<PAGE>
Filed pursuant to Rule 424(B)(1)
SEC File No. 333-89229
PROSPECTUS
5,000,000 Shares
[QUICKSILVER RESOURCES INC. LOGO APPEARS HERE]
Common Stock
----------------
We are offering for sale 5,000,000 shares of common stock of Quicksilver
Resources Inc. All of the shares are being sold by us.
Our common stock is traded on the American Stock Exchange under the symbol
"KWK". On November 16, 1999, the last reported sales price of our common stock
on the American Stock Exchange was $5.38 per share.
We are an independent energy company engaged in the acquisition, development,
exploration, production and sale of natural gas and crude oil and the
gathering, processing and transmission of natural gas. Our producing
properties are principally in the states of Michigan, Wyoming and Montana.
See "Risk Factors" beginning on page 9 to read about some of the risks that
you should consider before buying shares of our common stock.
Neither the Securities and Exchange Commission nor any other state securities
commission has approved or disapproved these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
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<TABLE>
<CAPTION>
Per Share Total
--------- -----------
<S> <C> <C>
Public offering price.................................... $5.00 $25,000,000
Underwriting discounts and commissions................... $ .31 $ 1,562,500
Proceeds, before expenses, to us......................... $4.69 $23,437,500
</TABLE>
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The underwriters may also purchase up to an additional 750,000 shares of our
common stock from us at the public offering price less the underwriting
discount.
The underwriters are severally underwriting the shares being offered. The
underwriters expect to deliver the shares to purchasers on November 22, 1999.
----------------
Bear, Stearns & Co. Inc.
Dain Rauscher Wessels
Morgan Keegan & Company, Inc.
The date of this prospectus is November 16, 1999.
<PAGE>
[Maps of Michigan, Wyoming and Montana will be shown here, in each case
depicting our reserves, present value of cash flows from estimated proved
reserves, acreage and well data.]
<PAGE>
TABLE OF CONTENTS
<TABLE>
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Page
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<S> <C>
Prospectus Summary....................................................... 1
Risk Factors............................................................. 9
Forward-Looking Statements............................................... 16
Use of Proceeds.......................................................... 17
Dividend Policy.......................................................... 17
Price Range of Common Stock.............................................. 17
Capitalization........................................................... 18
Selected Historical and Pro Forma Consolidated Financial Data............ 19
Selected Historical Financial Data of Predecessors....................... 21
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 23
Business and Properties.................................................. 30
Management............................................................... 40
Certain Transactions..................................................... 44
Security Ownership of Management and Certain Beneficial Holders.......... 47
Description of Capital Stock............................................. 49
Underwriting............................................................. 53
Legal Matters............................................................ 55
Experts.................................................................. 55
Where You Can Find More Information...................................... 55
Glossary of Oil and Gas Terms............................................ 57
Index to Financial Statements............................................ F-1
Report of Independent Petroleum Engineers................................ A-1
</TABLE>
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In this prospectus, the terms "Quicksilver," "we," "our," and "us" refer to
Quicksilver Resources Inc. and, where appropriate, to our predecessors: Mercury
Exploration Company; Quicksilver Energy, L.C.; Michigan Gas Partners Limited
Partnership; and MSR Exploration Ltd. The term "you" refers to a prospective
investor. We have included definitions of technical terms important to an
understanding of our business under "Glossary of Oil and Gas Terms" on page 57.
You should rely only on the information contained in this prospectus or to
which we have referred you. We have not authorized anyone to provide you with
information that is different. This document may be used only where it is legal
to sell these securities. The information in this prospectus may only be
accurate on the date of this prospectus.
i
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PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
This summary is not complete and does not contain all of the information that
you should consider before investing in the common stock offered through this
prospectus. You should read the entire prospectus carefully, especially the
risks of investing in the common stock discussed under "Risk Factors".
Quicksilver Resources Inc.
We are an independent energy company engaged in the acquisition,
development, exploration, production and sale of natural gas and crude oil and
the gathering, processing and transmission of natural gas. Our producing
properties are located principally in the states of Michigan, where we are the
largest independent natural gas producer, Wyoming and Montana. We acquired our
first properties in Canada in August 1999. Over the past four years, we have
significantly increased our proved reserves and production. We have
accomplished this growth primarily through the acquisition of reserves in well-
established producing areas followed by aggressive exploitation and development
drilling and the purchase of additional interests in those or nearby similar
properties. Our properties are located in well-established producing areas that
have long productive histories and typically exhibit low annual decline rates.
We have established a high quality reserve base that is primarily located in
Michigan and the Rocky Mountain states of Montana and Wyoming. As of September
1, 1999, we had proved reserves of 364 Bcfe, of which approximately 58% were
natural gas and 42% were crude oil and condensate, with an estimated PV-10
value of $348.6 million. The average prices used in this calculation were $2.75
per Mcf of gas and $19.36 per barrel of oil, which takes into account all
applicable hedging arrangements and basis and quality differentials.
Approximately 66% of our proved reserve volumes are classified as proved
developed and we are the operator of the proved reserves that constitute
approximately 92% of our PV-10 value. Our production for the twelve months
ended September 30, 1999, on a pro forma basis, was 20.6 Bcfe, assuming the
acquisition of producing properties from Unocal on May 17, 1999 had occurred as
of January 1, 1999. Approximately 78% of this production was natural gas. Based
on our proved reserves as of September 1, 1999, we had a reserve life of 18.4
years. As of September 1, 1999, we had interests in 1,623 gross (769 net)
producing wells and were the operator of approximately 69% of the gross wells.
No individual well accounts for a significant amount of our production.
Since 1995, we have experienced significant growth in reserves and
production and achieved high drilling success rates. We have increased our
reserves by 139% from 152 Bcfe on December 31, 1995 to 364 Bcfe as of September
1, 1999, and the average acquisition, development and finding cost of our
proved reserves is $0.62 per Mcfe. In 1998, we replaced 154% of our production
through extensions and discoveries at an average cost of $0.32 per Mcfe.
Average daily production has increased by 199% from 18.0 Mmcfe in 1996 to
approximately 53.8 Mmcfe in 1999. Our average daily production for August 1999
was approximately 60.0 Mmcfe. Since 1996, we have participated in the drilling
of 132 gross (61 net) wells and have achieved a success rate of 98%. Since
1996, 86% of our drilling has been classified as development and 14% has been
classified as exploratory.
The following table sets forth the total amount we spent to acquire and
develop our proved reserves and the amount of such reserves on an Mcfe basis,
from October 1995 to September 1, 1999:
<TABLE>
<CAPTION>
Average Cost
Costs Mmcfe Per Mcfe
-------------- -------------- ------------
(in thousands) (in thousands)
<S> <C> <C> <C>
Acquisition of producing
properties................... $146,730 353,114 $0.42
Exploration and development of
properties................... 16,160 49,799 0.32
-------- -------
Total....................... $162,890 402,913 $0.40
======== ======= =====
</TABLE>
1
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We were formed in December 1997 for the purpose of combining natural gas and
crude oil properties owned by Mercury Exploration Company, Quicksilver Energy,
L.C., referred to in this prospectus as QELC, and Michigan Gas Partners Limited
Partnership. Effective January 1, 1998, Michigan Gas Partners was merged into
us and assets and liabilities of Mercury and QELC were transferred to and
assumed by us. Later, in March 1999, we became the surviving company in a
merger with MSR, a publicly-traded company. Although we are a new company, we,
through our principal predecessor, Mercury, have operated in the oil and gas
industry since 1963.
Our Strengths
We believe that our historical success and future prospects are directly
related to our unique combination of strengths, including the following:
High Quality Property Base. Approximately 80% of our production revenue
results from the sale of natural gas, and our properties are characterized by
long reserve lives and predictable well production profiles. Based on current
production from 769 net producing wells, the average reserve-to-production
index, determined by dividing our proved reserves by our annual production, for
our proved reserves at September 1, 1999 was 18.4 years. In general, these
properties have extensive production histories and still contain significant
reserves and production enhancement opportunities. We are principally engaged
in activities in two core areas and the producing fields within these areas are
in close proximity to each other, allowing for substantial economies of scale
in production and cost-effective application of advanced reservoir management
techniques. Our natural gas is primarily produced and sold in Michigan, which
imports approximately 75% of its gas supply and has prices slightly higher than
standard industry benchmarks.
Significant Inventory of Exploitation and Development Opportunities. We have
generated an inventory of approximately 1,035 potential drilling locations
within our existing properties, of which 590 have been classified as proved
undeveloped locations. In addition, we have over 260 recompletion and workover
opportunities within our existing property base. This inventory should continue
to support future net reserve additions and production growth over the next
several years.
Experience and Success with Acquisition and Exploitation. We employ a
disciplined acquisition program to augment our core properties and expand our
reserve base. Our engineering and geoscience professionals use their expertise
and experience, gained through the management of existing core properties, to
target acquisition opportunities in the same geographic area or in areas with
similar geological and reservoir characteristics. Following an acquisition,
these professionals implement development programs to enhance production,
increase revenues and reduce costs.
Experienced Technical Team. We have greater technical expertise than most
independent companies our size. Our technical team has a significant number of
engineering and geo-science professionals who have held very senior positions
with major oil and gas exploration and production companies. Among others, our
team includes: the former Chief Petrophysical Engineer in Shell's corporate
headquarters, who was formerly the president of the Society of Professional
Engineers; one of Shell's former senior engineers, who was responsible for most
of Shell's western U.S. thermal recovery projects and also designed and
implemented the world's largest enhanced oil recovery project; and one of
Shell's former senior geologists, who was responsible for much of Shell's
technical reservoir and geological engineering training provided to Shell's
technical professionals. Others on our team are senior geologists and senior
engineers from larger independent oil and gas companies, and they have spent
years working the areas on which we focus. We have achieved success in the
areas in which we operate because of the depth of our technical team and their
high levels of experience.
2
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Operational Control. We believe that controlling the operations of our
properties, including facilities related to gathering, transportation,
processing and marketing, is critical to our success in acquiring and
exploiting producing properties. As of September 1, 1999, we were the operator
of properties representing approximately 92% of the PV-10 value from our
estimated proved reserves. Control over operations provides several advantages
that enhance our ability to increase the value of our property base.
Operational control allows us to have greater control over the timing, scope
and level of expenditures associated with exploitation and development drilling
activities and other field operations. Given the level of expertise our
technical team has with our property base, we believe we are able to conduct
these activities in a cost-effective manner, lowering our overall finding,
development and operating costs. In particular, our significant operational
control over gathering, transportation, processing and marketing facilities
associated with our Michigan properties allows us to lower operating costs and
increase the net price received for our production.
Our Strategy
Our business strategy focuses on growth in value per share through
development of our existing property base, the selective acquisition of high-
quality, long-lived producing properties, managing our exposure to commodity
price volatility, reducing operating costs, improving efficiency and increasing
production and reserves.
Exploit Existing Property Base. A principal component of our strategy is the
increase of production and reserves through aggressive management of operations
and low-risk development drilling. Our principal properties possess geological
and reservoir characteristics that make them well-suited for production
increases through exploitation activity and development drilling. We regularly
review operations and mechanical data on operated properties to determine if
actions can be taken to reduce operating costs or increase production. These
actions include installing, repairing and upgrading lifting equipment,
redesigning equipment to improve production from different zones, modifying
gathering and other surface facilities and conducting restimulations and
recompletions.
Pursue Complementary Acquisitions. We seek to acquire operated, long-lived
producing properties that present opportunities to profitably increase reserves
and production levels through the implementation of technically advanced
reservoir management techniques and the reduction of expenses through more
efficient field operations. While we are continually evaluating opportunities
to acquire properties in or near our existing core areas in Michigan, Wyoming
and Montana, we also evaluate acquisitions outside our existing core areas that
possess the characteristics to become a new core area. We target acreage that
would expose us to high potential prospects located in areas that are
geologically similar to neighboring areas with large developed fields. While we
believe that many of the well-established North American producing basins
possess such opportunities, we seek properties in areas that provide the
potential to establish meaningful reserves and production. In addition, we
believe that larger oil and gas companies will continue to sell domestic
onshore properties and that this will present opportunities for us to grow our
reserves and production on a cost-effective basis.
Manage Commodity Price Risk. To help ensure a level of predictability in the
prices received for our product and, therefore, the resulting cash flow, we
have natural gas sales contracts, of up to 10 years in length, and financial
hedges in place for approximately 70% of our production volumes of natural gas
and crude oil. Our strategy is to seek arrangements that provide a guaranteed
minimum price that assures acceptable rates of return on that portion of our
production committed under those contracts. As incremental production is added
or contracts or financial instruments expire, we will continue to enter into
similar contracts for up to 70% of our production, when favorable terms are
available. We believe our commodity risk management strategy helps to ensure a
base level of cash flow to execute our drilling and exploitation program, meet
our debt service requirements, and pursue acquisition opportunities, even in
times of weakness in the prices of natural gas and crude oil.
3
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Participate in Exploration Activities. We will continue to focus the bulk of
our activities on lower risk exploitation activity and development drilling.
However, we may allocate up to 10% of our future capital budgets to exploration
projects. We have a significant inventory of exploration projects and over
100,000 net undeveloped acres. Some of this acreage overlays coal deposits that
we believe are possible prospects for coal bed methane gas development, which
is extensive in surrounding areas with similar coal deposits. We are
particularly interested in exploration activity that has the ability to create
a sizable amount of follow-on development drilling and exploitation activity,
such as the development of coal bed methane reserves, to which our technical
and operational expertise is well suited. Since we have already established the
acreage position, we intend to involve industry partners in the initial capital
intensive higher risk phases of the exploration activity, while maintaining our
ability to participate in any subsequent lower risk development and
exploitation activities.
Recent Developments
MSR Merger. In early 1999, our stockholders approved our merger with MSR.
The merger was completed on March 4, 1999. As a result of the merger, we
acquired all of MSR's interests in oil and gas mineral leases, gas gathering
pipeline systems and producing wells located principally in the states of
Montana and Texas. MSR's Montana properties acquired in the merger fit
strategically with some of our adjoining properties.
Reliant Energy Agreement. In May 1999, Reliant Energy Services, Inc., the
wholesale trading and marketing organization of the Reliant Energy Wholesale
Group, entered into a long-term agreement to purchase natural gas from us.
Reliant is a large, investment grade transporter and marketer of energy
products. Terms of the agreement call for us to supply 25,000 Mmbtu of natural
gas per day at $2.49 per Mmbtu, or 91 billion Btu of gas over a 10-year period.
Approximately two-thirds of these volumes will be our production with the
balance supplied by third parties. This contract provides a predictable revenue
stream for a portion of our natural gas production and access to additional
markets for our natural gas.
Unocal Acquisition. On May 17, 1999, we completed a purchase from Unocal
Corporation's Spirit Energy 76 unit of substantially all of Unocal's natural
gas and crude oil assets in Michigan. The assets purchased, consisting of
ownership interests in the Garfield Unit and the Beaver Creek Unit, include
approximately 20,000 net leasehold acres and about 13.0 Mmcfe per day of
production. As a result of the acquisition, we increased our ownership in
fields we already controlled, obtained assets which complemented existing
assets and increased our total production substantially. Our ownership in the
Garfield Unit increased from 54% to 99%. The purchase price for the Unocal
acquisition was $30 million, consisting of $27 million in cash, adjusted to
$25.8 million cash at closing, and 404,381 unregistered shares of our common
stock. The stock portion of the purchase price was placed in escrow and may be
distributed to Unocal over a three-year period, subject to downward adjustment
in correlation to costs, expenses, and liabilities which may be incurred during
this period.
Beaver Creek Pipeline, L.L.C. In June 1999, we and Mercury Michigan, Inc.,
an affiliate of our largest stockholder, formed Beaver Creek Pipeline, L.L.C.
We and Mercury Michigan, Inc. each acquired a 50% interest in Beaver Creek.
Beaver Creek purchased from Dow Chemical a 125-mile natural gas pipeline
extending from our Beaver Creek field in northern Michigan to the Midland,
Michigan industrial corridor. A number of large end-use customers, including
Dow Chemical, are located in the area of the pipeline and we expect demand for
natural gas to significantly increase due to increasing industrial activity and
power generation in the area. We expect this pipeline acquisition to decrease
our transportation expenses and, as a result, increase the net prices we
receive for our natural gas.
4
<PAGE>
MGV Energy Acquisition. On August 26, 1999, we purchased a 89.5% interest in
MGV Energy, Inc., which is a Calgary-based natural gas production company, for
$1.6 million. MGV is involved in a joint venture relationship with Pan
Canadian, one of the largest independent oil and gas companies in Canada. Under
the arrangement, MGV identifies acquisition and development prospects for Pan
Canadian within a 36,000 square mile area of mutual interest primarily in
southern Alberta. Should Pan Canadian decide to acquire a submitted prospect,
MGV has a right to participate in the acquisition at up to a 20% level. MGV is
free to pursue on its own any prospects outside of the area of mutual interest
and also may take 100% of any prospect within the area of mutual interest which
Pan Canadian rejects. MGV recently made its first acquisition of an interest in
375 existing gas wells in southern Alberta, Canada, incurring approximately
$2.1 million of debt to finance its purchase. MGV acquired current daily net
production of 1.2 Mmcf and 10.1 Bcf of proved reserves.
Our Executive Offices
Our principal executive offices are located at 1619 Pennsylvania Avenue in
Fort Worth, Texas 76104, and our telephone number is (817) 877-3151.
The Offering
<TABLE>
<S> <C>
Common stock offered.................. 5,000,000 shares(1)
Common stock to be outstanding after
the offering......................... 17,877,692 shares(1)(2)
Use of proceeds....................... We intend to use all of the net proceeds from this offering
to repay a portion of our existing debt.
American Stock Exchange symbol........ KWK
</TABLE>
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(1) Excludes a 30-day option granted to the underwriters to purchase up to
750,000 additional shares of common stock to cover over-allotments, if any.
(2) Excludes 1,152,857 shares of common stock issuable upon exercise of
outstanding warrants and vested stock options, 6,400 shares to be issued to
four of our non-employee directors as compensation for services in 1998,
warrants for 5,750 shares exercisable only after the closing price of our
stock reaches $10.00 and 404,381 contingently issuable shares held in trust
in connection with the Unocal property acquisition.
Risk Factors
For a description of some of the risks that you should consider before
buying shares of our common stock, see "Risk Factors" beginning on page 9.
5
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Summary Historical and Pro Forma Consolidated Financial Data
The following table gives a summary of our historical and pro forma
consolidated financial data. You should read the data with our consolidated
financial statements and pro forma and unaudited financial statements included
elsewhere in this prospectus. The pro forma adjustments give effect to the
purchase of properties from Unocal on May 17, 1999 and the purchase of the
remaining minority interest in MSR on March 4, 1999 as if those purchases had
occurred at the beginning of each period presented. The pro forma adjustments
include revenues and operating expenses attributed to those properties, as well
as depletion charges based on our purchase price, and interest on the debt
incurred to acquire the properties. The net losses of MSR attributed to
minority interest owners are reversed in the pro forma amounts.
<TABLE>
<CAPTION>
Nine Months Ended Year Ended
September 30, December 31,
------------------------- -----------------
(unaudited)
Pro Pro
Forma(1) Forma(1)
1999 1999 1998 1998 1998
-------- ------- ------- --------- -------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues:
Natural gas and oil revenues... $36,671 $33,471 $32,582 $51,798 $42,080
Other income................... 3,247 3,247 2,281 3,607 3,607
------- ------- ------- ------- -------
Total revenues............... 39,918 36,718 34,863 55,405 45,687
Expenses:
Lease operating expenses....... 16,106 15,214 13,439 20,451 17,781
Depreciation, depletion and
amortization.................. 11,373 10,110 9,375 16,231 12,365
General and administrative..... 2,733 2,733 1,075 1,430 1,430
Provision for doubtful
accounts...................... 1,350 1,350 - - -
Interest expense............... 7,039 6,324 4,951 8,844 6,698
------- ------- ------- ------- -------
Total expenses............... 38,601 35,731 28,840 46,956 38,274
Income before income taxes and
minority interest.............. 1,317 987 6,023 8,449 7,413
------- ------- ------- ------- -------
Minority interest............... - 141 583 - 758
------- ------- ------- ------- -------
Income before income taxes...... 1,317 1,128 6,606 8,449 8,171
Income tax provision............ 444 378 2,062 3,383 3,286
------- ------- ------- ------- -------
Net income...................... 873 750 4,544 5,066 4,885
======= ======= ======= ======= =======
Basic and diluted earnings per
share.......................... $ 0.07 $ 0.06 $ 0.39 $ 0.44 $ 0.42
======= ======= ======= ======= =======
Weighted average number of
shares outstanding--basic and
diluted........................ 12,578 12,578 11,511 11,511 11,511
======= ======= ======= ======= =======
Other Data:
EBITDA(2)...................... $19,729 $17,421 $20,349 $33,524 $26,476
Net cash provided by operating
activities.................... 11,815 16,095 16,335
Net cash used in investing
activities.................... (39,748) (13,601) (16,097)
Net cash provided by (used in)
financing activities.......... 30,813 (2,481) (607)
Capital expenditures........... 36,659 13,601 16,097
</TABLE>
6
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<TABLE>
<CAPTION>
September 30, 1999
-----------------------
Actual As Adjusted(3)
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(unaudited)
(in thousands)
<S> <C> <C>
Balance Sheet Data:
Cash and cash equivalents............................. $ 3,174 $ 3,174
Total assets.......................................... 191,320 191,320
Long-term debt and other long-term liabilities........ 119,860 96,782
Total equity.......................................... 43,608 66,686
</TABLE>
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(1) See "Selected Historical and Pro Forma Consolidated Financial Data".
