RESERVES GROWTH THROUGH 
ADVANCED TECHNOLOGIES

                                           1995 ANNUAL REPORT

Management's Discussion and Analysis of
Financial Condition and Results of Operations 

 

The following discussion should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto.

General

Swift Energy Company's principal corporate objectives are the accumulation of crude oil and natural gas reserves for current and future production and sale and the enhancement of the net present value of those reserves. The Company has historically financed most of its growth with capital raised through limited partnership financing, having raised approximately $463 million through limited partnership financing from 1979 through 1995. Beginning in 1985, the Company increasingly emphasized this financing vehicle thereby enabling the Company to accelerate its growth and purchase larger producing properties. Commencing in 1991, the Company began re-emphasizing the addition of reserves through increased drilling on internally generated exploration and development prospects.

The Company's revenue is primarily comprised of oil and gas sales attributable to properties in which the Company owns a direct or indirect interest. Additionally, prior to 1994, the Company also recorded earned interests and fees from limited partnerships and joint ventures. Effective January 1, 1994, the Company changed its revenue recognition policy for earned interests. The cumulative effect in 1994 of this change in accounting principle resulted in a one-time accounting adjustment of $16.8 million, or a loss of $2.52 per share (after reduction for income taxes of $8.6 million), from applying the new method retroactively. Earned interests represented revenues in the form of interests in proved developed oil and gas properties conveyed to limited partnerships and joint ventures formed in connection with the Company's organization and management of limited partnerships and joint ventures, representing the difference between the Company's capital contributions to each limited partnership or joint venture and its earned revenue interest in the limited partnership's or venture's properties (based upon the expected levels of cash distributions to the limited partners or joint ventures). Under the Company's current method of accounting for earned interests, such amounts will not be recognized as income, thereby reducing the Company's investment in oil and gas property. The Company believes the change in policy results in financial statements that better reflect its business focus and that are more comparable to prevalent practices in the oil and gas exploration and production industry.

In May 1992, the Company purchased interests in certain wells from the Manville Corporation for $13.8 million using funds provided by the Company's sale of a volumetric production payment in these properties to a subsidiary of Enron Corp. Net proceeds from the sale of the production were recorded as deferred revenues. Deliveries under the volumetric production payment are recorded as oil and gas sales revenues which are offset by a corresponding reduction of deferred revenues. Under this arrangement, the Company is required to deliver a fixed quantity of hydrocarbons produced from the properties over specified periods through October 2000. Volumes remaining to be delivered under the volumetric production payment (approximately 4.1 Bcfe) are not included in the Company's proved reserves. Under the volumetric production payment, hydrocarbons produced in excess of the amount required to be delivered are sold by the Company for its own account.

Proved Oil and Gas Reserves. From 1993 to 1994, the Company's proved natural gas reserves increased 11.8 Bcf (18%) and its proved oil reserves increased by 282,198 barrels (7%). In 1995, the Company's proved natural gas reserves increased 67.3 Bcf (88%) and its proved oil reserves increased 868,714 barrels (19%). As detailed in Note 9 to the Company's financial statements, the composition of these reserves shifted substantially, with proved developed reserves comprising 77% of total proved reserves at year-end 1993, 63% of total proved reserves at year-end 1994, and 58% of total proved reserves at year-end 1995. This shift reflects the increased portion of the Company's reserves generated by recent exploration and development activities, resulting in additions of substantial proved undeveloped reserves.

Proved developed reserves additions in 1995 resulted from drilling activity (which increased undeveloped reserves to a much larger degree), revisions of previous quantities estimates and higher year-end 1995 prices. The increase in the Standardized Measure of Discounted Future Net Cash Flows (see Note 9 to the Company's financial statements) and in the Estimated Present Value of Proved Reserves (see Form 10-K Excerpts"--Oil and Gas Reserves") from year-end 1994 to year-end 1995 is due to additions in reserves through the Company's drilling activity (primarily in the AWP Olmos Field and the Giddings Field), to the 30% increase in year-end 1995 natural gas prices ($2.41 per Mcf versus $1.85 per Mcf at year-end 1994), and to the 20% increase in year-end 1995 oil prices ($18.07 per barrel at year-end 1995, compared to $15.09 per barrel a year earlier).

