ITEM 1. BUSINESS
South Texas Drilling & Exploration, Inc. and its subsidiaries (the "Company") are engaged in the business of providing land contract drilling services for the oil and gas industry; oil and gas exploration and development activity for its own account; and operation of oil and gas wells for its own account and those of outside investors. The Company's main focus continues to be its land contract drilling services and in fiscal year 1998, the oil and gas operations contributed an immaterial amount towards the Company's gross revenue. The revenues; earnings (loss) from operations; identifiable assets; depreciation, depletion and amortization; and capital expenditures are reported for each of its business segments for the fiscal years ended March 31, 1997 and 1996 in note 5 ("Business Segments and Supplementary Earnings Information") of the Notes to Consolidated Financial Statements, which note is incorporated herein by reference. Fiscal 1998 oil and gas operations are immaterial, and therefore separate disclosure of this information has been omitted.
This Form 10K contains certain "forward-looking" statements as such term is defined in The Private Securities Litigation Reform Act of 1995 and information relating to the Company and its subsidiaries that are based on the beliefs of the Company's management. When used in this report, the words "anticipate," "believe," "estimate," "expect" and "intend" and words or phrases of similar import, as they relate to the Company or its subsidiaries or Company management, are intended to identify forward-looking statements. Such statements reflect the current risks, uncertainties and assumptions related to certain factors including, without limitation, competitive factors, general economic conditions, customer relations, relationships with vendors, the interest rate environment, governmental regulation and supervision, seasonality, distribution networks, product introductions and acceptance, technological change, changes in industry practices, one-time events and other factors described herein and in other filings made by the Company with the Securities and Exchange Commission. Based upon changing conditions, should any one or more of these risks or uncertainties materialize, or should any underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected, or intended. The Company does not intend to update these forward-looking statements.
CONTRACT DRILLING
At the end of fiscal 1998, the Company owned seven land drilling rigs with approximate depth capabilities ranging from 6,000 feet to 12,000 feet. Of the seven rigs, six are operational. The seventh rig was purchased in October, 1997, and is scheduled to be refurbished during fiscal 1999. Of the remaining six rigs, four were operated during all of fiscal 1998. The other two were in operation from June, 1997, when they were purchased. Additionally, the Company operated a leased rig, Rig 10, from June 1997 to January 1998. The Company's rigs are presently operating in south Texas and along the Gulf Coast of Texas. All six of the rigs are currently in operation.
On June 18, 1997, the Company closed on the purchase of the drilling operations of San Patricio Corporation, a drilling contractor based in Corpus Christi, Texas. Equipment purchased in this transaction included two land drilling rigs with depth capabilities ranging from 6,000' to 10,500' and a leased land drilling rig, Rig 10, with depth capability of 9,500'. The acquisition was accomplished with $900,000 of third-party financing, $300,000 of seller financing and $300,000 of the Company's Common Stock. The leased rig was returned to the lessor in February, 1998.
On October 20, 1997, the Company purchased a Skytop-Brewster N-46 drilling rig. This rig, designated Rig 15, is stored in the Company's yard in Kenedy, Texas awaiting refurbishment. Once the rig is refurbished it will have a depth capability of approximately 14,000 feet.
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Drilling Equipment
A land drilling rig consists of engines, drawworks, mast, pumps to circulate the drilling mud, blowout preventors, drillstring and related equipment. The size and type of rig used depends upon well depth and site conditions, among other factors. A description of the type and capability of the land drilling rigs operated by the Company during fiscal 1998 is set forth in the following table:
(1) Rig 10 was the leased rig which was returned to the lessor in February, 1998.
Minor repair work on the drilling rigs is performed on-site by the Company's employees, but major repair work and overhaul of drilling equipment on a contractual basis are performed by unaffiliated oil field service companies. In the event of major breakdowns or mechanical problems, the Company's rigs could be subject to significant idle time and a resulting loss of revenue if such repair services were not immediately available. The Company engages in periodic maintenance and improvement of its drilling equipment and believes that its drilling rigs and other related equipment are in good operating condition. The Company has experienced no substantial down time as the result of repair or overhaul of its equipment.
Principal materials, supplies and equipment necessary for drilling operations are fuels to operate drilling equipment, drilling mud, tubular steel, cement, drill bits, and other miscellaneous items. Certain of these items were in short supply from time to time during prior periods of high drilling demand. At the present time, the Company is not experiencing any significant shortages of materials, supplies and equipment used in drilling, and does not foresee any shortages materially affecting its operations. However, certain equipment items, such as used drill pipe, are becoming more difficult to find, requiring the purchase of more expensive new equipment.
Contracts
All contracts under which the Company is presently conducting its land drilling operations provide for rate charges determined on a daywork, footage or turnkey basis, with rates dependent on the anticipated complexity of drilling the well, on-site drilling conditions, the type of equipment to be used, the Company's estimate of the risks involved, the duration of the work to be performed and competitors' rates among other considerations. Daywork contracts provide for a fixed charge per day for drilling the well, and the customer generally bears the major portion of the related costs and risks of drilling.
With certain limitations, contracts entered into on a footage basis provide for an agreed price per foot drilled regardless of the time required or the problems involved in drilling the well. Related costs of drilling (i.e., rig
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
mobilization, labor, fuel usage and other costs) are included in the footage charge. As compared to daywork contracts, footage contracts involve a higher degree of risk to the Company.
Contracts entered into on a turnkey basis usually require the Company to deliver to the operator a completed hole drilled to a specified depth. In addition to all costs incurred when drilling on a footage basis, the Company is usually also responsible for drilling fluids, water and other costs. As this type of contract places a greater degree of risk on the Company than daywork or footage contracts, the anticipated gross margin on this type of contract is usually greater than on daywork or footage contracts.
Drilling contracts are obtained either through competitive bidding or through direct negotiation. Contracts are usually entered into by the Company covering the drilling of one well and obligate the Company to advance certain costs and to assume certain expenses in connection with drilling operations. During the year ended March 31, 1998 the Company drilled 68 wells with 59% of contract drilling revenues attributable to daywork contracts, 10% to footage contracts, and 31% to turnkey contracts. During the year ended March 31, 1997 the Company drilled 46 wells with 72% of contract drilling revenues attributable to daywork contracts, 17% to footage contracts, and 11% to turnkey contracts.
In several previous years uncertainty relating to oil and gas prices and the domestic gas surplus has led to significant reductions in drilling activity by oil and gas producing companies. Furthermore, the phased-in reduction of the highest marginal income tax rates applicable to individual investors has previously reduced commitments of capital to oil and gas drilling funds. Additionally, increased costs due to government regulation have resulted in the movement of much of the drilling activities to locations overseas. The aggregate impact of these diverse economic factors has resulted in significant reductions of oil company commitments to domestic oil and gas exploration and consequent slackening of overall demand for drilling rigs prior to fiscal 1997. Fiscal 1997, however, saw a reversal of the downward trend of prior years. The increased drilling activity continued through the third quarter of fiscal 1998, but it has weakened considerably since January, 1998 due primarily to a substantial decrease in oil prices.
During the year ended March 31, 1998, the largest customer of the Company's drilling rigs was Michael Petroleum Corporation. This customer accounted for approximately 18% of contract drilling revenues of the Company during that period. Only one other customer, Samedan Oil Corporation with approximately 14%, accounted for more than 10% of the Company's contract drilling revenues for 1998.
The Company actively markets its rigs and completed contracts for 37 customers in 1998 compared to 32 customers in 1997 and 27 customers in 1996.
The loss of any of the Company's land drilling customers could have a material adverse effect on the Company's business, particularly with respect to the time required to find other users of the rig concerned. See "Competitive, Business and Operational Risks in Contract Drilling" in Part I.
Competitive, Business and Operational Risks in Contract Drilling
The Company encounters substantial competition in its contract drilling operations from other drilling contractors. The usual method of competition in the contract drilling industry is on the basis of price, customer relations, rig availability and suitability, service, performance and condition of equipment used. Competition for contract drilling is primarily on a regional basis, and many of the Company's competitors in south Texas have financial resources, and technical staffs and facilities substantially greater than those of the Company.