(2) EBITDA means earnings before interest, income taxes, depreciation,
depletion and amortization, and impairment of natural gas and oil
properties. EBITDA is not a calculation based upon generally accepted
accounting principles. EBITDA should not be considered as an alternative to
net income as an indicator of our operating performance, or as an
alternative to cash flow as a better measure of liquidity. EBITDA measures
presented in this prospectus may not be comparable to other similarly
titled measures reported by other companies. We believe EBITDA is a widely
accepted financial indicator of a company's ability to incur and service
debt and to fund capital expenditures. In evaluating EBITDA, we believe
that investors should consider, among other things, the amount by which
EBITDA exceeds interest costs, how EBITDA compares to principal repayments
on debt and how EBITDA compares to capital expenditures for each period.
(3) The "as adjusted" balance sheet data:
. gives effect to the application of the $23.1 million of estimated net
proceeds from the sale of common stock in this offering to repay a
portion of our debt;
. gives effect to an offering price for our common stock equal to the
public offering price appearing on the cover page of this prospectus;
and
. assumes that the underwriters do not elect to exercise their over-
allotment option. See "Underwriting".
Please read "Use of Proceeds".
7
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Summary Reserve Information
The table below presents our summary reserve information as of September 1,
1999. Estimates of proved reserves are based on the September 1, 1999 reserve
report prepared by Holditch-Reservoir Technologies Consulting Services, a
Schlumberger company, our independent petroleum engineering consultants.
Appendix A to this prospectus contains a letter prepared by Holditch
summarizing the reserve report. For additional information relating to our
natural gas and oil reserves, please read "Business and Properties--Natural Gas
and Crude Oil Reserves" and note 11 of the notes to our December 31, 1998
consolidated financial statements.
As of September 1, 1999, our PV-10 value was $348.6 million. For purposes of
this calculation, the August 31, 1999 New York Mercantile Exchange prices on
this date of $2.83 per Mmbtu of natural gas and $22.86 per barrel of crude oil
were used. These NYMEX prices were then adjusted for volumes subject to long-
term contracts and financial hedges and all applicable basis and quality
differentials. After taking into account such adjustments, the average actual
prices used to calculate our PV-10 value were $2.75 per Mmbtu for natural gas
and $19.36 per barrel for crude oil and condensate. Please read note 11 of the
notes to our December 31, 1998 consolidated financial statements.
<TABLE>
<CAPTION>
As of
September 1,
1999
------------
<S> <C>
Estimated proved reserves:
Natural gas (Mmcf)............................................... 217,124
Oil and condensate (Mbbls)....................................... 24,483
Total (Mmcfe).................................................... 364,022
Proved developed reserves as a percentage of proved reserve
volumes......................................................... 66%
PV-10 value (in thousands)....................................... $348,567
</TABLE>
Summary Operating Data
The following table presents information regarding the production volumes
of, average sales prices received for and average production costs associated
with our sales of natural gas and crude oil for the periods indicated. The pro
forma adjustments give effect to the purchase of properties from Unocal on May
17, 1999 as if the purchases had occurred at the beginning of the period
presented.
<TABLE>
<CAPTION>
Nine Months Ended September 30,
---------------------------------- Year Ended
Pro Forma December 31,
1999 1999 1998 1998
----------------------- ---------- ------------
<S> <C> <C> <C> <C>
Production:
Natural gas (Mmcf)........... 12,775 11,696 11,737 15,315
Crude oil and condensate
(Mbbls)..................... 563 504 524 667
Total (Mmcfe)................ 16,153 14,720 14,881 19,317
Average sales price per unit:
Natural gas (per Mcf)........ $ 2.27 $ 2.29 $ 2.33 $ 2.33
Crude oil and condensate (per
Bbl)........................ 13.62 13.31 9.97 9.55
Total (per Mcfe)............. 2.27 2.27 2.19 2.17
Expenses (per Mcfe):
Lease operating.............. $ 1.00 $ 1.03 $ 0.90 $ 0.92
General and administrative... 0.17 0.19 0.07 0.07
Depreciation, depletion and
amortization................ 0.70 0.69 0.63 0.64
</TABLE>
8
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RISK FACTORS
Investing in our common stock will provide you with an equity ownership in
our company. Your investment will be subject to risks inherent in our business.
The trading price of your shares will be affected by the performance of our
business relative to, among other things, competition, market conditions and
general economic and industry conditions. The value of your investment may
decrease, resulting in a loss. You should carefully consider the following
factors as well as other information contained in this prospectus before
deciding to invest in shares of our common stock. This prospectus contains
forward-looking statements. See "Forward-Looking Statements." Our actual
results may differ materially from those projected in the forward-looking
statements as a result of any number of factors, including the risk factors set
forth below.
Because we have a limited operating history, our future operating results are
difficult to forecast, and our failure to sustain profitability in the future
could adversely affect the market price of our common stock.
Although our predecessors operated for years in the oil and gas industry
prior to our formation, we began operations in 1998, and have a limited
operating history in our current form upon which you may base your evaluation
of our performance. As a result of our recent formation and our brief operating
history, the operating results from the properties contributed by Mercury
Exploration Company and others to us when we were formed may not indicate what
our future results will be. We cannot assure you that we will maintain the
current level of revenues, natural gas and crude oil reserves or production we
now attribute to the properties contributed to us when we were formed. Any
future growth of our natural gas and crude oil reserves, production and
operations could place significant demands on our financial, operational and
administrative resources. Our failure to sustain profitability in the future
could adversely affect the market price of our common stock.
Natural gas and crude oil prices fluctuate widely, and low prices could have a
material adverse impact on our business.
Our revenues, profitability and future growth depend on prevailing natural
gas and crude oil prices. Prices also affect the amount of cash flow available
for capital expenditures and our ability to borrow and raise additional
capital. The amount we can borrow under our credit facility is subject to
periodic redetermination based in part on changing expectations of future
prices. Lower prices may also reduce the amount of natural gas and crude oil
that we can economically produce.
Prices for natural gas and crude oil fluctuate widely. For example, natural
gas and crude oil prices declined significantly in 1998 and, for an extended
period of time, remained substantially below prices obtained in previous years.
Among the factors that can cause this fluctuation are:
. the level of consumer product demand;
. weather conditions;
. domestic and foreign governmental regulations;
. the price and availability of alternative fuels;
. political conditions in oil and gas producing regions;
. the domestic and foreign supply of oil and gas;
. the price of foreign imports; and
. overall economic conditions.
9
<PAGE>
Reserve estimates depend on many assumptions that may turn out to be inaccurate
and any material inaccuracies in these reserve estimates or underlying
assumptions will materially affect the quantities and present value of our
reserves.
The process of estimating oil and gas reserves is complex. It requires
interpretations of available technical data and various assumptions, including
assumptions relating to economic factors. Any significant inaccuracies in these
interpretations or assumptions could materially affect the estimated quantities
and present value of reserves shown in this prospectus. Please read "Business
and Properties--Natural Gas and Crude Oil Reserves".
In order to prepare these estimates we must project production rates and
timing of development expenditures. We must also analyze available geological,
geophysical, production and engineering data, and the extent, quality and
reliability of this data can vary. The process also requires economic
assumptions such as natural gas and crude oil prices, drilling and operating
expenses, capital expenditures, taxes and availability of funds. Therefore,
estimates of natural gas and crude oil reserves are inherently imprecise.
Actual future production, oil and gas prices, revenues, taxes, development
expenditures, operating expenses and quantities of recoverable natural gas and
crude oil reserves most likely will vary from our estimates. Any significant
variance could materially affect the estimated quantities and present value of
reserves shown in this prospectus. In addition, we may adjust estimates of
proved reserves to reflect production history, results of exploration and
development, prevailing natural gas and crude oil prices and other factors,
many of which are beyond our control.
At September 1, 1999, approximately 34% of our estimated proved reserves
were undeveloped. Undeveloped reserves, by their nature, are less certain.
Recovery of undeveloped reserves requires significant capital expenditures and
successful drilling operations. The reserve data assumes that we will make
significant capital expenditures to develop our reserves. Although we have
prepared estimates of our natural gas and crude oil reserves and the costs
associated with these reserves in accordance with industry standards, we cannot
assure you that the estimated costs are accurate, that development will occur
as scheduled or that the actual results will be as estimated.
You should not assume that the present value of future net revenues referred
to in this prospectus and the information incorporated by reference is the
current market value of our estimated oil and gas reserves. In accordance with
Securities and Exchange Commission requirements, the estimated discounted
future net cash flows from proved reserves are generally based on prices and
costs as of the date of the estimate. Actual future prices and costs may be
materially higher or lower than the prices and costs as of the date of the
estimate. Any changes in consumption by gas purchasers or in governmental
regulations or taxation will also affect actual future net cash flows. The
timing of both the production and the expenses from the development and
production of oil and gas properties will affect the timing of actual future
net cash flows from proved reserves and their present value. In addition, the
10% discount factor, which is required by the Securities and Exchange
Commission to be used in calculating discounted future net cash flows for
reporting purposes, is not necessarily the most accurate discount factor. The
effective interest rate at various times and the risks associated with us or
the oil and gas industry in general will affect the accuracy of the 10%
discount factor.
We may have difficulty financing our planned growth.
We have experienced and expect to continue to experience substantial capital
expenditure and working capital needs, particularly as a result of our property
acquisition and development drilling activities. In the future, we will require
additional financing, in addition to cash generated from our operations, to
fund our planned growth. If revenues decrease as a result of lower natural gas
or crude oil prices or otherwise, we may have limited ability to expend the
capital necessary to replace our reserves or to maintain production at current
levels, resulting in a decrease in production over time. If our cash flow from
operations is not sufficient to satisfy our capital expenditure requirements,
we cannot be certain that additional financing will be available to
10
<PAGE>
us on acceptable terms or at all. In the event additional capital resources are
unavailable, we may curtail our acquisition, development drilling and other
activities or be forced to sell some of our assets on an untimely or
unfavorable basis.
We are vulnerable to operational hazards, transportation dependencies,
regulatory risks, and other uninsured risks associated with our activities.
The oil and gas business involves operating hazards such as well blowouts,
craterings, explosions, uncontrollable flows of crude oil, natural gas or well
fluids, fires, formations with abnormal pressures, pipeline ruptures or spills,
pollution, releases of toxic gas and other environmental hazards and risks, any
of which could cause us to experience substantial losses. Also, the
availability of a ready market for our natural gas and crude oil production
depends on the proximity of reserves to, and the capacity of, natural gas and
crude oil gathering systems, pipelines and trucking or terminal facilities.
Federal and state regulation of oil and gas production and transportation,
tax and energy policies, changes in supply and demand and general economic
conditions all could adversely affect our ability to produce and market our
natural gas and crude oil. In addition, we may be liable for environmental
damage caused by previous owners of property purchased and leased by us.
As a result of operating hazards, regulatory risks and other uninsured
risks, we could incur substantial liabilities to third parties or governmental
entities, the payment of which could reduce or eliminate funds available for
exploration, development or acquisitions. According to customary industry
practices, we maintain insurance against some, but not all, of such risks and
losses. The occurrence of an event that is not covered, or not fully covered,
by insurance could have a material adverse effect on our business, financial
condition and results of operations. In addition, pollution and environmental
risks generally are not fully insurable.
We may be unable to make additional acquisitions of producing properties or
successfully integrate them into our operations.
Our growth in recent years has been due in significant part to acquisitions
of producing properties. We expect to continue to evaluate and, where
appropriate, pursue acquisition opportunities on terms our management considers
to be favorable to us. We cannot assure you that we will be able to identify
suitable acquisitions in the future, or that we will be able to finance these
acquisitions on favorable terms or at all. In addition, we compete against
other companies for acquisitions, and we cannot assure you that we will be
successful in the acquisition of any material property interests. Further, we
cannot assure you that any future acquisitions that we make will be integrated
successfully into our operations or will achieve desired profitability
objectives.
The successful acquisition of producing properties requires an assessment of
recoverable reserves, exploration potential, future oil and gas prices,
operating costs, potential environmental and other liabilities and other
factors beyond our control. These assessments are necessarily inexact and their
accuracy inherently uncertain, and such a review may not reveal all existing or
potential problems, nor will it necessarily permit us to become sufficiently
familiar with the properties to fully assess their merits and deficiencies.
Inspections may not always be performed on every well, and structural and
environmental problems are not necessarily observable even when an inspection
is undertaken.
In addition, significant acquisitions can change the nature of our
operations and business depending upon the character of the acquired
properties, which may be substantially different in operating and geological
characteristics or geographic location than existing properties. While our
current operations are located primarily in Michigan, Montana, Wyoming and
Canada, we cannot assure you that we will not pursue acquisitions or properties
located in other locations.
11
<PAGE>
The failure to replace our reserves could adversely affect our production and
cash flows.
Our future success depends upon our ability to find, develop or acquire
additional oil and gas reserves that are economically recoverable. Our proved
reserves will generally decline as reserves are depleted, except to the extent
that we conduct successful exploration or development activities or acquire
properties containing proved reserves, or both. In order to increase reserves
and production, we must continue our development drilling and recompletion
programs or undertake other replacement activities. Our current strategy is to
maintain our focus on low-cost operations while increasing our reserve base,
production and cash flow through acquisitions of producing properties where we
can utilize our experience as a low-cost operator and use available cash flows
to continue to exploit our existing properties. We cannot assure you, however,
that our planned development projects and acquisition activities will result in
significant additional reserves or that we will have continuing success
drilling productive wells at low finding and development costs. Furthermore,
while our revenues may increase if prevailing oil and gas prices increase
significantly, our finding costs for additional reserves could also increase.
For a discussion of our reserves, see "Business and Properties--Natural Gas and
Crude Oil Reserves".
We cannot control the activities on properties we do not operate.
Other companies operate some of the properties in which we have an interest.
As a result, we have a limited ability to exercise influence over operations
for these properties or their associated costs. Our dependence on the operator
and other working interest owners for these projects and our limited ability to
influence operations and associated costs could materially adversely affect the
realization of our targeted returns on capital in drilling or acquisition
activities. As a result, the success and timing of our drilling and development
activities on properties operated by others depend upon a number of factors
that are outside of our control, including:
. timing and amount of capital expenditures;
. the operator's expertise and financial resources;
. approval of other participants in drilling wells; and
. selection of technology.
The loss of key personnel could adversely affect our ability to operate.
Our operations are dependent on a relatively small group of key management
and technical personnel. We cannot assure you that these individuals will
remain with us for the immediate or foreseeable future. The unexpected loss of
the services of one or more of these individuals could have a detrimental
effect on us.
Competition in our industry is intense, and we are smaller and have a more
limited operating history than most of our competitors.
We compete with major and independent oil and gas companies for property
acquisitions. We also compete for the equipment and labor required to operate
and develop these properties. Most of our competitors have substantially
greater financial and other resources than we do. In addition, larger
competitors may be able to absorb the burden of any changes in federal, state
and local laws and regulations more easily than we can, which would adversely
affect our competitive position. These competitors may be able to pay more for
exploratory prospects and productive natural gas and oil properties and may be
able to define, evaluate, bid for and purchase a greater number of properties
and prospects than we can. Our ability to explore for oil and gas prospects and
to acquire additional properties in the future will depend on our ability to
conduct operations, to evaluate and select suitable properties and to complete
transactions in this highly competitive environment. In addition, many of our
competitors have been operating for a much longer time than we have and have
demonstrated the ability to operate through industry cycles. Furthermore, the
oil and gas industry competes with other industries in supplying the energy and
fuel needs of industrial, commercial, and other consumers.
12
<PAGE>
Leverage materially affects our operations.
As of September 30, 1999, our long-term debt was $117,074,000, including
$114,850,000 outstanding under our bank credit facility and $2,224,000 of
subsidiary and other debt. We had no additional available borrowing capacity
under our bank credit facility. The borrowing base limitation on our credit
facility is periodically redetermined. Upon a redetermination, we could be
forced to repay a portion of our bank debt. We may not have sufficient funds to
make such repayments. On December 1, 1999, the borrowing base will be reviewed
and we could be required to repay up to $20,000,000 of the outstanding balance
if the borrowing base is reduced.
Our level of debt affects our operations in several important ways,
including the following:
. a large portion of our cash flow from operations is used to pay interest
on borrowings;
. the covenants contained in the agreements governing our debt limit our
ability to borrow additional funds or to dispose of assets;
. the covenants contained in the agreements governing our debt may affect
our flexibility in planning for, and reacting to, changes in business
conditions;
. a high level of debt may impair our ability to obtain additional
financing in the future for working capital, capital expenditures,
acquisitions, general corporate or other purposes;
. our leveraged financial position may make us more vulnerable to economic
downturns and may limit our ability to withstand competitive pressures;
. any debt that we incur under our credit facility will be at variable
rates, making us vulnerable to increases in interest rates; and
. a high level of debt will affect our flexibility in planning for or
reacting to changes in market conditions.
In addition, we may significantly alter our capitalization in order to make
future acquisitions or develop our properties. These changes in capitalization
may significantly increase our level of debt. A higher level of debt increases
the risk that we may default on our debt obligations. Our ability to meet debt
obligations and to reduce our level of debt depends on our future performance.
General economic conditions and financial, business and other factors affect
our operations and our future performance. Many of these factors are beyond our
control.
If we are unable to repay our debt at maturity out of cash on hand, we could
attempt to refinance the debt or repay the debt with the proceeds of an equity
offering. We cannot assure you that we will be able to generate sufficient cash
flow to pay the interest on our debt or that future borrowing or equity
financing will be available to pay or refinance the debt. The terms of our debt
may also prohibit us from taking these actions. Factors that will affect our
ability to raise cash through an offering or our capital stock or a refinancing
of our debt include financial market conditions and our market value and
operations performance at the time of the offering or other financing. We
cannot assure you that any offering or refinancing can be successfully
completed.
Several companies have entered into purchase contracts with us for a
significant part of our production and if they default on these contracts, we
could be materially and adversely affected.
Several long-term contracts for the sale of a significant portion of our
natural gas production are currently in place and account for a significant
portion of our total revenues. We cannot assure you that the other parties to
these contracts will continue to perform under the contracts. If the other
parties were to default, it could have a material adverse effect on our cash
flows for the period in which the default occurred.
13
<PAGE>
Our activities are regulated by complex laws and regulations, including
environmental regulations, that can adversely affect the cost, manner or
feasibility of doing business.
Oil and gas operations are subject to various federal, state, and local
government laws and regulations which may be changed from time to time in
response to economic or political conditions. Matters that are typically
regulated include:
. discharge permits for drilling operations;
. drilling bonds;
. reports concerning operations;
. spacing of wells;
. unitization and pooling of properties;
. environmental protection; and
. taxation.
From time to time, regulatory agencies have imposed price controls and
limitations on production by restricting the rate of flow of oil and gas wells
below actual production capacity to conserve supplies of natural gas and crude
oil. We also are subject to changing and extensive tax laws, the effects of
which cannot be predicted.
The development, production, handling, storage, transportation and disposal
of natural gas and crude oil, by-products, and other substances and materials
produced or used in connection with oil and gas operations are subject to laws
and regulations primarily relating to protection of human health and the
environment. The discharge of natural gas, crude oil or pollutants into the
air, soil or water may give rise to significant liabilities on our part to the
government and third parties and may result in the assessment of civil or
criminal penalties or require us to incur substantial costs of remediation.
Legal requirements frequently are changed and subject to interpretation, and
we are unable to predict the ultimate cost of compliance with these
requirements or their effect on our operations. We cannot assure you that
existing laws or regulation, as currently interpreted or reinterpreted in the
future, or future laws or regulations, will not materially adversely affect our
business, results of operations and financial condition.
Hedging our production may result in losses.
To reduce our exposure to fluctuations in the prices of natural gas and
crude oil, we have entered into long-term gas contracts and hedging
arrangements. These hedging arrangements expose us to risk of financial loss in
some circumstances including the following:
. our production is less than expected;
. there is a change in the expected difference between the underlying
price in the hedging agreement and actual prices received;
. the other parties to the hedging contracts fail to perform their
contract obligations; or
. a sudden unexpected event materially impacts natural gas or crude oil
prices.
In addition, these hedging arrangements may limit the benefit we would
receive from increases in the prices for natural gas and crude oil.
Furthermore, if we choose not to engage in hedging arrangements in the future,
we may be more adversely affected by changes in natural gas and crude oil
prices than our competitors who engage in hedging arrangements.
14
<PAGE>
A small number of existing stockholders control our company, which could limit
your ability to influence the outcome of stockholder votes.
Members of the Darden family, together with Mercury and QELC, companies
primarily owned by the members of the Darden family, beneficially own on the
date of this prospectus approximately 77.1% of our common stock, and will own
approximately 56.8% after the offering, assuming that the over-allotment option
is not exercised by the underwriters. As a result, these entities and
individuals will be able to control the outcome of stockholder votes, including
votes concerning the election of directors, the adoption or amendment of
provisions in our charter or bylaws and the approval of mergers and other
significant corporate transactions.
A large number of our outstanding shares may be sold into the market in the
near future which could cause the market price of our common stock to drop
significantly, even if our business is doing well.
Our shares that are eligible for future sale may have an adverse affect on
the price of our stock. After this offering, approximately 17,877,692 shares of
common stock will be outstanding, assuming the underwriters' over-allotment
option is not exercised. In addition, options and warrants to purchase
1,152,857 shares are outstanding, all of which are exercisable. These options
and warrants are exercisable at prices ranging from $8.75 to $33.75 per share.
Approximately 6,400,000 shares, assuming that the over-allotment option is not
exercised by the underwriters, will be freely tradeable without substantial
restriction or the requirement of future registration under the Securities Act.
Our officers and directors who are stockholders and a number of other
stockholders have entered into lock-up agreements under which they have agreed
not to offer or sell any shares of common stock or similar securities for a
period of 180 days from the date of this prospectus without the prior written
consent of Bear Stearns, on behalf of the underwriters; however, Bear Stearns
may at any time waive the terms of these lock-up agreements as specified in the
underwriting agreement. Sales of substantial amounts of common stock, or a
perception that such sales could occur, and the existence of options or
warrants to purchase shares of common stock at prices that may be below the
then current market price of the common stock could adversely affect the market
price of our common stock and could impair our ability to raise capital through
the sale of our equity securities.
