NOTES
TO
FINANCIAL STATEMENTS
December
31, 2005 and 2006
NOTE
A – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
|
1.
|
Organization
and Basis
of Presentation
|
AROC
Energy, L.P. (the “Partnership”) was formed August 14, 2003 as a Texas limited
partnership. On August 18, 2003 the Partnership acquired
producing oil and gas properties from subsidiaries of AROC Inc. (“AROC”) for
$68,171,412, of which $66,807,967 was funded with cash contributed by TIFD
III-X
LLC, the Limited Partner. AROC contributed property interests valued
at $1,363,445 in exchange for the general partner interest. AROC
Resources LLC, a wholly owned subsidiary of Southern Bay Energy, LLC serves
as
general partner.
Partnership
revenues, costs and expenses are generally shared 98% by the limited partner
and
2% by the general partner, until the limited partner has achieved “Cumulative
Payout” (as defined in the Agreement of Limited Partnership), at which time the
sharing percentages change to 64.3434% to the limited partner and 35.6566%
to
the general partner.
The
Agreement of Limited Partnership provides that the General Partner has the
full
and exclusive authority to manage, control, administer and operate the
properties, business and affairs of the Partnership. However, the
General Partner may not perform certain acts without the consent of the Limited
Partner. Those restrictions generally relate to the ability of the General
Partner to borrow money on behalf of the Partnership, mortgage or otherwise
encumber Partnership properties, dispose of Partnership properties, make
guarantees on behalf of the Partnership, make advance payments of compensation
to the General Partner, loan money to the General Partner, merge the
Partnership, acquire leases in the name of the Partnership, enter into, amend
or
terminate hedging transactions and to generally perform any acts which would
be
detrimental to the Partnership.
The
Partnership’s oil and gas interests are located primarily in Louisiana and Texas
and, to a lesser extent, in Mississippi, Alabama, New Mexico, Oklahoma, Colorado
and Montana.
During
December 2006, the Partnership acquired properties located in Port Neches,
Texas, from Aspen Exploration for cash of approximately $1.0
million. All costs were allocated to oil and gas properties and none
to goodwill.
Unaudited
Information
Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America have been omitted with respect to the unaudited
financial statements as of and for the nine months ended September 30, 2006
and
2007. The information reflected herein for these periods has
been taken from the books and records of the Partnership without
audit. However, the information reflects all adjustments, which are,
in the opinion of management, normal recurring adjustments necessary for the
fair statement of the financial position and results for the periods
presented. The results of operations for the interim periods are not
necessarily indicative of the results to be expected for the year or for any
other interim period.
|
|
The
carrying amounts of the Partnership's financial instruments, which
include
accounts receivable, accounts payable and accrued expenses, approximate
fair values because of their short-term nature. The
Partnership’s derivative instruments are measured and recorded at fair
value.
|
|
|
Revenues
represent income from production and delivery of oil and gas, recorded
net
of royalties. The Partnership follows the sales method of
accounting for gas imbalances. A liability is recorded only if
the Partnership's takes of gas production exceed its share of estimated
recoverable reserves from the respective well. No receivables
are recorded for those wells where the Partnership has taken less
than its
ownership share of production. Volumetric production is
monitored to minimize imbalances, and such imbalances were not significant
at December 31, 2006 and 2005.
|
|
|
The
Partnership sells crude oil and natural gas to various
customers. Substantially all of the Partnership’s accounts
receivables are due from purchasers of crude oil and natural
gas. Crude oil and natural gas sales are generally
unsecured.
|
|
|
As
is common industry practice, the Partnership generally does not require
collateral or other security as a condition of sale, rather relying
on
credit approval, balance limitation and monitoring procedures to
control
the credit use on accounts receivable. The allowance for
doubtful accounts is an estimate of the losses in the Partnership’s
accounts receivable. The Partnership periodically reviews the
accounts receivable from customers for any collectibility
issues. An allowance for doubtful accounts is established based
on reviews of individual customer accounts, recent loss experience,
current economic conditions, and other pertinent factors. Accounts
deemed uncollectible are charged to the allowance. Provisions for
bad debts and recoveries on accounts previously charged-off are added
to
the allowance.
|
|
|
Accounts
receivable allowance for bad debt was $0 at December 31, 2006 and
December
31, 2005.
|
|
5.
|
Oil
and Gas
Properties
|
|
|
The
Partnership follows the successful efforts method of accounting for
oil
and gas operations whereby costs to acquire mineral interests in
oil and
gas properties, drill exploratory wells that find proved reserves
and
drill and equip development wells are capitalized. Exploration
costs, including exploratory dry holes, geological and geophysical
and
costs of carrying and retaining unproved properties, are charged
to
operations as incurred.
|
|
|
The
Partnership's acquisition and development costs of proved oil and
gas
properties are amortized using the unit-of-production method based
on
total proved reserves and proved developed reserves, respectively,
as
estimated by independent petroleum
engineers.