Land contract drilling in oil and gas operations is subject to a number of operational risks and hazards including blowouts, cratering, fires and explosions. Any one of these happenings could cause serious damage to equipment, personnel, property and/or the financial condition of the Company. In addition, there is a risk that damage to the environment could result from some of the Company's operations, particularly through oil spillage or extensive, uncontrolled fires. While the Company believes that it is adequately insured against normal and foreseeable risks in its
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
operations in accordance with industry standards, such insurance may not be adequate to protect the Company against liability from all consequences of well disasters, extensive fire damage, or damage to the environment. In the event that such insurance was not adequate, the occurrence of a significant event could have a material adverse effect on the Company's financial position and results of operations. Under current conditions, the Company anticipates that its present insurance coverage will be maintained, but no assurance can be given that insurance coverage will continue to be available at rates considered reasonable or that certain types of coverage will be available at any cost.
OIL AND GAS OPERATIONS AND PROPERTIES
The Company's oil and gas operations consist of the ownership of certain oil and gas properties and the exploration, development and production of oil and gas. In June, 1992, the Company acquired operating interests in 17 producing wells. During fiscal 1994 and fiscal 1995 the Company drilled three additional wells. No wells have been added since fiscal 1995. In fiscal 1997, the Company sold its interest in one well. At the present time, the Company is in negotiations to purchase additional working interests in the wells it operates. Due to the Company's acquisitions of substantial amounts of drilling equipment in fiscal 1998, the Company's oil and gas operations no longer constitute a significant portion of the Company's operations. Accordingly, separate disclosure of fiscal 1998 oil and gas information has been omitted from this report. However, any information disclosed in years still being reported on in this report will continue to be disclosed.
Production Information
The Company is involved in oil and gas exploration, development and production. Oil and gas production accounted for approximately 1.8% of the Company's total revenues in the fiscal year ended March 31, 1998 compared with 4.7% in the fiscal year ended March 31, 1997 and 5.1% in the fiscal year ended March 31, 1996.
(1) Oil and gas production is shown net of royalties attributable to the interests of others and is based upon production reports furnished to the Company by the operators.
(2) "Production (lifting) costs" are costs directly related to the extraction of oil or gas including production taxes, but do not include depreciation, or amortization of exploration and development costs.
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
(3) Average production costs per unit were determined on the basis of six Mcf of gas being equivalent to one barrel of oil.
GOVERNMENTAL REGULATION
Governmental regulations promulgated by various state and federal authorities directly influence the Company's operations insofar as they regulate operations of the Company's rigs, impact prices and therefore supplies of and demands for oil and gas, and influence various costs associated with petroleum exploration and production.
Future Legislation
Currently there are many legislative proposals pertaining to regulation of the oil and gas industry, which may directly or indirectly affect the Company's activities. No prediction can be made as to what additional energy legislation may be proposed, if any, or which bills may be enacted or when any such bills, if enacted, would become effective.
Regulation of the Environment
The exploration, development, production and processing of oil and gas, including the disposal of produced water, are subject to various federal and state laws and regulations designed to protect the environment. Compliance with these regulations is part of the Company's day-to-day operating procedures. Infrequently, accidental discharge of such materials as oil, natural gas, drilling fluids or contaminated water can and does occur. Such accidents can require material expenditures to correct.
Various state and governmental agencies are considering, and some have adopted, other laws and regulations regarding environmental control which could adversely affect the business of the Company. Compliance with such measures, together with any penalties resulting from noncompliance therewith, may increase the cost of oil and gas development, production and processing operations or may affect the ability of the Company to complete existing or future activities in a timely manner.
Compliance with Regulations
The Company believes that it complies with all material legislation and regulations affecting its operations in the drilling and operation of oil and gas wells, and in controlling the discharge of wastes. Compliance has not, to date, materially affected the capital expenditures, earnings or competitive position of the Company, although these measures add to the costs of operating drilling equipment in some instances, and in others they may operate to reduce drilling activity. The Company does not expect to incur material capital expenditures in the next fiscal year in order to comply with current environmental control regulations. Further legislation or regulation may reasonably be anticipated, but the effects thereof on operations cannot be predicted.
The Company is subject to the requirements of the federal Occupational Safety and Health Act ("OSHA") and comparable state statutes. The OSHA hazard communication standard, the Environmental Protection Agency "community right-to-know" regulations under Title III of the Federal Superfund Amendment and Reauthorization Act and comparable state statutes require the Company to organize and report certain information about the hazardous materials used in its operations to employees, state and local government authorities, and local citizens.
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
PRINCIPAL CUSTOMERS
During the fiscal year ended March 31, 1998, Michael Petroleum Corporation accounted for 18% of the Company's total drilling revenues. Only one other customer, Samedan Oil Corporation with approximately 14%, accounted for 10% or more of the Company's total drilling revenue. The loss of either of these customers could have a material adverse effect on the Company's business resulting from the time required to find other users of the Company's rigs. See "Contract Drilling - Contracts" in this Item I.
EMPLOYEES
Prior to the last quarter of fiscal 1997, the Company leased its personnel from a personnel leasing company. In December, 1996, the leasing contract was terminated and the Company became the employer of the personnel.
At May 23, 1998, the Company had 161 full-time employees, of whom 135 were paid on an hourly basis and were engaged in operating the Company's drilling rigs or in other operations. Of the total employees, 13 were administrative employees and 13 were supervisory. None of the employees are represented by any union or collective bargaining group, and there is no history of strikes, slow downs, or other material labor disputes. Management believes that the Company's relations with its employees are satisfactory.
ITEM 2.
ITEM 2. PROPERTIES
For purposes of property description, see "Contract Drilling - Drilling Equipment" and "Oil and Gas Operations and Properties" contained in this Part I. The Company's principal executive office in San Antonio, Texas is maintained in office space which the Company purchased in September, 1995. The Company also owns a six-acre tract in Kenedy, Texas utilized as an operating yard.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is currently involved in a lawsuit styled National Energy Group, Inc. v. South Texas Drilling Company, cause No. 96-98, 357 Judicial District Court, Willacy County, Texas. This case arose out of a dispute with a drilling customer over a billing for work performed under a daywork drilling contract. In the course of drilling the well, some of the Company's equipment was lost in the hole. Under the terms of the contract, the customer was billed for the drilling operations and replacement cost of the lost equipment. The customer has declined to pay the billed amount of $279,000 alleging negligence and seeking damages in excess of $460,000 plus attorney's fees. A jury trial in this case commenced in August, 1997. The jury found in favor of the company and a judgment was entered November 7, 1997, granting the Company $163,000 plus attorneys' fees of $70,000. The customer filed an appeal of the judgment and at fiscal year-end, the case was in the early stages of the appeal. On June 10, 1998, the Company received $213,000 from National Energy Group in settlement of the lawsuit. Per the terms of the settlement each of the parties agrees to release the other from all claims related to the lawsuit. The Company's accounts related to this matter will be adjusted in the period of resolution.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fiscal year covered by this report, no matter was submitted to a vote of the Company's security holders through the solicitation of proxies or otherwise.
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
PART II
ITEM 5.
ITEM 5. MARKET PRICE OF THE COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
The initial public offering of the Company's Common Stock occurred on February 4, 1981, and from that date until August 18, 1981, the Common Stock was traded in the over-the-counter market. From August 19, 1981 until February 10, 1986, the Company's Common Stock was listed on the American Stock Exchange (AMEX) (Symbol: SDR). On February 10, 1986, trading of the Company's stock was discontinued on the AMEX as the Company no longer met the net worth requirement for listing on the AMEX. At the present time, the Company's Common Stock (Symbol: STXD) is not traded on a stock exchange. However, the Company's Common Stock is traded in the "pink sheets". Shareholders interested in trading the Company's Common Stock should contact their stockbroker or the Company for further information. In fiscal years prior to 1998, the Company's common stock was lightly traded. Therefore, the Company reported bid and ask prices rather than actual stock prices. In fiscal 1998, trading activity in the Company's common stock became more regular and the stocks' high/low prices are now more relevant. The following table sets forth for the period indicated quotations from a marketmaker for the Company's common stock. For fiscal 1998, the table presents the high and low stock price for each quarter. For fiscal 1997, the table presents, as in prior years, the bid and ask prices as of the end of each quarter.