Our certificate of incorporation contains provisions that could discourage an
acquisition or change of control.
Our certificate of incorporation authorizes our board of directors to issue
preferred stock without stockholder approval. If our board of directors elects
to issue preferred stock, it could be more difficult for a third party to
acquire control of us, even if that change of control might be beneficial to
stockholders. Please read "Description of Capital Stock".
Our computer systems and the computer systems of our business partners may not
be Year 2000 compliant, which may cause system failures and disruptions
adversely affecting our operations.
The "Year 2000" issue is a general term used to refer to the business
implications of the arrival of the new millennium. In simple terms, on January
1, 2000, all computer hardware and software systems that use the two-digit year
convention could fail completely or create erroneous data as a result of the
system failing to recognize the two-digit internal date "00" as representing
the Year 2000. Our computer systems and the computer systems of our business
partners may not be Year 2000 compliant, which may cause system failures and
disruptions adversely affecting our operations. Please read "Management's
Discussion and Analysis of Financial Condition and Results of Operations--Year
2000 Compliance".
We cannot assure you that our internal operations do not have any material
issues with respect to Year 2000 compliance. In addition, we may not properly
identify all potential problems or all potentially affected systems or remedy
all problems in our systems. Furthermore, the Year 2000 issue also affects our
customers, our suppliers and other third parties with whom we do business. The
failure of any of these entities to become
15
<PAGE>
Year 2000 compliant could adversely affect our operations. The most reasonably
likely "worst case" impacts would be:
. impairment of our ability to deliver our production to, or receive
payment from, third parties gathering and/or purchasing our production
from affected facilities;
. impairment of the ability of third-party suppliers or service companies
to provide needed materials or services to our planned or ongoing
operations, necessitating deferral or shut-in of exploration,
development or production operations;
. impairment of our ability to receive and process data, which would
hinder our ability to conduct development drilling and exploitation
activities; and
. our inability to execute financial transactions with our banks or other
third parties whose systems fail or malfunction.
FORWARD-LOOKING STATEMENTS
Some of the statements contained in this prospectus under "Prospectus
Summary," "Risk Factors," "Managements' Discussion and Analysis of Financial
Condition and Results of Operations" and "Business and Properties" that relate
to our business and the industry in which we operate are forward-looking.
Statements or assumptions related to or underlying such forward-looking
statements include, without limitation, statements regarding:
. the quality of our properties with regard to, among other things, the
existence of reserves in economic quantities;
. our ability to increase our reserves through exploration and
development;
. the number of locations to be drilled and the time frame within which
they will be drilled;
. future prices of natural gas and crude oil;
. anticipated domestic demand for natural gas; and
. the adequacy of our capital resources and liquidity.
Actual results may differ materially from those suggested by the forward-
looking statements for various reasons, including those discussed under "Risk
Factors".
16
<PAGE>
USE OF PROCEEDS
We estimate that the net proceeds to us from the sale of the 5,000,000
shares of common stock in this offering will be approximately $23.1 million
($26.6 million if the underwriters' over-allotment option is exercised in
full), after deducting underwriting discounts and commissions and estimated
offering expenses of approximately $360,000.
We intend to use all of the net proceeds to repay a portion of our
outstanding debt under our credit facility.
At September 30, 1999, we had $114,850,000 outstanding under our credit
facility. The weighted average interest rate for outstanding borrowings under
our credit facility as of September 30, 1999 was 8.0%. The credit facility has
a maturity of March 4, 2004. We have used borrowings under our current credit
facility to refinance prior debt, fund a portion of our acquisitions and for
other corporate purposes.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our common stock. We
currently intend to retain future earnings, if any, for the operation and
development of our business and do not anticipate paying any cash dividends on
our common stock in the foreseeable future. In addition, our current credit
facility prohibits us from paying cash dividends on our common stock. Any
future dividends may also be restricted by any loan agreements which we may
enter into from time to time.
PRICE RANGE OF COMMON STOCK
Since March 4, 1999, our common stock has been traded on the American Stock
Exchange under the symbol "KWK." The following table sets forth the high and
low closing prices for our common stock as reported on the American Stock
Exchange for the period from March 4, 1999 through November 16, 1999.
<TABLE>
<CAPTION>
High Low
------- -------
<S> <C> <C>
First quarter 1999 (beginning March 4, 1999)............. $ 7 5/8 $ 7 1/4
Second quarter 1999...................................... 7 3/8 6 1/8
Third quarter 1999....................................... 7 3/8 6 1/2
Fourth quarter 1999 (through November 16, 1999).......... 7 5/8 5 3/8
</TABLE>
On November 16, 1999, the last reported sales price of our common stock on
the American Stock Exchange was $5.38 per share. As of September 1, 1999,
there were approximately 1,310 stockholders of record of our common stock.
17
<PAGE>
CAPITALIZATION
The following table presents our capitalization as of September 30, 1999 on
two bases:
. on a historical basis; and
. on a pro forma basis as adjusted to reflect our anticipated use of the
estimated net proceeds of this offering at a public offering price of
$5.00 per share.
You should read the table together with "Use of Proceeds," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our consolidated financial statements included elsewhere in this prospectus.
<TABLE>
<CAPTION>
September 30, 1999
---------------------------
Actual As Adjusted(1)
--------- --------------
(in thousands)
<S> <C> <C>
Total debt.......................................... $ 117,074(2) $ 93,996
Stockholders' equity................................ 43,608(3) 66,686(3)
--------- --------
Total capitalization.............................. $ 160,682 $160,682
========= ========
</TABLE>
- --------
(1) The "as adjusted" balance sheet data:
. gives effect to the application of the $23.1 million of estimated net
proceeds from the sale of common stock in this offering to repay a
portion of our debt;
. gives effect to an offering price for our common stock equal to the
public offering price appearing on the cover page of this prospectus;
and
. assumes that the underwriters do not elect to exercise their over-
allotment option. See "Underwriting".
(2) Included is $2,108,000 of long-term debt incurred by our subsidiary, MGV
Energy, on August 26, 1999.
(3) Does not reflect the 404,381 contingently issuable shares of unregistered
common stock currently held in escrow to be released over a three year
period in connection with the acquisition of properties from Unocal (see
note 3 of the condensed notes to our consolidated financial statements for
the nine months ended September 30, 1999) or 6,400 shares to be issued to
four of our non-employee directors as compensation for services in 1998.
18
<PAGE>
SELECTED HISTORICAL AND PRO FORMA CONSOLIDATED FINANCIAL DATA
The following table gives a summary of our selected historical and pro forma
consolidated financial data for the nine months ended September 30, 1999 and
1998 and for the year ended December 31, 1998. Balance sheet data only is also
presented for the year ended December 31, 1997. You should read the data with
our consolidated financial statements and unaudited financial statements
included elsewhere in this prospectus. The pro forma adjustments give effect to
the purchase of properties from Unocal on May 17, 1999 and the purchase of the
remaining minority interest in MSR on March 4, 1999 as if those purchases had
occurred at the beginning of each period presented. The pro forma adjustments
include revenues and operating expenses attributed to those properties, as well
as depletion charges based on our purchase price, and interest on the debt
incurred to acquire the properties. The net losses of MSR attributed to
minority interest owners are reversed in the pro forma amounts.
<TABLE>
<CAPTION>
Nine Months Ended
September 30, Year Ended December 31,
-------------------------- -------------------------
(unaudited)
Pro Pro
Forma(1) Forma(1)
1999 1999 1998 1998 1998
-------- -------- ------- -------------------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues:
Natural gas and oil
revenues.............. $36,671 $ 33,471 $32,582 $ 51,798 $ 42,080
Other income........... 3,247 3,247 2,281 3,607 3,607
------- -------- ------- ----------- ------------
Total revenues....... 39,918 36,718 34,863 55,405 45,687
Expenses:
Lease operating
expenses.............. 16,106 15,214 13,439 20,451 17,781
Depreciation, depletion
and amortization...... 11,373 10,110 9,375 16,231 12,365
General and
administrative........ 2,733 2,733 1,075 1,430 1,430
Provision for doubtful
accounts.............. 1,350 1,350 - - -
Interest expense....... 7,039 6,324 4,951 8,844 6,698
------- -------- ------- ----------- ------------
Total expenses....... 38,601 35,731 28,840 46,956 38,274
Income before income
taxes and minority
interest............... 1,317 987 6,023 8,449 7,413
------- -------- ------- ----------- ------------
Minority interest....... - 141 583 - 758
------- -------- ------- ----------- ------------
Income before income
taxes.................. 1,317 1,128 6,606 8,449 8,171
Income tax provision.... 444 378 2,062 3,383 3,286
------- -------- ------- ----------- ------------
Net income.............. $ 873 $ 750 $ 4,544 $ 5,066 $ 4,885
======= ======== ======= =========== ============
Basic and diluted
earnings per share..... $ 0.07 $ 0.06 $ 0.39 $ 0.44 $ 0.42
======= ======== ======= =========== ============
Weighted average number
of shares outstanding--
basic and diluted...... 12,578 12,578 11,511 11,511 11,511
======= ======== ======= =========== ============
Other Data:
EBITDA(2).............. $19,729 $ 17,421 $20,349 $ 33,524 $ 26,476
Net cash provided by
operating activities.. 11,815 16,095 16,335
Net cash used in
investing activities.. (39,748) (13,601) (16,097)
Net cash provided by
(used in) financing
activities............ 30,813 (2,481) (607)
Capital expenditures... 36,659 13,601 16,097
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
September 30, December 31,
----------------- -----------------
1999 1998 1998 1997
-------- -------- -------- --------
(unaudited)
(in thousands)
<S> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents................ $ 3,174 $ 656 $ 294 $ 643
Current assets........................... 15,363 8,149 8,821 2,497
Total assets............................. 191,320 149,016 144,600 133,912
Short-term debt.......................... 14 71,949 67 161
Other current liabilities................ 12,144 8,859 7,463 1,954
Long-term debt and other long-term
liabilities............................. 119,860 12,674 86,310 87,336
Total equity............................. 43,608 37,854 32,588 27,852
</TABLE>
- --------
(1) Pro forma adjustments give effect to the purchase of properties from Unocal
on May 17, 1999 and the purchase of the remaining minority interest in MSR
on March 4, 1999 as if those acquisitions had occurred at the beginning of
each period presented, as follows:
<TABLE>
<CAPTION>
Nine Months Ended Year Ended
September 30, December 31,
1999 1998
----------------- ------------
(unaudited)
(in thousands)
<S> <C> <C>
Revenues........................................ $3,200 $9,718
Operating expenses.............................. 892 2,670
Depletion and depreciation...................... 1,263 3,866
Interest on acquisition debt.................... 715 2,146
Reversal of minority interest in MSR............ (141) (758)
Tax effect of pro forma adjustments............. (66) (97)
------ ------
Net income effect of pro forma adjustments...... $ 123 $ 181
====== ======
</TABLE>
(2) EBITDA means earnings before interest, income taxes, depreciation,
depletion and amortization, and impairment of natural gas and crude oil
properties. EBITDA is not a calculation based upon generally accepted
accounting principles. EBITDA should not be considered as an alternative to
net income as an indicator of our operating performance, or as an
alternative to cash flow as a better measure of liquidity. EBITDA measures
presented in this prospectus may not be comparable to other similarly
titled measures reported by other companies. We believe EBITDA is a widely
accepted financial indicator of a company's ability to incur and service
debt and to fund capital expenditures. In evaluating EBITDA, we believe
that investors should consider, among other things, the amount by which
EBITDA exceeds interest costs, how EBITDA compares to principal repayments
on debt and how EBITDA compares to capital expenditures for each period.
20
<PAGE>
SELECTED HISTORICAL FINANCIAL DATA OF PREDECESSORS
Set forth below, in separate tables, is summary selected historical
financial data of our predecessors: Mercury, QELC, Michigan Gas Partners and
MSR. The financial data of our predecessors is for fiscal periods ended in
1997, 1996 and 1995 and is derived from the predecessors' audited consolidated
financial statements and related notes presented elsewhere in this prospectus.
We do not believe that presentation of this financial data of our predecessors
in combined form provides useful comparative data because of the differing
fiscal periods of the predecessors and because only a portion of Mercury's
assets were contributed to us as part of our formation in 1998. Further, we do
not consider separate financial data for fiscal periods ended in 1994 to be
material to us or useful for comparative purposes.
MERCURY EXPLORATION COMPANY
(includes Quicksilver Energy, L.C.)
(in thousands, except for per share data)
<TABLE>
<CAPTION>
Fiscal Years Ended
Three Months Ended September 30,
December 31, --------------------------
1997 1997 1996 1995
------------------ -------- ------- -------
<S> <C> <C> <C> <C>
Statements of Operations Data:
Revenues...................... $ 11,049 $ 41,328 $17,388 $ 6,703
Net income.................... 2,354 5,115 2,248 1,463
Net income per common share... 9.38 20.38 8.96 5.83
Weighted average shares
outstanding.................. 251 251 251 251
Cash dividends................ - - - -
Other Information:
Capital expenditures.......... $ 27,750 $ 54,231 $19,779 $ 2,227
<CAPTION>
September 30,
December 31, --------------------------
1997 1997 1996 1995
------------ -------- ------- -------
<S> <C> <C> <C> <C>
Balance Sheet Data:
Working capital (deficit)..... $ (9,324) $(13,133) $(5,813) $(5,068)
Total assets.................. 126,506 102,880 50,186 28,743
Long-term debt................ 65,275 47,174 19,560 2,150
Stockholders' equity.......... 17,670 15,316 10,427 6,988
</TABLE>
MICHIGAN GAS PARTNERS LIMITED PARTNERSHIP
(in thousands)
<TABLE>
<CAPTION>
Year Ended December
31,
-----------------------
1997 1996 1995
------ ------- -------
<S> <C> <C> <C>
Statements of Operations Data:
Revenues............................................. $3,021 $ 3,368 $ 1,930
Net income (loss).................................... 19 (617) (613)
Other Information:
Capital expenditures................................. $ 13 $ 132 $ 4,837
Balance Sheet Data:
Working capital...................................... $ 343 $ 261 $ 324
Total assets......................................... 9,835 10,551 13,160
Long-term debt....................................... - - -
Partners' capital ................................... 9,453 10,313 13,025
</TABLE>
21
<PAGE>
MSR EXPLORATION LTD.
For the Period from Inception on March 7, 1997, to December 31, 1997
(in thousands)
Statements of Operations Data:
<TABLE>
<S> <C>
Revenues......................................................... $ 854
Net income ...................................................... 30
Other Information:
Capital expenditures............................................. $ 592
Balance Sheet Data:
Working capital.................................................. $ 42
Total assets .................................................... 25,963
Long-term debt................................................... 10,560
Stockholders' equity............................................. 13,070
</TABLE>
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We engage in the acquisition, exploration, production and sale of natural
gas, crude oil and condensate and the gathering, processing and transmission of
natural gas. We pursue our business through the acquisition of oil and gas
mineral leases, gas gathering systems and producing natural gas and crude oil
properties. Based upon the specifics of each lease, as well as geological and
engineering interpretations, we develop our inventory of leases by drilling
wells, redrilling wells or recompleting existing wells located on those leases
for the recovery of the reserves located there. We currently have an interest
in natural gas and crude oil mineral leases, gas gathering pipeline systems and
wells producing natural gas and crude oil that are located principally in the
states of Michigan, Wyoming and Montana. We evaluate other opportunities for
the development of reserves and related assets as they become available and, in
some circumstances, may explore opportunities in regions other than those in
which we are currently involved.
We are not a user or refiner of the natural gas or crude oil produced,
except as needed in the operation of wells that produce natural gas. Once
extracted from the ground, we connect the natural gas production to a pipeline
gathering system and store the crude oil in storage tanks located close to the
producing field for collection by crude oil purchasers.
We own or hold working interests in 1,623 gross producing wells (769 net
wells). We also hold interests in properties that contain proved undeveloped
natural gas and crude oil reserves that require additional drilling, workovers,
waterflooding or other forms of enhancement in order to become productive.
We were formed as a Delaware corporation in December 1997 to combine oil and
gas properties in a reorganization and merger. On January 1, 1998, we, Mercury,
QELC, Michigan Gas Partners, Trust Company of the West and Joint Energy
Development Investments Limited Partnership, an affiliate of Enron Corp.
referred to below as JEDI, entered into an agreement and plan of reorganization
and merger to combine some of the oil and gas properties owned by Mercury, QELC
and Michigan Gas Partners by causing Michigan Gas Partners to be merged into us
and by causing some of the assets and liabilities of Mercury and QELC to be
transferred to and assumed by us. We were the surviving corporation of the
merger.
In early 1999, our stockholders approved the merger of MSR into us. In the
merger, stockholders of MSR received approximately 2,577,700 shares of our
common stock. As a result of the merger, MSR ceased to exist, and all of its
assets and liabilities were transferred to us. The merger was accounted for, in
part, as a pooling of interest. As a result, our financial statements have been
combined with those of MSR. The merged net assets attributable to minority
interest stockholders were reported as a minority interest at December 31,
1998. This minority interest was acquired in March 1999 and was accounted for
under the purchase method of accounting.
On May 17, 1999, we completed the purchase from Unocal of substantially all
of Unocal's natural gas and crude oil assets in Michigan. The assets purchased,
consisting of ownership interests in the Garfield Unit and the Beaver Creek
Unit, included approximately 20,000 net leasehold acres and about 13,000 Mcfe
production per day. Our ownership in the Garfield Unit increased from 54% to
99%. Revenues attributable to the purchased assets were $9,718,000 in 1998 and
operating expenses totaled $2,670,000, resulting in operating income and cash
flow of $7,048,000, before depreciation, depletion, administrative and interest
expense. The sales price for gas realized by Unocal of $1.98 per Mcf was $0.35
per Mcf lower than the average price we received in 1998. For the four months
ended April 30, 1999, we estimate that Unocal reported $3,200,000 total
revenues comprised of $2,240,000 in natural gas sales and $960,000 in crude oil
sales. Direct operating expenses were an estimated $892,000. For further
information on the Unocal acquisition, see condensed notes to consolidated
financial statements (unaudited) for the nine months ended September 30, 1999
and 1998.
23
<PAGE>
We use the full-cost method of accounting for our investments in properties.
Under this method, all costs of exploration, development and acquisition of oil
and gas reserves are capitalized into separate country-by-country "full-cost
pools" as incurred. Properties in each pool are depleted and charged to
operations using the unit-of-production method, based on a ratio of current
production to total proved reserves. To the extent that the capitalized costs,
net of accumulated depreciation, depletion and amortization, less deferred
taxes, exceed the PV-10 value of proved natural gas and crude oil reserves and
the lower of cost or fair value of unproved properties, the excess costs are
charged to operations. If a write-down were required, it would result in a non-
cash charge to earnings but would not have an impact on cash flows.
Liquidity and Capital Resources
Cash Flow. We believe that our cash flows from operations are adequate to
meet the requirements of our business. However, future cash flows are subject
to a number of variables, including our level of production and prices, and we
cannot assure you that operations and other capital resources will provide cash
in sufficient amounts to maintain planned levels of capital expenditures. Our
principal operating sources of cash include sales of natural gas and crude oil,
as well as revenues from transportation and processing of natural gas.
Our net cash provided by operations for the nine months ended September 30,
1999 was $11,815,000, compared to $16,095,000 for the same period last year.
The reduction resulted from lower earnings and a $2,450,000 account receivable
not collected, which was partially offset by other working capital changes.
Our net cash used in investing for the nine months ended September 30, 1999
was $39,748,000, including $25,800,000 for the Unocal property acquisition.
Investing activities were comprised primarily of additions to oil and gas
properties through acquisitions and development and additions of field service
assets. We have budgeted approximately $30,175,000 in 2000 for capital
investments. Our activities have been financed through a combination of
operating cash flow and bank borrowings. Our primary source of financing has
been borrowing the under our credit facility. We believe we will have
sufficient cash flow from operations, borrowings under our credit facility and
proceeds from this stock offering to meet our obligations and operating needs.
Credit Facilities. As part of the merger with MSR on March 4, 1999, we
entered into a new five-year credit facility agreement. Our then existing debt
of $73,993,000 and $10,848,000 from MSR was transferred into the new credit
facility. The credit facility permits us to obtain revolving credit loans and
to issue letters of credit for our own account from time to time in a total
amount not to exceed the lesser of $200,000,000 or the borrowing base. Under an
amendment to the credit facility dated May 17, 1999, the borrowing base is
$115,000,000 and is subject to semi-annual determination and other
redeterminations based upon a variety of factors, including the PV-10 value of
our reserves. On December 1, 1999, the borrowing base will be reviewed and we
could be required to repay up to $20,000,000 of the outstanding balance if the
borrowing base is reduced. As of September 30, 1999, $114,850,000 was
outstanding under the credit facility. At our option, loans may be prepaid, and
revolving credit commitments may be reduced, in whole or in part at any time in
specified minimum amounts. We can designate the interest rate on amounts
outstanding at either the London Interbank Offered Rate (LIBOR) + 2.375% or at
bank prime. The collateral for this loan agreement consists of substantially
all of our existing assets and any future reserves acquired. The loan agreement
contains a number of dividend restrictions and restrictive covenants which,
among other things, require the maintenance of a minimum current ratio.
Market Risk. We sell approximately 70% of our natural gas under long-term,
fixed price contracts and swap agreements and, therefore, benefit from
significant predictability of our natural gas revenues. Commodity market price
fluctuations affect those natural gas volumes that are not sold under contract
and also affect our crude oil sales that are not hedged. In April 1999, we
entered into a contract to swap 7,500 Mmbtu per day at $2.40 per Mmbtu. The
contract, which expires in April 2004, increased our revenues by an
insignificant amount in the third quarter of 1999.