|
|
|
Oil
and gas properties are assessed for impairment whenever changes in
facts
and circumstances indicate a possible significant deterioration in
the
future cash flows expected to be generated by an asset
group. If, upon review, the sum of the undiscounted pretax cash
flows is less than the carrying value of the asset group, the carrying
value is written down to estimated fair value. Individual
assets are grouped for impairment purposes at the lowest level for
which
there are identifiable cash flows that are largely independent of
the cash
flows of other groups of assets, generally on a field-by-field
basis. The fair value of impaired assets is determined based on
expected future cash flows using discount rates commensurate with
the
risks involved, using prices and costs consistent with those used
for
internal decision making. Long-lived assets committed by
management for disposal are accounted for at the lower of cost or
fair
value, less costs to sell. Impairments of $443,486 were
recognized during 2006 due to revisions of reserve
estimates.
|
|
|
The
Partnership is generally not subject to Federal or state income tax
on its
taxable income. The taxable income and deductions are generally
reported by the partners in their respective income tax returns and
all
tax obligations are borne solely by the partners. Therefore,
except as discussed below, the Partnership generally makes no provision
for income taxes in its financial
statements.
|
During
2006, the state of Texas enacted legislation, which, effective in 2007 subjects
the Partnership to a margin tax (“Texas Margin Tax” or “TMT”) on its taxable
margin, as defined. The taxable margin is essentially gross revenue
less certain deductions and is further reduced to reflect the percent of
business derived from Texas. Generally accepted accounting principles
require that this tax be accounted for as an income tax. Therefore
the Partnership is required to recognize deferred tax assets and liabilities
for
the estimated future tax consequences attributable to differences between
financial statement carrying amounts of assets and liabilities and their
respective tax bases. As a result, the Partnership recognized a
deferred tax liability of $155,281 at December 31, 2006.
|
7.
|
Derivative
Instruments
and Hedging Activities
|
|
|
The
Partnership enters into derivative contracts, primarily options and
swaps,
to hedge future crude oil and natural gas production in order to
mitigate
the risk of downward movements of market prices. As required,
the Partnership adopted Statement of Financial Accounting Standards
(“SFAS”) No. 133,
Accounting for
Derivative
Instruments and Hedging Activities
, as
amended. Effective with the adoption of SFAS No. 133, all
derivatives are recognized on the balance sheet and measured at fair
value. If the derivative does not qualify as a hedge or is not
designated as a hedge, the gain or loss on the derivative is recognized
currently in earnings. If the derivative qualifies and is
designated for hedge accounting, the gain or loss on the derivative
is
either recognized in income along with an offsetting adjustment to
the
basis of the item being hedged for fair value hedges or deferred
in other
comprehensive income to the extent the hedge is effective for cash
flow
hedges. To qualify for hedge accounting, the derivative must
qualify as either a fair value, cash flow or foreign currency
hedge.
|
|
|
The
hedging relationship between the hedged instruments and hedged
transactions must be highly effective in achieving the offset of
changes
in fair values and cash flows attributable to the hedged risk, both
at the
inception of the hedge and on an ongoing basis. The Partnership
measures hedge effectiveness on a quarterly basis. Hedge
accounting is discontinued prospectively when a hedging instrument
becomes
ineffective. The Partnership assesses hedge effectiveness based
on total changes in the fair value of options used in cash flow hedges
rather than changes in intrinsic value only. As a result,
changes in the entire value of option contracts are deferred in
accumulated other comprehensive income until the hedged transaction
affects earnings to the extent such contracts are
effective. Gains and losses deferred in accumulated other
comprehensive income related to cash flow hedge derivatives that
become
ineffective remain unchanged until the related production is
delivered.
|
|
|
Gains
and losses resulting from hedge settlements are included in oil and
gas
revenues and are included in realized prices in the period that the
related production is delivered. Gains and losses on hedging
instruments that represent hedge ineffectiveness and gains and losses
on
derivative instruments that do not qualify for hedge accounting are
included in the determination of net income in the period in which
they
occur. The resulting cash flows are reported as cash flows from
operating activities.
|
|
8.
|
Cash
and Cash
Equivalents
|
|
|
The
Partnership treats all unrestricted investments with an original
maturity
of three months or less to be cash equivalents. The Partnership
maintains its cash in one financial institution and periodically
assesses
the financial condition of the institution. The General Partner
believes that any possible credit risk is
minimal.
|
|
|
In
the course of preparing financial statements in conformity with generally
accepted accounting principles, management makes various assumptions
and
estimates to determine the reported amounts of assets, liabilities,
revenue and expenses in relation to the disclosure of commitments
and
contingencies. Changes in these assumptions and estimates will
occur as a result of the passage of time and the occurrence of future
events and, accordingly, the actual results could differ from the
amounts
estimated.
|
|
10.
|
Comprehensive
Income
(Loss)
|
|
|
The
Partnership follows SFAS No. 130,
Reporting Comprehensive
Income
, which established standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. Accumulated other comprehensive loss for
2006 and 2005 consists of unrealized values (liabilities) of commodity
hedges qualifying as cash flow hedges in accordance with SFAS No.