Liquidity and Capital Resources

The Company historically relied on limited partnership capital as its principal financing vehicle to fund its acquisitions of producing properties. Since 1991, however, the Company's strategy has shifted toward an increased reliance on exploration and development activities, and it has significantly expanded reserves added through these efforts. As a result, the Company has reduced its reliance on cash flows generated from, and capital raised through, limited partnerships. Supplemental cash and working capital are provided through internally generated cash flows and debt and equity financing.

Net Cash from Operations. In 1995, 1994, and 1993, the Company's operating activities provided net cash of $14,376,000, $10,395,000, and $7,238,000, respectively. The 1995 increase of $3,982,000 was primarily due to an increase in cash flows from oil and gas sales, which increased $2,932,000 (16%), exclusive of the non-cash amortization of deferred revenues associated with the Company's volumetric production payment. During 1995, the Company also had a $689,000 increase in other revenues, and a $680,000 decrease in interest expense, partially offset by a $1,187,000 increase in oil and gas production costs. The 1994 increase of $3,156,000 in net cash from operations was primarily due to the cash flows from oil and gas sales, which increased $4,577,000 (35%), exclusive of the non-cash amortization of deferred revenues associated with the Company's volumetric production payment, partially offset by a $1,099,000 increase in oil and gas production costs and a $1,198,000 increase in interest expense.

Sale of Common Stock. During the third quarter of 1995, the Company closed the sale to the public of 5,750,000 shares of common stock at a price of $8.50 per share. Net proceeds from this stock sale were $45,698,912. Consequently, the Company's stockholders' equity at December 31, 1995, grew to over $93,000,000. Net proceeds from the offering were used to repay outstanding indebtedness, and the remainder of the proceeds will be used or have been used to finance the Company's exploration and development activities and to acquire producing oil and gas properties, including limited partnership interests.

Sale of Convertible Subordinated Debentures. On June 30, 1993, the Company issued $28,750,000 of Convertible Subordinated Debentures (Debentures) due June 30, 2003, in a public offering. Proceeds of the offering were used primarily to acquire producing oil and gas properties and to finance the Company's expanding exploration and development programs. The principal terms of these Debentures are more fully described in Note 5 to the Company's financial statements.

Other Financing Activities. Between 1991 and 1995, the Company offered interests in oil and gas production partnerships under its Swift Depositary Interests (SDI) offering and since late 1993 has offered private partnerships formed to drill for oil and gas. The SDI program concluded at the end of 1995. Four SDI partnerships were formed during 1995, with total subscriptions of approximately $12,400,000, compared to $32,100,000 raised in eight 1994 SDI partnerships. During 1995, the Company closed three drilling partnerships with a total of $15,900,000 of subscriptions, compared to $2,600,000 of drilling partnership subscriptions in 1994. The Company anticipates that it will continue to offer drilling partnerships in the foreseeable future.

At December 31, 1995, limited partnership formation and marketing costs (which under the current drilling partnership offerings are borne by the Company as part of the Company's general partner contribution) amounted to $858,559, a decrease of $2,133,314, when compared with the December 31, 1994, balance. Upon the Company's decision to conclude the SDI offering, the remaining limited partnership formation and marketing costs related to the SDI offering (approximately $1,750,000) were accordingly transferred to the oil and gas properties account.

Credit Facilities. The Company has established credit facilities which formerly were used principally to finance the Company's purchase of producing oil and gas properties on an interim basis pending transfer of the properties to newly formed partnerships and joint ventures and to provide working capital. More recently the Company's credit facilities have been used to fund a portion of the Company's exploration and development activities. The principal terms and restrictions of these credit facilities are described in Note 4 to the Company's financial statements included herein.