24
<PAGE>
In addition, we have entered into interest rate swap agreements covering
$50,000,000 of our debt. These agreements consist of one covering $25,000,000
through May 8, 2000, which converts the debt floating LIBOR base rate to a
5.75% fixed rate, and a second for $25,000,000 through June 17, 2002, which
converts the debt floating LIBOR base rate to a 5.70% fixed rate. Interest
expense for the nine months ended September 30, 1999 was $251,000 higher as a
result of these rate swaps.
Inflation and Changes in Prices. Our revenues and the value of our oil and
gas properties have been and will be affected by changes in natural gas and
crude oil prices. Our ability to maintain current borrowing capacity and to
obtain additional capital on attractive terms is also substantially dependent
on natural gas and crude oil prices. These prices are subject to significant
seasonal and other fluctuations that are beyond our ability to control or
predict. During 1999, we have received an average of $13.31 per barrel of crude
oil and $2.29 per Mcf of gas. Although some costs and expenses are affected by
the level of inflation, inflation has not had a significant effect in 1999.
Should conditions in the industry improve, causing an increase in competition
resulting in a relative shortage of oilfield supplies and/or services,
inflationary cost pressures may resume.
Results of Operations
Our revenue, profitability, and future rate of growth are dependent upon
prevailing prices for oil and gas, which, in turn, depend upon numerous factors
such as economic, political, and regulatory developments as well as competition
from other sources of energy. The energy markets historically have been highly
volatile, and future decreases in prices could have an adverse effect on our
financial position, results of operations, quantities of reserves that may be
economically produced, and access to capital.
Due to our limited existence, comparisons of our and our predecessors'
results of operations may not be meaningful. Results of operations for the nine
months ended September 30, 1999 and the twelve months ended December 31, 1998
include MSR's results. The 1997 results of operations are from our predecessors
and include MSR's from its inception March 7, 1997 through December 31, 1997;
Mercury's for the fiscal year ended September 30, 1997; and Michigan Gas
Partners' for the year ended December 31, 1997. A significant portion of
Mercury's assets and associated revenue and expenses, which result primarily
from contract operating and maintenance, were not conveyed to us at the time of
our formation.
You should read the following discussion and analysis together with our
consolidated financial statements and the related notes and with our audited
combined consolidated financial statements and the related notes for the fiscal
year ended December 31, 1998 and the audited financial statements of our
predecessors for the years ended in 1997 and 1996.
Nine Months Ended September 30, 1999 Compared With Nine Months Ended September
30, 1998
Revenues. Revenues for the nine months ended September 30, 1999 of
$36,718,000 were 5% higher than the $34,863,000 for the comparable 1998 period.
Natural gas sales for the first three quarters of 1999 of $26,763,000 were
down 2% from 1998 reflecting a $0.04 per Mcf decrease in average sales prices.
Crude oil sales of $6,708,000 were $1,486,000 higher than for the comparable
1998 period as a result of a 34% increase in average sales price to $13.31 per
barrel in 1999. Other income rose almost $1,000,000 to $3,247,000 as a result
of stronger transportation and processing income.
Expenses. Expenses of $35,731,000 were up 24% for the first nine months of
1999 compared to the first nine months of 1998, reflecting higher well workover
costs, a higher depletion unit rate, a $1,350,000 bad debt provision recorded
in the first quarter of 1999, higher staffing levels and an interest expense
increase from higher debt levels.
Net Income. We reported net income of $750,000 during the first three
quarters of 1999 compared to net income of $4,544,000 in the comparable period
of 1998. Higher operating expenses, a
25
<PAGE>
provision for doubtful accounts and general and administrative and interest
expense increases resulted in the decrease in net income from the prior year.
Year Ended December 31, 1998 Compared With Predecessors' 12 Month Periods Ended
September 30, 1997 and December 31, 1997
Revenue. Total oil and gas revenues for the 12 months ended December 31,
1998 were $45,687,000, an increase of 25% over $36,588,000 of combined
predecessor revenue for 1997. Natural gas revenues for the 1998 period were
$35,713,000, approximately 31% higher than 1997 predecessor natural gas
revenues of $27,264,000. Natural gas sales volumes for the 1998 period were
15,315,000 Mcf, a 29% increase over 11,854,000 Mcf in 1997. Average natural gas
sale prices increased from $2.30 per Mcf in the 1997 period to $2.33 in 1998.
For 1998, approximately 84% of our product sales were natural gas. A majority
of our natural gas production was sold under long-term contracts with
approximately 35% under one- to three-year contracts and 60% under 10-year
contracts. Crude oil revenues for 1998 were $6,367,000, a 31% decrease from
$9,171,000 of predecessor revenues for the same period in 1997. Crude oil
production in the 1998 period was 667,000 barrels compared to 619,000
predecessor barrels, an increase of 8%. The average crude oil sales price for
1998 was $9.55 per barrel, compared to an average price of $14.62 per barrel in
1997, a decrease of 35%.
Interest and Other Income. Interest and other income for the year ended
December 31, 1998 was $3,607,000 and primarily consisted of $1,632,000 from the
sale of tax credits and $1,879,000 from transportation and processing of
natural gas.
Minority Interest. The minority interest in net loss of MSR for 1998 was
$758,000. This was the minority interest's 53.5% share of MSR's before tax net
loss of approximately $1,416,000. As described in the footnotes to the
financial statements, this minority interest relates to the portion of the
merger with MSR that was accounted for under the purchase method of accounting.
Expenses. Operating expenses for the year ended December 31, 1998 were
$17,781,000, or $0.92 per Mcfe, a 5% decrease compared to $18,786,000 or $1.20
per Mcfe of predecessor operating expenses for the same period in 1997.
Depreciation and depletion expense was $12,365,000, or approximately $0.64 per
Mcfe, compared to $7,093,000 for 1997. General and administrative expense was
$1,430,000, or approximately $0.07 per Mcfe, compared to $1,941,000 for 1997.
Interest expense was $6,698,000, compared to $5,561,000 for 1997. Our interest
rate averaged approximately 7.4%.
Income Tax Expense. Income taxes for the year ended December 31, 1998
consisted of $950,000 due currently and deferred taxes of $2,336,000. The
effective tax rate was 40%.
Net Income. Net income for the year ended December 31, 1998 was $4,885,000
or $0.42 per share, which was approximately 10% of total revenues.
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Mercury Exploration Company
Results of Operations
The following discussion and analysis should be read in conjunction with
Mercury's statement of income contained elsewhere in this prospectus.
Year Ended September 30, 1997 Compared With Year Ended September 30, 1996
Mercury acquired the Shell Michigan properties on November 14, 1996. The
results of operations of these properties have been included in Mercury's
results since November 1, 1996. Unless otherwise indicated, the changes in
operating results were primarily the result of the acquisition of these
properties.
26
<PAGE>
Revenues. Total oil and gas revenues for the 1997 period were $41,328,000,
an increase of 138% compared to $17,388,000 for the 1996 period. In 1997,
$32,714,000 of the revenues were related to the sale of natural gas and crude
oil, compared to $11,771,000 for the 1996 period. Sales volumes for 1997 were
12,864,000 Mcfe, sold at an average price of $2.54 per Mcfe, compared to
4,332,000 Mcfe sold in the 1996 period at an average price of $2.72 per Mcfe.
This increase in sales was principally due to the purchase of the Shell
Michigan properties. The remainder of the revenues for 1997, of approximately
$8,614,000, as well as $5,617,000 in 1996, resulted from contract field
services and gas marketing.
Costs and Expenses. Total costs and expenses for the 1997 period were
$24,156,000, a 69% increase compared to $14,265,000 for the 1996 period.
Production expenses for the 1997 period were $16,454,000, or $1.28 per Mcfe,
and a 38% increase compared to $11,907,000, or $2.75 per Mcfe. General and
administrative expenses for 1997 were $1,784,000, a 30% increase compared to
$1,372,000 for 1996. Depreciation and depletion for the 1997 period was
$5,918,000, or $0.45 per Mcfe, compared to $986,000, or $0.23 per Mcfe, for
1996.
Interest Expense. Interest expense for the nine months ended September 30,
1997 was $5,414,000 compared to $1,620,000 for the 1996 period. Almost all of
the increase in interest expense relates to the approximately $57,000,000
borrowed to purchase the Shell Michigan properties.
Other Income and Expenses. Excluding interest expense noted above, the
remainder of other income totals $1,738,000 for the 1997 period, a decrease of
$254,000, or 13%, from $1,992,000 for 1996. Most of the change is attributable
to the $279,000 decrease in equity in partnership income. The decrease in net
income from the partnerships was primarily due to higher operating costs.
Income. Income before minority interest and income taxes was $13,496,000 for
the 1997 period compared to $3,495,000 for 1996. These amounts include 100% of
the results of operations of QELC, of which 52% is owned by Mercury. The
minority interest in income of subsidiaries principally applies to QELC.
Earnings. Net income was $5,115,000, or $20.38 per share, for the 1997
period compared to $2,248,000, or $8.96 per share, for 1996. Most of the
increase relates to the acquisition of the Shell Michigan properties.
Liquidity and Capital Resources
Cash Flow from Operating Activities. Mercury's net cash flow from operations
for the year ended September 30, 1997 was $15,356,000, compared to $3,951,000
for the same period in 1996. The increase was principally attributable to the
Shell Michigan properties.
Cash Flow from Investing Activities. Mercury's net cash used for investing
activities during the twelve months ended September 30, 1997 totaled
$53,578,000. Of this amount, $54,231,000 was for capital expenditures, which
were principally used for the acquisition of the Shell Michigan properties.
Cash Flow from Financing Activities. For the year ended September 30, 1997,
cash provided by financing activities totaled $39,794,000. Mercury borrowed
$94,323,000 and repaid $54,529,000 of debt.
On October 9, 1997, Mercury completed the acquisition of the Destec
properties in Michigan from ECT Enocene Enterprises II, Inc. The properties
consist of 143 wells with combined proved reserves of approximately 30.8 Bcfe.
The purchase price was approximately $23,500,000, which was paid in cash
provided primarily by bank debt.
Effective January 1, 1998, Mercury exchanged most of its natural gas and
crude oil producing properties and most of its long-term debt for our common
stock.
27
<PAGE>
Three Months Ended December 31, 1997 Compared With Three Months Ended
December 31, 1996
Revenues. Total oil and gas revenues for the three months ended December 31,
1997 were $11,049,000, an increase of 10% compared to $10,016,000 for the 1996
period. In 1997, $9,456,000 of the revenues related to the sale of natural gas
and crude oil, compared to $8,178,000 for the 1996 period. Sales volumes for
the 1997 period were 4,342,800 Mcfe sold at an average price of $2.18 per Mcfe,
compared to 3,177,000 Mcfe sold in the 1996 period at an average price of $2.58
per Mcfe. The increase in natural gas and crude oil sales was primarily due to
the purchase of the Shell Michigan and the Destec properties. The remainder of
the revenues, approximately $1,593,000 for the 1997 period and $1,838,000 in
1996, was from natural gas and crude oil contract operations, providing
services such as field operations, well supervision, well maintenance, and gas
marketing.
Costs and Expenses. Total costs and expenses for the 1997 period were
$7,734,000, an increase of 28% over $6,039,000 for the 1996 period. Generally,
the increase in expense is the result of the acquisition of the Destec and
Shell Michigan properties. The Destec results have been included since October
1, 1997, and Shell Michigan since November 1, 1996. Operating expenses for the
three months ended December 31, 1997, were $4,736,000 or $1.09 per Mcfe,
compared to $4,114,000, or $1.30 per Mcfe for the 1996 period. A portion of the
improvement in cost per unit of sales was due to economies of scale. The recent
acquisitions included mostly producing natural gas properties. Natural gas
properties generally cost less to operate on a per unit of sales basis than do
oil properties.
Depletion and depreciation expense for the 1997 period was $2,466,000, or
$0.57 per Mcfe, compared to $1,479,000 or $0.47 per Mcfe, for 1996. The
increase in 1997 was due to Mercury's property acquisitions.
General and administrative expenses for the 1997 period were $532,000, a 19%
increase over $446,000 for the 1996 period, largely attributable to the
increased size of Mercury's asset base.
Other Income and Expense. Interest expense for the three months ended
December 31, 1997 was $1,879,000, an increase of 39% over $1,353,000 for the
1996 period. The increase in interest expense primarily was due to the increase
in debt related to Mercury's property acquisitions. During the 1997 period,
Mercury received a settlement on a lawsuit in the amount of $2,781,000, which
was included in other income. The other income items for the 1997 period
totaled $652,000, down slightly compared to $750,000 for 1996.
Income. Income before income taxes and minority interest was $4,869,000 for
the 1997 period compared to $3,374,000 in 1996. These amounts include 100% of
the results of operations of QELC.
The minority interest in income of subsidiary of $1,277,000 for the 1997
period and $1,422,000 for 1996 primarily applies to QELC.
Income taxes were calculated using a statutory rate of 34%.
Earnings. Net income was $2,354,000, or $9.38 per share, for the 1997
period, compared to $1,279,000, or $5.10 per share, for 1996. Most of the
increase in earnings relates to the recent property acquisitions.
28
<PAGE>
Year 2000 Compliance
We have developed a Year 2000 Plan to address the Year 2000 issue created by
computer programs and applications that use two digit rather than four digit
date fields to designate a year. As a result, computer equipment, software, and
devices with embedded technology that are date-sensitive may be unable to
recognize or may misinterpret the actual date. This could result in a system
failure or miscalculations causing disruptions of operations.
We have assessed our information technology, referred to as "IT," and our
non-IT systems. We believe that all of our computer equipment and software as
well as our operational and control systems are currently Year 2000 compliant.
We are also monitoring the compliance efforts of the significant suppliers,
customers, and service providers with whom we do business and whose IT and non-
IT systems interface with ours to ensure that they will be Year 2000 compliant.
Management believes that ongoing communications with and assessment of the
compliance efforts of these third parties will minimize any noncompliance
risks.
Although we do not expect to experience significant operational problems due
to the Year 2000 issue, we cannot assure you that this issue will not
materially impact our results of operations or adversely affect our
relationship with customers or vendors.
The inability of third parties to complete their Year 2000 resolution in a
timely fashion could materially impact our results of operations and cash
flows. The effect of non-compliance by third parties is not determinable. The
most reasonably likely "worst case" impacts would be:
. impairment of our ability to deliver our production to, or receive
payment from, third parties gathering and/or purchasing our production
from affected facilities;
. impairment of the ability of third-party suppliers or service companies
to provide needed materials or services to our planned or ongoing
operations, necessitating deferral or shut-in of exploration,
development or production operations;
. impairment of our ability to receive and process data, which would
hinder our ability to generate development drilling and exploitation
activities; and
. our inability to execute financial transactions with our banks or other
third parties whose systems fail or malfunction.
We do not anticipate significant operational or financial problems due to
the Year 2000 issue. However, there are currently no commercially reasonable
alternatives to our current IT and non-IT systems. As a result, contingency
plans would include working with vendors, suppliers and various third parties
to remedy any Year 2000-related problems as quickly as possible. Costs incurred
to date for Year 2000 compliance have been insignificant and we expect the
remaining costs to be minimal.
29
<PAGE>
BUSINESS AND PROPERTIES
General
We are an independent energy company engaged in the acquisition,
development, exploration, production and sale of natural gas and crude oil and
the gathering, processing and transmission of natural gas. Our producing
properties are located principally in the states of Michigan, where we are the
largest independent natural gas producer, Wyoming and Montana. We acquired our
first properties in Canada in August 1999. Over the past four years, we have
significantly increased our proved reserves and production. We have
accomplished this growth primarily through the acquisition of reserves in well-
established producing areas followed by aggressive exploitation and development
drilling and the purchase of additional interests in those or nearby similar
properties. Our properties are located in well-established producing areas that
have long productive histories and typically exhibit low annual decline rates.
We have established a high quality reserve base that is primarily located in
Michigan and the Rocky Mountain states of Montana and Wyoming. As of September
1, 1999, we had proved reserves of 364 Bcfe, of which approximately 58% were
natural gas and 42% were crude oil and condensate, with an estimated PV-10
value of $348.6 million. The average prices used in this calculation were $2.75
per Mcf of gas and $19.36 per barrel of oil, which takes into account all
applicable hedging arrangements and basis and quality differentials.
Approximately 66% of our proved reserve volumes are classified as proved
developed and we are the operator of the proved reserves that constitute
approximately 92% of our PV-10 value. Our production for the twelve months
ended September 30, 1999, on a pro forma basis, was 20.6 Bcfe, assuming the
acquisition of producing properties from Unocal on May 17, 1999 had occurred as
of January 1, 1999. Approximately 78% of this production was natural gas. Based
on our proved reserves as of September 1, 1999, we had a reserve life of 18.4
years. As of September 1, 1999, we had interests in 1,623 gross (769 net)
producing wells and were the operator of approximately 69% of the gross wells.
No individual well accounts for a significant amount of our production.
Since 1995, we have experienced significant growth in reserves and
production and achieved high drilling success rates. We have increased our
reserves by 139% from 152 Bcfe on December 31, 1995 to 364 Bcfe as of September
1, 1999, and the average acquisition, development and finding cost of our
proved reserves is $0.62 per Mcfe. In 1998, we replaced 154% of our production
through extensions and discoveries at an average cost of $0.32 per Mcfe.
Average daily production has increased by 199% from 18.0 Mmcfe in 1996 to
approximately 53.8 Mmcfe in 1999. Our average daily production for August 1999
was approximately 60.0 Mmcfe. Since 1996, we have participated in the drilling
of 132 gross (61 net) wells and have achieved a success rate of 98%. Since
1996, 86% of our drilling has been classified as development and 14% has been
classified as exploratory.
We were formed in December 1997 for the purpose of combining natural gas and
crude oil properties owned by Mercury, QELC and Michigan Gas Partners.
Effective January 1, 1998, Michigan Gas Partners was merged into us and assets
and liabilities of Mercury and QELC were transferred to and assumed by us.
Later, in March 1999, we became the surviving company in a merger with MSR.
Although we are a new company, we, through our principal predecessor, Mercury,
have operated in the oil and gas industry since 1963.
Our Strengths
We believe that our historical success and future prospects are directly
related to our unique combination of strengths, including the following:
. our high quality property base;
. our significant inventory of exploitation and development opportunities;
. our experience and success with acquisition and exploitation;
30
<PAGE>
. our experienced technical team; and
. our high degree of operational control.
Our Strategy
Our business strategy focuses on growth in value per share through
development of our existing property base, the selective acquisition of high-
quality, long-lived producing properties, managing our exposure to commodity
price volatility, reducing operating costs, improving efficiency and increasing
production and reserves. The key elements of our strategy are to:
. exploit our existing property base;
. pursue complementary acquisitions;
. manage commodity price risk; and
. participate in exploration activities.
Antrim Shale Versus Conventional Natural Gas
The majority of our natural gas reserves are in the Antrim Shale formation.
The Antrim Shale is a thick blanket formation, generally found from 500 feet to
2,200 feet in depth, which underlies much of northern and western Michigan.
Natural gas reserves in the Antrim are developed and produced using methodology
which is very similar to that used in developing and producing coal bed methane
reserves. Typically, commercial natural gas and crude oil are found in a
porous, permeable layer of rock, to which hydrocarbons have migrated, which is
surrounded by a non-permeable layer or barrier of rock which then traps the
hydrocarbons until extracted. The Antrim Shale is fairly porous with naturally
occurring fracturing. As in coal bed methane production, when wells are drilled
and placed on production, they initially produce significant quantities of
water; as water is taken out of the reservoir, the reservoir pressure decreases
and the natural gas leaves (desorbs from) the shale and can flow to the
wellbore. The ability of the Antrim Shale to produce commercial quantities of
natural gas depends on the amount of gas originally in the shale, the level of
natural fracturing (permeability) through which the natural gas released can
flow to the wellbore and the amount that the reservoir pressure can be reduced
to promote the release of gas from the shale.
Description of Our Properties
We own significant interests in the following properties:
Michigan
Reserve and Production Data
<TABLE>
<CAPTION>
Reserve Data Estimated Daily
as of Production Data
September 1, 1999 for August 1999
-------------------- --------------------
Gas Oil Total Gas Oil Total
(Bcf) (Mmbbls) (Bcfe) (Mmcf) (Bbls) (Mmcfe)
----- ------- ----- ----- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Producing Formation:
Antrim Shale...................... 108.2 - 108.2 17.1 - 17.1
Prairie du Chien.................. 80.9 0.6 84.5 27.3 437 30.0
Other............................. 9.4 2.8 26.2 0.3 583 3.8
----- ----- ----- ----- ----- -----
Total........................... 198.5 3.4 218.9 44.7 1,020 50.9
===== ===== ===== ===== ===== =====
</TABLE>
31
<PAGE>
The Antrim Shale. The Antrim Shale underlies a large percentage of our
Michigan acreage and is fairly homogeneous in terms of reservoir quality; wells
tend to produce relatively predictable amounts of natural gas. While subsurface
fracturing can increase reserves and production attributable to any particular
well, the over 6,300 wells drilled in the trend and the approximately 500 wells
we have drilled suggest typical per well reserves of 600 Mmcf to 800 Mmcf and a
total productive life of more than 20 years, with an average reserve life of 15
years. As new wells produce and the de-watering process takes place, they tend
to reach a production level of 150 Mcf to 200 Mcf per day in six to 12 months.
They remain at these levels for one to two years and then decline at 8% to 10%
per year thereafter. The total cost to drill and complete an Antrim well is
approximately $225,000, including all acreage, production facilities and
flowlines, and wells tend to produce the best economic results when drilled in
large numbers in a fairly concentrated area. This well concentration provides
for a more rapid de-watering of a specific area, which decreases the time to
natural gas production and increases the amount of natural gas production. It
also enables us to maximize the use of existing production infrastructure,
which decreases per unit operating costs. Since reserve quantities and
production levels over a large number of wells are fairly predictable,
maximizing per well recoveries and minimizing per unit production costs through
a sizeable well-engineered drilling program are the keys to profitable Antrim
development. In addition, Michigan has very favorable natural gas supply/demand
characteristics in that Michigan has been importing an increasing percentage of
its natural gas, and currently imports approximately 75%. This supply/demand
situation generally allows Michigan producers to sell their natural gas at a
slight premium to typical industry benchmark prices. It also provides
opportunities for long-term contracts at favorable terms with end users who
value such supply arrangements.