The above over-the-counter quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
As of June 5, 1998, there were approximately 1,000 registered stockholders of Common Stock of the Company.
The Board of Directors has followed a policy of reinvesting the earnings of the Company in its business and of not distributing any part thereof as dividends to shareholders. The Board of Directors has no present intention to initiate the payment of cash dividends, and future dividends of the Company will depend upon the earnings, capital requirements and financial condition of the Company and other relevant factors. Additionally, the Company's debt facility includes a provision preventing the Company from issuing dividends except for dividends on the preferred stock issued in fiscal 1998.
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA (In thousands, except per share amounts)
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Liquidity
During the past fifteen years, drilling activity in the oil and gas industry has been volatile with periods of high activity and other periods of low activity. In fiscal 1996, drilling activity began to increase. This increased activity continued through the third quarter of fiscal 1998. During fiscal 1997, the utilization rate for the Company's rigs was 80 percent while operating four rigs. In fiscal 1998, the utilization rate decreased to 76 percent while operating up to seven rigs. The actual number of drilling days increased to 1,684 in fiscal 1998 from 1,175 in fiscal 1997. Drilling rates charged to customers on drilling contracts in fiscal 1998 showed some increase over those charged in fiscal 1997. This increase in drilling rates reflects the increased demand for drilling rigs during the period. At March 31, 1998, the Company's current ratio was 1.37 compared to 1.02 at March 31, 1997. Working capital at March 31, 1998 was $1,118,907 compared to $29,166 at March 31, 1997. This increase was due, in part, to the increased drilling activity and to the two preferred stock issues in fiscal 1998.
In June, 1997, the Company financed its purchase of drilling and rig moving equipment from San Patricio Corporation with $1,050,000 in principal amount of debt. Incident to this financing the Company obtained more favorable terms for its debt facility secured by drilling and transportation equipment and its equipment yard. Under the new terms, the term loan carries an interest rate of prime plus 2.25% and the revolving loan an interest rate of prime plus 2.25%. The monthly payments on the new note are $12,500 plus interest. In October, 1997, further financing was secured to purchase additional drilling equipment. This loan was in the amount of $600,000 and carries an interest rate of prime plus 2.25%. The monthly payments, based on seven-year amortization, are $7,143 plus interest. Also in October, 1997, the Company secured a $600,000 capital expenditure line of credit for the purchase of additional drilling equipment. This line carries an interest rate of prime plus 2.25%. The Company has made two advances under this line. The monthly payments on these advances, in the amount of $519,466, are $14,430 plus interest. All these loans are due in June, 1999
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
and, per the loan agreement, shall be automatically renewed for successive periods of one year unless paid in full earlier or there is an Event of Default for which no waiver is obtained from the lender.
In acquiring the drilling assets of San Patricio Corporation, the Company also secured $300,000 in seller financing. This loan carries an interest rate of 10% and is payable in monthly payments of $5,000 plus interest. The loan is due in June, 2002.
In March, 1998, the Company purchased additional transportation equipment. The equipment was purchased through the use of $60,000 in cash and seller financing of $60,000. The debt is payable in monthly payments of $5,000 plus interest at 8%. The loan is due in April, 1999.
The ratio of trade accounts receivable to total revenue decreased to 2.2% at the end of fiscal 1998 from 6.8% at the end of fiscal 1997. This decrease was the result of increased total revenue in fiscal 1998 and a decrease in outstanding accounts receivable at year end. The ratio of the Company's shareholders' equity in relation to outstanding debt (vendor and bank notes payable) improved in fiscal 1998. At March 31, 1997, the ratio of shareholders' equity to notes payable was 1 to .71. At March 31, 1998, the ratio was 1 to .50. The increase in shareholders' equity was primarily due to the Company's profitability and the issuance of preferred stock.
The Company's liquidity was also affected by an uncollected account receivable of $279,000 from drilling operations in fiscal 1996. In this case, the Company drilled a well under a daywork contract. In the course of drilling the well, some of the Company's equipment was lost in the hole. Under the terms of the contract, the customer was billed for the drilling operations and the replacement cost of the lost equipment. The customer filed a lawsuit alleging negligence, denying responsibility for the $279,000 billed by the Company, and seeking additional damages of $460,000 plus attorney's fees. Management, which believes the customer's claim to be without merit, filed a counter-suit seeking payment in full of the original invoice in the amount of $279,000. In fiscal 1996, an allowance for uncollectible accounts in the amount of $140,000 was established for this account. A jury trial in this case commenced in August, 1997. The jury found in favor of the Company and a judgment was entered in November, 1997 granting the Company $163,000 plus attorneys' fees of $70,000. The customer filed an appeal of the judgment and at fiscal year-end, the case was in the early stages of the appeal. On June 10, 1998, the Company received $213,000 from National Energy Group in settlement of the lawsuit. Per the terms of the settlement each of the parties agrees to release the other from all claims related to the lawsuit. The Company's accounts related to this matter will be adjusted in the period of resolution.
Other significant factors affecting liquidity were problems on a turnkey contract and expenses incurred while rigs were stacked, primarily in the fourth quarter of fiscal 1998. The Company encountered problems with the drilling of a well on a turnkey contract and was required to re-drill the well for the operator. Because of the problems, the Company incurred additional costs in attempting to correct the problems and in re-drilling the well. The direct effect on working capital was a decrease of approximately $368,000. Liquidity also suffered due to the additional time spent on the well, thereby depriving the Company of potential drilling revenue from other contracts. During the month of February, 1998, rig utilization declined significantly due to inclement weather and to reduced rig demand. While rigs were stacked, the Company elected to retain the drilling crews and to repair and maintain the rigs in preparation for drilling activity in the future. In doing so, the Company incurred approximately $175,000 in costs which could have been deferred to a later period.
In April, 1997, the Company issued a new Series A 8% Convertible Preferred Stock. The issue consisted of 400,000 shares with a redemption value of $800,000. Dividends payable in respect of Series A 8% convertible Preferred Stock shall accrue from day to day whether or not earned or declared and shall be cumulative. Accumulation of dividends on the Series A 8% Convertible Preferred Stock shall not bear interest. Dividends are payable annually. This Preferred Stock is convertible into 800,000 shares of Common Stock and one share of Common Stock for each $.50 of due but unpaid dividends on the Series A 8% Convertible Preferred Stock. The conversion rate is subject to adjustment on the third and seventh anniversary dates of issuance, depending on the trading value of the common stock. The stock is redeemable at the Company's option at or following the third anniversary of the issuance of such stock provided,
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
generally, that the price of the Company's common stock equals or exceeds $2.50 per share. The proceeds from the stock were used to reduce trade accounts payable, bank debt and to acquire drilling equipment. Prior to the issuance of this new Series A preferred stock, the Company redeemed its previously issued and outstanding Series A preferred stock consisting of 235,000 shares of stock with a stated par value of $1.00 per share. The outstanding shares were redeemed for a cash payment of $75,000.
In January, 1998, the Company issued a new Series B 8% Convertible Preferred Stock. The issue consisted of 184,615 shares with a redemption value of $2,999,994. Dividends payable in respect of Series B 8% convertible Preferred Stock shall accrue from day to day whether or not earned or declared and shall be cumulative. Accumulation of dividends on the Series B 8% Convertible Preferred Stock shall not bear interest. Dividends are payable annually. This preferred stock is convertible into 923,075 shares of the Company's common stock and one share of common stock for each $1.62 of due but unpaid dividends. The conversion rate is subject to adjustment on its third and seventh anniversary dates of issuance depending on the trading value of the common stock. The stock is redeemable at the Company's option at or following the first anniversary of the issuance of such stock provided, generally, that the price of the Company's common stock equals or exceeds $5.00 per share. The proceeds from the stock have been and will be used for equipment purchases, debt reduction and working capital.