133.
|
|
|
The
Partnership recognizes estimated proceeds from insurance recoveries
only
when the amount of the recovery is determinable and when the Partnership
believes that the proceeds are probable of recovery. When the
amount of the estimated recoveries has been determined and when the
Partnership has considered that the recovery probable, the recoveries
are
recognized in the statement of
income.
|
|
|
Certain
reclassifications have been made to prior-period amounts to conform
with
the current period presentation.
|
NOTE
B – RELATED PARTY TRANSACTIONS
Accounts
receivable from the General Partner represent oil and gas revenues collected
by
the General Partner on behalf of the Partnership. Accounts payable to
the General Partner represent the Partnership’s share of property operating
expenditures and capital expenditures that were incurred by operating
subsidiaries of the General Partner on behalf of the Partnership and accrued
management fees.
|
|
Subsidiaries
of the General Partner operate most oil and gas properties in which
the
Partnership has an interest. Under this arrangement, these
subsidiaries collect the Partnership’s share of revenues from purchasers
and incur property operating and development expenditures on behalf
of the
Partnership. Monthly, the Partnership’s revenues are paid to
the Partnership and the Partnership reimburses these entities for
its
share of expenditures.
|
|
|
The
Partnership Agreement provides for a monthly management fee to be
paid to
the General Partner equal to 4% of the Partnership’s Net Monthly Income,
as defined in the partnership agreement. During 2006 and 2005,
the Partnership incurred $259,768 and $565,553, respectively, in
management fees pursuant to this
provision.
|
NOTE
C – RESTRICTED CASH
|
|
Restricted
cash consists of the Partnership’s share of an escrow deposit required
under the terms of an agreement among the Partnership and AROC (“Buyers”)
and the seller of certain oil and gas properties in which the Partnership
has an interest. The purpose of this deposit is to assure
maintenance and administration of a plugging bond and Buyers’ compliance
with plugging and abandonment obligations assumed in connection with
Buyers’ acquisition of the
properties.
|
NOTE
D – ASSET RETIREMENT OBLIGATIONS
|
|
In
accordance with SFAS No. 143,
Accounting for
Asset
Retirement Obligations (“ARO”)
, and in connection with the
properties acquired in August 2003, the Partnership recorded the
present
value of estimated future abandonment cost totaling $7,249,300 as
both a
liability and as an addition to the capitalized cost of its oil and
gas
properties. The Company will increase the abandonment liability
associated with its oil and gas wells when those assets are placed
in
service. The changes to the ARO during the years ended December
31, 2006 and 2005 are as follows:
|
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
Balance
beginning of year
|
|
$
|
6,613,458
|
|
|
$
|
6,739,849
|
|
|
Additional
liabilities incurred
|
|
|
116,153
|
|
|
|
39,124
|
|
|
Disposals
of properties
|
|
|
-
|
|
|
|
(92,873
|
)
|
|
Accretion
expense
|
|
|
281,069
|
|
|
|
282,283
|
|
|
Revisions
of estimates
|
|
|
(434,829
|
)
|
|
|
(354,925
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Balance
end of year
|
|
$
|
6,575,851
|
|
|
$
|
6,613,458
|
|
NOTE
E – HEDGING ACTIVITIES
|
|
The
Partnership enters into fixed price oil and natural gas swap agreements
to
fix the price of anticipated future
production.
|
|
|
As
of December 31, 2006, the Partnership had a fixed price oil swap
contract
and two fixed price natural gas swap contracts. Hedged volumes
and fixed prices by year, as of December 31, 2006, are summarized
below. Settlements occur monthly based on equal monthly amounts
for each year.
|
|
|
|
Oil
(Bbl)
|
|
|
Natural
Gas (Mmbtu)
|
|
|
Natural
Gas (Mmbtu)
|
|
|
|
|
Price
|
|
|
Volumes
|
|
|
Price
|
|
|
Volumes
|
|
|
Price
|
|
|
Volumes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
$
|
24.47
|
|
|
|
277,008
|
|
|
$
|
4.745
|
|
|
|
1,056,876
|
|
|
$
|
6.355
|
|
|
|
513,480
|
|
|
2008
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
4.765
|
|
|
|
917,004
|
|
|
$
|
5.960
|
|
|
|
460,740
|
|
|
2009
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
4.785
|
|
|
|
779,268
|
|
|
$
|
5.610
|
|
|
|
427,200
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4.745
|
|
|
|
|
|
|
|
|
|
|
|
|
|
277,008
|
|
|
|
|
|
|
|
2,753,148
|
|
|
|
|
|
|
|
1,401,420
|
|
|
|
The
fair market value of these contracts at December 31, 2006 was a liability
of $19,450,108, of which $13,270,676 is classified as a current liability
and $6,179,432 as a non-current liability. The fair market
value of hedge contracts at December 31, 2005 was a liability of
$48,206,693, of which $21,962,699 was classified as a current liability
and $26,243,994 as a non-current
liability.
|
|
|
Realized
hedge settlement losses included in oil and gas revenues were $15,933,634
and $20,398,476 for the years ended December 31, 2006 and 2005,
respectively. The Partnership recognized a gain of $4,312,713
in 2006 and a loss of $4,115,041 in 2005 due to ineffectiveness on
these
hedge contracts.
