for on the purchase method, resulted in the following noncash investing activities:
The liabilities assumed include amounts recorded for preacquisition contingencies and bank debt of OEDC and Carrollton.
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements (Continued)
On December 16, 1997, the Company completed the acquisition of certain oil and gas properties from Pioneer Natural Resources Company (the "Pioneer Acquisition"). The Company funded the acquisition from its debt facilities. The results of operations from the Pioneer Acquisition from the closing date are not included in the Company's 1997 results of operations as the amounts are not material. The acquisition of these oil and gas properties, accounted for using the purchase method, resulted in the following noncash investing activities:
Recorded amount of assets acquired, including receivables of $2,760,683 $55,794,243 Liabilities assumed (1,061,330) ----------- Cash paid $54,732,913 ===========
Included in assets recorded is a $224,785 long-term receivable recorded as a purchase price adjustment related to the Pioneer Acquisition for a gas imbalance receivable.
On October 31, 1996, the Company completed the acquisition of certain oil and gas properties from a major integrated company (the "1996 Acquisition"). The Company funded the acquisition from its debt facilities. The acquisition of these oil and gas properties, accounted for using the purchase method, resulted in the following noncash investing activities:
Recorded amount of assets acquired, including receivables of $300,187 $135,983,556 Liabilities assumed (1,570,490) ------------ Cash paid $134,413,066 ============
Included in receivables assumed is a $300,187 long-term receivable recorded as a purchase price adjustment related to the 1996 Acquisition for a gas imbalance. It is shown net of other gas imbalance liabilities in the consolidated financial statements. Liabilities assumed are amounts recorded as purchase price adjustments related to the 1996 Acquisition for potential environmental remediation.
On December 11, 1995, the Company completed the acquisition of certain oil and gas properties from a large independent oil and gas company (the "1995 Acquisition"). The Company funded the acquisition from its debt facilities. The total consideration paid for the properties was $39,881,094. The acquisition of these oil and gas properties, accounted for using the purchase method, resulted in the following noncash investing activities:
Recorded amount of assets acquired, including receivables of $396,719 $40,992,065 Liabilities assumed (1,110,971) ----------- Cash paid $39,881,094 ===========
Included in liabilities assumed is a $963,898 long-term liability recorded as a purchase price adjustment related to the 1995 Acquisition for a gas imbalance liability.
Pro Forma Results of Operations (Unaudited)
The following table reflects the pro forma results of operations for the years ended December 31, 1997 and 1996 as though the 1996 Acquisition, the Pioneer Acquisition and the OEDC and Carrollton acquisitions had
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements (Continued)
occurred as of January 1, 1996 and as if the Conversion had taken place on January 1, 1996. The pro forma amounts are not necessarily indicative of the results that may be reported in the future (in thousands).
Year ended December 31, -------------------------------- 1997 1996 ---------- -------- Revenues $105,016 $102,975 Net income (loss) (40,897) 17,125 Net income (loss) per common share (1.01) .43 Net income (loss) per common share - assuming dilution (1.01) .41
(6) INVESTMENTS
Dauphin Island Gathering Partners
The Company has a one percent investment in Dauphin Island Gathering Partners ("DIGP"), which owns a natural gas gathering system in the Gulf of Mexico, that is accounted for using the equity method. The Company's investment in DIGP is the result of the acquisition of OEDC. The Company has been delegated, by the operator of DIGP, to manage the commercial development and construction activities of DIGP through November 1999, and the Company will be paid $22,910 per month plus .5% of all construction costs of DIGP.
The Company's interest in DIGP will increase up to a maximum of 11.15% when its DIGP partners receive the return of their investment plus a 10% rate of return, subject to certain other conditions.
The Company's cost basis in DIGP exceeds the underlying historical net assets of DIGP by approximately $18,964,000 at December 31, 1997. The excess basis will be amortized over 30 years and included in the equity in income (loss) from DIGP.
Mobile Bay Processing Partners
The Company owns a 1% general partnership interest in Mobile Bay Processing Partners ("MBPP") which was formed for the purpose of constructing, owning and operating, or providing financing for one or more natural gas processing facilities onshore in Mobile County, Alabama. The Company's investment in MBPP is the result of the acquisition of OEDC. The Company accounts for its investment in MBPP on the equity method. According to estimates of the managing partner of MBPP the operations of the first construction in MBPP is expected to commence in the fourth quarter of 1998. The Company has an option to buy up to an additional 24.3% interest in MBPP, exercisable until the third anniversary of the commencement of commercial operations at MBPP's initial processing facility. The costs of the additional partnership interest will be equal to the historical book value of the plant reduced for depreciation on the date the option is exercised and increased by 12% per year.
