Edge Petroleum Corporation

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Edge Petroleum Corporation

1301 Travis Suite 2000
Houston, Texas 77002
U.S.A.
Telephone: (713) 654-8960
Fax: (713) 654-7722
Web site: http://www.edgepet.com

Public Company
Founded: 1983
Employees: 35
Sales: $33.9 million (2003)
Stock Exchanges: NASDAQ
Ticker Symbol: EPEX
NAIC: 211111 Crude Petroleum and Natural Gas Extraction

Edge Petroleum Corporation is a Houston, Texas-based, publicly traded, independent energy company. Using 3-D seismic information and visualization software, it is engaged in the exploration, development, and production of oil and natural gas, concentrating its activities onshore in the Gulf of Mexico in south Texas and Louisiana, where the company has either options or leases on nearly 100,000 acres. Edge also works acreage in the northern Rocky Mountains in the states of Wyoming and Montana, and a 2003 acquisition has brought new properties in Michigan to evaluate. All told, Edge has proved reserves of some 64 million cubic feet of natural gas equivalent.

Early 1980s Foundation

Edge was founded by John E. Calaway in 1983. As a son of a successful independent Houston oilman, James C. Calaway, he grew up in the energy business. His parents also were interested in other areas, including the arts, and expected John and his twin brother, James D. Calaway, to earn college degrees. But after just a single semester, John quit school, eager to begin a career in oil exploration. After initially opposing the idea, the elder Calaway eventually relented and helped his son get a start in the industry. When John Calaway was still in his early 20s he was able to line up investors to form an energy company that would act as a prospect generator using cutting-edge technology. Hence, Calaway chose the name Edge Petroleum when he founded his new company in 1983. In 1986 he became chief executive officer and chairman of the board.

Because the most readily available sources of oil and gas had long since been tapped out, energy companies operating in the United States had to drill much deeper wells. These "deep plays" were more expensive to develop and required the use of seismic surveys to locate prospects. The use of seismic instruments dates to the mid-1800s when they were used to measure ground movements during earthquakes. Early in the 20th century sound waves were used to detect icebergs and determine water depths, and during World War I became an effective way for the German army to determine the location of opposing artillery. In Oklahoma in the early 1920s John C. Karchner and colleagues developed reflection seismology, which used underground sound waves to map geological structures beneath the earth to locate likely oil and gas deposits. They formed a company known as Geophysical Service. Because such technology required computing power, the company became involved in calculators and computers and is better known as Texas Instruments.

During its first decade of operation Edge relied on 2-D seismic technology. Although more sophisticated 3-D seismic technology had been developed, it required the use of expensive computers that put it out of reach of all but the largest energy companies. Nevertheless, Edge was able to use the tools at hand to enjoy considerable drilling success, hitting on one out of every three attempts. As a result, Edge was able to remain viable during the mid-1980s when the industry was suffering through one of the worst periods in its history and many companies failed. Unlike most energy executives, John Calaway found a unique way to cope with the stress of these difficult times: art. Although not formally trained, Calaway grew into an accomplished painter and sculptor, whose work was bought by the likes of playwright Edward Albee and financier Feyez Sarofim. According to a 1990 Business Month profile, "His sculptures range from classic nude torsos to abstract bronze arcs. . . . His paintings are dark canvases overlaid with rich but often somber colors augmented by a pale, matte-textured substance—marble dust." Until he got married, Calaway found time to work in his studio seven days a week. During the workweek he spent his evenings there, from 5:30 to 11:00, and on Saturday and Sunday he spent his days in the studio. He told Business Month, "During 1986, at the bottom of the bust, a lot of good people in this business were terribly depressed because we'd all run up against a brick wall, and there was nothing we could do about it. But I'd go down to my studio and get onto a big piece of stone with my chisel, and all my worries would fall away. The next morning, I'd walk into my office, and people would say, 'How can you be so up?' I was up because I had made progress on my rock."

Better Times Emerging in the 1990s

Edge survived the crash of the 1980s and with the emergence of better times in the 1990s changed its strategy. In 1992 the company began to make the transition from 2-D seismic technology to 3-D, due to the advent of robust but affordable computers as well as the availability of economic 3-D seismic surveys. Over the next few years, Edge cut back on its reliance on 2-D data in favor of building up a library of 3-D seismic data for use in developing drilling prospects. Moreover, Edge began to do some drilling on its own account, primarily in south Texas and Louisiana. By 1995 Edge was almost totally reliant on 3-D seismic data. The company's success rate jumped from 33 percent to about 67 percent, making it an attractive drilling partner for the likes of Chevron Corp., KCS Energy Inc., and Pennzoil Co. In 1995 and 1996 Edge used its 3-D data to drill 69 wells in south Texas and to a lesser extent in Mississippi and Alabama. By focusing on specific geologic areas, Edge was able to gain insights that allowed it to locate overlooked deposits.

John Calaway was joined by his twin brother James, who became a director of Edge in 1991. He had displayed an entrepreneurial spirit as well. In 1982 he cofounded Space Industries International, Inc. to produce spaceflight equipment and later became involved in the funding and organization of a number of high-tech start-ups. In December 1996 he became president of Edge as part of a reorganization of the company in preparation for going public. An initial public offering (IPO) of common stock was successfully completed in March 1997, underwritten by Raymond James & Associates Inc., which acted as lead manager. Co-managing were Jefferies and Co. Inc. and Principal Financial Securities Inc. The parties had hoped to sell two million shares priced from $15 million to $17 million, but interest was strong enough that Edge was able to command a price in the upper range of the asking price, $16.5 million, and sell 760,000 additional shares. Edge netted some $40 million, earmarked to pay down debt and finance a capital expenditure program to collect more 3-D seismic data on onshore Gulf Coast properties and pursue an aggressive exploration strategy in 1997 and 1998.

