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| EPEX > SEC Filings for EPEX > Form 10-K on 16-Mar-2009 | All Recent SEC Filings |
16-Mar-2009
Annual Report
The following is a review of our financial position and results of operations for the periods indicated. Our Consolidated Financial Statements and Supplementary Information and the related notes thereto contain detailed information that should be referred to in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A").
GENERAL OVERVIEW
Edge Petroleum Corporation ("Edge", "we" or the "Company") is a Houston-based independent energy company that focuses its exploration, development, production, acquisition and marketing activities in selected onshore basins of the United States. In late 1998, we undertook a top-level management change and began a shift in strategy from pure exploration, which focused more on prospect generation, to a strategy which focused on a balanced program of exploration, exploitation and development and acquisition of oil and gas properties. In late 2007, in an attempt to enhance shareholder value we began to assess our strategic alternatives and have subsequently expanded this process to include a further evaluation of both our financial and strategic alternatives in late 2008 and continuing into 2009. Our current primary focus is on capital preservation and resolving the uncertainty and challenges we face.
We generate revenues, income and cash flows by producing and marketing oil and natural gas produced from our oil and natural gas properties. We have historically made significant capital expenditures in our exploration, development, and production activities that have allowed us to continue generating revenue, income and cash flows. In recent years, we have also spent considerable efforts on acquisitions, including both corporate and asset acquisitions. We are currently operating with a reduced capital spending program as we continue to pursue the sale of some or all of our assets, a merger or other business combination involving the Company or the restructuring or recapitalization of the Company.
This overview provides our perspective on the individual sections of MD&A. Our MD&A includes the following sections:
º •
º Outlook and Review of Financial and Strategic Alternatives-additional
discussion relating to management's outlook to the future of our
business.
º •
º Industry and Economic Factors-a general description of value drivers
of our business as well as opportunities, challenges and risks related
to the oil and gas industry.
º •
º Approach to the Business-additional information regarding our approach
and strategy.
º •
º Acquisitions and Divestitures-information about significant changes in
our business structure.
º •
º Critical Accounting Policies and Estimates-a discussion of certain
accounting policies that require critical judgments and estimates.
º •
º Results of Operations-an analysis of our consolidated results for the
periods presented in our financial statements.
º •
º Liquidity and Capital Resources-an analysis of cash flows, sources and
uses of cash, and contractual obligations.
º •
º Fair Value Measurements-supplementary discussion regarding fair value
measurements and implementation of SFAS No. 157, Fair Value
Measurements.
º •
º Risk Management Activities-Derivatives & Hedging-supplementary
information regarding our price-risk management activities.
º •
º Tax Matters-supplementary discussion of income tax matters.
º •
º Recently Issued Accounting Pronouncements-a discussion of certain
recently issued accounting pronouncements that may impact our future
results.
OUTLOOK AND REVIEW OF FINANCIAL AND STRATEGIC ALTERNATIVES
On December 18, 2007, we announced the hiring of a financial advisor to assist our Board of Directors with an assessment of strategic alternatives. On February 7, 2008, we provided an update on the strategic alternatives process and announced publicly that we would implement a process to explore a merger or sale of the company. As a result of the strategic alternatives process, on July 14, 2008, we entered into an Agreement and Plan of Merger (the "Merger Agreement") with Chaparral Energy, Inc. ("Chaparral") and Chaparral Exploration, L.L.C., a Delaware limited liability company and wholly owned direct subsidiary of Chaparral ("Sub"), whereby we would merge with and into Sub. The Merger Agreement was unanimously approved by our Board of Directors and Chaparral's Board of Directors and stockholders. To provide additional funding for the transaction, Chaparral expected to sell 1.5 million shares of its Series B convertible preferred stock, par value $0.01 per share for $150 million in a private sale to Magnetar Financial LLC, on behalf of itself and one or more of its affiliates and assigns (collectively, "Magnetar"). On October 23, 2008, we adjourned our annual meeting of stockholders and announced our plans to reconvene the meeting on December 4, 2008, when our common stockholders would vote on the adoption of the Merger Agreement. The adjournment to the later date was intended to allow additional time for Edge common stockholders to receive and consider additional information regarding the proposed merger with Chaparral. On December 3, 2008, we announced that we would reconvene the annual meeting of stockholders on December 29, 2008. The credit crisis and related turmoil in the global financial system and economic recession in the U.S. during the fourth quarter of 2008, along with declines in commodity prices and our stock prices, created a challenging environment for the successful completion of our proposed merger with Chaparral. On December 17, 2008, we announced the termination of the Merger Agreement after both we and Chaparral determined it was highly unlikely that the conditions to the closing of the proposed merger would be satisfied or that Chaparral would be able to obtain sufficient debt and equity financing to allow them to complete the proposed merger and operate as a combined company, particularly in light of the challenging environment in the financial markets and the energy industry. As a result, after consultation with our legal and financial advisors, our Board of Directors approved a merger termination agreement with Chaparral and a termination and settlement agreement among us, Chaparral and Magnetar. Pursuant to the termination agreements, Magnetar reimbursed Chaparral $5.0 million for certain expenses, of which $1.5 million was paid to us at Chaparral's direction, of which we paid $0.3 million to our then-financial advisor, Merrill Lynch.