|
|
|
Unaudited
hedge
information as of September 30,
2007
|
As
of
September 30, 2007, the Partnership had three fixed price oil swap contracts
and
two fixed price gas swap contracts. Hedged volumes and fixed prices
by year, as of September 30, 2007 are summarized below. Settlements
occur monthly based on equal monthly amounts for each year.
|
|
|
Swap
|
|
|
Volumes
|
|
|
|
|
price
|
|
|
2007
|
|
|
2008
|
|
|
2009
|
|
|
Oil:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
24.47
|
|
|
|
69,252
|
|
|
|
|
|
|
|
|
|
|
$
|
62.73
|
|
|
|
|
|
|
|
130,020
|
|
|
|
|
|
|
|
$
|
69.90
|
|
|
|
|
|
|
|
69,156
|
|
|
|
|
|
|
|
$
|
62.78
|
|
|
|
|
|
|
|
|
|
|
|
109,560
|
|
|
|
|
$
|
68.90
|
|
|
|
|
|
|
|
|
|
|
|
54,348
|
|
|
Total
oil (bbl)
|
|
|
|
|
|
|
69,252
|
|
|
|
199,176
|
|
|
|
163,908
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Natural
Gas:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4.745
|
|
|
|
264,219
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
6.355
|
|
|
|
128,370
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4.765
|
|
|
|
|
|
|
|
917,004
|
|
|
|
|
|
|
|
|
$
|
5.960
|
|
|
|
|
|
|
|
460,740
|
|
|
|
|
|
|
|
|
$
|
4.785
|
|
|
|
|
|
|
|
|
|
|
|
779,268
|
|
|
|
|
$
|
5.610
|
|
|
|
|
|
|
|
|
|
|
|
427,200
|
|
|
Total
(Mmbtu)
|
|
|
|
|
|
|
392,589
|
|
|
|
1,377,744
|
|
|
|
1,206,468
|
|
The
fair
market value of these contracts at September 30, 2007 was a liability of
$15,216,082, of which $9,026,144 is classified as a current liability and
$6,189,938 as a non-current liability.
Realized
hedge settlement losses included in oil and gas revenues were $10,594,278 and
$12,223,839 for the nine months ended September 30, 2007 and 2006,
respectively. The Partnership recognized gains from hedge
ineffectiveness of $5,031 and $4,186,541 for the first nine months of 2007
and
2006, respectively.
On
October 17, 2007, the Partnership paid $12,951,792 to cancel all hedges except
for gas hedges for 2007 and 2009 volumes.
NOTE
F – GAIN ON INVOLUNTARY CONVERSION
|
|
In
August 2005, Hurricane Katrina caused severe damage to the facilities
at
two Partnership oil and gas properties located in Southeast
Louisiana. The carrying amount of the destroyed property was
$1,405,155. Insurance proceeds of $7,059,192 were collected in
December 2005. FASB Interpretation No. 30,
Accounting for
Involuntary
Conversions of Nonmonetary Assets to Monetary Assets,
requires the
recognition of gain to the extent that monetary assets received exceed
the
carrying amount of the nonmonetary assets involuntarily converted,
even
though the monetary assets are reinvested to replace the nonmonetary
asset. Consequently, the Partnership recognized a gain of
$5,654,037.
|
|
|
As
a result of the aforementioned damage, there has been only minimal
production from those properties since August 2005. These
properties accounted for approximately 26% of the Partnership’s oil
production in 2005 (114,265 barrels) and approximately 25% in 2004
(155,428 barrels). Partial production was restored in 2006, and
reconstruction of the remaining damaged facilities is currently in
progress with completion expected in 2007. The Partnership
recognized business interruption recoveries in the amount of $681,000
and
$1,255,500 for the years ended December 31, 2006 and 2005,
respectively.
|
NOTE
G – SIGNIFICANT CUSTOMERS
|
|
In
2006, two purchasers accounted for 19% and 13% of the Partnership’s oil
and gas revenues. In 2005, two purchasers accounted for 15% and
14% of the Partnership’s oil and gas revenues. No other
purchasers accounted for 10% or more of oil and gas revenue in 2006
or
2005. There are adequate purchasers of the Partnership’s
production such that the General Partner believes the loss of one
or more
of the above purchasers would not have a material adverse effect
on its
results of operations or cash
flows.
|
NOTE
H – SUPPLEMENTAL FINANCIAL INFORMATION FOR OIL AND GAS
PRODUCING
ACTIVITIES (UNAUDITED)
|
|
Costs
Incurred
Relating to Oil and Gas
Activities
|
|
|
Costs
incurred in 2006 and 2005 in acquisition, development and exploration
of
oil and gas properties are as
follows:
|
|
|
|
2006
|
|
|
2005
|
|
|
Acquisition
|
|
$
|
1,420,497
|
|
|
$
|
-
|
|
|
Developement
|
|
|
10,478,815
|
|
|
|
6,320,731
|
|
|
Exploration
(delay rentals)
|
|
|
-
|
|
|
|
25,853
|
|
|
|
Estimated
Quantities
of Proved Oil and Gas
Reserves
|
|
|
The
estimates of proved oil and gas reserves are based on a report by
independent petroleum engineers. The estimates at December 31,
2006 and 2005 were prepared by Cawley, Gillespie & Associates,
Inc. The General Partner emphasizes that reserve
estimates are inherently imprecise. Accordingly, the estimates
are expected to change as more current information becomes
available. In addition, a portion of the Partnership's proved
reserves is undeveloped, which increases the imprecision inherent
in
estimating reserves that may ultimately be
produced.