The proceeds of the IPO also came in handy in August 1997 when Edge paid $3.6 million to acquire a 10 percent stake in Houston-based Frontera Resources Corp. and forge a mutually beneficial alliance. Frontera was involved in producing fields in Russia and Latin America, a situation that allowed Edge to apply its 3-D seismic technology to international plays and gain valuable knowledge in doing business outside of the United States. Investment in Edge's domestic drilling program paid off more immediately in 1997. The company drilled 75 new wells, and despite a drop in oil prices, revenues grew from $7.7 million to $13.5 million in 1998.

New Leadership in the Late 1990s

Oil prices continued to slump in 1998 and presented some challenges for Edge, which tried to market its drilling prospects to industry partners as a way to spread the risk inherent in deep plays. In general, however, the company was involved in too many of these risky projects and took steps during the year to develop an inventory of prospects that offered a better balance between risk and reward. Leading this effort at Edge would be a new CEO and chairman, as John Calaway decided in November 1998 that the time had arrived to step away from the company he founded and devote more time to his artistic career and other business interests. His replacement was John W. Elias, who had 35 years of experience in the oil and gas industry. After graduating from the University of Oklahoma with a degree in geology and attending the Advanced Management Program at Harvard University, he spent 30 years with Amoco Corporation and another five years with Seagull Energy Corporation. Calaway expressed his faith in his successor, noting that Elias had the kind of international experience that would help Edge reach the next level in its development. James Calaway would stay on as president and help with the transition for the next year before he too resigned as an officer and director in order to pursue other opportunities in the vein of his early work with start-up companies. In addition to bringing strong organizational skills to the company, Elias was also instrumental in changing the compensation structure of the company, making it performance-based, and using stock to reward all employees rather than rely on a royalty compensation system. In this way, Edge became more competitive with its peers in attracting and retaining key talent.

Key Dates:

1983:: The company is founded by John Calaway.
1992:: The company switches to 3-D seismic technology.
1997:: Edge goes public.
1998:: John Elias succeeds John Calaway as CEO and chairman.
2003:: Miller Exploration Company is acquired.

Edge made other fundamental changes to the way it traditionally did business. Throughout its history, the company generated all of its prospects but it relied on the selling of individual prospects to raise necessary capital. But selling these prospects placed demands on the staff and there was too much uncertainty about when a prospect would be drilled. The goal now was to build a program that was more predictable. In addition to producing its own prospects, Edge was open to acquisitions, farm-ins, and alliances. The company's stake in Frontera, however, was no longer considered a strategic asset and management decided to sell its position. The company also took steps in 1999 to better control overhead costs, which were not in keeping with the company's size. Headcount was cut by some 30 percent and a salary freeze went into effect. In the field in 1999, Edge enjoyed continued success in south Texas but was disappointed with two dry holes drilled in southern Louisiana. All told in 1999, Edge participated in the drilling of 13 exploratory wells, of which nine were successful, and six development wells, of which five were successful.

Edge prospered on a number of fronts in 2000. It participated in the drilling of 26 wells, of which 24 were successful. As a result, the company replaced 190 percent of its total production and a 19 percent increase in proved reserves. Edge benefited from higher than expected gas prices, but could have realized even greater growth were it not for a hedging program that failed to correctly anticipate the market. Also during the year, Edge and its partners acquired new 3-D seismic data on acreage in south central Louisiana, and after some analysis identified a number of prospects. However, while they held a great deal of potential, these leads were highly risky.

The energy sector faced a number of challenges in 2001, including a glut of natural gas and a sluggish worldwide economy. Entering the year with a strong balance sheet, Edge again enjoyed solid success with the drill bit, succeeding with 17 out of 22 wells it completed. It also spent $6.7 million to add 5.6 billion cubic feet of proven reserves during the year. Edge planned to drill slightly more wells in 2002, but because of delays in acquiring and processing some new 3-D data, it managed to drill only 13. Again the company enjoyed a high success rate, around 85 percent, but the dry holes, all located in Louisiana, were expensive ventures, leading to an unacceptable development cost of $1.74 per thousand cubic feet of gas equivalent (Mfce).

Edge performed much better in 2003, more in keeping with its strategic plan. It drilled 36 new wells and proved reserves grew by 30 percent. As a result, the price of Edge stock improved by more than 200 percent, rising from $3.75 per share to a high of $11.40. Edge also completed a significant acquisition in 2003, using $13 million in stock to buy Miller Exploration Company, a Traverse City, Michigan-based company with operations in the Mississippi Salt basin of central Mississippi as well as options on some 100,000 undeveloped acres in northern Montana. The deal provided some diversity and added about 10 percent to Edge's proved reserves.

Edge came under pressure from its largest shareholder, Chicago-based Capital Corp., which expressed displeasure with the company's pursuit of high-risk wells. Marlin wanted to declassify the company's board and made no secret that it would prefer Edge to be open to acquisition overtures as a way to maximize shareholder value. Edge's management disagreed and continued to pursue its strategy of improving shareholder value through the drill bit. During the first half of 2004 Edge enjoyed record success, due to increased production and higher commodity prices, putting to rest, at least temporarily, talk of selling the company.