Changes in Financial Condition
During fiscal 1998, the Company had a net increase in property and equipment of $6,080,000 before accumulated depreciation, depletion and amortization. This net increase was the product of a write off of $418,000 in fully depreciated drilling equipment and the expenditure of $6,498,000 for major repairs and the purchase of additional equipment. Of this amount, $6,154,000 was attributable to the purchase of drilling equipment, $280,000 to the purchase of transportation equipment, $59,000 to the purchase or acquisition of oil and gas properties or interests and $5,000 to the purchase of furniture and fixtures.
At March 31, 1998, the current portion of long-term debt was $629,000. Of this amount, $1,000 was owed on oil and gas properties, $613,000 on drilling equipment and $15,000 on land and buildings and improvements. Trade accounts payable at March 31, 1998 were $1,650,000 compared to $1,147,000 at March 31, 1997. At March 31, 1998, long-term debt was $2,696,000. Of this amount, $203,000 was owed on land and buildings and equipment; and $2,493,000 on drilling equipment.
Results of Operations
Rig utilization rates for the years ended March 31, 1998, 1997 and 1996 were 76%, 80% and 64%, respectively. In fiscal 1998, the Company completed 1,684 drilling days while in fiscal 1997, the Company completed 1,175 drilling days. This was a 43% increase in number of drilling days in 1998 when the Company operated up to seven rigs compared to fiscal 1997 when the Company operated four rigs. This increase reflects the increased demand during the period for drilling rigs and the increased efforts of the Company's staff to obtain contracts for the rigs.
During fiscal 1998, the Company's drilling margin increased when compared to both fiscal 1997 and fiscal 1996. In fiscal 1998, the drilling margin was $2,689,711, while in fiscal 1997 and fiscal 1996 it was $1,366,798 and $912,230, respectively. The increase in fiscal 1998 over fiscal 1997 was principally the result of the 43% increase in the number of drilling days during fiscal 1998 and the increase in drilling rates charged on contracts. When compared to drilling revenue, the drilling margin was 16%, 17% and 13% in fiscal 1998, fiscal 1997 and fiscal 1996, respectively. Two significant factors had a negative impact on the drilling margin in fiscal 1998. The first was problems with a turnkey contract. Because of problems with the well, the company was required to re-drill the well for the operator and also incurred additional costs in attempting to correct the problems on the original job. This resulted in a loss of approximately $368,000. The second factor affecting the drilling margin in fiscal 1998 was the significantly reduced rig utilization during the month of February, 1998. The reduced utilization was caused by inclement weather and by reduced rig
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
demand. The Company decided to use the idle time to perform repair and maintenance activities on the stacked rigs in preparation for drilling activity in the future. These costs approximated $175,000.
The Company markets its rigs to a number of customers. In fiscal 1998, the Company drilled for 37 different customers. In fiscal 1997, the Company drilled for 32 different customers. Of the 37 customers in fiscal 1998, 26 were customers the Company had not drilled for in fiscal 1997. These 26 customers accounted for over 47% of the Company's drilling revenue in fiscal 1998. In fiscal 1996, three customers accounted for 34% of total drilling revenue. In fiscal 1997, three customers accounted for 24% of total drilling revenue. In fiscal 1998, two customers accounted for 32% of total drilling revenue. Of these two customers, none was included in the top three customers of fiscal 1997. The loss of any of these customers could have a material adverse effect on the Company's business resulting from the time required to find other users of the rig concerned.
Oil and gas revenue for fiscal 1998 decreased by $90,912 from fiscal 1997. The decrease was primarily due to a 15% decrease in the average price per barrel of oil, a 3% decrease in the average price per MCF of gas, a 12% decrease in oil production and a 17% decrease in gas production. In fiscal 1998, the Company's average production cost per unit in barrel equivalents increased 16% from fiscal 1997. This compares with a 36% increase in the average production cost for 1997 compared to 1996.
Depreciation, depletion and amortization expense in fiscal 1998 increased to $1,114,866 from $623,614 in fiscal 1997. Depreciation expense increased to $988,210 in fiscal 1998 from $475,135 in fiscal 1997. This increase was the result of equipment purchased in late fiscal 1997 and fiscal 1998. Depletion expense decreased to $126,656 in fiscal 1998 compared to $148,479 in fiscal 1997. Production decreased to 17,915 barrel equivalents in fiscal 1998 from 21,001 barrel equivalents in fiscal 1997. In fiscal 1997 and fiscal 1998, the Company was not subject to the ceiling test limitation as it applies to oil and gas properties. Under such a test, the depleted carrying value of the Company's oil and gas properties is compared to the net present worth of estimated future oil and gas revenues based on period end prices, discounted at 10%. If the depleted carrying value exceeds the discounted net present worth of estimated future oil and gas revenues, the carrying value must be written down. Conversely, if the discounted net present value exceeds the carrying value of the properties, no adjustment is made to the carrying value, even if there had been a write-off in prior years.
General and administrative expenses increased from $549,656 in fiscal 1997 to $712,485 in fiscal 1998. The primary components of the change in general administrative expenses were increases in payroll costs, consulting fees and insurance.
Earnings from operations increased to $1,121,336 in fiscal 1998 from $551,333 in fiscal 1997. Of the $1,121,336, $1,018,439 was contributed by drilling operations and $102,897 by oil and gas operations.
The exploration, development, production and processing of oil and gas, including the disposal of produced water, are subject to various federal and state laws and regulations designed to protect the environment. Compliance with these regulations is part of the Company's day-to-day operating procedures. The Company is not aware of any potential clean-up obligations which would have a material effect on its financial condition or results of operations.
Forward Looking Information
This Form 10K contains certain "forward-looking" statements as such term is defined in The Private Securities Litigation Reform Act of 1995 and information relating to the Company and its subsidiaries that are based on the beliefs of the Company's management. When used in this report, the words "anticipate," "believe," "estimate," "expect" and "intend" and words or phrases of similar import, as they relate to the Company or its subsidiaries or Company management, are intended to identify forward-looking statements. Such statements reflect the current risks, uncertainties and assumptions related to certain factors including, without limitation, competitive factors, general economic conditions, customer relations, relationships with vendors, the interest rate environment, governmental regulation and supervision, seasonality, distribution networks, product introductions and acceptance, technological change, changes in industry
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
practices, one-time events and other factors described herein and in other filings made by the Company with the Securities and Exchange Commission. Based upon changing conditions, should any one or more of these risks or uncertainties materialize, or should any underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected, or intended. The Company does not intend to update these forward-looking statements.
Accounting Matters
In June, 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income." This statement establishes standards for reporting comprehensive income and its components in a full set of general-purpose financial statements. SFAS No. 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement displayed with the same prominence as other financial statements. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. The Company believes that the disclosure of comprehensive income in accordance with the provisions of SFAS No. 130 will not materially impact the manner of presentation of its financial statements as currently and previously reported.
In June, 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. The Company believes that the reporting requirements regarding segments of an enterprise will not materially impact the manner of presentation of its financial statements.
Year 2000
In fiscal 1998, the Company began the process of identifying, evaluating and implementing changes to computer programs necessary to address the year 2000 issue. This issue affects computer systems that have time-sensitive programs that may not properly recognize the year 2000. This could result in system failures or miscalculations. The Company is currently addressing its internal year 2000 issue with modifications to existing programs and conversions to new programs. The Company does not expect to incur any material expenses relating to year 2000 compliance.
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Independent Auditors' Report
The Board of Directors South Texas Drilling & Exploration, Inc.:
We have audited the consolidated balance sheets of South Texas Drilling & Exploration, Inc. and subsidiaries as of March 31, 1998 and 1997 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended March 31, 1998. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule (Schedule II) for each of the years in the three-year period ended March 31, 1998. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. 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 South Texas Drilling & Exploration, Inc. and subsidiaries as of March 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 1998, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
KPMG Peat Marwick LLP
San Antonio, Texas June 16, 1998
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements. (Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Continued)
See accompanying notes to consolidated financial statements.