|
|
|
Proved
reserves are estimated quantities of crude oil, natural gas, and
natural
gas liquids which geological and engineering data demonstrate with
reasonable certainty to be recoverable in future years from known
reservoirs under existing economic and operating
conditions. Proved developed reserves are those which are
expected to be recovered through existing wells with existing equipment
and operating methods.
|
|
|
The
following is a summary of the Partnership’s proved oil and gas reserves,
all of which are located in the United States. Gas volumes
include quantities that will be converted to natural gas liquids
upon
processing.
|
|
|
|
Oil
|
|
|
Gas
|
|
|
|
|
(Bbls)
|
|
|
(Mcf)
|
|
|
|
|
|
|
|
|
|
|
Proved
reserve quantities, December 31, 2004
|
|
|
6,571,427
|
|
|
|
32,892,137
|
|
|
Purchase
of minerals-in-place
|
|
|
-
|
|
|
|
-
|
|
|
Production
|
|
|
(438,833
|
)
|
|
|
(3,265,161
|
)
|
|
Sales
of minerals-in-place
|
|
|
(163
|
)
|
|
|
(1,012,801
|
)
|
|
Revision
of quantity estimates
|
|
|
(589,303
|
)
|
|
|
(3,600,599
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Proved
reserve quantities, December 31, 2005
|
|
|
5,543,128
|
|
|
|
25,013,576
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases
of minerals-in-place
|
|
|
268,468
|
|
|
|
-
|
|
|
Production
|
|
|
(307,508
|
)
|
|
|
(2,205,424
|
)
|
|
Revision
of quantity estimates
|
|
|
6,972
|
|
|
|
(2,504,379
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Proved
reserve quantities, December 31, 2006
|
|
|
5,511,060
|
|
|
|
20,303,773
|
|
|
|
|
|
|
|
|
|
|
|
|
Proved
developed reserves
|
|
|
|
|
|
|
|
|
|
December
31, 2005
|
|
|
4,633,169
|
|
|
|
21,042,692
|
|
|
December
31, 2006
|
|
|
4,602,319
|
|
|
|
16,428,991
|
|
|
|
Di
scounted
Future Net
Cash Flows
|
|
|
In
accordance with SFAS No. 69, estimates of the standardized measure of
discounted future cash flows were determined by applying period-end
prices
(adjusted for location and quality differentials) to the estimated
future
production of year-end proved reserves. Future cash inflows
were reduced by the estimated future production and development costs
based on period-end costs to determine cash inflows in the associated
proved oil and gas properties. Future net cash
inflows were discounted using a 10% annual discount rate to arrive
at the
standardized measure.
|
|
|
Estimated
future income taxes included in standardized measure of discounted
future
net cash flows are restricted to the Texas Margin Tax. No other
income taxes have been taken into account, since future taxable income
or
loss is generally taxed directly to the partners, not to the
Partnership.
|
|
|
The
standardized measure of discounted future net cash flow amounts contained
in the following tabulation does not purport to represent the fair
market
value of oil and gas properties. No value has been given to
unproved acreage. There are significant uncertainties inherent
in estimating quantities of proved reserves and in projecting rates
of
production and the timing and amount of future costs. Future
realization of oil and gas prices over the remaining reserve lives
may
vary significantly from current prices. In addition, the method
of valuation utilized, based on year-end prices and costs and the
use of a
10% discount rate, and is not necessarily appropriate for determining
fair
value.