The Company's cost basis in MBPP exceeds the underlying historical net assets of MBPP by approximately $32,591,000 at December 31, 1997. The excess basis will be amortized over 25 years, upon commencement of the first operations of MBPP, and included in the equity in income (loss) from MBPP.
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
Other
The Company has a 13.33% limited partnership interest in Asia-Pacific Refinery Investment, L.P. ("APRI"), which is carried at cost. APRI is involved in the construction and operation of a refinery unit. The Company has no responsibility to provide additional funds to APRI.
(7) COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company has non-cancelable operating leases for office facilities. The Company's non-cancellable operating lease for its Midland, Texas offices is with an entity controlled by an officer of the Company. Future minimum lease commitments under non-cancellable operating leases at December 31, 1997 are as follows (in thousands):
Lease expense during 1997 and 1996 was $200,474 and $110,625, respectively, all incurred with an affiliate.
Litigation
The following is a brief description of certain litigation to which the Company is subject, as a result of assuming the obligations of OEDC. The Company believes it has meritorious defenses to the claims and intends to vigorously defend against such claims. The Company does not believe that it has a probable and estimable loss with respect to any such litigation in excess of currently provided reserves, if any. If such loss becomes probable and estimable, the amount of any recorded liability could have a material adverse effect on the Company's (i) results of operations for the period in which such liability is recorded, (ii) consolidated financial position as a whole and (iii) liquidity and capital resources. However, the Company does not expect that any such liability will have a material adverse effect on its consolidated financial position as a whole or on its liquidity or capital resources. Due to the uncertainties inherent in litigation, no assurance can be given to the ultimate outcome of these matters.
OEDC and certain of its officers and directors, as well as Natural Gas Partners, L.P. ("NGP"), the managing underwriters of OEDC's initial public offering and an analyst from each of the managing underwriters, have been named as defendants in a suit styled Eric Barron and Edward C. Allen, On behalf of Themselves and all Others Similarly Situated, v. David B. Strassner, Douglas H. Kiesewetter, David R. Albin, Natural Gas Partners, L.P., David Garcia, John J. Myers, Offshore Energy Development Corporation, Morgan Keegan & Company, Inc. and Principal Securities Inc., which was filed October 20, 1997, in the Texas State District Court of Harris County, Texas 270th Judicial District. The defendants removed plaintiffs' claims to federal court in the United States Southern District of Texas. Plaintiffs have sought to have the case remanded to the state court. As of this date, the federal judge has not decided whether to deny plaintiffs' request for remand. The suit seeks class certification on behalf of certain holders of common stock of OEDC, excluding the defendants and holders related to or affiliated
(Continued)
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
with the defendants. The suit alleges generally that the defendants wrongfully made false or misleading statements or omissions relating to OEDC's business and prospects in the course of OEDC's initial public offering and subsequent thereto. The suit seeks rescission of sales of common stock of OEDC and unspecified monetary damages, including punitive damages.
OEDC and certain of its officers and directors, as well as NGP, have also been named defendants in a suit styled John W. Robertson, et al. v. David B. Strassner, Douglas H. Kiesewetter, David R. Albin, Natural Gas Partners, L.P. and Offshore Energy Development Corporation, which was filed February 6, 1998, in the United States Southern District of Texas, Houston Division. This suit mirrors the allegations of the foregoing matter, but adds request for relief under federal securities laws. It, too, seeks certification of a class of certain purchasers of common stock of OEDC. The suit seeks compensatory damages, including rescissory damages, where applicable.
The Company is seeking to consolidate both of these lawsuits as the Company believes the claims are connected. Plaintiffs in both lawsuits are represented by the same lawyers.
The Company is involved in other various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations or liquidity.
Letters of Credit
At December 31, 1997, the Company had outstanding letters of credit of $275,000, which are issued through the Credit Agreement.
(8) STATEMENTS OF CASH FLOWS
Interest expense of $1,524,576 and $3,062,656 was paid as of December 31, 1997 and 1996, respectively. No interest was paid in 1995.
During 1996, a $1,300,000 noncash contribution of interests in oil and gas properties was made in exchange for interest in the Company. Also at December 31, 1996, a $341,250 noncash property addition was recorded as a purchase price adjustment related to the Conversion.
(9) Restricted Investments
The Company carries a $3.0 million Gulf of Mexico area-wide abandonment bond with the Minerals Management Service, which is secured by cash balances currently invested in certificates of deposit at a commercial bank. The sum on deposit related to this area-wide abandonment bond is approximately $2.3 million at December 31, 1997. The deposit was released to the Company in February 1998.