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes to consolidated financial statements.
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
See accompanying notes to consolidated financial statements (Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (continued)
See accompanying notes to consolidated financial statements
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements (Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
See accompanying notes to consolidated financial statements.
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Organization and Summary of Significant Accounting Policies
Business and Principles of Consolidation
The Company provides land contract drilling services for the oil and gas industry, primarily in southern Texas, and engages in oil and gas exploration and development activity for its own account. The Company's main focus is considered to be its land contract drilling services. The oil and gas operations contributed an immaterial amount towards the Company's gross revenues in fiscal 1998 and constitute an insignificant amount of its total assets, therefore, disclosure of fiscal 1998 oil and gas information has been omitted. The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries and its limited partnership interest through December, 1995. All significant intercompany accounts and transactions have been eliminated in consolidation.
The financial statements have been prepared in accordance with generally accepted accounting principles. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the balance sheets and income and expenses for the periods. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes in the near term relate to the determination of depreciation, depletion and amortization expense.
Reclassifications
Certain reclassifications of prior period amounts have been made to conform with the current period presentation.
Income Taxes
The Company files a consolidated Federal income tax return with its subsidiaries using a December 31 year-end.
Pursuant to Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", the Company follows the asset and liability method of accounting for income taxes under which 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 Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Earnings (Loss) Per Common Share
In February 1997, the Financial Accounting Standards Board issued SFAS No. 128 "Earnings per Share," which establishes standards for computing and presenting earnings per share. This Standard, effective for financial statements issued for periods ending after December 15, 1997, replaces the presentation of primary earnings per share with a presentation of basic earnings per share. In addition, this standard requires dual presentation of basic and diluted earnings per share on the face of the statement of operations. This Statement requires restatement of all prior period EPS data presented. All prior-period earnings per share data presented
(Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
in the accompanying consolidated financial statements has been restated to conform to the requirements of SFAS No. 128.
The following table presents a reconciliation of the numerators and denominators of the basic EPS and diluted EPS comparisons as required by FAS 128:
(Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Stock-Based Compensation
On April 1, 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation." This SFAS allows a Company to adopt a fair value based method of accounting for a stock-based employee compensation plan or to continue to use the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." The Company has chosen to continue to account for stock-based compensation under the intrinsic value method. Under this method, the Company records no compensation expense for stock options granted when the exercise price of options granted is equal to the fair market value of the Company's common stock on the date of grant. The pro forma effects of adoption of SFAS No. 123 is disclosed in footnote 4 in the Notes to Consolidated Financial Statements.
Contract Drilling in Progress
Contract drilling revenues are earned on footage, daywork and turnkey contracts and such revenues and related costs are included in the determination of earnings as work progresses. Contract drilling in progress consists of revenues earned on contracts which have not yet been billed.
Prepaid Expenses
Prepaid expenses include loan fees which are amortized over the life of the debt.
Property and Equipment
Oil and gas producing activities are accounted for using the full cost method. Under the full cost method, all costs incurred in the acquisition, exploration and development of all oil and gas properties, including surrendered and abandoned leaseholds, delay lease rentals and dry hole costs, are capitalized. All costs related to production, general corporate overhead and other similar activities are expensed in the period incurred.
Depletion of oil and gas properties is provided by the unit of production method based on the Company's interest in the aggregated, estimated recoverable reserves of all properties. Depletion includes a ceiling
(Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
limitation adjustment required under the full cost method of accounting. The ceiling limitation adjustment is applicable when the carrying value of oil and gas properties exceeds the discounted net present worth of estimated future cash flows on those properties based on prices at the end of the period.
Depreciation of drilling, transportation and other equipment is provided using the straight-line method over estimated useful lives ranging from three to ten years.
Maintenance and repairs are charged to operations; renewals and betterments are charged to appropriate property and equipment accounts.
Long -lived assets and intangible assets are reviewed for impairment whenever events or circumstances provide evidence that suggests that the carrying amount of the asset may not be recovered.
Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. At March 31, 1998 and 1997, cash includes a restricted account in the amount of $106,275 and $102,629, respectively.
New Accounting Pronouncements
Comprehensive Income
In June, 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income." This statement establishes standards for reporting comprehensive income and its components in a full set of general-purpose financial statements. SFAS No. 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement displayed with the same prominence as other financial statements. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. The Company believes that the disclosure of comprehensive income in accordance with the provisions of SFAS No. 130 will not materially impact the manner of presentation of its financial statements as currently and previously reported.
Segment Reporting
In June, 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. The Company believes that the reporting requirements regarding segments of an enterprise will not materially impact the manner of presentation of its financial statements.
(Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(2) Notes Payable and Long-term Debt
Notes payable and long-term debt of the Company are described below:
(Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Long-term debt maturing each year subsequent to March 31, 1998 is as follows: 1999 - $706,014; 2000 - $1,805,498; 2001 - $648,856; 2002 - $80,262; 2003 - $37,285 and thereafter - $125,018.
At March 31, 1998, the Company had obtained waivers with respect to capital expenditure and dividend covenants and was in compliance with all other negative and affirmative covenants on its note payable secured by drilling equipment, transportation equipment and land and improvements. Such covenants included the maintenance of a net worth of at least $1,500,000, a debt to net worth ratio of less than 2.0 to 1.0, and a total debt service coverage ratio of greater than 1.0 to 1.0, at all times.
Note a: On April 14, 1995, the Company executed a Master Real Estate Lien Note in the amount of $800,000 with a bank. This note provides the Company with a $400,000 "Guidance Line of Credit Facility" to be used for drilling, completion and equipping expenses of wells to be drilled. This note has an interest rate of one percent over the Bank's prime rate, 9.50% at March 31, 1998, and is due January 1, 1999. In addition to the Guidance Line of Credit Facility, the Master Note covers the other notes executed by the Company in favor of the Bank, and the loan secured by oil and gas properties purchased in 1992 and drilled in 1993.
Note b: In September, 1995, the Company executed a note payable, in the amount of $245,250, to a bank for the purchase of the office building which the Company occupies as its headquarters in San Antonio, Texas. The note has a term of ten years and is payable in monthly payments of $1,900 including interest at 0.5% over the Bank's prime rate, 9.50% at March 31, 1998. In November, 1995 the Company closed on financing with
(Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
the Small Business Administration which became a second lien on the headquarters building. The loan is in the amount of $114,000 and was used to pay down the amount borrowed from the bank for the purchase. This debt has a 20 year term and is payable in monthly payments of $921 including interest at 6.713%.
Note c: On May 8, 1996, the Company closed on a debt restructuring which included a term loan of $1,250,000 and a revolving line of credit of $500,000, which allowed the Company to pay off all its bank debt with the exception of the loan secured by the headquarters building in San Antonio and a minimal balance on the loan secured by the oil and gas properties. The new debt also allowed the Company to pay off the seller financing on the rig purchased in May, 1995. Proceeds from the new debt were also used to reduce trade accounts payable and to provide funds for future drilling equipment purchases. The term loan is secured by drilling equipment, transportation equipment and the yard facility in Kenedy, Texas. The loan carries an interest rate of prime (8.50% at March 31, 1998) plus 2.25% and is payable in monthly payments of $14,881 plus interest. Payments are based on a seven-year amortization and the loan is due in June, 1999. The revolving line of credit is secured by the Company's trade accounts receivable and carries an interest rate of prime (8.5% at March 31, 1998) plus 2.25%. The revolving line of credit had no outstanding balance at March 31, 1998.
Note d: In June, 1997, the Company closed additional financing with the same lender for the purchase of drilling and transportation equipment. This note, in the amount of $1,050,000, carries an interest rate of prime (8.5% at March 31, 1998) plus 2.25% and is due in June, 1999. The note provides for monthly payments of $12,500 (based on seven year amortization) plus interest. In October, 1997, the same lender approved and funded another loan for drilling equipment. This loan, in the amount of $600,000, has terms identical to the loan closed in June, 1997. This note provides for monthly payments of $7,143 plus interest.