|
|
|
The
estimated standardized measure of discounted future cash flows at
December
31, 2006 and 2005 is as follows:
|
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
Future
cash inflows
|
|
$
|
427,113,250
|
|
|
$
|
532,398,188
|
|
|
Future
production costs
|
|
|
173,391,542
|
|
|
|
174,887,328
|
|
|
Future
development costs
|
|
|
25,709,996
|
|
|
|
25,686,766
|
|
|
Future
income taxes
|
|
|
871,604
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Future
net cash flows
|
|
|
227,140,108
|
|
|
|
331,824,094
|
|
|
|
|
|
|
|
|
|
|
|
|
10%
annual discount for estimated timing of cash flows
|
|
|
92,095,105
|
|
|
|
131,079,828
|
|
|
|
|
|
|
|
|
|
|
|
|
Standardized
measure of discounted future net cash flows
|
|
$
|
135,045,003
|
|
|
$
|
200,744,266
|
|
|
|
The
changes in standardized measure of discounted future net cash flows
(not
including the effects of hedging) for the year ended December 31,
2006 (in thousands):
|
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
Standardized
measure, beginning of year
|
|
$
|
200,744,266
|
|
|
$
|
179,210,906
|
|
|
Changes
in prices, net of production cost
|
|
|
(45,476,358
|
)
|
|
|
71,247,922
|
|
|
Previously
estimated development cost incurred
|
|
|
-
|
|
|
|
2,327,410
|
|
|
Revision
of quantity estimates
|
|
|
(6,965,985
|
)
|
|
|
(26,487,481
|
)
|
|
Change
in future development costs
|
|
|
(13,823
|
)
|
|
|
(523,914
|
)
|
|
Purchases
of minerals-in-place
|
|
|
5,687,000
|
|
|
|
-
|
|
|
Sales,
net of production cost
|
|
|
(21,170,652
|
)
|
|
|
(31,799,142
|
)
|
|
Sales
of minerals-in-place
|
|
|
-
|
|
|
|
(1,593,661
|
)
|
|
Accretion
of discount
|
|
|
22,024,140
|
|
|
|
19,066,319
|
|
|
Change
in estimated future income taxes
|
|
|
(513,153
|
)
|
|
|
-
|
|
|
Changes
in timing of estimated cash flows and other
|
|
|
(19,270,432
|
)
|
|
|
(10,704,093
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Standardized
measure, end of period
|
|
$
|
135,045,003
|
|
|
$
|
200,744,266
|
|
|
|
Current
prices at year end, used in standardized
measure:
|
|
Oil
(per barrel)
|
|
$
|
57.62
|
|
|
$
|
57.63
|
|
|
Gas
(per Mcf)
|
|
|
5.17
|
|
|
|
8.52
|
|
UNAUDITED
PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The
following unaudited pro forma condensed consolidated financial statements give
effect to the acquisition of the limited partner interest in AROC Energy, L.P.
(“AROC”) by GeoResources, Inc. (“GeoResources”). The unaudited pro
forma condensed consolidated balance sheet at September 30, 2007 has been
prepared as if the transaction had been consummated on September 30,
2007. The unaudited pro forma condensed consolidated statements of
income for the year ended December 31, 2006 and for the nine months ended
September 30, 2007 were prepared as if this acquisition had been consummated
on
January 1, 2006. The unaudited pro forma condensed consolidated
statements of income also include the pro forma effects of the mergers of
Southern Bay Oil & Gas, L.P. (“Southern Bay”) and PICA Energy, LLC (“PICA”)
into GeoResources, which occurred April 17, 2007.
These
pro
forma financial statements are presented under the successful efforts method
of
accounting for oil and gas properties. The acquisition will be
accounted for as a purchase by GeoResources, Inc.
The
pro
forma results as presented in these statements may not be indicative of the
actual results that would have occurred had the AROC acquisition and the mergers
occurred at the beginning of the periods presented and may not be indicative
of
future results. The pro forma financial statements should be read in conjunction
with the historical financial statements of AROC Energy, L.P. The pro forma
financial statements should also be read in conjunction with the pro forma
financial statements of GeoResources, Inc. as of, and for the year ended
December 31, 2006, as well as the historical financial statements of the
entities included in the merger with GeoResources on April 17, 2007, all of
which were included in Form 8-K/A filed on June 22, 2007.
|
GeoResources,
Inc.
|
|
|
Unaudited
Pro Forma Condensed Consolidated Balance Sheet
|
|
|
September
30, 2007
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Historical
|
|
|
|
|
|
|
|
|
|
|
|
Geo
|
|
|
AROC
|
|
|
|
Pro
Forma
|
|
|
Pro
Forma
|
|
|
|
|
Resources
|
|
|
Energy
|
|
|
|
Adjustments
|
|
|
Consolidated
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
17,372
|
|
|
$
|
7,017
|
|
(a)
|
|
$
|
2,401
|
|
|
$
|
13,838
|
|
|
|
|
|
|
|
|
|
|
|
(b)
|
|
|
(12,952
|
)
|
|
|
|
|
|
Receivables
and other
|
|
|
25,861
|
|