As of September 1, 1999, we own interests in 747 Antrim wells and operate
375 of these wells, or 50% of our total Antrim wells. Our average net
production during August 1999 was 17.1 Mmcf per day. Since 1996 we have drilled
115 Antrim wells and successfully completed 114 for a success rate of 99%. We
have 120 identified Antrim drilling locations of which 81 are currently
classified as proved undeveloped locations. In 1998 we drilled 49 gross (37.7
net) Antrim wells, successfully completing all of them, and as of September 1,
1999 we have drilled four gross (four net) Antrim wells, all of which were
successfully completed. In the remainder of 1999 we expect to drill 28 gross
(28 net) wells for a cost of approximately $4.8 million, and in 2000 we have
budgeted for the drilling of 53 gross (33.5 net) Antrim wells at a cost of
approximately $7.4 million.
The Prairie du Chien. Our Prairie du Chien wells produce from several
Ordovician age reservoirs with the majority being in the 1,000 feet to 1,200
feet thick Prairie du Chien Group that has three major sands: the Lower PdC,
Middle PdC and Upper PdC. Many of these wells also can produce from the St.
Peter sandstone and the Glenwood formations, both of which lie directly above
the PdC. Some of the wells are producing from two or more of these zones.
Depending upon the area and the particular zone, the PdC will produce dry gas,
gas and condensate or oil with associated gas. The average depths of these
wells range from 7,000 feet to 12,000 feet.
As a result of the Unocal acquisition in May 1999, we own an average working
interest of 92%, on a Bcfe basis, in the wells comprising our PdC reserves. We
operate over 90% of these reserves. Our PdC production is well established.
Three development wells have been drilled in recent years to increase
production from existing fields. As a result of some of this work and the
Unocal acquisition, we have identified 14 additional proved undeveloped
locations. In addition, there are numerous proved non-producing zones in
existing wellbores that provide recompletion opportunities, allowing us to
maintain or, in some cases, increase production from our PdC wells as currently
producing reservoirs deplete. As of September 1, 1999, we had 53 gross (32.6
net) PdC wells producing 29.9 Mmcfe per day. For the rest of 1999 and 2000 we
have budgeted $50,000 and $690,000, respectively, for various workovers and
recompletions on our PdC wells, and we plan to spend $5.2 million in 2000 to
drill four new wells.
Richfield/Detroit River. The Unocal acquisition included 115 producing oil
wells in the Beaver Creek field, which is being waterflooded in the Devonian
Richfield formation. Additional interests were also acquired
32
<PAGE>
in the nearby Garfield Richfield field, which has seven producing oil wells.
Our average daily production from the Richfield and Detroit River formations
totals approximately 3.5 Mmcfe. We have budgeted $2.4 million to drill ten new
Richfield wells and $5.1 million to drill and recomplete 36 Detroit River wells
in 2000.
Rocky Mountain Region
Our Rocky Mountain properties are located in Montana and Wyoming, and our
production, which is primarily crude oil, is from well-established producing
formations at depths ranging from 1,000 feet to 11,000 feet. These properties
typically have multiple producing zones, some of which include the Phosphoria
at 750 feet to 1,000 feet, the Tensleep at 1,000 feet to 3,000 feet and the
Muddy/Morrow at 8,400 feet to 9,000 feet. Our Rocky Mountain producing
properties possess significant development drilling, secondary recovery and
other exploitation opportunities. As of September 1, 1999, our Rocky Mountain
proved reserves were 21 Mmbbls of crude oil and 5.9 Bcf of natural gas, for
total equivalent reserves of 131.7 Bcfe. In 1998, our daily production averaged
9.5 Mmcfe, and during the month of August 1999 our daily production averaged
8.5 Mmcfe. In 1998 we drilled no wells in the area; however, we spent $160,000
on various exploitation projects. In 1999, we have spent $400,000 on the
drilling of five gross (4.7 net) wells, four of which were successful. We have
also spent approximately $200,000 on various exploitation activities. We are
currently conducting an active exploitation program on several of our Rocky
Mountain fields that involves recompletions in existing wells. For the rest of
1999, we expect to spend approximately $2.2 million on various exploitation
projects. In 2000 we have budgeted $4.9 million for the drilling of 40 gross
(40 net) wells and $3.7 million for exploitation activities.
South Casper Creek Steamflood Project
In October 1995, we acquired the South Casper Creek steamflood project in
Natrona County, Wyoming as part of a larger acquisition from Unocal. In the
1970s and 1980s, Unocal had conducted several steamflood evaluations of the
Tensleep formation, a producing horizon that contains 14 degree gravity crude
oil which is relatively heavy and is more effectively recovered when heated
with steam, allowing the oil to flow toward the wellbore at a faster rate. In
the late 1980s, Unocal attempted several additional redesigned pilot
steamfloods and had encouraging results. Based on these results, Unocal
undertook full development of the project, drilling additional steam injection
wells and installing four 50 Mmbtu per hour generators providing 13,000 barrels
of steam per day through eleven injection wells. The post-steamflood production
peaked in 1992 at 1,500 barrels per day, an 88% increase from the pre-
steamflood production of 800 barrels per day, exceeding Unocal's original
expectations. Despite this success, Unocal decided to cut the project's budget,
resulting in a decrease in steam injection, a decrease in production and the
eventual discontinuation of the project. Our acquisition of this project
included all of the associated steam generating equipment in place that had
been installed by Unocal. This equipment is in good condition and could be
restarted at minimal cost. While the project is economically viable at current
crude oil prices, we have excluded this project from our reserve report and are
studying our options in light of the project's sensitivity to long-term oil
prices.
Canada
We believe that a number of producing areas in Canada offer excellent
opportunities for acquisition and exploitation oriented companies such as
ourselves. Our purchase of MGV, a Calgary-based independent energy company,
provides a vehicle for us to evaluate and selectively participate in such
opportunities. MGV's main strength lies in conducting detailed reservoir
engineering studies over producing fields to identify remaining reserves not
currently being exploited by the current operator. MGV's technical staff has
developed proprietary reservoir analysis software designed to integrate large
amounts of engineering and geologic data to identify such opportunities.
Additionally, MGV has an arrangement with Pan Canadian where MGV identifies
opportunities in a 36,000 square mile area of mutual interest. This area of
mutual interest is primarily in southern Alberta, which has historically and
continues to produce significant amounts of hydrocarbons. When MGV identifies a
prospect, it has the right to acquire up to a 20% interest if Pan Canadian
participates, and a 100% interest if Pan Canadian declines. MGV recently made
its first acquisition of 375 existing gas wells in southern Alberta with net
daily production of 1.2 Mmcf and 10.1 Bcf of proved reserves. We believe MGV
will allow us to methodically build a reserve and production base in Canada in
a fashion similar to the development of our Michigan reserves.
33
<PAGE>
Exploration Activities
We have interests in 19 exploratory prospects located in Montana and
Wyoming. Eleven are crude oil prospects and the remaining eight are natural gas
prospects. These prospects are located in the Crazy Mountain Basin, the Big
Horn Basin, and the Montana Thrust Belt. Our interest in these prospects ranges
from 25% to 50%, with 50% being our most common interest. The target depths of
these prospects range from 3,000 feet to 19,500 feet, with 7,000 feet being the
average depth. We believe that several of these prospects have significant
reserve potential and that we can test many of them at a relatively low cost.
Big Horn Basin. The Big Horn Basin is located in northern Wyoming and
southern Montana. Several of the prospects in the Big Horn are known to contain
oil, however, the oil is a low gravity, heavy crude. Due to the low gravity of
the oil, pressures at the wellbore required to produce the oil are high,
resulting in high levels of water production. We believe that drilling
horizontal wells would reduce the pressure required to produce the oil and
decrease associated water production. A producing horizontal well on one of
these prospects is currently being evaluated, and the other prospects will be
developed based on the results of this well.
Crazy Mountain Basin. The Crazy Mountain Basin is located in south central
Montana and is an extension of the Big Horn Basin. Our prospects are
approximately 30 miles from existing production and consist of two Fort Union
coal bed methane prospects and a deep Frontier prospect. The two Fort Union
prospects are less than 4,000 feet deep and were identified by a well drilled
on our acreage in 1996, which encountered numerous thin gassy coal beds between
500 feet and 4,500 feet. The Frontier prospect, which is at a depth of 14,600
feet, is designed to test the Big Elk member of the Frontier formation. We have
3-D seismic data over this prospect and have identified several large geologic
structures.
Montana Thrust Belt. The Montana Thrust Belt is located in western Montana.
These prospects target fractured rocks of the Mississippian Madison formation,
which has been over-thrust from the west by older Pre-Cambrian rocks. We
believe the geologic environment is similar to the Alberta Foothills area that
has significant reserves and production. We have five prospects in the Thrust
Belt area.
Natural Gas and Crude Oil Reserves
The following table presents our estimated net proved natural gas and crude
oil reserves and the present value of our reserves at September 1, 1999 and
December 31, 1998, in each case based on a reserve report prepared by Holditch.
Appendix A to this prospectus contains a letter prepared by Holditch
summarizing the reserve report. The PV-10 values shown in the table are not
intended to represent the current market value of the estimated natural gas and
crude oil reserves we own. For further information concerning the PV-10 values
of these proved reserves, please read note 11 of the notes to our December 31,
1998 consolidated financial statements.
<TABLE>
<CAPTION>
September 1, December 31,
1999 1998
------------ ------------
<S> <C> <C>
Proved reserves:
Oil (Mbbl).................................. 24,483 17,983
Natural gas (Mmcf).......................... 217,124 153,202
Total (Mmcfe)............................... 364,022 261,100
Proved developed reserves:
Oil (Mbbl).................................. 15,180 9,829
Natural gas (Mmcf).......................... 149,130 123,743
Total (Mmcfe)............................... 240,210 182,717
Estimated future net cash flows before income
taxes........................................ $620,881 $275,737
PV-10 value................................... $348,567 $160,495
</TABLE>
34
<PAGE>
The process of estimating natural gas and crude oil reserves is complex. It
requires various assumptions, including assumptions relating to natural gas and
crude oil prices, drilling and operating expenses, capital expenditures,
production taxes and availability of funds. Production rates and timing of
development expenditures must be projected. Reserve estimates require an
analysis of available geological, geophysical, production and engineering data,
and the extent, quality and reliability of this data can vary. Therefore,
estimates of natural gas and crude oil reserves are inherently imprecise.
Actual future production, natural gas and crude oil prices, revenues,
production taxes, development expenditures, operating expenses and quantities
of recoverable natural gas and crude oil reserves most likely will vary from
our estimates. Any significant variance could materially affect the estimated
quantities and present value of reserves shown in this prospectus. In addition,
estimates of proved reserves may be adjusted to reflect production history,
results of exploration and development, prevailing natural gas and crude oil
prices and other factors that are beyond our control.
Recovery of undeveloped reserves generally requires significant capital
expenditures and successful drilling operations. The reserve data assumes that
we will make these expenditures. Although reserve estimates and the associated
development costs are prepared in accordance with industry standards, the
estimated costs may be inaccurate, development may not occur as scheduled and
results may not be as predicted.
You should not assume that the PV-10 value of our reserves referred to in
this prospectus is the current market value of our estimated natural gas and
crude oil reserves. In accordance with Securities and Exchange Commission
requirements, we generally base the PV-10 value on prices and costs on the date
of the estimate. Actual future prices and costs may differ materially from
those used in the estimate.
Volumes, Prices and Operating Expenses
The following table presents information regarding the production volumes
of, average sales prices received for, and average production costs associated
with, our sales of natural gas and crude oil for the periods indicated. Pro
forma adjustments give effect to the purchase of properties from Unocal on May
17, 1999 as if the purchase had occurred at the beginning of 1999.
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------- Year Ended
Pro Forma December 31,
1999 1999 1998 1998
--------- ------ ------ ------------
<S> <C> <C> <C> <C>
Production:
Natural gas (Mmcf)...................... 12,775 11,696 11,737 15,315
Oil and condensate (Mbbls).............. 563 504 524 667
Total (Mmcfe) .......................... 16,153 14,720 14,881 19,317
Average sales price unit:
Natural gas (per Mcf)................... $ 2.27 $ 2.29 $ 2.33 $ 2.33
Oil and condensate (per Bbl)............ 13.62 13.31 9.97 9.55
Total (per Mcfe)........................ 2.27 2.27 2.19 2.17
Expenses (per Mcfe):
Lease operating......................... $ 1.00 $ 1.03 $ 0.90 $ 0.92
General and administrative.............. 0.17 0.19 0.07 0.07
Depreciation, depletion and
amortization........................... 0.70 0.69 0.63 0.64
</TABLE>
35
<PAGE>
Development, Exploration and Acquisition Capital Expenditures
The following table presents information regarding our net costs incurred in
the purchase of proved and unproved properties and in exploration and
development activities.
<TABLE>
<CAPTION>
Nine Months
Ended Year Ended
September 30, December 31,
-------------- ------------
1999 1998 1998
------- ------ ------------
(in thousands)
<S> <C> <C> <C>
Acquisition costs................................... $29,911 $1,693 $ 1,715
Exploration......................................... - 733 1,095
Development......................................... 6,748 6,573 8,283
------- ------ -------
Total costs incurred.............................. $36,659 $8,999 $11,093
======= ====== =======
</TABLE>
Drilling Activity
The following table shows our drilling activity for the nine months ended
September 30, 1999 and for the year ended December 31, 1998. In the table,
"gross" refers to the total wells in which we have a working interest and "net"
refers to gross wells multiplied by our working interest in such wells.
<TABLE>
<CAPTION>
Nine Months Ended Year Ended
September 30, December 31,
-------------------- --------------
1999 1998 1998
--------- ---------- --------------
Gross Net Gross Net Gross Net
----- --- ----- ---- ------- ------
<S> <C> <C> <C> <C> <C> <C>
Exploration Wells:
Productive................................. - - 8.0 8.0 9.0 9.0
Non-productive............................. - - - - 1.0 0.5
---- --- ---- ---- ------ ------
Total.................................... - - 8.0 8.0 10.0 9.5
==== === ==== ==== ====== ======
Development Wells:
Productive................................. 9.0 8.2 24.0 14.5 41.0 29.7
Non-productive............................. 1.0 0.9 - - - -
---- --- ---- ---- ------ ------
Total.................................... 10.0 9.1 24.0 14.5 41.0 29.7
==== === ==== ==== ====== ======
</TABLE>
Productive Wells
The following table sets forth the number of productive natural gas and
crude oil wells in which we owned an interest as of September 1, 1999:
<TABLE>
<CAPTION>
Total Productive Wells
-----------------------
Gross Net
------------ ----------
<S> <C> <C>
Natural gas....................................... 1,120 297
Crude oil......................................... 503 472
------------ ----------
Total........................................... 1,623 769
============ ==========
</TABLE>
Productive wells consist of producing wells and wells capable of production,
including natural gas wells awaiting pipeline connections to commence
deliveries and crude oil wells awaiting connection to production facilities.
36
<PAGE>
Acreage Data
The following table presents information regarding our developed and
undeveloped lease acreage as of September 1, 1999. Developed acreage refers to
acreage within producing units and undeveloped acreage refers to acreage that
has not been placed in producing units.
<TABLE>
<CAPTION>
Developed Undeveloped
Acreage Acreage Total
--------------- --------------- ---------------
Gross Net Gross Net Gross Net
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Michigan........................ 125,773 48,105 20,210 13,329 145,983 61,434
Montana......................... 77,328 76,488 274,105 143,447 351,433 219,935
Canada.......................... 59,494 4,743 9,648 197 69,142 4,940
Wyoming......................... 7,285 6,702 56,608 38,632 63,893 45,334
------- ------- ------- ------- ------- -------
Total......................... 269,880 136,038 360,571 195,605 630,451 331,643
======= ======= ======= ======= ======= =======
</TABLE>
Marketing
We have typically marketed the natural gas and crude oil produced from our
properties through normal channels for these products. We generally sell our
crude oil at local field prices paid by the principal purchasers of crude oil.
The majority of our natural gas production is sold under long-term contracts of
up to 10 years in length and is transported in intrastate pipelines.
Both natural gas and crude oil are purchased by refineries, major oil
companies, public utilities, industrial customers and other users and
processors of petroleum products. We are not confined to, or dependent upon,
any one purchaser or small group of purchasers. Accordingly, the loss of a
single purchaser, or a few purchasers, would not have a long-term material
effect on our business because there are numerous purchasers in the areas in
which we sell our production. In September 1999, purchases by the following
companies exceeded 10% of our total oil and gas revenues: CMS Energy, Coenergy
Trading Company, Reliant Energy Resources Corp. and Unocal Energy Trading Inc.
Competition
We face competition from other oil and gas companies in all aspects of our
business, including acquisition of producing properties and oil and gas leases,
marketing of oil and gas, and obtaining goods, services and labor. Many of our
competitors have substantially larger financial and other resources. Factors
that affect our ability to acquire producing properties include available
funds, available information about the property and our standards established
for minimum projected return on investment. Because gathering systems are the
only practical method for the intermediate transportation of natural gas,
competition for natural gas delivery is presented by other pipelines and gas
gathering systems. Competition is also presented by alternative fuel sources,
including heating oil and other fossil fuels. Because of the long-lived nature
of our natural gas and crude oil reserves, our ownership interest in Beaver
Creek Pipeline, L.L.C., and our expertise in developing our reserves, we
believe that we are competing effectively in the market.
Regulation
Federal Regulation of Transportation of Natural Gas. Historically, the
transportation and sale for resale of natural gas in interstate commerce have
been regulated by the Natural Gas Act of 1938, the Natural Gas Policy Act of
1978 and the regulations promulgated by the Federal Energy Regulatory
Commission. In the past, the federal government has regulated the prices at
which natural gas could be sold. Deregulation of natural gas sales by producers
began with the enactment of the Natural Gas Policy Act. In 1989, Congress
enacted the Natural Gas Wellhead Decontrol Act, which removed all remaining
Natural Gas Act and Natural Gas Policy Act price and non-price controls
affecting producer sales of natural gas effective January 1, 1993. Congress
could, however, reenact price controls in the future.
37
<PAGE>
Our sales of natural gas are affected by the availability, terms and cost of
pipeline transportation. The price and terms for access to pipeline
transportation remain subject to extensive federal regulation. Beginning in
April 1992, the Federal Energy Regulatory Commission issued Order No. 636 and a
series of related orders, which required interstate pipelines to provide open-
access transportation on a basis that is equal for all natural gas suppliers.
The Federal Energy Regulatory Commission has stated that it intends for Order
No. 636 to foster increased competition within all phases of the natural gas
industry. Although Order No. 636 does not directly regulate our production and
marketing activities, it does affect how buyers and sellers gain access to the
necessary transportation facilities and how we and our competitors sell natural
gas in the marketplace. The courts have largely affirmed the significant
features of Order No. 636 and the numerous related orders, although some
appeals remain pending and the Federal Energy Regulatory Commission continues
to review and modify its regulations regarding the transportation of natural
gas. We cannot predict what action the Federal Energy Regulatory Commission
will take on these matters, nor can we accurately predict whether the Federal
Energy Regulatory Commission's actions will achieve the goal of increasing
competition in markets in which our natural gas is sold. However, we do not
believe that any action taken will affect us in a way that materially differs
from the way it affects other natural gas producers, gatherers and marketers.
Additional proposals and proceedings that might affect the natural gas
industry are pending before Congress, the Federal Energy Regulatory Commission
and the courts. The natural gas industry historically has been very heavily
regulated; therefore, we cannot assure you that the less stringent regulatory
approach recently pursued by the Federal Energy Regulatory Commission and
Congress will continue.
Federal Regulation of Transportation of Oil. Sales of crude oil, condensate
and natural gas liquids by us are not currently regulated and are made at
market prices. Effective as of January 1, 1995, the Federal Energy Regulatory
Commission implemented regulations establishing an indexing system for
transportation rates for interstate common carrier oil pipelines. These rates
are generally indexed to inflation, subject to conditions and limitations.
These regulations may, over time, tend to increase transportation costs or
reduce wellhead prices for crude oil. However, we do not believe that these
regulations affect us any differently than other natural gas producers,
gatherers and marketers.
State Regulation. Our oil and gas operations are subject to various types of
regulation at the state and local levels. These regulations require drilling
permits, regulate the methods for developing new fields and the spacing and
operating of wells and waste prevention, and sometimes impose production
limitations. These regulations may limit our production from wells and the
number of wells or locations we can drill.
Some states have adopted regulations with respect to gathering systems.
These regulations have not had a material effect on the operation of our
gathering systems, but we cannot predict whether any future regulations in this
area may have a material impact on our gathering systems.
Federal, State and Indian Leases. Our operations on federal, state or Indian
oil and gas leases are subject to numerous restrictions, including
nondiscrimination statutes. We must conduct our operations on these leases
pursuant to permits and authorization and other regulations issued by the
Bureau of Land Management, Minerals Management Service and other agencies.
Environmental Regulations. Our operations are subject to numerous laws and
regulations governing the discharge of materials into the environment or
otherwise relating to environmental protection. Our exploration and production
operations and facilities for gathering, treating, processing and handling
hydrocarbons and related exploration and production wastes are subject to
stringent environmental regulation. These laws and regulations sometimes
require government approvals before activities occur, limit or prohibit
activities because of protected areas or species, impose substantial
liabilities for pollution and provide penalties for non-compliance. As with the
industry generally, compliance with existing and anticipated regulations
increases our overall cost of business. These regulations, however, generally
affect us and our competitors similarly. Environmental laws and regulations are
subject to frequent change, and we are not able to predict the costs or other
impacts of environmental regulation on our future operations.