Note e: In October, 1997, this lender approved a line of credit in the amount of $600,000 for capital expenditures. This line carries an interest rate of prime (8.5% at March 31, 1998) plus 2.25% and is due in June, 1999. In fiscal 1998, two draws were made on the capital expenditure line. The first, in the amount of $370,730, provides for monthly payments of $10,298 (three year amortization) plus interest. The second, in the amount of $148,736, provides for monthly payments of $4,132 (three year amortization) plus interest. At March 31, 1998, $80,534 was available under the capital expenditures line of credit.
(3) Income Taxes
Due to the utilization of net operating loss carryforwards, the Company had no Federal income tax liability at March 31, 1997 and an estimated alternative minimum tax liability of $18,000 at March 31, 1998. The Company has also accrued a $44,688 liability for state franchise taxes for fiscal 1998 and a $33,000 liability for fiscal 1997.
At March 31, 1998, for Federal income tax purposes the Company had a net operating loss carryforward of approximately $14,934,000, investment tax credit carryforwards of approximately $15,000 and minimum tax credit carryforward of approximately $18,000 available to offset future taxable income and taxes.
(Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Unless utilized, net operating loss and investment tax credit carryforwards will expire as follows:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at March 31, 1998 and 1997 are presented below:
A valuation allowance has been established to decrease total gross deferred tax assets to the amount of the total gross deferred tax liabilities due to the uncertainties involved in the ultimate realization of the deferred tax assets. The valuation allowance for deferred tax assets at March 31, 1997 was $5,113,000. The net change in total valuation allowance for the year ended March 31, 1998 was an increase of $380,000 due to the change in the corresponding gross deferred tax assets and liabilities.
(Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(4) Stock Options, Warrants and Stock Option Plan
In December, 1988, the Board of Directors issued certain directors, officers and employees warrants to purchase 435,000 shares of the Company's common stock at $.15 per share, of which three warrants for a total of 55,000 shares have been exercised as of March 31, 1998 and two warrants for 245,000 shares have been canceled. These warrants are exercisable upon issuance and expire December 8, 1998. As of March 31, 1998, 135,000 shares of Common stock were reserved for future issuance in connection with warrants issued to employees, directors, officers and former employees.
In August, 1992, the Board of Directors issued certain directors, officers and employees warrants to purchase 235,000 shares of the Company's stock at $.10 per share, all of which have been exercised as of March 31, 1998.
On May 1, 1995, the Board of Directors issued an option to Mr. Locke, President and Chief Executive Officer, to purchase 1,200,000 shares of the Company's common stock at $.375 per share. This option expires on May 1, 2005. At March 31, 1998, 100,000 shares have been purchased and 60,000 shares have been canceled under this option.
On June 15, 1995, the Board of Directors issued certain directors, officers and employees options to purchase 128,500 shares of the Company's common stock at $.375 per share, 15,000 of which have been exercised as of March 31, 1998.
On December 12, 1995, the Board of Directors issued certain officers options to purchase 100,000 shares of the Company's common stock at $.41 per share, none of which has been exercised and 50,000 shares of which have been canceled as of March 31, 1998.
On June 15, 1996, the Board of Directors issued certain directors options to purchase 10,000 shares of the Company's common stock at $.47 per share, 5,000 of which have been exercised as of March 31, 1998.
On July 1, 1997, the Board of Directors issued certain directors options to purchase 15,000 shares of the Company's common stock at $1.38 per share, 5,000 of which have been exercised as of March 31, 1998.
Under the Company's stock option plan, employee stock options become exercisable over a five year period and all options expire 10 years after the date of grant. All of the Company's options shall be granted at the fair market value of the Company's Common Stock on the date of grant. Accordingly as discussed in Note 1, no compensation expense relating to these options is recognized in the Company's results of operations.
In addition, on June 18, 1997, the Board of Directors issued a seller of drilling equipment an option to purchase 150,000 shares of the Company's common stock at $1.50 per share, none of which has been exercised as of March 31, 1998.
(Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Information relating to stock options outstanding at March 31 is summarized as follows:
At March 31, 1998, the weighted average price of options outstanding was $0.50 per share and the weighted average price of exercisable options was $0.64 per share.
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 (SFAS No. 123) "Accounting for Stock-Based Compensation." Accordingly, no compensation has been recognized for the stock option plan. If the Company had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by SFAS No. 123, net earnings and net earnings per share would have been reduced to the pro forma amounts indicated in the table below:
The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model. The model assumed expected volatility of 65%, 46% and 46%, weighted average risk-free interest rates of 6.3%, 6.7% and 6.3% for grants in 1998, 1997 and 1996, respectively, and an expected life of five years. As the Company has not declared dividends since it became a public entity, no dividend yield was used. Actual value realized, if any, is dependent on the future performance of the Company's common stock, and overall stock market conditions. There is no assurance the value realized by an optionee will be at or near the value estimated by the Black-Scholes model.
(Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(5) Business Segments and Supplementary Earnings Information
The Company is engaged in contract drilling of oil and gas wells and in oil and gas exploration, development and production. The oil and gas operations contributed an immaterial amount towards the Company's gross revenues in fiscal 1998 and constitute an insignificant amount of its total assets, therefore, disclosure of fiscal 1998 oil and gas information has been omitted. Information concerning business segments and supplementary earnings information is as follows:
In fiscal 1998, two customers each accounted for 10% or more of contract drilling revenues. The revenue attributed to those customers was $2,968,694 and $2,326,773.
In fiscal 1997, only one customer accounted for 10% or more of contract drilling revenues. The revenue attributed to that customer was $1,116,322.
In fiscal 1996, only one customer accounted for 10% or more of contract drilling revenues. The revenue attributed to that customer was $1,204,983.
(6) Related Party Transactions
A director owns an interest in several oil and gas properties in which the Company owns an interest. Two directors own interests in the well which the Company drilled in February, 1995 and continues to operate.
(Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(7) Commitments and Contingencies
The Company is currently involved in a lawsuit styled National Energy Group, Inc. v. South Texas Drilling Company, cause No. 96-98, 357 Judicial District Court, Willacy County, Texas. This case arose out of a dispute with a drilling customer over a billing for work performed under a daywork drilling contract. In the course of drilling the well, some of the Company's equipment was lost in the hole. Under the terms of the contract, the customer was billed for the drilling operations and replacement cost of the lost equipment. The customer filed a lawsuit alleging negligence, denying responsibility for the $279,000 billed by the Company, and seeking additional damages of $460,000 plus attorney's fees. Management, which believes the customer's claim to be without merit, filed a counter-suit seeking payment in full of the original invoice in the amount of $279,000. In fiscal 1996, an allowance for uncollectible accounts in the amount of $140,000 was established for this account. A jury trial in this case commenced in August, 1997. The jury found in favor of the Company and a judgment was entered in November, 1997 granting the Company $163,000 plus attorneys' fees of $70,000. The customer filed an appeal of the judgment and at fiscal year-end, the case was in the early stages of the appeal. On June 10, 1998, the Company received $213,000 from National Energy Group in settlement of the lawsuit. Per the terms of the settlement, each of the parties agrees to release the other from all claims related to the lawsuit. The Company's accounts related to this matter will be adjusted in the period of resolution.
(8) Fair Value of Financial Instruments
Cash and cash equivalents, trade receivables and payables and short-term debt:
The Company holds cash and cash equivalents, trade receivables and payables and short-term debt. The carrying amount of these instruments approximates fair value due to the short maturity of the instruments.
Long-term debt:
The carrying amount of the Company's long-term debt approximates fair value due to the recent issuance of the debt and the variable interest rate.
(9) Acquisition
In June, 1997, the Company acquired the drilling operations of San Patricio Corporation which included two land drilling rigs, rig handling trucks and trailers and miscellaneous drilling equipment. In addition, the Company assumed the lease of a third land drilling rig. The leased rig was returned to the lessor in February, 1998. The aggregate purchase price of $1,500,000 consisted of $900,000 of third-party financing, $300,000 of seller financing and $300,000 of the Company's Common Stock. The transaction was accounted for as a purchase with the results of operations being included in the Statement of Operations since the acquisition date.