(10) Common Stock
On December 16, 1996, the Company completed an initial public offering (the "Offering") of 14,391,500 shares of common stock at a price of $11.00 per share. Proceeds received, net of related expenses, were approximately $148,376,365.
(Continued)
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
In May 1997, the Company announced a plan to repurchase up to $25 million of the Company's common stock. The repurchase will be made periodically, depending on market conditions, and will be funded with cash flow from operations and, as necessary, borrowings under the Credit Agreement. At December 31, 1997, the Company had purchased 55,000 shares of its common stock for approximately $504,000. Subsequent to December 31, 1997 and through March 10, 1998, the Company purchased an additional 630,000 shares of its common stock for approximately $5.3 million.
(11) INCOME TAXES
Upon Conversion, the Company became a tax paying entity for U.S. Federal income tax purposes. At the date of Conversion, the book basis of the Company's assets and liabilities exceeded the tax basis by approximately $8,566,000, resulting in a deferred tax liability of approximately $2,998,000.
The reconciliation between the tax expense computed by multiplying pretax income (loss) by the U.S. federal statutory rate and the reporting amounts of income tax expense (benefit) is as follows:
(Continued)
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1997 and 1996 are as follows:
A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. Based on expectations for the future and the availability of certain tax planning strategies that would generate taxable income to realize the net tax benefits, if implemented, management has determined that taxable income of the Company will more likely than not be sufficient to fully utilize available carryforwards prior to their ultimate expiration.
At December 31, 1997, the Company has net operating loss carryforwards ("NOLs") for U.S. federal income tax purposes of approximately $37,000,000, which are available to offset future regular taxable income, if any. Of the Company's NOLs approximately $16,500,000 related to pre-acquisition NOLs which are subject to annual limitations on their utilization. The carryforwards begin to expire in 2011.
(12) RELATED PARTY TRANSACTIONS
For the years ended December 31, 1997 and 1996, the Company received $9,656 and $144,167, respectively, for administrative services from a related party. During 1995 revenue received was $241,563.
Financial advisory service fees of $185,854 were paid to two shareholders during 1996. For the period March 31, 1995 (date of inception) through December 31, 1996, $428,958 were paid to two shareholders and two affiliates of shareholders. The contracts underlying the financial advisory service fees were terminated December 16, 1996 pursuant to the contracts.
Director's fees of $45,000, $10,000 and $20,833 were paid during 1997, 1996 and 1995, respectively.
The Company, in 1995, has recorded in other assets approximately $425,000 of organization costs which were paid to related parties for consulting and advisory fees. These costs are being amortized over a period of five years.
(Continued)
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
Certain properties that were owned or controlled by certain shareholders were acquired by the Company for $100,000, $21,708 and $1,142,000 in 1997, 1996 and 1995, respectively, which approximates the predecessor cost of the properties.
During 1997, 1996 and 1995, the Company received (paid) approximately $551,000, ($635,000) and ($147,000) from (to) Enron Capital and Trade Corp., an affiliate of a significant stockholder of the Company relating to financial instruments associated, primarily, with the Company's hedging activities.
The Company regularly uses certain aircraft owned by an affiliate. The Company is billed for any use of such aircraft by Company personnel. Payments made for the use of such aircraft were $3,371 and $17,348 for the years ended December 31, 1997 and 1996, respectively, and $4,140 for the period ended March 31, 1995 (date of inception) through December 31, 1995.
The President, Chief Executive Officer and Chairman of the Board of the Company, and certain of his affiliates have a common ownership interest in oil and gas properties that are operated by the Company and, in accordance with a standard industry operating agreement, make payments to the Company of leasehold costs and lease operating and supervision charges. These payments were approximately $88,473 and $229,332 for the years ended December 31, 1997 and 1996, respectively, and $12,000 for period March 31, 1995 (date of inception) through December 31, 1995. Revenue received in connection with these oil and gas properties was $16,098 and $6,868 for the years ended December 31, 1997 and 1996, respectively. These interests were owned by the Chief Executive Officer and his affiliates prior to the formation of the Company on March 31, 1995.