38
<PAGE>
The Comprehensive Environmental Response, Compensation, and Liability Act
("CERCLA"), also known as the "Superfund" law, imposes liability, without
regard to fault or the legality of the original conduct, on some classes of
persons that are considered to have contributed to the release or threat of
release of a "hazardous substance" into the environment. These persons include
the owner or operator of the disposal site or sites where the release occurred
and companies that disposed or arranged for the disposal of the hazardous
substances found at the site. Persons who are or were responsible for releases
of hazardous substances under CERCLA may be subject to joint and several
liability for the costs of cleaning up the hazardous substances that have been
released into the environment and for damages to natural resources, and it is
not uncommon for neighboring landowners and other third parties to file claims
for personal injury and property damage allegedly caused by the hazardous
substances released into the environment.
Our operations are also subject to regulation of air emissions under the
Clean Air Act and comparable state and local requirements. Implementation of
these laws could lead to the gradual imposition of new air pollution control
requirements on our operations. As a result, we may incur capital expenditures
over the next several years to upgrade our air pollution control equipment. We
do not believe that our operations would be materially affected by any such
requirements, nor do we expect such requirements to be any more burdensome to
us than to other companies our size involved in natural gas and oil exploration
and production activities.
In addition, legislation has been proposed in Congress from time to time
that would reclassify some natural gas and oil exploration and production
wastes as "hazardous wastes," which would make the reclassified wastes subject
to much more stringent handling, disposal and clean-up requirements. If
Congress were to enact this legislation, it could increase our operating costs,
as well as those of the natural gas and oil industry in general. Initiatives to
further regulate the disposal of natural gas and oil wastes are also pending in
some states, and these various initiatives could have a similar impact on us.
The Clean Water Act imposes restrictions and controls on the discharge of
oil and gas wastes and other forms of pollutants into waters of the United
States. Federal law also imposes strict liability on owners of facilities for
consequences of an oil spill where the spill is in navigable waters or along
shorelines. These laws impose penalties for unauthorized discharges and
substantial liability for costs of removal and damages resulting from an
unauthorized discharge. State laws for the control of water pollution provide
similar penalties and liabilities. The cost of compliance with water pollution
laws has not historically been material to our operations. There can be no
assurance that changes in federal, state or local water pollution laws and
programs will not materially adversely affect our operations in the future.
Our management believes that we are in substantial compliance with current
environmental laws and regulations that affect us and that continued compliance
with these requirements will not have a material adverse impact on us.
Employees
At September 30, 1999, we had 19 full-time employees. We believe that our
relationships with our employees are satisfactory. None of our employees is
covered by a collective bargaining agreement. From time to time, we use the
services of independent consultants and contractors to perform various
professional services, particularly in the areas of construction, design, well-
site surveillance, permitting and environmental assessment. Independent
contractors usually perform field and on-site production operation services for
us, including pumping, maintenance, dispatching, inspection and testing. In
addition, Mercury provides accounting services to us under a management
agreement. See "Certain Transactions--Mercury Operating Agreement".
Legal Proceedings
From time to time, we may be a party to various legal proceedings. We
currently are not a party to any material litigation.
39
<PAGE>
MANAGEMENT
Executive Officers and Directors
The following table sets forth the names, ages and positions of our
executive officers and directors as of September 30, 1999.
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Thomas F. Darden................. 46 Chairman of the Board, Chief Executive Officer
Glenn M. Darden.................. 44 President, Chief Operating Officer and Director
Bill Lamkin...................... 54 Executive Vice President, Chief Financial Officer
Houston Kauffman................. 45 Vice President-Acquisitions
Fred van Naerssen................ 58 Vice President and Controller
Robert N. Wagner................. 35 Vice President-Engineering
Frank Darden..................... 72 Director
D. Randall Kent.................. 73 Director
Steven M. Morris................. 47 Director
W. Yandell Rogers III............ 36 Director
Anne Darden Self................. 41 Director
Mark Warner...................... 36 Director
</TABLE>
The following biographies describe the business experience of our executive
officers and directors.
THOMAS F. DARDEN has served on our board since December 1997. Previously, he
served as President of Mercury. While he was President of Mercury, Mercury
developed and acquired interests in over 1,200 producing wells in Michigan,
Indiana, Kentucky, Wyoming, Montana, New Mexico and Texas. A graduate of Tulane
University with a BA in Economics in 1975, Mr. Darden had been employed by
Mercury or its parent corporation, Mercury Production Company, for 22 years. He
became a director and the President of MSR on March 7, 1997. On January 1,
1998, he was named Chairman of the Board and Chief Executive Officer of MSR.
Mr. Darden has been one of our directors and our President since our inception
in December 1997 and was elected Chairman of the Board and Chief Executive
Officer on March 4, 1999.
GLENN M. DARDEN has served on our board since December 1997. He also served
with Mercury for 18 years, and for the last five years was the Executive Vice
President of that company. Prior to working for Mercury, Mr. Darden worked as a
geologist for Mitchell Energy Corporation. He graduated from Tulane University
in 1979 with a BA in Earth Sciences. Mr. Darden became a director and Vice
President of MSR on March 7, 1997, and was named President and Chief Operating
Officer of MSR on January 1, 1998. Mr. Darden has been one of our directors
since our inception in December 1997. He served as our Vice President until he
was elected President and Chief Operating Officer on March 4, 1999.
BILL LAMKIN is a Certified Management Accountant and a Certified Cash
Manager with over 20 years of experience in the oil and gas industry. He
graduated from Texas Wesleyan University with a BBA in Accounting in 1968. He
served as Controller/Chief Financial Officer at Whittaker Corporation and
Sargeant Industries, Inc. between 1970 and 1978. Beginning in 1978, he worked
as Treasurer, Controller, and then Director of Financial Services at Union
Pacific Resources until he became our Executive Vice President and Chief
Financial Officer when he joined us in June 1999.
HOUSTON KAUFFMAN is a professional landman and graduated from the University
of Texas in 1978 with a degree in Petroleum Land Management. From 1979 to 1991,
he held various staff and supervisory positions with Amoco Production Company.
After receiving his Master's degree in Business Administration from Houston
Baptist University in 1991, he was a land manager and ultimately land
acquisition and divestment manager with CNG Producing Company. He became
manager of business development for Mercury in 1995 and is now our manager of
acquisitions, divestments and trades. On March 4, 1999, Mr. Kauffman was
elected our Vice President-Acquisitions.
40
<PAGE>
FRED VAN NAERSSEN is a Certified Public Accountant with over 30 years
experience in public and industry accounting. He was with
PricewaterhouseCoopers for seven years before joining Union Pacific Corporation
in 1973. At Union Pacific he served in various capacities in the financial
field, including 13 years at Union Pacific Resources. Mr. van Naerssen joined
us in July 1999 after retiring from Union Pacific Corporation.
ROBERT N. WAGNER has served as our Vice President-Engineering since July
1999. From January 1999 to July 1999, he was our manager of eastern region
field operations. From November 1995 to January 1999, Mr. Wagner held the
position of district engineer with Mercury. Prior to 1995, Mr. Wagner was with
Mesa, Inc. and served as both a drilling engineer and production engineer. Mr.
Wagner received a BS in Petroleum Engineering from the Colorado School of Mines
in Golden, Colorado in 1987.
FRANK DARDEN is a registered professional engineer and Chairman of the Board
of Mercury. He founded Mercury's parent corporation and has served as its
Chairman of the Board since 1965 and as Chairman of Mercury since its founding
in 1978. Mr. Darden began his career in the oil and gas business with Humble
Oil and Refining Company in 1948. From 1954 through 1955, he was retained by
Empresa Colombiana de Petroleos to organize an engineering department and guide
the company's planning for the secondary recovery program in the La Cira Field
in the Magdelena Valley of Colombia. From 1956 through 1964, Mr. Darden served
as Manager of Operations for Newmont Oil Company, the energy subsidiary of
Newmont Mining Corporation, and as Executive Vice President and director of
Yucca Water Company. He was a director of MSR from March 7, 1997, until MSR's
merger with us. Mr. Darden became one of our directors upon our formation in
December 1997.
D. RANDALL KENT is a retired Vice President of the General Dynamics
Corporation. He joined General Dynamics/Fort Worth Division in 1949 and served
in various engineering management positions, including Vice President and Chief
Engineer of the F-16 Fighter Program. Following his retirement in 1991, Mr.
Kent served as a consultant to the Lockheed-Martin Corporation. He graduated
from Louisiana State University in 1947 with a BS in Mechanical Engineering,
and from Cornell University in 1949 with an MS in engineering. Mr. Kent was
elected a director of MSR in 1997 and, upon the merger of MSR with us, became
one of our directors.
STEVEN M. MORRIS is a Certified Public Accountant and President of Morris &
Co., a private investment firm in Houston, Texas. From 1988 to 1991, he was
Vice President of Finance for ITEX Enterprises, Inc. From 1981 to 1988, Mr.
Morris was Financial Vice President of Hanson Minerals Company, a Houston-based
oil and gas exploration company. From 1978 to 1981, he was a partner in the
certified public accounting firm of Haley & Morris. He served as Senior
Accountant with the Houston office of Arthur Young and Company from 1974 to
1977. Mr. Morris was elected a director of MSR in October 1994. Upon the merger
of MSR with us on March 4, 1999, Mr. Morris became one of our directors.
W. YANDELL ROGERS III has served as Vice President and General Manager of
Ridgway's, Inc., based in Houston, Texas, since July 1997. For more than five
years prior, he served as Regional Manager for Ridgway's, the largest privately
held reprographics firm in the U.S., with more than 60 locations nationwide. He
graduated from Southern Methodist University in 1987 with a BBA in Finance. Mr.
Rogers was elected a director of MSR in 1997 and, upon the merger of MSR into
us, became one of our directors.
ANNE DARDEN SELF is currently Senior Vice President of Human Resources for
Mercury, where she has worked since 1992. From 1988 to 1991, she was with
BancPLUS Savings Association in Houston, Texas. She was employed as Marketing
Director and then spent three years as Vice President of Human Resources. She
worked from 1987 to 1988 as an Account Executive for NW Ayer Advertising
Agency. Prior to 1987, she spent several years in real estate management. She
attended Sweet Briar College and graduated from the University of Texas in
Austin in 1980 with a BA in History. Ms. Self was elected as one of our
directors in September 1999.
41
<PAGE>
MARK WARNER is currently a director of Domestic Energy Finance for Enron
North America Corp. in Houston, Texas, where he has worked since 1995. He
received a Bachelor's degree in Geological Engineering from the University of
Missouri-Rolla in 1985 and a Master's degree in Petroleum Engineering from the
University of Oklahoma in 1987. From 1987 to 1989, he was a reservoir engineer
with Marathon Oil Company in Lafayette, Louisiana. From 1989 to 1993, he
served as Manager of Petroleum Engineering for Remington Oil Company (formerly
Box Energy) in Dallas, Texas. In 1995, he received an MBA from Southern
Methodist University in Dallas. Mr. Warner currently serves as a member of the
board of directors of HV Marine Services, Inc. Mr. Warner was elected as one
of our directors at our 1999 meeting of stockholders.
Thomas F. Darden, Glenn M. Darden, and Anne Darden Self are siblings. Frank
Darden is their father.
Committees of the Board of Directors
Our audit committee currently consists of Messrs. Morris, Kent, Rogers and
Warner. The audit committee reviews, acts on and reports to the board of
directors with respect to various auditing and accounting matters, including
the selection of our independent accountants, the scope of the annual audit,
fees to be paid to the independent accountants, the performance of our
independent accountants and our accounting practices.
Our compensation committee currently consists of Messrs. Morris, Kent,
Rogers and Warner. This committee's responsibilities include establishment of
salaries, incentives and other forms of compensation for our officers and
other employees and administration of our incentive compensation and benefit
plans.
Compensation Committee Interlocks and Insider Participation
To date, no member of our compensation committee has served as an officer
or employee of our company or any of our subsidiaries. No member of our
compensation committee serves as a member of the board of directors or
compensation committee of any entity that has one or more executive officers
serving as a member of our board of directors or its compensation committee.
Compensation of Directors
Directors receive no cash remuneration for serving on the board of
directors but are reimbursed for reasonable expenses incurred by them in
attending board and committee meetings. On May 25, 1999, our board of
directors approved the issuance of $10,000 of our common stock to each of
Messrs. Frank Darden, Steven Morris, D. Randall Kent and Yandell Rogers, III
as compensation for their services during 1998. Based upon the average of the
high and low closing prices of our common stock on that date, we plan to issue
1,600 shares of our common stock to each of these non-employee directors prior
to or shortly after completion of this offering.
Executive Compensation
Neither our Chairman of the Board nor any of our other officers received
any compensation during 1998. The following table sets forth the names of our
executive officers, the date each began employment with us and the current
annual salary of each officer.
<TABLE>
<CAPTION>
Date of
Name Employment Annual Salary
---- ------------- -------------
<S> <C> <C>
Thomas F. Darden.............................. December 1997 $150,000
Glenn M. Darden............................... December 1997 $150,000
Houston Kauffman.............................. March 1999 $105,000
Bill Lamkin................................... May 1999 $135,000
Fred van Naerssen............................. July 1999 $120,000
Robert N. Wagner.............................. July 1999 $100,000
</TABLE>
42
<PAGE>
Bonus Arrangements
In addition to their salaries, our executive officers are eligible for
bonuses each year equal to up to 100% of their salary. The bonuses vest over a
three year period at the rate of 50% in the year of award, and 25% in each of
the two years following. As much as 75% of each bonus is payable in cash, at
the option of the officer, and the remainder is payable in shares of our common
stock. Bonus awards are based on our achievement of growth targets. The
employee must be employed at the time of vesting to receive the bonus.
1999 Stock Option and Retention Stock Plan
Our Board of Directors adopted our 1999 Stock Option and Retention Stock
Plan on October 4, 1999. We plan to submit the stock option plan to our
stockholders for approval at their next annual meeting, expected to be held in
the second quarter of 2000. The stock option plan provides for the grant of
incentive stock options, non-qualified stock options, stock appreciation rights
and retention stock awards to our key employees. The purpose of the stock
option plan is to:
. strengthen our ability to reward performance which enhances long-term
stockholder value;
. increase employee stock ownership through performance based compensation
plans; and
. strengthen our ability to attract and retain an outstanding employee and
executive team.
We have reserved 1.3 million shares of common stock for issuance under the
stock option plan. As of the date of this prospectus, no shares had been issued
under the stock option plan, and no options or grants under the stock option
plan are outstanding. Shares of common stock subject to options issued under
the stock option plan which expire or terminate prior to exercise will be
available for future issuance under the stock option plan.
The Board's Compensation Committee administers the stock option plan. The
stock option plan administrator has discretion to determine which eligible
individuals are to receive option grants or other awards, and the terms and
conditions of such options or other awards.
The exercise price for options granted under the stock option plan may be
paid:
. in cash;
. by surrender to us at the time of exercise of shares of common stock
already owned by and issued to the optionee; or
. by authorizing us to withhold common stock otherwise issuable on
exercise of the option.
Shares surrendered to or withheld by us will be valued at the fair market
price of the shares on the date the option is exercised.
43
<PAGE>
CERTAIN TRANSACTIONS
Our Formation
We were organized in December 1997 for the purpose of combining natural gas
and crude oil properties owned by Michigan Gas Partners, Mercury and QELC. At
the time of our formation, Mercury was the sole general partner of Michigan Gas
Partners and JEDI, an affiliate of Enron, was the sole limited partner. The
membership interests in QELC are owned by Mercury and members of the Darden
family: Frank Darden, Thomas F. Darden, Glenn Darden and Anne Darden Self. The
Darden family also owns, directly or indirectly, substantially all of the stock
of Mercury.
Effective January 1, 1998, Michigan Gas Partners was merged into us and
various assets and liabilities of Mercury and QELC were transferred to and
assumed by us. All of the debt owed by QELC to Trust Company of the West and by
Mercury and QELC to Bank of America was also assumed by us and restructured as
part of our formation.
As a result of the merger of Michigan Gas Partners into us, the separate
existence of Michigan Gas Partners ceased and we became the owner of Michigan
Gas Partners' Michigan natural gas and crude oil properties. All of the
partnership interests of JEDI in Michigan Gas Partners were converted into the
right to receive 1,340,405 shares of our common stock. The interests of Mercury
in Michigan Gas Partners were canceled without payment of any consideration and
all shares of our common stock outstanding prior to the merger, consisting of
1,000 shares held by QELC, were canceled without payment of any consideration.
Mercury transferred to us all of its oil and gas properties in the states of
Michigan, Montana and Wyoming, except for some of its excluded Michigan
properties. As consideration for the transfer, we assumed the liabilities of
Mercury relating to the transferred properties, including debt in the amount of
$34,355,000 owed by Mercury to Bank of America under a credit agreement dated
January 31, 1997. We also issued 3,251,820 shares of our common stock to
Mercury. In addition, at Mercury's request, 74,135 shares of our common stock
to which Mercury was entitled under the merger agreement were issued to
Mercury's employee, Jeff Cook, as part of his agreed compensation.
QELC transferred all of its oil and gas properties in the states of Michigan
and Montana to us as part of our formation. As consideration for this transfer,
we assumed the liabilities of QELC relating to the transferred properties and
debt in the amount of approximately $39,600,000 owed by QELC to TCW and Bank of
America under credit agreements dated November 14, 1996. We issued an
additional 3,030,860 shares of our common stock to QELC.
Messrs. Frank, Thomas and Glenn Darden, Anne Darden Self and Jack L. Thurber
transferred to us the contractual after payout or net profits interests owned
by those individuals in some of the assets of Mercury or QELC that were
transferred to us in our formation. As consideration for those transfers of
contractual rights, we issued 242,922 shares of our common stock to each of
Frank Darden, Thomas F. Darden, Glenn Darden and Anne Darden Self and 301,488
shares of our common stock to Mr. Thurber.
We satisfied our debt assumed from QELC and owed to TCW under a credit
agreement dated November 14, 1996 by paying $17,075,000 in cash to TCW and
issuing 1,340,405 shares of our common stock to TCW, in exchange for a
$10,000,000 credit. Mercury later purchased all of the shares of our common
stock issued to TCW and TCW is no longer a shareholder of ours. Bank of America
financed the prepayment of the debt to TCW pursuant to the terms of a credit
agreement, dated April 9, 1998, between us, Bank of America, as Agent, and
other financial institutions named in our credit agreement. Mercury's and
QELC's debt to Bank of America that was assumed by us was restructured under
our credit agreement.
The numbers of our shares referred to in the above discussion have been
adjusted to reflect a stock dividend which was declared in February 1999 as
part of our merger with MSR described below.
44
<PAGE>
MSR Merger
In early 1999, our stockholders approved the merger of MSR into us pursuant
to the terms of an agreement and plan of merger dated September 1, 1998. The
merger was completed on March 4, 1999.
Pursuant to the MSR merger agreement and as a result of the MSR merger:
. the separate corporate existence of MSR ceased, and all of the
properties, rights, privileges, powers and franchises of MSR vested in
us as the surviving corporation of the merger, and all the debts,
liabilities and duties of MSR became ours;
. each share of common stock of MSR outstanding immediately prior to the
effective time of the merger was converted into the right to receive one
tenth of one share of our common stock. The exchange ratio was
determined pursuant to arm's-length negotiations between us and the
disinterested directors of MSR. We issued a total of 2,577,694 shares to
the MSR stockholders in this merger.
At the time of the merger, Messrs. Thomas and Glenn Darden were each an
officer and director of ours and of MSR. Frank Darden was an officer and
director of ours and also a director of MSR. The Darden family and its
affiliated companies also owned approximately 43.7% of the outstanding MSR
common stock. In the merger, these MSR shares held by the Darden family were
converted into 1,128,002 shares of our common stock. In addition, Thomas and
Glenn Darden collectively owned options to purchase 228,570 shares of MSR
common stock at an exercise price of $0.875 per share, which were converted
into options to purchase 22,857 shares of our common stock at a purchase price
of $8.75 per share. Messrs. Frank, Thomas and Glenn Darden, Anne Darden Self,
Mercury, Jack Thurber and Jeff Cook also collectively owned immediately
exercisable warrants to acquire an aggregate of 5,500,000 shares of MSR common
stock at an exercise price of $1.25 per share, as well as warrants for an
aggregate of 5,500,000 shares of MSR common stock at an exercise price of $2.00
per share. All of the warrants were converted into warrants to acquire a number
of shares of our common stock, at adjusted prices, in a manner similar to the
conversion of the options described above.
Paribas, a former lender to MSR, also held warrants to acquire MSR shares at
the time of the MSR merger. These warrants were converted into warrants to
acquire 28,000 of our shares at an exercise price of $33.75 per share and 5,750
of our shares at an exercise price of $0.10 per share. The second of the two
warrants expires on October 31, 2002 and is exercisable only after the closing
price per share of our common stock on the American Stock Exchange reaches
$10.00.
Prior to the MSR merger, our bank debt was guaranteed by Mercury, Mercury
Production Company, and QELC. The bank debt was also secured by pledges of the
MSR stock and our stock owned by the Darden family, Mercury and QELC. As a
condition to the merger, the bank debt was restructured so as not to require
those guarantees and pledges.
Patrick Montalban
Mr. Patrick Montalban was a director and officer of MSR until his
resignation as an officer on December 31, 1998. Pursuant to a severance
agreement with MSR, Mr. Montalban continued to receive compensation from us,
totaling $54,453, for a period of seven months following his resignation. Mr.
Montalban remained as a director of MSR until completion of the MSR merger.
Mercury Operating Agreement
Prior to the MSR merger, we had no direct employees other than our top
manager and officers. Instead, our businesses were managed under a management
agreement entered into with Mercury in April 1998. According to the management
agreement, Mercury was responsible for the supervision and management of our
day-to-day operations. These services included administrative and management
activities. In addition, Mercury acted as the operator of our oil and gas
properties in Michigan, Wyoming and Montana. We paid Mercury a fee
45
<PAGE>
based on the number of hours each Mercury employee spent on activities relating
to our business, less overhead expenses paid by MSR under any joint operating
agreements. In addition, we reimbursed Mercury for specified out of pocket
expenses.