At December 31, 1995, the Company had no outstanding balances under these borrowing arrangements, since these borrowings were repaid with proceeds from the Company's 1995 stock offering. The borrowings since year-end 1994 had been used primarily to fund a substantial portion of the Company's 1995 capital expenditures described below.

At December 31, 1994, the Company had $27,229,000 outstanding under these borrowing arrangements. Approximately $8,000,000 used to finance producing oil and gas property purchases was either reimbursed in January 1995 or reflected at December 31, 1994, in the "Producing oil and gas properties held for transfer" account on the balance sheet. The Company used the remainder of the outstanding balance of the credit facilities, along with internally generated cash flows, principally to fund the Company's capital expenditures in 1994 and, to a lesser extent, to provide working capital.

Working Capital. The Company's working capital increased significantly since year end, from a working capital deficit of $13,137,441 at December 31, 1994, to positive working capital of $3,247,185 at December 31, 1995. This increase is primarily the result of the net proceeds from the 1995 common stock offering.

Due to the nature of the Company's business highlighted above, the individual components of working capital fluctuate considerably from period to period. The Company incurs significant working capital requirements in connection with its role as operator of approximately 770 wells and the management of affiliated partnerships. In this capacity, the Company is responsible for certain day-to-day cash management, including the collection and disbursement of oil and gas revenues and related expenses.

Capital Expenditures. The Company's capital expenditures were approximately $40,000,000, $34,500,000, and $24,200,000 for 1995, 1994, and 1993, respectively. Including the Company's general partner capital contribution to drilling partnerships formed in 1995 ($3,200,000), approximately $23,600,000 (59%) of the 1995 capital expenditures were spent on developmental drilling (primarily in the AWP Olmos Field and Giddings Field) and $2,300,000 (6%) was expended on exploratory drilling. The Company expended approximately $6,400,000 (16% of 1995 capital expenditures) for prospect costs, principally prospect leasehold, seismic and geological costs of unproven prospects for the Company's account. The Company funded approximately $2,100,000 (5%) for the Company's general partner capital contribution to partnerships formed under its SDI offering. The Company also purchased approximately $500,000 (1%) of limited partner interests primarily in previously formed partnerships through the right of presentment arrangement provided in those partnerships. In its foreign activities, as described in Note 9 to the Company's financial statements, the Company invested another $2,800,000 (7%), $300,000 (1%), and $200,000 (1%), respectively in its Russia, Venezuela, and New Zealand initiatives. Finally, the Company spent the remaining amounts on fixed assets (primarily for computer equipment) and other additions.

Capital expenditures for 1996 are estimated to be approximately $62,000,000, including investments in all areas in which 1995 capital was spent, with the exception of its general partner contribution in SDI. Expenditures for exploratory and development drilling are expected to make up a higher proportion of 1996 capital expenditures. The Company plans to continue its increased drilling effort in 1996, with current plans to drill 110 exploratory and development wells during the year.

The Company believes that 1996's anticipated internally generated cash flows (expected to increase as the Company's production base increases as a result of its accelerated drilling program), together with the remainder of the net proceeds from the sale of 5,750,000 shares of common stock in 1995, and its existing credit facilities, will be sufficient to finance the costs associated with its currently budgeted capital expenditures at least through 1996. Further liquidity needs may also be met by additional availability under its credit facilities based upon the value of the Company's proved reserves, as management continually evaluates future use of debt and/or equity to finance its capital needs.

Results of Operations

Revenues. The Company's revenues in 1995 increased by 14% over revenues in 1994, and by 5% in 1994 over 1993 revenues, principally due to increases in oil and gas sales revenues. Revenues for 1993 included recognition of earned interests, discussed above, amounting to $3,309,000. On a pro forma basis, after considering the retroactive application of the Company's change in accounting for earned interests, revenues for 1993 would have been reduced 14% to $20,824,030.