We are currently undertaking the evaluation and assessment of various financial and strategic alternatives, which may include the sale of some or all of our assets, a merger or other business combination involving the Company, restructuring or recapitalization of the Company to address our liquidity issues and the Deficiency under our Revolving Facility (see discussion below). We have retained an investment banking firm to assist further in the evaluation of our strategic and financial alternatives.
During January 2009, we announced that the lenders ("Lenders") to our Fourth Amended and Restated Credit Agreement (as amended, the "Revolving Facility") had completed their borrowing base redetermination and reduced our borrowing base to $125 million, resulting in a $114 million borrowing base deficiency (the "Deficiency"). Pursuant to the terms of the Revolving Facility, we elected to prepay the Deficiency in six equal monthly installments, with the first $19 million installment being due on February 9, 2009. On February 9, 2009, we entered into a Consent and Agreement (the "February Consent") among us and the Lenders, deferring the payment date of the first $19 million installment until March 10, 2009, and extending the due date for each subsequent installment by one month with
the last of the six $19 million installment payments to be due on August 10, 2009. In connection with the February Consent, we agreed to prepay $5.0 million of our outstanding advances under the Revolving Facility, in two equal installments. The first $2.5 million prepayment was paid on February 9, 2009 and the second $2.5 million prepayment was paid on February 23, 2009. Each of the prepayments will be applied on a pro rata basis to reduce the remaining six $19 million deficiency payments. On March 10, 2009, we entered into a Consent and Agreement (the "March Consent") with the Lenders under the Revolving Facility, which provided, among other things, for the extension of the due date for the first installment to repay the Deficiency from March 10, 2009 to March 17, 2009. Notwithstanding such extension, we agreed with the Lenders that each of the other five equal installment payments required to eliminate the Deficiency would be due and payable as provided for in the February Consent.
On March 16, 2009, we entered into Consent and Amendment No. 4 to our
Revolving Facility (the "Amended Consent") which provides, among other things,
(1) that we will make a $25 million payment on May 31, 2009 with all remaining
principal, fees and interest amounts under our Revolving Facility to be due and
payable on June 30, 2009, (2) that it will be an event of default (i) if we fail
to have executed and delivered on or before May 15, 2009 at least one of the
following (a) a commitment letter from a lender or group of lenders reasonably
satisfactory to our Lenders providing for the provision by such lender or group
of lenders of a credit facility in an amount sufficient to repay all of our
obligations under the Revolving Facility on or before June 30, 2009, (b) a
merger agreement or similar agreement involving us as part of a transaction that
results in the repayment of our obligations under the Revolving Facility on or
before June 30, 2009, and (c) a purchase and sale agreement with a buyer or
group of buyers reasonably acceptable to our Lenders providing for a sale
transaction by us that results in the repayment of all of our obligations under
the Revolving Facility on or before June 30, 2009, or (ii) if we are in default
under or our hedging arrangements have been terminated or cease to be effective
without the prior written consent of our Lenders, (3) that our advances under
the Revolving Facility will bear interest at a rate equal to the greater of
(a) the reference rate publicly announced by Union Bank of California, N.A. for
such day, (b) the Federal Funds Rate in effect on such day plus 0.50% and (c) a
rate determined by the Administrative Agent to be the Daily One-Month LIBOR (as
defined in the Revolving Facility), in each case plus 2.5% or, during the
continuation of an event of default, plus 4.5% (resulting in an effective
interest rate of approximately 5.75% as of March 16, 2009), (4) for limitations
on the making of capital expenditures and certain investments, and (5) for the
elimination of the current ratio, leverage ratio and interest coverage ratio
covenant requirements. The Amended Consent also eliminates the six $19 million
deficiency payments which were contemplated by the February Consent and the
March Consent. To comply with the terms of the Amended Consent, we anticipate
that we will need to (i) sell select individual assets prior to May 31, 2009 to
enable us to make the $25 million payment which is due on May 31, 2009, and/or
(ii) negotiate a commitment letter with a new lender or group of lenders prior
to May 15, 2009 in an amount sufficient to repay all of our obligations under
the Revolving Facility on or before June 30, 2009, and/or (iii) have negotiated
the sale, merger or other business combination involving us which results in the
repayment of all of our obligations under the Revolving Facility prior to
May 15, 2009 and to have closed such transaction on or before June 30, 2009. The
Amended Consent limits the making of capital expenditures and we anticipate a
severe curtailment of our drilling plans and other capital expenditures in 2009.