(13) COMPANY OPTION PLANS
Stock Option Plan
Prior to the consolidation of Titan Exploration, Inc., Titan Resources, L.P. established a unit option plan (the "Plan") for certain officers and key employees of the Partnership and the General Partner. On September 30, 1996, upon the consolidation of Titan Exploration, Inc., the Plan was replaced by a new stock option plan the ("Stock Plan"). The Stock Plan provides for the issuance of 3,631,350 options to acquire common stock of the Company, in four separate series with a fixed exercise price of $2.08. Option A series, covering 2,410,728 shares of common stock, was to vest at a rate of one-third of the options at each of the dates of March 31, 1996, 1997 and 1998; Option B, C, and D series cover 387,265, 406,390, and 426,967 shares of common stock, respectively. Options B, C and D series each vest on March 31, 1997, 1998 and 1999, respectively. Deferred compensation was recorded based on the value of the Company's common stock on September 30, 1996, and will be amortized to expense over a 39 month period. Deferred compensation of approximately $17,576,000 (before reduction by amounts previously amortized to expense under the Plan, as described above) was recorded at September 30, 1996. At December 31, 1997, unamortized deferred compensation was $10,106,919.
1996 Incentive Plan
The Board of Directors and the stockholders of the Company approved the adoption of the Company's 1996 Incentive Plan (the "1996 Incentive Plan") as of October 1, 1996. The purpose of the 1996 Incentive Plan is to reward selected officers and key employees of the Company and others who have been or may be in a position to benefit the Company, compensate them for making significant contributions to the success of the Company and provide them with a proprietary interest in the growth and performance of the Company.
(Continued)
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
Participants in the 1996 Incentive Plan are selected by the Board of Directors or such committee of the Board as is designated by the Board to administer the 1996 Incentive Plan (the Compensation Committee of the Board of Directors) from among those who hold positions of responsibility with the Company and whose performance, in the judgment of the Compensation Committee, can have a significant effect on the success of the Company. An aggregate of 850,000 shares of Common Stock have been authorized and reserved for issuance pursuant to the 1996 Incentive Plan. These options vest ratable on each of the first through fourth anniversaries of the grant date.
Subject to the provisions of the 1996 Incentive Plan, the Compensation Committee will be authorized to determine the type or types of awards made to each participant and the terms, conditions and limitations applicable to each award. In addition, the Compensation Committee will have the exclusive power to interpret the 1996 Incentive Plan and to adopt such rules and regulations as it may deem necessary or appropriate in keeping with the objectives of the 1996 Incentive Plan.
Pursuant to the 1996 Incentive Plan, participants will be eligible to receive awards consisting of (i) stock options, (ii) stock appreciation rights, (iii) stock, (iv) restricted stock, (v) cash or (vi) any combination of the foregoing. Stock options may be either incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, or nonqualified stock options.
OEDC Stock Awards Plan
Pursuant to the OEDC merger agreement the Company converted the outstanding stock options of OEDC to stock options of the Company at the agreed common stock exchange rate. At December 31, 1997, there are 118,175 and 340,200 options to purchase shares of the Company common stock at $5.73 and $19.05 per share, respectively. All options were exercisable at December 31, 1997.
(Continued)
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
The Company applies APB 25 and related interpretations in accounting for its stock option plans. If compensation expense for the stock option plans had been determined consistent with Statement of Financial Accounting Standards 123, "Accounting for Stock-Based Compensation ("FAS 123"), the Company's net loss and net loss per share would have been adjusted to the pro forma amounts indicated below :
The pro forma net loss and pro forma net loss per share amounts noted above are not likely to be representative of the pro forma amounts to be reported in future years. The pro forma amounts for 1996 and 1995 reflect the initial phase- in of FAS 123. Pro forma adjustments in future years will include compensation expense associated with the options granted in 1997, 1996 and 1995 plus compensation expense associated with any options awarded in future years. As a result, such pro forma compensation expense is likely to be higher than the levels experienced in 1997, 1996 and 1995.
Under FAS 123, the fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 1997, 1996 and 1995:
(Continued)
A summary of the Company's stock option plans as of December 31, 1997, 1996 and 1995, and changes during the periods ended on those dates is presented below:
Options outstanding as of December 31, 1997 have expected lives ranging from 2 to 9 years with exercise prices ranging from $2.08 to $19.05 per share.
(Continued)
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
(14) NET LOSS PER COMMON SHARE
The following table sets forth the computation of basic and diluted net loss per common share :
Employee stock options to purchase 4,429,440, 3,716,350 and 3,387,674 shares of common stock were outstanding during 1997, 1996 and 1995, respectively, but were not included in the computation of diluted net loss per common share because either (i) the employee stock options' exercise price was greater than the average market price of the common stock of the Company or (ii) the Company had a loss from continuing operations and, therefore, the effect would be antidilutive.