Upon completion of the merger, the prior management agreement terminated. We
and Mercury entered into a new agreement, which replaced the prior management
agreement. Under the new agreement, Mercury provides accounting services to us
and operates our oil and gas properties, including the daily activities of
producing oil and/or gas from individual wells and leases, and continues to
provide services as an operator under existing operating agreements. Mercury's
compensation consists of payments and overhead reimbursements to which it or we
are entitled as operator under existing and future operating agreements for the
properties. Mercury was paid $1,366,000 under the management agreement during
the first nine months of 1999 and it is anticipated an additional $456,000 will
be paid during the remainder of 1999. During the first nine months of 1999 we
reimbursed Mercury or one of its affiliates for office rent, computer services,
marketing services, interest on debt and other administrative costs not covered
under the management agreement in the amount of $407,000, and it is anticipated
an additional $154,000 will be paid during the remainder of 1999.
Under the terms of our management agreement with Mercury, Mercury pays
accounts payable attributable to our operations and we then reimburse Mercury
on a regular basis. At any point in time, the average balance of the amount we
owe to Mercury as reimbursement ranges from $2,100,000 to $2,500,000. We are
not charged interest on this amount by Mercury.
Beaver Creek Pipeline
In June 1999, we and Mercury Michigan, Inc., an affiliate of our largest
stockholder, formed Beaver Creek Pipeline, L.L.C. We and Mercury Michigan, Inc.
each acquired a 50% interest in Beaver Creek. Beaver Creek purchased from Dow
Chemical a 125-mile natural gas pipeline extending from our Beaver Creek field
in northern Michigan to the Midland, Michigan industrial corridor. Because of
this pipeline's proximity to our Michigan reserves, we use it for the
transmission of our natural gas production and pay customary fees to Beaver
Creek Pipeline, L.L.C. for the transmission. The terms for transmission of our
natural gas production are no less favorable to us than could be obtained from
unaffiliated third parties.
46
<PAGE>
SECURITY OWNERSHIP OF MANAGEMENT
AND CERTAIN BENEFICIAL HOLDERS
The following table presents information regarding beneficial ownership of
our common stock as of September 30, 1999, and as adjusted to reflect the sale
of common stock in this offering, assuming there is no exercise of the over-
allotment option by the underwriters. The number of shares considered to be
outstanding for purposes of the percentages shown in the table does not include
404,381 contingently issuable shares of unregistered common stock currently
held in escrow to be released over a three year period in connection with the
acquisition of properties from Unocal or a total of 6,400 shares to be issued
to four of our non-employee directors prior to or shortly after completion of
this offering. The table presents the beneficial ownership for:
. each of our directors;
. each of our executive officers named in "Executive Compensation";
. each person who we know owns beneficially more than 5% of our common
stock;
. all our executive officers and directors as a group; and
. the Darden family as a group.
Unless otherwise indicated in the footnotes, each person listed has sole
voting and dispositive power over the shares indicated as owned by that person,
and the address of each stockholder is the same as our address.
<TABLE>
<CAPTION>
Shares Beneficially Shares Beneficially
Owned Before the Owned After the
Offering Offering
------------------- -------------------
Executive Officers, Number of
Directors and 5% Shares
Stockholders Number Percent Offered Number Percent
------------------- ------------ ------------------- ------------ ----------
<S> <C> <C> <C> <C> <C>
Directors
Frank Darden (1)(2)..... 464,043 3.6% - 464,043 2.6%
Glenn M. Darden (1)..... 495,850 3.8 - 495,850 2.8
Thomas F. Darden (1).... 501,110 3.9 - 501,110 2.8
Anne Darden Self (1).... 467,373 3.6 - 467,373 2.6
Steven M. Morris
(2)(3)................. 299,632 2.3 - 299,632 1.7
D. Randall Kent (2)..... 4,600 * - 4,600 *
W. Yandell Rogers III
(2).................... 6,600 * - 6,600 *
Mark Warner (4)......... - * - - *
Executive Officers not
named above
Houston Kauffman........ 3,900 * - 3,900 *
Bill Lamkin............. - * - - *
Fred van Naerssen....... - * - - *
Robert N. Wagner........ 1,000 * - 1,000 *
Directors and Executive
Officers as a
Group (5).............. 2,233,878 16.7 - 2,233,878 12.2
Holders of 5% or more
not named above
Mercury Exploration
Company (6)(7)......... 5,808,927 43.1 - 5,808,927 31.5
Quicksilver Energy, L.C.
(8).................... 3,030,861 23.5 - 3,030,861 17.0
Joint Energy Development
Investments Limited
Partnership (7)........ 1,340,405 10.4 - 1,340,405 7.5
Darden Family Group
(9).................... 10,757,934 77.1 - 10,757,934 56.8
</TABLE>
- --------
*Indicates less than 1%.
47
<PAGE>
(1) Does not include shares beneficially owned by Mercury or QELC. See
footnotes 3, 4 and 5 below. Does include with respect to each person
110,000 shares subject to immediately exercisable warrants. Also includes
with respect to each of Thomas F. Darden and Glenn M. Darden 11,428 shares
subject to immediately exercisable options. Also includes with respect to
each of Thomas F. Darden and Glenn M. Darden 18,660 and 15,250 shares
respectively, for which each is co-trustee for family member trusts. Also
includes with respect to Frank Darden 2,000 shares owned by his spouse.
(2) Number of shares indicated includes 1,600 shares to be issued to this non-
employee director as compensation for service during 1998. The address of
Steven M. Morris is 952 Echo Lane, Suite 335, Houston, Texas 77024. The
address of D. Randall Kent is 4421 Tamworth Road, Fort Worth, Texas 76116.
The address of W. Yandell Rogers III is 5711 Hillcroft, Houston, Texas
77036.
(3) Number of shares indicated includes 120,922 shares owned of record by Pozo
Resources, Inc., which shares are beneficially owned by Mr. Morris.
(4) Mr. Warner was designated by JEDI as director under the Stockholder's
Agreement dated April 9, 1998 between JEDI, us and others. The address for
Mark Warner is 1400 Smith Street, Houston, Texas, 77002.
(5) Includes 440,000 shares subject to immediately exercisable warrants, 22,856
shares subject to immediately exercisable options and a total of 6,400
shares to be issued to four non-employee directors. Does not include shares
beneficially owned by Mercury or QELC.
(6) Number of shares indicated includes 594,000 shares subject to immediately
exercisable warrants. Each of Frank Darden, Thomas F. Darden, Glenn M.
Darden and Anne Darden Self are directors and shareholders of Mercury and
share voting and investment power with respect to the 5,808,927 shares of
our common stock beneficially owned by Mercury. Each of these persons
disclaims beneficial ownership of all such shares.
(7) Does not reflect the effect, if any, of the right of Mercury to require
JEDI to transfer a portion of JEDI's shares to Mercury under a stock
transfer agreement. See "Description of Capital Stock--Stock Transfer
Agreement".
(8) Each of Frank Darden, Thomas F. Darden, Glenn M. Darden and Anne Darden
Self are members of QELC and share voting and investment power with respect
to the 3,030,861 shares of our common stock beneficially owned by QELC.
Each such person disclaims beneficial ownership of those shares.
(9) The Darden Family Group includes Darden family members, QELC, Mercury and
affiliates of Mercury which presently control 9,701,077, representing 75.3%
of the outstanding shares, and beneficially approximately 10,757,934,
representing 77.1% of our outstanding shares.
48
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The description of our capital stock below is only a summary and is not
intended to be complete. For a complete description of our capital stock, we
urge you to read our restated certificate of incorporation and bylaws, which
have been filed with the Securities and Exchange Commission.
Our authorized capital stock consists of 40,000,000 shares of common stock,
par value $0.01 per share, and 10,000,000 shares of preferred stock, par value
$0.01 per share. As of September 30, 1999, we had outstanding 12,877,692 shares
of common stock. No shares of preferred stock were outstanding. On completion
of this offering, we will have outstanding 17,877,692 shares of common stock,
or 18,627,692 shares if the underwriters' over-allotment option is exercised.
The outstanding share figures shown above do not include 404,381 contingently
issuable shares held in trust in connection with our acquisition of properties
from Unocal or a total of 6,400 shares to be issued to four of our non-employee
directors prior to or shortly after completion of this offering.
Common Stock
Subject to the preferential rights of any outstanding series of preferred
stock, the holders of our common stock are entitled to one vote per share on
all matters voted on by stockholders, including in the election of directors.
Our certificate of incorporation does not provide for cumulative voting in the
election of directors or grant preemptive rights with respect to future
issuances of our common stock. We may in the future, however, enter into
contracts with stockholders to grant holders preemptive rights.
Subject to any preferential rights of any series of preferred stock
outstanding, the holders of our common stock are entitled to dividends, if any,
as may be declared from time to time by our board from funds legally available
to pay dividends and, upon liquidation, are entitled to receive a pro rata
share of all of our assets that are available for distribution to stockholders.
All our common stock is fully paid and nonassessable.
Exchange Listing
Our common stock is listed on the American Stock Exchange and trades under
the symbol "KWK".
Transfer Agent
The transfer agent and registrar for our common stock is ChaseMellon
Shareholder Services.
Preferred Stock
Our preferred stock may be issued from time to time in one or more series
without stockholder approval. With regard to the preferred stock, our board may
determine:
. the preferences;
. conversion or other rights;
. voting powers;
. restrictions;
. limitations on dividends; and
. qualifications and terms and conditions of redemption.
As a result, without stockholder approval, our board could authorize the
issuance of preferred stock with voting, conversion and other rights that could
dilute the voting power and other rights of the holders of common stock. Our
board has not authorized any shares of preferred stock.
49
<PAGE>
Stockholders Agreement
We, Mercury, QELC, the Darden family, Jeff Cook, Jack Thurber, TCW, JEDI and
Mercury Production Company, owner of 100% of Mercury, entered into a
Stockholders Agreement dated April 9, 1998, which was later amended on
September 1, 1998. On July 15, 1999, TCW transferred all of its shares of our
common stock to Mercury and TCW no longer has any rights or obligations under
the Stockholders Agreement. Mercury has succeeded to those rights and
obligations. Many provisions of the Stockholders Agreement expired when our
stock became publicly traded on March 4, 1999. Provisions that remain in effect
include:
. an agreement by all parties not to transfer their shares of our common
stock prior to March 4, 2000; and
. an obligation by Mercury, QELC and the Darden family to provide a right
of first refusal to JEDI in the event any of them then decide to
transfer any of their stock and to provide JEDI with a proportionate
right to join in any such transfers.
In addition, each of JEDI and Mercury, as long as it holds any of our common
stock, has the right to elect a number of members of our board of directors
representing a percentage of the entire board that is as close as possible to
the percentage of outstanding shares of our common stock held by it, but in no
case less than one. The Stockholders Agreement does not apply to any transfer
by Mercury to its employees, independent consultants or directors of options to
purchase from Mercury shares of our common stock not to exceed 200,000 shares
or to transfers by Mercury of our shares pursuant to the exercise of such
options.
We are bound by certain covenants contained in the Stockholders Agreement
concerning the conduct of our business, including a requirement to deliver
specific information about us to JEDI as long as it owns any of our common
stock. The other parties to the Stockholders Agreement have agreed to vote
their shares of our common stock to cause us not to breach those covenants as
long as JEDI holds any of our common stock.
Registration Rights
We, JEDI and Mercury, as a result of its purchase of shares from TCW in July
1999, are parties to a registration rights agreement, dated as of April 9,
1998. The registration rights agreement provides each of JEDI and Mercury with
demand registration rights and "piggyback" registration rights. No more than
three demands may be made by JEDI or Mercury. In connection with registration
of JEDI's or Mercury's shares of our common stock under the registration rights
agreement, we are responsible for all registration expenses such as
registration and filing fees and fees and disbursements to our counsel. JEDI
and Mercury are responsible for selling expenses, including underwriting fees,
discounts and selling commissions. On the second and third occasions of the
exercise of demand registration rights by JEDI, JEDI is also responsible for
registration expenses. In connection with this offering, JEDI and Mercury have
waived their rights to include their shares in this offering and have agreed
not to demand a registration of their shares for 180 days from the date of this
prospectus.
Warrants to acquire shares of our common stock held by Messrs. Frank, Thomas
and Glenn Darden, Anne Darden Self, Mercury, the Estate of Jack Thurber, Jeff
Cook and Paribas provide each of the holders of the warrants with "piggyback"
registration rights covering the warrant shares. One of the warrants held by
Paribas also provides Paribas with demand registration rights covering the
warrant shares. See "Certain Transactions--MSR Merger" for more information
regarding the warrants. In connection with this offering, all of the warrant
holders have waived their right to include their shares in this offering and
Paribas has agreed not to demand a registration of its warrant shares for 180
days from the date of this prospectus.
Stock Transfer Agreement
To preserve the economic consequences of provisions of the Michigan Gas
Partners partnership agreement, which would have allowed Mercury's interest in
Michigan Gas Partners to increase from 10% to 85% upon
50
<PAGE>
JEDI's receipt of distributions from the partnership equal to the amount
invested by JEDI plus a specified rate of return, Mercury and JEDI are parties
to a stock transfer agreement which provides Mercury with the right to require
JEDI to transfer to Mercury a portion of the 1,340,405 shares of our common
stock that JEDI received in our formation. This portion is the number of shares
of our common stock having an aggregate "market value" equal to 85% of the
excess of the "market value" of JEDI's shares of our common stock over the
amount of $20,995,205, plus interest compounded at a monthly rate of 1.530948%
from September 9, 1999. "Market value" is the average of the high and low sale
prices of our common stock on the American Stock Exchange over thirty trading
days, subject to adjustments for trading by Mercury or any of its affiliates
and for volumes of trading below or above specified parameters. Mercury may
request the transfer on only one occasion prior to the first anniversary of the
date on which our common stock became publicly traded.
Agreement Regarding Warrants
Mercury, the Darden family and JEDI are parties to an agreement regarding
warrants concerning warrants held by Mercury and the Darden family to acquire a
total of 517,000 shares of our common stock at an exercise price of $12.50 per
share. See "Certain Transactions -- MSR Merger" for more information regarding
the warrants. Mercury and the Darden family have agreed that they will not
exercise their warrants until either:
. the market value of our common stock owned by JEDI exceeds $20,995,200;
. JEDI no longer owns any of our common stock; or
. JEDI consents to the exercise in writing.
Business Combinations under Delaware Law
We are a Delaware corporation and are governed by Section 203 of the
Delaware General Corporation Law. Section 203 prevents an interested
stockholder, which is a person who owns 15% or more of our outstanding voting
stock, from engaging in business combinations with us for three years following
the time that the person becomes an interested stockholder. These restrictions
do not apply if:
. before the person becomes an interested stockholder, our board of
directors approves the transaction in which the person becomes an
interested stockholder or the business combination;
. upon completion of the transaction that results in the person becoming
an interested stockholder, the interested stockholder owns at least 85%
of our outstanding voting stock at the time the transaction began,
excluding for purposes of determining the number of shares outstanding
those shares owned by persons who are directors and also officers and
employee stock plans in which employee participants do not have the
right to determine confidentially whether shares held subject to the
plan will be tendered in a tender or exchange offer; or
. following the transaction in which the person became an interested
stockholder, the business combination is approved by our board of
directors and authorized at an annual or special meeting of our
stockholders, and not by written consent, by the affirmative vote of at
least two-thirds of our outstanding voting stock not owned by the
interested stockholder.
In addition, the law does not apply to interested stockholders who became
interested stockholders before our common stock was listed on the American
Stock Exchange.
Delaware law defines the term "business combination" to encompass a wide
variety of transactions with, or caused by, an interested stockholder,
including mergers, asset sales and other transactions in which the interested
stockholder receives or could receive a benefit on other than a pro rata basis
with other stockholders. This law could have an anti-takeover effect with
respect to transactions not approved in advance by our board of directors,
including discouraging takeover attempts that might result in a premium over
the market price for the shares of our common stock.
51
<PAGE>
Limitation of Liability and Indemnification of Officers and Directors
Limitation of Liability. Delaware law authorizes corporations to limit or
eliminate the personal liability of their officers and directors to them and
their stockholders for monetary damages for breach of officers' and directors'
fiduciary duty of care. The duty of care requires that, when acting on behalf
of the corporation, officers and directors must exercise an informed business
judgment based on all material information reasonably available to them. Absent
the limitations authorized by Delaware law, officers and directors are
accountable to corporations and their stockholders for monetary damages for
conduct constituting gross negligence in the exercise of their duty of care.
Delaware law enables corporations to limit available relief to equitable
remedies such as injunction or rescission.
Our certificate of incorporation limits the liability of our directors to us
or our stockholders to the fullest extent permitted by Delaware law.
Specifically, our directors will not be personally liable for monetary damages
for breach of a director's fiduciary duty in such capacity, except for
liability:
. for any breach of the director's duty of loyalty to us or our
stockholders;
. for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
. for unlawful payments of dividends or unlawful stock repurchases or
redemptions as provided in Section 174 of the Delaware General
Corporation Law; or
. for any transaction from which the director derived an improper personal
benefit.
Indemnification. Delaware law also authorizes corporations to indemnify its
officers, directors, employees and agents for liabilities, other than
liabilities to the corporation, arising because that individual was an officer,
director, employee or agent of the corporation so long as the individual acted
in good faith and in a manner he or she reasonably believed to be in the best
interests of the corporation and not unlawful.
Our bylaws provide that our officers and directors will be indemnified by us
for liabilities arising because such individual was one of our officers or
directors to the fullest extent permitted by Delaware law. Our bylaws also
provide that we may, by action of our board of directors, provide similar
indemnification to our employees and agents.
These provisions in our certificate of incorporation and our bylaws may
reduce the likelihood of derivative litigation against our officers and
directors and may discourage or deter our stockholders or management from
bringing a lawsuit against our officers and directors for breach of their duty
of care, even though the action, if successful, might otherwise have benefitted
us and our stockholders.
These provisions in our certificate of incorporation and bylaws do not alter
the liability of our officers and directors under federal securities laws and
do not affect the right to sue under federal securities laws for violations
thereof.
52
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the underwriting agreement dated
November 16, 1999, between us and the underwriters, the underwriters named
below, who are represented by Bear, Stearns & Co. Inc.; Dain Rauscher
Incorporated; and Morgan Keegan & Company, Inc. have severally agreed to
purchase from us the respective numbers of shares of common stock at the public
offering price less the underwriting discounts and commissions set forth on the
cover page of this prospectus.
<TABLE>
<CAPTION>
Number of
Underwriters Shares
------------ ---------
<S> <C>
Bear, Stearns & Co. Inc........................................ 2,150,000
Dain Rauscher Incorporated..................................... 1,075,000
Morgan Keegan & Company, Inc. ................................. 1,075,000
A.G. Edwards & Sons, Inc. ..................................... 100,000
First Union Securities, Inc. .................................. 100,000
J.C. Bradford & Co. ........................................... 50,000
Gaines, Berland Inc. .......................................... 50,000
Hanifen, Imhoff Inc. .......................................... 50,000
Johnson Rice & Company L.L.C. ................................. 50,000
McDonald Investments Inc., a KeyCorp Company................... 50,000
Petrie Parkman & Co. .......................................... 50,000
Raymond James & Associates, Inc. .............................. 50,000
Sanders Morris Mundy Inc. ..................................... 50,000
Scott & Stringfellow, Inc. .................................... 50,000
Stephens Inc. ................................................. 50,000
---------
Total........................................................ 5,000,000
=========
</TABLE>
The underwriting agreement provides that the obligations of the several
underwriters to purchase and accept delivery of the shares included in this
offering are subject to approval of legal matters by their counsel and to
customary conditions, including the effectiveness of the registration
statement, the continuing correctness of our representations to them, the
receipt of "comfort letters" from our accountants and no occurrence of an event
that would have a material adverse effect on our business. The underwriters are
obligated to purchase all the shares, other than those covered by the over-
allotment option described below, if they purchase any of the shares.
We have granted to the underwriters an option, exercisable for 30 days from
the date of the underwriting agreement, to purchase up to 750,000 additional
shares at the public offering price less the underwriting fees. The
underwriters may exercise this option solely to cover over-allotments, if any,
made in connection with this offering. To the extent that the underwriters
exercise the option, each underwriter will become obligated, subject to
conditions, to purchase a number of additional shares approximately
proportionate to such underwriter's initial purchase commitment.
The underwriters propose initially to offer some of the shares directly to
the public at the public offering price set forth on the cover page of this
prospectus and some of the shares to dealers at the public offering price less
a concession not in excess of $.19 per share. The underwriters may allow, and
such dealers may re-allow, a concession not in excess of $.10 per share on
sales to other dealers. After the offering of the shares to the public, the
representatives of the underwriters may change the public offering price and
such concessions.
Holders of 91% of our issued and outstanding shares of common stock have
agreed pursuant to lock-up agreements not to sell or offer to sell or otherwise
dispose of any shares of common stock for a period of 180 days after the date
of this prospectus without the prior written consent of Bear Stearns.
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<PAGE>
In addition, we have agreed with the underwriters not to dispose of or hedge
any shares of common stock or securities convertible into or exchangeable for
shares of common stock during the period from the date of this prospectus and
continuing through the date 180 days after the date of this prospectus, except
with the prior written consent of Bear Stearns. These agreements do not apply
to issuances or sales of common stock by us pursuant to any existing employee
benefit plans or upon conversion or exchange of any currently outstanding
convertible or exchangeable securities.