If we breach any of the provisions of the Amended Consent or the Revolving Facilities, our Lenders will be entitled to declare an event of default, at which point the entire unpaid principal balance of the loans, together with all accrued and unpaid interest and other amounts then owing to our Lenders, would become immediately due and payable. In any event, the entire unpaid principal balance of the loans, together with all accrued and unpaid interest and other amounts then owing to our Lenders, will be payable on June 30, 2009 unless earlier paid or a further extension with respect to payment is negotiated with our Lenders. Our Lenders may take action to enforce their rights with
respect to the outstanding obligations under the Revolving Facility. Because substantially all of our assets are pledged as collateral under the Revolving Facility, if our Lenders declare an event of default, they would be entitled to foreclose on and take possession of our assets. In such an event, we may be forced to liquidate or to otherwise seek protection under Chapter 11 of the U.S. Bankruptcy Code. These matters, as well as the other risk factors related to our liquidity and financial position raise substantial doubt as to our ability to continue as a going concern. See ITEM 7. "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-LIQUIDITY AND CAPITAL RESOURCES-REVOLVING FACILITY." With respect to our compliance with the Amended Consent, there can be no assurance that we will be able to further negotiate the terms of the Amended Consent or negotiate a further restructuring of the related indebtedness or that we will be able to make any required payments when they become due. Moreover, there can be no assurance that we will be successful in our efforts to comply with the terms of the Amended Consent, including our ongoing efforts to evaluate and assess our various financial and strategic alternatives (which may include the sale of some or all of our assets, a merger or other business combination involving the Company, or the restructuring or recapitalization of the Company). If such efforts are not successful, we may be required to seek protection under Chapter 11 of the U.S. Bankruptcy Code.
Going Concern-In addition to the Deficiency under our Revolving Facility, the capital expenditures required to maintain and/or grow production and reserves are substantial. Our stock price has significantly declined over the past year which makes it more difficult to obtain equity financing on acceptable terms to address our liquidity issues. In addition, we are reporting negative working capital at December 31, 2008 and a third consecutive year of net losses for the year ended December 31, 2008, which is largely the result of impairments of our oil and natural gas properties. Therefore, there is substantial doubt as to our ability to continue as a going concern for a period longer than the current fiscal year. Our ability to continue as a going concern is dependent upon the success of our financial and strategic alternatives process, which may include the sale of some or all of our assets, a merger or other business combination involving the Company or the restructuring or recapitalization of the Company. Until the possible completion of the financial and strategic alternatives process, our future remains uncertain and there can be no assurance that our efforts in this regard will be successful.
Our consolidated financial statements have been prepared in accordance with
generally accepted accounting principles applicable to a going concern, which
implies we will continue to meet our obligations and continue our operations for
the next twelve months. Realization values may be substantially different from
carrying values as shown, and our consolidated financial statements do not
include any adjustments relating to the recoverability or classification of
recorded asset amounts or the amount and classification of liabilities that
might be necessary as a result of this uncertainty. Our independent auditors
have included an explanatory paragraph in their report on our consolidated
financial statements that raises substantial doubt about our ability to continue
as a going concern. See ITEM 8. "FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA-Report of the Independent Registered Accounting Firm."