The following pro forma financial information for the years ended March 31, 1998 and 1997 gives effect to the above acquisition as though it were effective at the beginning of each period. The pro forma information may not be indicative of the results that would have occurred had the acquisition been effective on the dates indicated or of the results that may be obtained in the future. The pro forma information should be read in conjunction with the consolidated financial statements and notes thereto of the Company.
(Continued)
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
(10) Preferred Stock
In April, 1997, the Company issued a new Series A 8% Convertible Preferred Stock. The issue consisted of 400,000 shares with a redemption value of $800,000. Dividends payable in respect of Series A 8% convertible Preferred Stock shall accrue from day to day whether or not earned or declared and shall be cumulative. Accumulation of dividends on the Series A 8% Convertible Preferred Stock shall not bear interest. Dividends are payable annually. Dividends of $61,333 were accrued as of March 31, 1998. Subsequent to March 31, 1998 a payment of $64,000 was made to the preferred stockholder. This Preferred Stock is convertible into 800,000 shares of Common Stock and one share of Common Stock for each $.50 of due but unpaid dividends on the Series A 8% Convertible Preferred Stock. The conversion rate is subject to adjustment on the third and seventh anniversary dates of issuance, depending on the trading value of the common stock. The stock is redeemable at the Company's option at or following the third anniversary of the issuance of such stock provided, generally, that the price of the Company's common stock equals or exceeds $2.50 per share. The proceeds from the stock were used to reduce trade accounts payable, bank debt and to acquire drilling equipment. Prior to the issuance of this new Series A preferred stock, the Company redeemed its previously issued and outstanding Series A preferred stock consisting of 235,000 shares of stock with a stated par value of $1.00 per share. The outstanding shares were redeemed for a cash payment of $75,000.
In January, 1998, the Company issued a new Series B 8% Convertible Preferred Stock. The issue consisted of 184,615 shares with a redemption value of $2,999,994. Dividends payable in respect of Series B 8% convertible Preferred Stock shall accrue from day to day whether or not earned or declared and shall be cumulative. Accumulation of dividends on the Series B 8% Convertible Preferred Stock shall not bear interest. Dividends are payable annually. Dividends of $47,233 were accrued as of March 31, 1998. This preferred stock is convertible into 923,075 shares of the Company's common stock and one share of common stock for each $1.62 of due but unpaid dividends. The conversion rate is subject to adjustment on its third and seventh anniversary dates of issuance depending on the trading value of the common stock. The stock is redeemable at the Company's option at or following the first anniversary of the issuance of such stock provided, generally, that the price of the Company's common stock equals or exceeds $5.00 per share. The proceeds from the stock have been and will be used for equipment purchases, debt reduction and working capital.
11) Oil and Gas Producing Activities (Unaudited)
The Company's oil and gas properties and operations are presented in the consolidated financial statements on the full cost method of accounting. All of the Company' exploration and production is conducted in the United States. Due to the Company's acquisitions of substantial amounts of drilling equipment in fiscal 1998, the
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Company's oil and gas operations no longer constitute a significant portion of the Company's assets. Therefore, to the extent permitted, fiscal year 1998 discussion and disclosure of information on oil and gas operations will be omitted.
The aggregate amount of capitalized costs relating to oil and gas producing activities at the dates indicated are as follows:
During the periods indicated in the preceding table, no internal costs were capitalized. Internal costs incurred during these periods were in the nature of general corporate overhead. All costs related to production, general corporate overhead and other similar activities are expensed in the period incurred. Costs of site restoration and dismantlement and abandonment have historically been equal to or less than revenue earned from salvage of the well equipment. Such costs, net of the salvage revenue, are added to or subtracted from the full cost of oil and gas properties. These costs have been minimal in the years being reported.
The following table sets forth information with respect to quantities of net proved oil and gas reserves, as estimated by an in-house petroleum engineer, and changes in proved reserves. Estimates of reserves and production performance are subjective and may change materially as actual production information becomes available.
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Costs incurred for property acquisition, exploration and development activities are summarized below:
Results of operations for producing activities for the periods indicated were as follows:
The following is a standardized measure of the discounted net future cash flows and changes applicable to proved oil and gas reserves required by FASB 69. The future cash flows are based on estimated oil and gas reserves utilizing prices and costs in effect as of year end discounted at 10% per year and assuming continuation of existing economic conditions.
The standardized measure of discounted future net cash flows, in management's opinion, should be examined with caution. The basis for this table is a reserve study, as prepared by an in-house petroleum engineer, which contains estimates of quantities and rates of production of reserves. Revisions of previous year estimates can have a significant impact on these results. Also, exploration costs in one year may lead to significant discoveries in later years and may significantly change previous estimates of proved reserves and their valuation. Therefore, the
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
standardized measure of discounted future net cash flow is not necessarily a "best estimate" of the fair value of the Company's proved oil and gas properties.
ITEM 9.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ROBERT R. MARMOR, 72, Chairman of the Board since April, 1980. Mr. Marmor was Chief Executive Officer of the Company from April, 1980 until February, 1992 and President from June, 1984 until November, 1991, at which time he voluntarily resigned from these positions and recommended his replacement. From December, 1979 until April, 1980, Mr. Marmor was President of the Company. From September, 1979 until December, 1979, Mr. Marmor was engaged in founding the Company. From October, 1978 until September, 1979 he was associated as a petroleum engineering consultant with Max K. Watson & Associates, Inc. of Austin, Texas, petroleum and natural gas consultants. From 1977 to October, 1978 he was engaged in various personal investment ventures. Mr. Marmor was employed from 1971 to 1977 in Adelaide, Australia by Delhi International Oil Corporation, Dallas, Texas, and served as project development manager and later as operations manager responsible for the exploration, drilling and production divisions.
WILLIAM D. HIBBETTS, 49, CPA, a Director since June, 1984. Mr. Hibbetts is Chief Accounting Officer of Southwest Venture Management Company. He was Treasurer/Controller of Gary Pools, Inc. from May, 1986 to July, 1988. He served as an officer of the Company from January 1, 1982 until May 1, 1986. Mr. Hibbetts served in various positions as an accountant with KPMG Peat Marwick LLP from June, 1971 to December, 1981. Mr. Hibbetts served as manager in that accounting firm's audit group from July, 1978 to December, 1981.
CHARLES B. TICHENOR, II, 71, a Director since May, 1988. Dr. Tichenor is Distinguished Corporation Chief Executive Professor of Business at Gardner-Webb University Broyhill School of Management since May, 1997. He was Distinguished Corporation Chief Executive-in-Residence/Professor at The Indiana University of Pennsylvania from January 1, 1995 to May, 1997. Mr. Tichenor was Vice-Chancellor at Elizabeth City State University from February, 1992 to December 31, 1994. He was a professor at the College of Business of Mississippi State University where he occupied the position of Distinguished Corporation Chief Executive Officer-in-Residence from 1987 to 1992. Mr. Tichenor is the retired Chairman of Champale, Inc., a Fortune 1000 Company, where he served as president and chairman of the board from 1975 to 1983. He is a member of the Board of Trustees of Rider College, Lawrenceville, NJ and he currently or formerly served on the Boards of Doughty Foods, Inc., NYP Container Corp., MCM Investments Co., Johnston Printing Co and Essex Bank of Virginia.
ALVIS L. DOWELL, 62, a Director since February, 1991. Mr. Dowell was President and Chief Executive Officer from November 7, 1992 to May 1, 1995. He was Chief Operating Officer from February, 1991 and Vice President from May 2, 1991. From 1988 until 1991, Mr. Dowell was employed by Maersk Oil and Gas, Copenhagen, Denmark as Assistant Manager, Drilling Department. From 1972 to 1988, Mr. Dowell was with Aramco, Saudi Arabian Operations as Drilling Safety Engineer and later as Superintendent Offshore Drilling and then Drilling Manager. He served as Director/Safety and Loss Prevention, Safety Engineering and Regional Engineering Manager with Holiday Inns, Inc., Texas Employers Insurance and Northwestern National Insurance Company.