|
|
7,749
|
|
(c)
|
|
|
(4,115
|
)
|
|
|
29,495
|
|
|
Total
current assets
|
|
|
43,233
|
|
|
|
14,766
|
|
|
|
|
(14,666
|
)
|
|
|
43,333
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
and gas properties
|
|
|
87,931
|
|
|
|
98,499
|
|
(a)
|
|
|
6,197
|
|
|
|
192,627
|
|
|
Other
property and equipment
|
|
|
1,093
|
|
|
|
-
|
|
|
|
|
|
|
|
|
1,093
|
|
|
|
|
|
89,024
|
|
|
|
98,499
|
|
|
|
|
6,197
|
|
|
|
193,720
|
|
|
Accumulated
depreciation,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
depletion
and amortization
|
|
|
(9,596
|
)
|
|
|
(27,435
|
)
|
(a)
|
|
|
27,435
|
|
|
|
(9,596
|
)
|
|
Net
property and equipment
|
|
|
79,428
|
|
|
|
71,064
|
|
|
|
|
33,632
|
|
|
|
184,124
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
in oil and gas limited partnerships
|
|
|
3,356
|
|
|
|
-
|
|
(a)
|
|
|
(1,512
|
)
|
|
|
1,844
|
|
|
Notes
receivable and other
|
|
|
1,323
|
|
|
|
488
|
|
(a)
|
|
|
1,249
|
|
|
|
3,060
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Assets
|
|
$
|
127,340
|
|
|
$
|
86,318
|
|
|
|
$
|
18,703
|
|
|
$
|
232,361
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities
|
|
$
|
34,261
|
|
|
$
|
13,273
|
|
(b)
|
|
$
|
(8,244
|
)
|
|
$
|
35,175
|
|
|
|
|
|
|
|
|
|
|
|
(c)
|
|
|
(4,115
|
)
|
|
|
|
|
|
Long-term
debt
|
|
|
-
|
|
|
|
|
|
(a)
|
|
|
96,000
|
|
|
|
96,000
|
|
|
Commodity
hedges, long-term portion
|
|
|
-
|
|
|
|
6,190
|
|
(b)
|
|
|
(4,708
|
)
|
|
|
1,482
|
|
|
Deferred
income taxes
|
|
|
3,725
|
|
|
|
155
|
|
(a)
|
|
|
(155
|
)
|
|
|
3,725
|
|
|
Asset
retirement obligations
|
|
|
5,199
|
|
|
|
6,784
|
|
|
|
|
|
|
|
|
11,983
|
|
|
Total
Liabilities
|
|
|
43,185
|
|
|
|
26,402
|
|
|
|
|
78,778
|
|
|
|
148,365
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
|
|
|
84,155
|
|
|
|
59,916
|
|
(a)
|
|
|
(60,075
|
)
|
|
|
83,996
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
liabilities and equity
|
|
$
|
127,340
|
|
|
$
|
86,318
|
|
|
|
$
|
18,703
|
|
|
$
|
232,361
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GeoResources,
Inc.
|
|
|
Unaudited
Pro Forma Condensed Consolidated Statement of Income
|
|
|
Year
ended December 31, 2006
|
|
|
(in
thousands, except share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Geo
|
|
|
AROC
|
|
|
|
|
|
|
|
|
|
|
|
Resources
|
|
|
Energy
|
|
|
|
Pro
Forma
|
|
|
Pro
Forma
|
|
|
|
|
Pro
Forma (*)
|
|
|
Historical
|
|
|
|
Adjustments
|
|
|
Consolidated
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
and gas revenues
|
|
$
|
30,500
|
|
|
$
|
18,438
|
|
(d)
|
|
$
|
15,934
|
|
|
$
|
64,872
|
|
|
Drilling
revenue
|
|
|
1,642
|
|
|
|
-
|
|
|
|
|
|
|
|
|
1,642
|
|
|
Other
|
|
|
3,000
|
|
|
|
1,235
|
|
(a)
|
|
|
(91
|
)
|
|
|
3,884
|
|
|
|
|
|
|
|
|
|
|
|
(c)
|
|
|
(260
|
)
|
|
|
|
|
|
|
|
|
35,142
|
|
|
|
19,673
|
|
|
|
|
15,583
|
|
|
|
70,398
|
|
|
Costs
and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
and gas production
|
|
|
10,597
|
|
|
|
13,201
|
|
|
|
|
|
|
|
|
23,798
|
|
|
Drilling
operations
|
|
|
1,485
|
|
|
|
|
|
|
|
|
|
|
|
|
1,485
|
|
|
Depreciation,
depletion and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
amortization
and impairments
|
|
|
6,692
|
|
|
|
5,687
|
|
(b)
|
|
|
1,782
|
|
|
|
14,161
|
|
|
Exploration
|
|
|
627
|
|
|
|
-
|
|
|
|
|
|
|
|
|
627
|
|
|
Hedge
ineffectiveness
|
|
|
(393
|
)
|
|
|
(4,313
|
)
|
(d)
|
|
|
4,313
|
|
|
|
(393
|
)
|
|
Selling,
general and administrative
|
|
|
4,567
|
|
|
|
400
|
|
(c)
|
|
|
(260
|
)
|
|
|
4,707
|
|
|
Interest
|
|
|
693
|
|
|
|
-
|
|
(e)
|
|
|
7,213
|
|
|
|
7,906
|
|
|
Other
|
|
|
518
|
|
|
|
-
|
|
|
|
|
|
|
|
|
518
|
|
|
|
|
|
24,786
|
|
|
|
14,975
|
|
|
|
|
13,048
|
|
|
|
52,809
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income taxes
|
|
|
10,356
|
|
|
|
4,698
|
|
|
|
|
2,535
|
|
|
|
17,589
|
|
|
Income
tax expense
|
|
|
3,658
|
|
|
|
155
|
|
(g)
|
|
|
2,519
|
|
|
|
6,332
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
6,698
|
|
|
$
|
4,543
|
|
|
|
$
|
16
|
|
|
$
|
11,257
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss)
per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.46
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.78
|
|
|
Diluted
|
|
$
|
0.46
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.77
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
14,466,720
|
|
|
|
|
|
|
|
|
|
|
|
|
14,466,720
|
|
|
Diluted
|
|
|
14,528,748
|
|
|
|
|
|
|
|
|
|
|
|
|
14,528,748
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(*)
Refer to the Company's Form 8-K/A filed on June 22, 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GeoResources,
Inc.