Our outlook and the expected results described above are both subject to change based upon factors that include, but are not limited to, drilling results, commodity prices, the results of our financial and strategic alternatives process, access to capital, the acquisitions market and factors referred to in "FORWARD LOOKING INFORMATION."
INDUSTRY AND ECONOMIC FACTORS
In managing our business, we must deal with many factors inherent to our industry. First and foremost is the fluctuation of oil and natural gas prices. Our revenues, the value of our assets, our ability to obtain bank loans or additional capital on attractive terms have been and will continue to be affected by changes in oil and natural gas prices and the costs to produce our reserves. Oil and natural
gas prices are subject to significant fluctuations that are beyond our ability to control or predict without losing some advantage of the upside potential. In recent years, oil and natural gas commodity prices have generally trended upwards in response to robust demand and constrained supplies, with oil and natural gas prices peaking at more than $140.00 per barrel and $13.00 per Mcf, respectively, in July 2008. In the second half of 2008, a world-wide economic recession and oversupply of natural gas in North America led to an unprecedented decline in oil and natural gas prices, with oil falling by more than $100.00 per barrel and natural gas falling more than $8.00 per Mcf from their peaks in July 2008.
Although certain of our costs and expenses are affected by general inflation, inflation does not normally have a significant effect on our business. Our costs and expenses tend to react to activity levels in our industry and commodity price movements. In response to the recent historically high commodity prices, the oil and natural gas industry experienced significant increases in activity and in demand for oil field services. The increased demand for these services resulted in significant inflation in both operating and capital costs. Although commodity prices have declined significantly in recent months, the inflated cost of oil field services resulting from recent historically high commodity prices did not decrease as rapidly. The prospect of continued low commodity prices and disproportionately high service costs will constrain the industry's capital reinvestment for the near future.
Our operations entail significant complexities. Advanced technologies requiring highly trained personnel are utilized in both exploration and production. Even when the technology is properly used, we may still not know conclusively if hydrocarbons will be present or the rate at which they will be produced. Exploration is a high-risk activity, oftentimes resulting in no commercially productive reserves being discovered. These factors, together with increased demand for rigs, equipment, supplies and services, have made it difficult at times for us to further our growth, and made timely execution of our planned activities difficult.
Our business, as with other extractive businesses, is a depleting one in which each gas equivalent produced must be replaced or our asset base and capacity to generate revenues in the future will shrink. This was a factor in our 2008 results, which reflected a 24% lower proved reserve base at year-end. We were unable to replace the production we generated due to our reduced capital spending program and higher drilling and operating costs. This will continue to be a factor in 2009 as we operate under a severely limited capital and operating budget.
The oil and natural gas industry is highly competitive. We compete with major and diversified energy companies, independent oil and natural gas businesses and individual operators in exploration, production, marketing and acquisition activities. In addition, the industry as a whole competes with other businesses that supply energy to industrial and commercial end users.
Extensive federal, state and local regulation of the industry significantly affects our operations. In particular, our activities are subject to stringent operational and environmental regulations. These regulations have increased the costs of planning, designing, drilling, installing, operating and abandoning oil and natural gas wells and related facilities. These regulations may become more demanding in the future.
The growing global economic crisis created an environment of uncertainty during the third and fourth quarters of 2008. We are unable to predict the impact on our business of a continued decline in commodity prices and the global economy. Possible negative impacts, among others, could include further declines in our revenue, cash flows and liquidity.
APPROACH TO THE BUSINESS
Historically, our goal has been to fund ongoing exploration and development projects with cash flow provided by operating activities, occasionally supplemented with external sources of capital. As a result of the strategic alternatives process that began in late 2007 (see discussion above), our Board
approved a reduced capital expenditure budget for 2008, while we assessed the potential sale or merger of the Company. This affected our spending in the third and fourth quarters of 2008.
More recently, in connection with our ongoing financial and strategic alternatives process and our liquidity issues resulting from the Deficiency under our Revolving Facility and the related Amended Consent, we have operated and will continue to operate with a severely limited capital spending program in 2009 as we continue to pursue the sale of some or all of our assets, a merger or other business combination involving the Company or the restructuring or recapitalization of the Company. Our strategy is currently to continue under a severely limited capital and operating budget, thereby reducing our normal exploration and development activities as we seek to preserve liquidity and resolve the uncertainty and challenges that we face as we pursue various financial and strategic alternatives.
We normally hedge our exposure to volatile oil and natural gas prices on a portion of our expected production to reduce price risk. As a result of changes to our forecasted 2008 production and the impact of certain asset divestitures, both of which reduced production as compared to that expected at the time we entered into the derivative contracts, we had approximately 115% and 190% of our 2008 natural gas and crude oil production, respectively, covered by derivative contracts. This overhedged position exposed us to greater risk of commodity price increases because at times we did not have the physical production cash inflows to offset the losses incurred on the portion of the contracts that were overhedged. During September and October 2008, we entered into two new contracts for certain fourth quarter 2008 production that were intended to offset a portion of the volumes that were overhedged and thereby reduce our exposure to significant increases in natural gas and crude oil prices.
ACQUISITIONS AND DIVESTITURES
Acquisitions-We became increasingly active in acquisitions in recent years. In the past, we have looked to acquisitions to enable us to achieve our growth objectives. Acquisitions add meaningful incremental increases in reserves and production and may range in size from acquiring a working interest in non-operated producing property to an entire field or company. Unlike drilling capital, which is planned and budgeted, acquisition capital is neither budgeted nor allocated. Specific timing and size of acquisitions cannot be predicted, but in light of current conditions, we do not expect to make any acquisitions in the coming year.
January 2007 Acquisition-During the first quarter of 2007, we completed the largest acquisition in our history. We acquired oil and natural gas properties located in 13 counties in south and southeast Texas, exploration rights, leasehold acreage, gathering facilities and gathering pipelines from a privately held company (the "January 2007 Acquisition"). This acquisition had a substantial impact on our reserves, production revenues, operating costs, and property base. The final adjusted cash purchase price was $384.4 million. We financed the purchase price of the January 2007 Acquisition through public offerings of common and preferred stock (see Notes 13 and 14 to our consolidated financial statements) and borrowings under our Revolving Facility (see Note 11 to our consolidated financial statements). We also capitalized approximately $1.4 million in other direct costs resulting from the acquisition and assumed asset retirement obligation ("ARO") liabilities of $0.9 million.
As part of this acquisition, we also acquired a 12.5% working interest in an approximate 160 square mile 3-D exploration area with approximately 55,000 gross acres of leases and options located in the Yates Ranch/Hostetter project area in McMullen and Duval Counties in south Texas. During the third quarter 2007, we elected to terminate this exploration venture. The effective date of termination for this venture was October 2, 2007. In exchange for returning all 3-D seismic data covering the area of mutual interest, the privately held company refunded our payments since January 2007 related to this exploration venture. In October 2007, we received $5.5 million, including the $5.0 million initial price paid for the venture and $0.5 million in expenses related to the venture, which were incurred and paid to the privately held company from January to September 2007.
Chapman Ranch Acquisition 2006-On December 12, 2006, we executed an agreement to acquire certain working interests in the Chapman Ranch Field in Nueces County, Texas from Kerr-McGee Oil & Gas Onshore LP ("Kerr-McGee"), a wholly-owned subsidiary of Anadarko Petroleum Corporation. Upon the closing of this acquisition on December 28, 2006, we assumed the role of operator of the Chapman Ranch Field and added to our existing working interest position in this field which we initially acquired in connection with two other acquisitions in late 2005. The final adjusted purchase price was approximately $25.3 million (including a previously paid deposit of $2.6 million) as a result of adjustments for the results of operations between the December 1, 2006 effective date and the December 28, 2006 closing date, and other purchase price adjustments. We financed the purchase price of this acquisition through $24.0 million in borrowings under our then-existing credit facility.
Divestitures-We regularly review our asset base for the purpose of identifying non-core assets, the disposition of which would increase capital resources available for other activities and create organizational and operational efficiencies. While in the past we have not generally disposed of assets solely for the purpose of reducing debt, in connection with our ongoing financial and strategic alternatives process, we are actively pursuing the possible sale of some or all of our assets or other business combinations involving the Company. We believe that we will need to make significant divestitures in 2009 in order to comply with the terms of the Amended Consent. . . .
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