WM. STACY LOCKE, 42, a Director since May 1, 1995. Mr. Locke is President and Chief Executive Officer since May 1, 1995. He was Vice President - Investment Banking with Arneson, Kercheville, Ehrenberg & Associates, Inc. from January 1, 1993 to April 30, 1995. From 1988-1992, Mr. Locke was Vice President - Investment Banking with Chemical Banking Corporation, Texas Commerce Bank. He was Senior Geologist with Huffco Petroleum Corporation from 1982-1986. From 1979 to 1982 Mr. Locke worked for Tesoro Petroleum Corporation and Valero Energy as a Geologist.
MARY L. KILGORE, 59, Vice President of Administration since December, 1993 and Corporate Secretary of the Company since May, 1986, has been employed in various positions by the Company and its predecessor from August, 1978.
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
CHRIS F. PARMA, 48, CPA, Vice President and Chief Financial Officer since December, 1995. He has been employed as Controller of the Company since October, 1990. He served in various accounting positions from Staff Accountant to Controller from 1972 to 1990 with J. H. Uptmore & Associates, Inc., Real Estate Developer. He served as Vice President of Uptmore from 1985 to 1990.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the compensation paid or accrued by the Company and its subsidiaries for services performed during the fiscal year ended March 31, 1998, to the chief executive officer of the Company. No other officer was paid total compensation of $100,000 or more. See Item 13 for a summary of compensation due to Mr. Locke, the chief executive officer of the Company, under his employment agreement with the Company.
Summary Compensation Table
(1) Includes value of personal use of company-provided vehicle.
(2) Includes 12,342 shares paid per employment agreement.
(3) Includes 84,734 shares accrued per employment agreement.
(4) Includes 48,889 shares accrued per employment agreement.
(5) Includes value realized on exercise of 100,000 shares of Stock Option Plan granted May, 1995. See "Option/SAR Grants in Last Fiscal Year".
(6) Includes value of personal use of company-provided vehicle and Directors' fee paid by the Company.
(7) Includes 50,000 shares issued as a bonus. Value is calculated based on the average of the bid and ask prices at issue date discounted due to 2-year restriction on sale or transfer of stock.
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
From December, 1988, through June, 1995, Directors received 1,000 shares of the Company's common stock for each directors' meeting attended. From July, 1995 through June 1996, Directors who were not officers or employees of the Company received $1,000 each quarter for their service on the Board and $250 for each meeting attended. From July 1996 through March 1997 those Directors received $500 each quarter for their service on the Board and $250 for each meeting attended. Beginning in April 1997 the Directors will once again receive $1,000 each quarter for their service on the Board and $250 for each meeting attended. Directors who are not officers or employees of the Company and reside outside of the surrounding area in which a board meeting is held are entitled to reimbursement for travel expenses incurred by them in attending directors' meetings for their service on the Board and $250 for each meeting attended. In fiscal 1998, the Board reinstated the $1,000 fee per quarter for outside directors for the period from July, 1996 through March, 1997.
The following table summarizes as to the chief executive officer of the Company, the number and terms of stock options granted during the year ended March 31, 1998:
Option/SAR Grants in Last Fiscal Year
The following table shows as to the chief executive officer of the Company the net value realized (market value less exercise price) with respect to stock options exercisable/unexercisable during the last year:
Aggregated Option/SAR Exercises in Last Fiscal Year and FY-End Option/SAR Values
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
The following table summarizes as to each of the executive officers of the Company, the number and terms of stock warrants granted during the year ended March 31, 1998:
Stock Warrants Granted in Last Fiscal Year Individual Grants
The following table shows as to each of the executive officers of the Company the net value of securities or cash realized (market value less exercise price) with respect to stock warrants exercisable/unexercisable during the last year:
Aggregated Stock Warrant Exercises in Last Fiscal Year and Fiscal Year End Stock Warrant Values
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information, as of June 5, 1998, with respect to each person who is known by the Company to be the beneficial owner of more than 5% of the outstanding shares of Common Stock, the Series A Preferred Stock and the Series B Preferred Stock, each director of the Company, and all officers and directors of the Company as a group. Except as otherwise indicated, each person has sole investment and voting power with respect to the shares shown.
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
(1) Does not include 180,420 shares owned by Mr. Marmor's children and grandchildren. Mr. Marmor disclaims beneficial ownership and has no voting rights or dispositive power in these 180,420 shares.
(2) Includes options issued to Mr. Hibbetts by the Board of Directors to purchase 15,000 shares .
(3) Includes options issued to Mr. Dowell by the Board of Directors to purchase 3,913 shares .
(4) Includes 240,000 shares and an option issued to San Patricio Corporation, which is wholly owned by Richard Phillips, to purchase an additional 150,000 shares, .
(5) Includes options issued to Mr. Locke to purchase an additional 1,040,000 shares. (See Item 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company's president and chief executive officer, Mr. Wm. Stacy Locke, commenced employment by the Company on May 1, 1995, under a two year employment agreement calling for a base salary of $100,000 for the first year of the two year term and $150,000 for year two. $20,000 of Mr. Locke's first year's salary was paid in Common Stock valued at the average market value of such shares during March, 1996. Likewise, $55,000 of the $150,000 salary payable to Mr. Locke during the second year of his employment with the Company was paid in Common Stock valued at its average market value during March, 1997.
The terms of Mr. Locke's agreement required the Company to issue ISO's to Mr. Locke for 1,200,000 shares of Common Stock with an exercise price of $.375 per share. While Mr. Locke remains employed by the Company
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
and after the earlier to occur of (I) May 1, 1998 or (ii) the acquisition by Mr. Locke of at least 10% of the Company's outstanding Common Stock, on a fully diluted basis, and assuming the exercise of all exercisable stock options held by Mr. Locke, on each May 1 Mr. Locke may accelerate his ability to exercise all or any part of the options to purchase 240,000 shares of Common Stock which would otherwise become exercisable on the next following May 1 under his ISO up to the amount necessary for him to achieve or maintain the 10% ownership of Common Stock determined as described above. After all of Mr. Locke's ISO's become exercisable, the Company has agreed to issue additional ISO's (or non-qualified options if ISO's cannot be made available) covering up to 240,000 shares on each May 1 at an exercise price equal to the then market value of Common Stock in order to provide Mr. Locke with an opportunity to acquire and maintain ownership of 10% of the Company's Common Stock on the basis described above. In the event the Company shall receive gross cash proceeds of $10 million or more in connection with an underwritten public offering of Common Stock, Mr. Locke's rights to additional options shall cease. All of Mr. Locke's options would become exercisable upon any acquisition or change in control of the Company.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Index to Financial Statements and Schedules and Exhibits
1. The following consolidated financial statements of South Texas Drilling & Exploration, Inc. and its subsidiaries are included in Part II, Item 8 of this Report:
Independent Auditors' Report.
Consolidated Balance Sheets at March 31, 1998 and 1997.
Consolidated Statements of Operations for the years ended March 31, 1998, 1997 and 1996.
Consolidated Statements of Shareholders' Equity for the years ended March 31, 1998, 1997 and 1996.
Consolidated Statements of Cash Flows for the years ended March 31, 1998, 1997 and 1996.
Notes to Consolidated Financial Statements.
2. Financial Statement Schedules:
Supplementary Income Statement Information is included in Part IV, Item 14, "Financial Statements and Supplementary data" of this Report.
Schedule II - Valuation and Qualifying Accounts.
(All other schedules are omitted as inapplicable, not required, or already covered in the financial statements and notes thereto).
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
3. The following exhibits are filed as part of this Report:
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
SCHEDULE II
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
Valuation and Qualifying Accounts
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, South Texas Drilling & Exploration, Inc. has duly caused this report to be signed on its behalf by the undersigned, this day of June, 1998 thereunto duly authorized.
By /s/ Robert R. Marmor ---------------------------------- Robert R. Marmor, Chairman
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.
INDEX TO EXHIBITS
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES