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| EPEX > SEC Filings for EPEX > Form 10-Q on 7-May-2009 | All Recent SEC Filings |
7-May-2009
Quarterly Report
The following is Management's Discussion and Analysis ("MD&A") of significant factors that have affected certain aspects of our financial position and operating results during the periods included in the accompanying unaudited condensed consolidated financial statements. The following MD&A is intended to help the reader understand Edge Petroleum Corporation ("Edge"). This discussion should be read in conjunction with the accompanying unaudited condensed consolidated financial statements included elsewhere in this Form 10-Q and with MD&A of Financial Condition and Results of Operations and our audited consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2008 ("2008 Annual Report").
FORWARD LOOKING STATEMENTS
The information contained in this quarterly Report on Form 10-Q includes certain forward-looking statements. The words "may," "will," "expect," "anticipate," "believe," "continue," "estimate," "project," "intend," and similar expressions used in this Form 10-Q are intended to identify forward-looking statements within the meaning of Section 27A of the U.S. Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. You should not place undue reliance on these forward-looking statements, which speak only as of the date made. We undertake no obligation to publicly release the result of any revision of these forward-looking statements to reflect events or circumstances after the date they are made or to reflect the occurrence of unanticipated events. You should also know that such statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions. Should any of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may differ materially from those included within the forward-looking statements. Such statements involve risks and uncertainties, including, but not limited to, those set forth under "ITEM 1A. RISK FACTORS" of our 2008 Annual Report and this Quarterly Report on Form 10-Q.
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 natural 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:
† Outlook and Review of Financial and Strategic Alternatives - additional discussion relating to management's outlook to the future of our business.
† 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 natural gas industry.
† Approach to the Business - information regarding our approach and strategy.
† Divestitures - information about our sales and divestitures.
† Critical Accounting Policies and Estimates - a discussion of certain accounting policies that require critical judgments and estimates.
† Results of Operations - an analysis of our consolidated results for the periods presented in our financial statements.
† Liquidity and Capital Resources - an analysis of cash flows, sources and uses of cash, and contractual obligations.
† Fair Value Measurements - supplementary discussion regarding fair value measurements and implementation of SFAS No. 157, Fair Value Measurements.
† Risk Management Activities - supplementary information regarding our price-risk management activities.
† Tax Matters - supplementary discussion of income tax matters.
† 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. During 2008, we focused our efforts on a proposed merger with Chaparral Energy, Inc. ("Chaparral"). However, on December 17, 2008, we announced the termination of the Chaparral 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.
Since December 2008, we have continued with our 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 are working with an investment banking firm to assist further in the evaluation of our financial and strategic 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 under the Revolving Facility 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 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, with each of the
prepayments to 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 May 7, 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 Facility, 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 2. "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. Prices for oil and natural gas declined materially during the fourth quarter of 2008, and natural gas prices continued to decline during the first quarter of 2009. A continued or extended decline in oil or natural gas prices will have a material adverse effect on our financial position, results of operations, cash flows and access to capital and on the quantities of oil and natural gas reserves that we can economically produce. Our stock price has significantly declined over the past year which also 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 March 31, 2009 and continue to report net losses in the first quarter of 2009 following three consecutive years of net losses. Therefore, there is substantial doubt as to our ability to continue as a going concern for a period longer than the next twelve months. Additionally, our independent auditors included an explanatory paragraph in their report on our consolidated financials statements as of and for the year ended December 31, 2008 that raises substantial doubt about our ability to continue as a going concern. 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 and an increase in commodity prices. 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 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" in our 2008 Annual Report.
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 late 2008 and early 2009, 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 $10.00 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 in 2008. 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. While these costs are declining, they have lagged in comparison to the rapid commodity price decline; thus the prospect of continued
low commodity prices and disproportionately higher 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. In 2008 and the first quarter of 2009, 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.
Poor economic conditions continue to create considerable challenges and uncertainties for the energy industry. We are unable to predict the impact on our business of a continued decline in commodity prices and the global economy, but the current conditions have made it difficult at times for us in our ongoing financial and strategic alternatives process. We expect that continued weakening in the economy could result in 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. 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 of March 31, 2009, we had derivative contracts in place covering 20,000 MMBtu/d of natural gas and 300 Bbl/d of crude oil for the remainder of 2009.
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 we generally do not dispose of assets solely for the purpose of reducing debt, such dispositions can have the result of furthering our objective of financial flexibility through reduced debt levels. We have not completed any divestitures in the first quarter of 2009, but during the first quarter of 2008, we
completed the sale of certain working interests in approximately 100 properties located in Texas to various buyers for aggregate proceeds of approximately $12.2 million.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, contingent assets and liabilities and the related disclosures in the accompanying financial statements. Changes in these estimates and assumptions could materially affect our financial position, results of operations or cash flows. Management considers an accounting estimate to be critical if:
† it requires assumptions to be made that were uncertain at the time the estimate was made, and
† changes in the estimate or different estimates that could have been selected could have a material impact on our consolidated results of operations or financial condition.
All other significant accounting policies that we employ are presented in the notes to the consolidated financial statements. The following discussion presents information about the nature of our most critical accounting estimates, our assumptions or approach used and the effects of hypothetical changes in the material assumptions used to develop each estimate.
Nature of Critical Estimate Item: Oil and Natural Gas Reserves - Our estimate of proved reserves is based on the quantities of oil and natural gas which geological and engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs under existing economic and operating conditions. The accuracy of any reserve estimate is a function of the quality of available data, engineering and geological interpretation, and judgment, as well as prices and cost levels at that point in time. Any significant variance in these assumptions could materially affect the estimated quantity and value of our reserves. Despite the inherent imprecision in these engineering estimates, our reserves are used throughout our financial statements.
Assumptions/Approach Used: Units-of-production method to amortize our oil and natural gas properties - The quantity of reserves is used in calculating depletion expense and could significantly impact our depletion expense. Any reduction in proved reserves without a corresponding reduction in capitalized costs will increase the depletion rate.
"Ceiling" Test - The full-cost method of accounting for oil and natural gas properties requires a quarterly calculation of a limitation on capitalized costs, often referred to as a full-cost ceiling test. The ceiling is the discounted present value of our estimated total proved reserves (using a 10% discount rate) adjusted for taxes and the impact of cash flow hedges on pricing, if cash flow hedge accounting is applied. The ceiling test calculation dictates that prices and costs in effect as of the last day of the period are to be used in calculating the discounted present value of our estimated total proved reserves. However, if prices increase subsequent to the balance sheet date, but before the filing date, SEC guidelines allow a company to use the subsequent date's higher prices in calculating the full-cost ceiling. To the extent that our capitalized costs (net of accumulated depletion and deferred taxes) exceed the ceiling, the excess must be written off to expense. Once incurred, this impairment of oil and natural gas properties is not reversible at a later date even if oil and natural gas prices increase. A ceiling test impairment could result in a significant loss for a reporting period; however, future depletion expense would be correspondingly reduced. Our estimated proved reserves volumes have decreased during the period from year-end 2008 to March 31, 2009, and the average oil, NGL and natural gas prices at the balance sheet date as of March 31, 2009 were $49.66 per barrel, $29.80 per barrel and $3.78 per MMBtu, respectively. As a result, we recorded a net ceiling test impairment for the three months ended March 31, 2009 of approximately $78.3 million, net of tax. This impairment will significantly affect the comparability of results between the 2009 and 2008 periods. Additionally the impairments taken in the third and fourth quarters of 2008 significantly impacted our depletion
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