|
|
|
Unaudited
Pro Forma Condensed Consolidated Statement of Income
|
|
|
Nine
Months Ended September 30, 2007
|
|
|
(in
thousands, except share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Historical
|
|
|
|
|
|
|
|
|
|
|
|
Geo
|
|
|
AROC
|
|
|
|
Pro
Forma
|
|
|
Pro
Forma
|
|
|
|
|
Resources
|
|
|
Energy
|
|
|
|
Adjustments
|
|
|
Consolidated
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
and gas revenues
|
|
$
|
18,110
|
|
|
$
|
16,720
|
|
(d)
|
|
$
|
10,594
|
|
|
$
|
47,531
|
|
|
|
|
|
|
|
|
|
|
|
(f)
|
|
$
|
2,107
|
|
|
|
|
|
|
Other
|
|
|
2,927
|
|
|
|
274
|
|
(a)
|
|
|
15
|
|
|
|
3,106
|
|
|
|
|
|
|
|
|
|
|
|
(c)
|
|
|
(194
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(f)
|
|
|
84
|
|
|
|
|
|
|
Total
revenues
|
|
|
21,037
|
|
|
|
16,994
|
|
|
|
|
12,606
|
|
|
|
50,637
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costs
and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
and gas production
|
|
|
7,825
|
|
|
|
13,149
|
|
(f)
|
|
|
917
|
|
|
|
21,891
|
|
|
Depreciation,
depletion and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
amortization
and impairments
|
|
|
4,589
|
|
|
|
4,292
|
|
(b)
|
|
|
1,306
|
|
|
|
10,765
|
|
|
|
|
|
|
|
|
|
|
|
(f)
|
|
|
578
|
|
|
|
|
|
|
Drilling
and other
|
|
|
|
|
|
|
|
|
(f)
|
|
|
145
|
|
|
|
145
|
|
|
Hedge
ineffectiveness
|
|
|
-
|
|
|
|
(5
|
)
|
(d)
|
|
|
5
|
|
|
|
-
|
|
|
Selling,
general and administrative
|
|
|
4,506
|
|
|
|
322
|
|
(c)
|
|
|
(194
|
)
|
|
|
5,073
|
|
|
|
|
|
|
|
|
|
|
|
(f)
|
|
|
439
|
|
|
|
|
|
|
Interest
|
|
|
380
|
|
|
|
-
|
|
(e)
|
|
|
5,410
|
|
|
|
5,793
|
|
|
|
|
|
|
|
|
|
|
|
(f)
|
|
|
3
|
|
|
|
|
|
|
Total
expense
|
|
|
17,300
|
|
|
|
17,758
|
|
|
|
|
8,609
|
|
|
|
43,667
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income taxes
|
|
|
3,737
|
|
|
|
(764
|
)
|
|
|
|
3,997
|
|
|
|
6,970
|
|
|
Income
tax expense
|
|
|
2,788
|
|
|
|
-
|
|
(g)
|
|
|
1,164
|
|
|
|
3,952
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
949
|
|
|
$
|
(764
|
)
|
|
|
$
|
2,833
|
|
|
$
|
3,018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss)
per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.08
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.21
|
|
|
Diluted
|
|
$
|
0.08
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.21
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
11,638,567
|
|
|
|
|
|
|
|
|
|
|
|
|
14,616,446
|
|
|
Diluted
|
|
|
11,638,567
|
|
|
|
|
|
|
|
|
|
|
|
|
14,616,446
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GeoResources,
Inc.
Notes
to
Unaudited Pro Forma Condensed Consolidated Financial Statements
The
unaudited pro forma condensed consolidated balance sheet reflects the
adjustments set forth below.
|
(a)
|
To
record the issuance of debt in the amount $ 96.0 million to acquire
the
limited partner interest of AROC Energy, L.P. and to fund certain
acquisition and loan costs.
|
|
(b)
|
To
record the extinguishment of certain of AROC’s hedge liabilities totaling
$12.952 million. This was funded with loan proceeds of $2.401
million and existing cash of $10.551
million.
|
|
(c)
|
Elimination
of inter-company receivables and
payables.
|
The
unaudited pro forma condensed consolidated statements of income reflect the
following adjustments:
|
(a)
|
To
eliminate general partner equity in net income (loss) of
AROC.
|
|
(b)
|
To
adjust depreciation, depletion and amortization of AROC’s oil and gas
properties to reflect their purchase price, utilizing the units of
production method under successful efforts
accounting.
|
|
(c)
|
To
eliminate the general partner’s management fee earned from
AROC
|
|
(d)
|
To
eliminate AROC hedging costs assuming that hedges had been extinguished
January 1, 2006.
|
|
(e)
|
To
record additional interest related to debt issued in the acquisition
of
AROC and amortization of loan acquisition costs. Interest
was computed using the Company’s current effective LIBOR rate of
7.08%. An increase or decrease in the effective rate of 1/8%
would increase or decrease the annual interest expense by $120,000
per
year at the Company’s current debt level of $96.0
million.
|
|
(f)
|
To
record revenue and expenses of GeoResources and PICA prior to the
merger
of April 17, 2007
|
|
|
(g)
|
To
adjust for income tax expense on the pro forma consolidated operating
results.
|