Oil and Gas Sales. The increase in oil and gas sales for 1995 was primarily the result of production from exploratory and developmental wells drilled in late 1994 and in 1995. In 1995, the Company's additions to reserves from drilling were approximately 13 times its additions to reserves from producing property acquisitions. In 1994, reserves added through drilling were approximately double the additions to reserves from producing property acquisitions. As a percentage of total revenues, oil and gas sales have risen from 64% of total revenues in 1993 to 78% of total revenues in 1995.

The Company's net sales volumes in 1995 (including the volumetric production payment associated with each year's production) increased by 17% (1,585,706 Mcfe) over net sales volumes in 1994, while 1994 net sales volumes increased by 30% (2,232,110 Mcfe) over net sales volumes in 1993. Combined oil and gas sales revenues in 1995 increased by 14% ($2,725,704) over those revenues for 1994, while in 1994 these revenues increased by 27% ($4,266,517) over oil and gas sales in 1993. Average prices for oil dropped from $15.10 per Bbl in 1993, to $14.35 per Bbl in 1994, back up to $15.66 per Bbl in 1995, while average gas prices decreased from $1.96 per Mcf in 1993, to $1.93 per Mcf in 1994, to $1.77 per Mcf in 1995.

Since the first quarter of 1994, the Company's quarterly net sales volumes have fluctuated within a certain range that has not significantly varied from quarter to quarter until the last quarter of 1995. For the preceding four quarters, average prices received were also very stable. Fourth quarter 1995 average gas prices have returned to levels last experienced in early to mid-1994, but the impact on the Company has been much more significant, as the net sales volumes have increased to a level 35% higher than the highest quarterly sales level during 1994. From the fourth quarter of 1994 to the third quarter of 1995, average gas prices ranged from $1.63 per Mcf to $1.68 per Mcf, then increased to $2.03 per Mcf in the fourth quarter of 1995.

Increased 1995 oil and gas sales were attributable to the sale of production from properties owned by the Company for its own account, which include production derived from (i) producing properties acquired for its own account in 1994 and (ii) wells placed into production in 1994 and 1995 through exploratory and development drilling (the largest primary contributor to the Company's increased oil and gas sales in 1995). In 1995, oil and gas sales, exclusive of both the Company's interests in partnerships and in sales delivered under the volumetric production payment, were $10,798,198 (5,257,365 Mcfe) compared to similar oil and gas sales in 1994 of $7,020,614 (3,244,150 Mcfe), an increase between years of $3,777,584 (2,013,215 Mcfe). These same sales in 1993 were $2,167,823 (940,618 Mcfe). As a percentage of total oil and gas sales, these sales have comprised 48%, 35%, and 14% of the total for the respective years 1995, 1994, and 1993.

The Company's oil and gas sales revenues derived through the Company's interest in partnerships was $7,619,437 (3,827,158 Mcfe) in 1995, $8,691,031 (4,210,449 Mcfe) in 1994, and $8,805,345 (3,979,487 Mcfe) in 1993. As a percentage of total oil and gas sales, revenues from these interests have comprised 34%, 44%, and 57% of the total for 1995, 1994, and 1993, respectively.

The final major source of the Company's oil and gas sales revenues is from the sale of production from the properties acquired from Manville Corporation in May 1992. The Company records the entire amount of hydrocarbons sold as revenue, which was $4,110,255 (18% of total oil and gas sales revenue) from 2,102,044 Mcfe sold in 1995, of which 44% was a non-cash amortization of deferred revenues associated with the volumetric production payment, while the remaining 56% equals cash proceeds from sale of oil and excess gas for the Company's account. For 1994, the Company recorded $4,090,543 of revenue (21% of total oil and gas sales revenue) from the sale of 2,146,268 Mcfe, of which 49% was non-cash amortization of deferred revenues and 51% cash proceeds from the sale of oil and excess gas. For 1993, the Company recorded $4,562,503 of revenue (29% of total oil and gas sales) from the sale of 2,448,652 Mcfe, of which 51% was non-cash amortization of deferred revenues and 49% cash proceeds from sale of oil and excess gas.