(Continued)
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
(15) 401(k) PLAN
The Company has established a qualified cash or deferred arrangement under IRS code section 401(k) covering substantially all employees. Under the plan, the employees have an option to make elective contributions of a portion of their eligible compensation, not to exceed specified annual limitations, to the plan and the Company has an option to match a portion of the employee's contribution. The Company has made matching contributions to the plan totaling $110,981, $23,034 and $8,199 in 1997, 1996 and 1995, respectively.
(16) MAJOR CUSTOMERS
The following purchasers accounted for 10% or more of the Company's oil and gas sales for the years ended December 31, 1997, 1996 and the period March 31, 1995 (date of inception) through December 31, 1995:
- -------------------------------- (a) Purchaser A is an affiliate of Enron Corp., a significant stockholder of the Company.
(17) DERIVATIVE FINANCIAL INSTRUMENTS
The Company utilizes various swap contracts and other financial instruments to hedge the effect of price changes on future oil and gas production. The following table sets forth the future volumes hedged by year and the range of prices to be received based upon the fixed price of the individual swap contracts and other financial instruments outstanding at December 31, 1997:
(18) IMPAIRMENT OF LONG-LIVED ASSETS
The Company, in accordance with FAS 121, estimated expected future cash flows of its oil and gas properties by amortization unit and compared the amounts determined to the carrying amount of its oil and gas properties to determine if the carrying amount was recoverable. For those oil and gas properties for which the carrying amount exceeded the estimated future cash flows, an impairment was determined to exist; therefore, the Company adjusted the carrying amount of those oil and gas properties to their estimated fair value as determined by discounting their expected future cash flows at a discount rate commensurate with the risks involved in the industry. As a result of this process, the Company recognized an impairment of approximately $69 million related to its oil and gas properties during 1997. No impairment was determined to exist during the year ended December 31, 1996 or the period March 31, 1995 (date of inception) through December 31, 1995.
(Continued)
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
(19) UNAUDITED SUPPLEMENTARY INFORMATION
Capitalized Costs
Costs Incurred
Reserve Quantity Information
The estimates of proved oil and gas reserves, which are located principally in the United States and offshore Gulf of Mexico, were prepared by independent petroleum consultants as of December 31, 1997 and 1996, and the Company as of December 31, 1995. Reserves were estimated in accordance with guidelines established by the SEC and FASB which require that reserve estimates be prepared under existing economic and operating conditions with no provision for price and cost escalations except by contractual arrangements. The Company has presented the reserve estimates utilizing an oil price of $16.11, $25.09 and $17.66 per Bbl and a gas price of $1.83, $2.70 and $1.38 per Mcf as of December 31, 1997, 1996 and 1995, respectively.
Oil and gas reserve quantity estimates are subject to numerous uncertainties inherent in the estimation of quantities of proved reserves and in the projection of future rates of production and the timing of development expenditures. The accuracy of such estimates is a function of the quality of available data and of engineering and geological interpretation and judgment. Results of subsequent drilling, testing and production may cause either upward or downward revision of previous estimates. Further, the volumes considered to be commercially
(Continued)
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
recoverable fluctuate with changes in prices and operating costs. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries are more imprecise than those of currently producing oil and gas properties. Accordingly, these estimates are expected to change as additional information becomes available in the future.
Oil And Gas Producing Activities
Standardized Measure Of Discounted Future Net Cash Flows
The standardized measure of discounted future net cash flows is computed by applying year-end prices of oil and gas (with consideration of price changes only to the extent provided by contractual arrangements) to the estimated future production of proved oil and gas reserves, less estimated future expenditures (based on period-end costs) to be incurred in developing and producing the proved reserves, less estimated future income tax expenses (based on period-end statutory tax rates, with consideration of future tax rates already legislated) to be incurred on
(Continued)
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
pretax net cash flows less tax basis of the properties and available credits, and assuming continuation of existing economic conditions. The estimated future net cash flows are then discounted using a rate of 10% per year to reflect the estimated timing of the future cash flows.
Discounted future cash flow estimates like those shown below are not intended to represent estimates of the fair value of oil and gas properties. Estimates of fair value should also consider probable reserves, anticipated future oil and gas prices, interest rates, changes in development and production costs and risks associated with future production. Because of these and other considerations, any estimate of fair value is necessarily subjective and imprecise.
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
TITAN EXPLORATION, INC.
Notes to Consolidated Financial Statements
(20) SELECTED QUARTERLY FINANCIAL RESULTS (UNAUDITED)
______________________ (a) The total expenses in the fourth quarter of 1997 include an impairment of long-lived assets of approximately $44.7 million after the income tax benefit of approximately $24.3 million.
The 1996 and first three quarters of 1997 net income (loss) per common share amounts have been restated to comply with FAS 128.