Supervision Fees. Supervision fees continue to increase slightly, having grown from $3,718,829 in 1993 to $3,751,061 in 1994 to $3,838,815 in 1995, due to the change in properties operated by the Company, the annual escalation in well overhead rates, and the increase in drilling activity by the Company, which in turn increases the drilling well overhead portion of such fees.

Costs and Expenses. General and administrative expenses, net of reimbursement to the Company for services performed on behalf of its limited partnerships, increased 3% from 1993 to 1994 and 1% from 1994 to 1995. A substantial portion of the costs of personnel involved in property acquisitions and operational activities is reimbursed by the production partnerships and joint ventures for which such activities are performed. However, the Company's general and administrative expenses per Mcfe produced decreased from $0.69 per Mcfe in 1993, to $0.54 per Mcfe produced in 1994, to $0.47 per Mcfe produced in 1995.

Depreciation, depletion, and amortization (DD&A) has steadily increased, primarily due to the increase in the Company's producing properties and the related sale of increased quantities of oil and gas therefrom. The Company's DD&A rate per Mcfe of production has, however, decreased from $0.99 in 1993 to $0.82 in 1994 to $0.79 in 1995, reflecting variations in the per unit cost of property additions and changes in the mix of reserves. Since 1994, DD&A also has been favorably affected by the reduction in the Company's oil and gas properties account as a result of the change in accounting principle relating to earned interests, as discussed in Note 2 to the Company's financial statements. This reduction in oil and gas properties from the accounting principle change should continue to have a favorable impact on DD&A in future years.

The 24% increase in oil and gas production costs from 1993 to 1994 and the 21% increase from 1994 to 1995 also relates to the growth in the Company's production volumes. The 1995 increase was also affected by certain one-time remedial well expenses. The Company's production costs were $0.62 per Mcfe produced in 1993, $0.59 per Mcfe produced in 1994, and $0.61 per Mcfe produced in 1995.

Interest expense in 1995 on the Debentures, including amortization of debt issuance costs, totaled $1,981,639 ($1,973,931 in 1994 and $984,239 in 1993), while interest expense on the credit facilities, including commitment fees, totaled $1,680,400 ($1,707,601 in 1994 and $598,839 in 1993) for a total of $3,662,039 (of which $2,546,678 was capitalized). The 1994 total was $3,681,531 (of which $1,886,398 was capitalized) while the 1993 total was $1,583,079 (of which $985,614 was capitalized). The Company capitalizes that portion of interest related to its exploration, partnership, and foreign business development activities. The lower amount of interest expense in 1993 was attributable to a smaller average balance under the Company's credit lines necessary to finance the Company's capital expenditures, as well as paying only six months of interest on the Debentures.

Net Income (Loss). Net income of $4,912,512 and earnings per share of $0.54 for 1995 were 32% higher and 4% lower, respectively than "Income before cumulative effect of change in accounting principle" of $3,725,671 and earnings per share of $0.56 in 1994. The increase in net income was primarily due to an increase in production volumes and the related oil and gas sales therefrom. The 1995 decrease in earnings per share reflects a 37% increase in weighted average shares outstanding for the period, as a result of the sale of 5,750,000 shares of common stock in the third quarter of 1995. The Company's consolidated effective tax rate was 26.1%, 23.0%, and 28.7% in 1993, 1994, and 1995, respectively.

Net loss for 1994 of $13,047,027 included a cumulative effect of a change in accounting principle (see Note 2 to the Company's financial statements) of $16,772,698. Income before cumulative effect of change in accounting principle for 1994 was 24% less than net income for 1993.

On a pro forma basis, after considering the retroactive application of the Company's change in accounting for earned interests, net income would have been $3,725,671 and $4,322,478 for 1994 and 1993, respectively.

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