In order to facilitate the offering of our common stock, the underwriters
may engage in transactions that stabilize, maintain, or otherwise affect the
market price of our common stock. Specifically, the underwriters may over-allot
shares of our common stock in connection with this offering, thereby creating a
short position in our common stock for their own account. In addition, to cover
over-allotments or to stabilize the market price of our common stock, the
underwriters may bid for, and purchase, shares of our common stock in the open
market. The representatives, on behalf of the underwriters, also may reclaim
selling concessions allowed to an underwriter or dealer if the underwriting
syndicate repurchases shares distributed by that underwriter or dealer. Any of
these activities may maintain the market price of our common stock at a level
above that which might otherwise prevail in the open market. These transactions
may be made on the American Stock Exchange, in the over-the-counter market or
otherwise. The underwriters are not required to engage in these activities and,
if begun, may end any of these activities at any time.
In connection with this offering, some of the underwriters and selling group
members who are qualified market markers on the American Stock Exchange may
engage in passive market making transactions in our common stock on the
American Stock Exchange according to Rule 103 of Regulation M under the
Securities Exchange Act, during the business day prior to the pricing of the
offering and before the start of offers or sales of our common stock, passive
market markers must comply with volume and price limitations and must be
identified as such. In general, a passive market maker must display its bid at
a price not in excess of the highest independent bid of such security. If all
independent bids are lowered below the passive market makers' bid, however, the
bid must then be lowered when specific purchase limits are exceeded.
We have agreed to indemnify the underwriters against a number of
liabilities, including liabilities under the Securities Act, or to contribute
to payments the underwriters may be required to make as a result of these
liabilities.
The representatives of the underwriters have advised us that the
underwriters do not intend to confirm sales to any account over which they
exercise discretionary authority.
Bear Stearns and its affiliates may provide in the future investment
banking, general financing, and banking services to us and our affiliates, for
which they may receive customary compensation.
The following table summarizes the compensation and estimated expenses we
will pay.
<TABLE>
<CAPTION>
Per Share Total
----------------------------- -----------------------------
Without With Without With
Over-allotment Over-allotment Over-allotment Over-allotment
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Underwriting discounts
and commissions payable
by us.................. $.31 $.31 $1,562,500 $1,796,875
Expenses payable by us.. $.07 $.06 $ 360,000 $ 360,000
</TABLE>
Our shares of common stock are listed on the American Stock Exchange under
the symbol "KWK."
54
<PAGE>
LEGAL MATTERS
The validity of the issuance of the shares of common stock offered by this
prospectus will be passed on for us by Cantey & Hanger, L.L.P., Fort Worth,
Texas. Certain legal matters relating to the common stock offered by this
prospectus will be passed on for the underwriters by Jenkens & Gilchrist, P.C.,
Dallas, Texas.
EXPERTS
Our audited combined consolidated balance sheets as of December 31, 1998 and
1997, and the related combined consolidated statement of income, stockholders'
equity and cash flows for the year ended December 31, 1998, the consolidated
balance sheet of MSR and subsidiaries as of December 31, 1997, and the related
consolidated statement of operations, stockholders' equity and cash flows for
the period from inception March 7, 1997 to December 31, 1997, and the statement
of revenues and direct operating expenses of the Unocal Corporation's Spirit
Energy 76 unit interests for the year ended December 31, 1998 included in this
prospectus have been audited by Deloitte & Touche LLP, independent auditors, as
stated in their reports appearing herein, and are included in reliance upon the
reports of such firm given upon their authority as experts in accounting and
auditing.
The audited consolidated balance sheet of Mercury as of September 30, 1997
and 1996, and the related consolidated statements of income, stockholders'
equity and cash flows for each of the three years in the period ended September
30, 1997, the audited consolidated balance sheet of Mercury as of December 31,
1997, and the related consolidated statements of income, stockholders' equity
and cash flows for the three-months then ended, the balance sheets of Michigan
Gas Partners as of December 31, 1997 and 1996, and the related statements of
operation, partners' capital and cash flows for each of the three years in the
period ended December 31, 1997, the statement of revenues and direct operating
expenses/Shell Michigan properties acquired of Mercury for the years ended
September 30, 1996 and 1995, and the statements of revenues and direct
operating expenses/Destec Michigan properties acquired of Mercury for the years
ended September 30, 1997 and 1996 included in this prospectus have been audited
by Weaver and Tidwell, L.L.P., independent auditors, as stated in their reports
appearing herein, and are included in reliance upon the reports of such firm
given upon their authority as experts in accounting and auditing.
The estimated reserve evaluations and related calculations of Holditch,
independent petroleum engineering consultants, included in this prospectus have
been included in reliance on the authority of said firm as experts in petroleum
engineering.
WHERE YOU CAN FIND MORE INFORMATION
This prospectus is part of a registration statement we have filed with the
Securities and Exchange Commission relating to our common stock. As permitted
by Securities and Exchange Commission rules, this prospectus does not contain
all of the information we have included in the registration statement and the
accompanying exhibits and schedules we filed with the Securities and Exchange
Commission. You may refer to the registration statement, exhibits and schedules
for more information about us and our common stock. You can read and copy the
registration statement, exhibits and schedules at the Securities and Exchange
Commission's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C.
20549 and at the Securities and Exchange Commission's regional offices located
at Seven World Trade Center, New York, New York 10048, and at 500 West Madison
Street, Chicago, Illinois 60661. You can obtain information about the operation
of the Securities and Exchange Commission's Public Reference Room by calling
the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and
Exchange Commission also maintains an Internet site that contains reports,
proxy and information statements, and other information regarding issuers that
file electronically with the Securities and Exchange Commission. The address of
that site is http://www.sec.gov.
55
<PAGE>
We are required to file current reports, quarterly reports, annual reports,
proxy statements and other information with the Securities and Exchange
Commission. You may read and copy those reports, proxy statement and other
information at the Securities and Exchange Commission's Public Reference Room
and regional offices or through its Internet site. We currently furnish and
intend to continue to furnish our stockholders with annual reports that will
include a description of our operations and audited consolidated financial
statements certified by an independent public accounting firm.
56
<PAGE>
GLOSSARY OF OIL AND GAS TERMS
The following are abbreviations and definitions of certain terms commonly
used in the oil and gas industry and this Prospectus:
Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used in this
prospectus in reference to crude oil or other liquid hydrocarbons.
Bcf. One billion cubic feet of natural gas.
Bcfe. One billion cubic feet of natural gas equivalent, determined using the
ratio of six Mcf of natural gas to one Bbl of crude oil, condensate or natural
gas liquids.
Btu or British Thermal Unit. The quantity of heat required to raise the
temperature of one pound of water by one degree Fahrenheit.
Completion. The installation of permanent equipment for the production of
natural gas or oil, or in the case of a dry hole, the reporting of abandonment
to the appropriate agency.
Condensate. Liquid hydrocarbons associated with the production of a
primarily natural gas reserve.
Developed acreage. The number of acres that are allocated or assignable to
productive wells or wells capable of production.
Development well. A well drilled into a proved natural gas or oil reservoir
to the depth of a stratigraphic horizon known to be productive.
Exploratory well. A well drilled to find and produce natural gas or oil
reserves that are not proved, to find a new reservoir in a field previously
found to be productive of natural gas or crude oil in another reservoir or to
extend a known reservoir.
Field. An area consisting of a single reservoir or multiple reservoirs all
grouped on or related to the same individual geological structural feature
and/or stratigraphic level.
Mbbls. One thousand barrels of crude oil or other liquid hydrocarbons.
Mcf. One thousand cubic feet of natural gas.
Mcfe. One thousand cubic feet equivalent, determined using the ratio of six
Mcf of natural gas to one Bbl of crude oil, condensate or natural gas liquids.
Mmbbls. One million barrels of crude oil or other liquid hydrocarbons.
Mmbtu. One million British Thermal Units.
Mmcf. One million cubic feet of natural gas.
Mmcf/d. One million cubic feet of gas per day.
Mmcfe. One million cubic feet equivalent, determined using the ratio of six
Mcf of natural gas to one Bbl of crude oil, condensate or natural gas liquids.
Productive well. A well that is found to be capable of producing sufficient
quantities of oil and gas so that proceeds from the sale of the production are
greater than production expenses and taxes.
57
<PAGE>
Prospect. A specific geographic area which, based on supporting geological,
geophysical or other data and also preliminary economic analysis using
reasonably anticipated prices and costs, is deemed to have potential for the
discovery of oil and natural gas.
Proved developed reserves. Reserves that can be expected to be recovered
through existing wells with existing equipment and operating methods.
Proved reserves. The estimated quantities of crude oil, natural gas and
natural gas liquids that geological and engineering data demonstrate with
reasonable certainty to be recoverable in future years from known reservoirs
under existing economic and operating conditions.
Proved undeveloped reserves. Reserves that are expected to be recovered from
new wells on developed acreage where the subject reserves cannot be recovered
without drilling additional wells.
PV-10 value. The estimated future net revenue to be generated from the
production of proved reserves discounted to present value using an annual
discount rate of 10%. These amounts are calculated net of estimated production
costs and future development costs, using prices and costs in effect as of a
certain date, without escalation and without giving effect to non-property
related expenses, such as general and administrative expenses, debt service,
future income tax expense, or depreciation, depletion, and amortization.
Recompletion. The completion of an existing well for production from a
formation that exists behind the casing of the well.
Reservoir. A porous and permeable underground formation containing a natural
accumulation of producible natural gas and/or oil that is confined by
impermeable rock or water barriers and is individual and separate from other
reservoirs.
Royalty interest. An interest in a natural gas and oil property entitling
the owner to a share of natural gas and oil production free of costs of
production.
Secondary recovery. A method of natural gas and oil recovery in which energy
sources from outside of the reservoir are used.
Standardized measure. The estimated future net cash flows from proved
natural gas and oil reserves computed using prices and costs, at a specific
date, after income taxes and discounted at 10%.
Steamflood. The injection of steam into a reservoir to heat the oil and
facilitate its production.
Tcf. One trillion cubic feet of natural gas.
Undeveloped acreage. Lease acreage on which wells have not been drilled or
completed to a point that would permit the production of commercial quantities
of natural gas and oil regardless of whether such acreage contains proved
reserves.
Waterflood. The injection of water into a reservoir to fill pores vacated by
produced fluids, which maintains reservoir pressure and assists production.
Working interest. The operating interest that gives the owner the right to
drill, produce and conduct operating activities on the property and receive a
share of production.
Workover. Operations on a producing well to restore or increase production.
58
<PAGE>
QUICKSILVER RESOURCES INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
QUICKSILVER RESOURCES INC.
Independent Auditors' Report............................................. F-3
Combined Consolidated Balance Sheets December 31, 1998 and 1997.......... F-4
Combined Consolidated Statement of Income for the Year ended December 31,
1998.................................................................... F-5
Combined Consolidated Statement of Stockholder's Equity for the Year
ended December 31, 1998................................................. F-6
Combined Consolidated Statement of Cash Flows for the Year ended December
31, 1998................................................................ F-7
Notes to Combined Consolidated Financial Statements for the Year ended
December 31, 1998....................................................... F-8
Condensed Consolidated Balance Sheets September 30, 1999 (Unaudited) and
December 31, 1998....................................................... F-20
Condensed Consolidated Statements of Operations for the Nine Months ended
September 30, 1999 and 1998 (Unaudited)................................. F-21
Condensed Consolidated Statements of Cash Flows for the Nine Months ended
September 30, 1999 and 1998 (Unaudited)................................. F-22
Condensed Notes to Consolidated Financial Statements for the Nine Months
ended September 30, 1999 and 1998....................................... F-23
PREDECESSOR FINANCIAL STATEMENTS
</TABLE>
<TABLE>
<S> <C>
MSR EXPLORATION LTD. AND SUBSIDIARIES
Independent Auditors' Report............................................. F-28
Consolidated Balance Sheet at December 31, 1997.......................... F-29
Consolidated Statement of Operations for the Period ended December 31,
1997.................................................................... F-30
Consolidated Statement of Stockholders' Equity for the Period ended
December 31, 1997....................................................... F-31
Consolidated Statement of Cash Flows for the Period ended December 31,
1997.................................................................... F-32
Notes to Consolidated Financial Statements............................... F-33
MERCURY EXPLORATION COMPANY--TRANSITION REPORTS
Independent Auditors' Report............................................. F-47
Consolidated Balance Sheets at September 30, 1997 and 1996............... F-48
Consolidated Statements of Income for the Years ended September 30, 1997,
1996 and 1995........................................................... F-49
Consolidated Statements of Stockholders' Equity for the Years ended
September 30, 1997, 1996 and 1995....................................... F-50
Consolidated Statements of Cash Flows for the Years ended September 30,
1997, 1996 and 1995..................................................... F-51
Notes to Consolidated Financial Statements............................... F-53
MERCURY EXPLORATION COMPANY--TRANSITION REPORTS
Independent Auditors' Report............................................. F-64
Consolidated Balance Sheet at December 31, 1997.......................... F-65
Consolidated Statement of Income for the Three Months ended December 31,
1997.................................................................... F-66
Consolidated Statement of Stockholders' Equity for the Three Months ended
December 31, 1997....................................................... F-67
Consolidated Statement of Cash Flows for the Three Months ended December
31, 1997................................................................ F-68
Notes to Consolidated Financial Statements............................... F-69
MICHIGAN GAS PARTNERS LIMITED PARTNERSHIP
Independent Auditors' Report............................................. F-79
Balance Sheet at December 31, 1997 and 1996.............................. F-80
Statement of Operations for the Years ended December 31, 1997, 1996 and
1995.................................................................... F-81
Statement of Partners' Capital for the Years ended December 31, 1997,
1996 and 1995........................................................... F-82
Statement of Cash Flows for the Years ended December 31, 1997, 1996 and
1995.................................................................... F-83
Notes to Financial Statements............................................ F-84
</TABLE>
F-1
<PAGE>
QUICKSILVER RESOURCES INC.
<TABLE>
<CAPTION>
Page
----
<S> <C>
ACQUISITION BY QUICKSILVER RESOURCES INC.
</TABLE>
<TABLE>
<S> <C>
Independent Auditors' Report--Unocal Corporation's Spirit Energy 76 unit
interests................................................................ F-88
Statement of Revenues and Direct Operating Expenses Unocal Corporation's
Spirit Energy 76 unit interests for the year ended December 31, 1998..... F-89
Notes to Statement of Revenues and Direct Operating Expenses for the year
ended December 31, 1998.................................................. F-90
ACQUISITIONS BY PREDECESSOR
</TABLE>
<TABLE>
<S> <C>
Independent Auditors' Report--Shell Michigan Properties acquired of
Mercury Exploration Company years ended September 30, 1996 and 1995..... F-92
Statement of Revenues and Direct Operating Expenses Shell Michigan
Properties--acquired years ended September 30, 1996 and 1995............ F-93
Notes to Financial Statements............................................ F-94
Independent Auditors' Report--Destec Michigan Properties acquired of
Mercury Exploration Company years ended September 30, 1997 and 1996..... F-96
Statement of Revenues and Direct Operating Expenses--Destec Michigan
Properties--acquired years ended September 30, 1997 and 1996............ F-97
Notes to Financial Statements............................................ F-98
</TABLE>
F-2
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Quicksilver Resources Inc.
Fort Worth, Texas
We have audited the accompanying combined consolidated balance sheets of
Quicksilver Resources Inc. (the Company) as of December 31, 1998 and 1997, and
the related combined consolidated statement of income, stockholders' equity and
cash flows for the year ended December 31, 1998. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements 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 misstatement. 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, such combined consolidated financial statements present
fairly, in all material respects, the financial position of the Company as of
December 31, 1998 and 1997, and the results of its operations and its cash
flows for the year ended December 31, 1998, in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Fort Worth, Texas
March 29, 1999
F-3
<PAGE>
QUICKSILVER RESOURCES INC.
COMBINED CONSOLIDATED BALANCE SHEETS
December 31, 1998 and 1997
In thousands, except for share and per share data
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents.................................. $ 294 $ 643
Accounts receivable........................................ 7,776 1,167
Inventories and other current assets....................... 751 687
-------- --------
Total current assets..................................... 8,821 2,497
Properties, plant, and equipment--net ("full cost").......... 134,810 131,060
Other assets................................................. 969 355
-------- --------
$144,600 $133,912
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt.......................... $ 67 $ 161
Accounts payable........................................... 5,772 1,362
Accrued liabilities........................................ 1,691 592
-------- --------
Total current liabilities................................ 7,530 2,115
Long-term debt............................................... 84,972 84,656
Unearned revenue............................................. 1,338 2,680
Deferred income taxes........................................ 11,953 9,617
Minority interest in MSR Exploration Ltd..................... 6,219 6,992
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01
Authorized 10,000,000 shares..............................
Issued and outstanding-none............................... - -
Common Stock, par value $0.01
Authorized 40,000,000 shares..............................
Issued and outstanding 11,510,800......................... 115 115
Additional paid in capital................................... 27,574 27,723
Retained earnings............................................ 4,899 14
-------- --------
Total stockholders' equity............................... 32,588 27,852
-------- --------
$144,600 $133,912
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
QUICKSILVER RESOURCES INC.
COMBINED CONSOLIDATED STATEMENT OF INCOME
For the Year Ended December 31, 1998
In thousands, except for per share data
<TABLE>
<S> <C>
REVENUES
Gas sales............................................................ $35,713
Oil sales............................................................ 6,367
Other income......................................................... 3,607
-------
Total revenues..................................................... 45,687
-------
EXPENSES
Operating expenses................................................... 17,781
Depletion and depreciation........................................... 12,365
General and administrative........................................... 1,430
Interest............................................................. 6,698
-------
Total expenses..................................................... 38,274
-------
Income before income taxes and minority interest....................... 7,413
-------
Minority interest in net loss of MSR Exploration Ltd................... 758
-------
Income before income taxes............................................. 8,171
-------
Income tax expense
Current.............................................................. 950
Deferred............................................................. 2,336
-------
Total income tax expense........................................... 3,286
-------
Net income............................................................. $ 4,885
=======
Basic and diluted earnings per share................................... $ 0.42
=======
Basic and diluted weighted average number of shares outstanding........ 11,511
=======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
QUICKSILVER RESOURCES INC.
COMBINED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the Year Ended December 31, 1998
In thousands
<TABLE>
<CAPTION>
Common Stock
-------------
Paid in
Capital Total
In Excess Retained Stockholders'
Shares Amount Of Par Earnings Equity
------ ------ --------- -------- -------------
<S> <C> <C> <C> <C> <C>
Inception January 1, 1998....... 100 $ 1 $27,851 $ - $27,852
Stock dividend retroactively
applied........................ 10,211 102 (102) -
Merger with MSR Exploration
Ltd., shares under common
control for merger effective on
March 4, 1999, retroactively
applied........................ 1,200 12 (26) 14 -
------ ---- ------- ------ -------
Adjusted balance January 1,
1998........................... 11,511 115 27,723 14 27,852
Stock registration fees......... (149) (149)
Net income...................... 4,885 4,885
------ ---- ------- ------ -------
Balance December 31, 1998....... 11,511 $115 $27,574 $4,899 $32,588
====== ==== ======= ====== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
QUICKSILVER RESOURCES INC
COMBINED CONSOLIDATED STATEMENT OF CASH FLOWS
For the Year Ended December 31, 1998
In thousands
<TABLE>
<S> <C>
OPERATING ACTIVITIES:
Net income.......................................................... $ 4,885
Charges and credits to net income not affecting cash
Depletion and depreciation........................................ 12,365
Deferred income taxes............................................. 2,336
Recognition of unearned revenues.................................. (1,342)
Change in minority interest in subsidiary......................... (758)
Amortization of deferred loan costs............................... 66
Changes in assets and liabilities
Accounts receivable............................................... (6,609)
Inventory and other assets........................................ (97)
Accounts payable.................................................. 4,410
Accrued liabilities............................................... 1,099
--------
Net cash from (Used for) operating activities......................... 16,355
--------
INVESTING ACTIVITIES:
Acquisition of properties and equipment............................. (16,097)
--------
Net cash from (used for) investing activities......................... (16,097)
--------
FINANCING ACTIVITIES:
Notes payable, bank proceeds........................................ 10,493
Principal payments on long-term debt................................ (10,271)
Deferred financing costs............................................ (680)
Stock registration fees............................................. (149)
--------
Net cash from (used for) financing activities......................... (607)
--------
Net increase (decrease) in cash....................................... (349)
Cash at beginning of period........................................... 643
--------
Cash at end of period................................................. $ 294
========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash payments for interest expense.................................. $ 5,617
========
Cash payments for income taxes...................................... $ 600
========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-7
<PAGE>
QUICKSILVER RESOURCES INC.
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS
For the Year Ended December 31, 1998
1. Business Combination
Formation of Quicksilver
Quicksilver Resources, Inc. (the "Company" or "Quicksilver") was formed as a
Delaware Corporation in December 1997 to combine certain oil and gas properties
pursuant to a merger. On January 1, 1998, Mercury Exploration Company
("Mercury"), Quicksilver Energy, L.C. ("QELC"), Michigan Gas Partners Limited
Partnership ("Michigan Gas Partners"), Trust Company of the West ("TCW"), Joint
Energy Development Investments Limited Partnership ("JEDI"), and Quicksilver
Resources Inc. entered into an agreement and plan of reorganization and merger
to combine certain oil and gas properties owned by Mercury, QELC, and Michigan
Gas Partners by causing Michigan Gas Partners to be merged with Quicksilver and
by causing certain assets and liabilities of Mercury and QELC to be transferred
to and assumed by Quicksilver. Quicksilver was the surviving corporation of the
merger.
In exchange for the contribution of properties and debt Quicksilver issued
shares of common stock. The common stock was issued to contributing parties
based on their ownership interest in the oil and gas properties. The oil and
gas properties were evaluated based on the net present value of their reserves.
The reserves were discounted at 10% and reduced for any associated debt. The
conversion of debt to equity was valued at its face value. The net values for
all properties and debt were summarized and the percentage of each contributed
piece to the total was used to allocate shares of common stock back to the
stockholders.
In the business combination, the surviving corporation issued 1,340,405 (13%
of the outstanding) shares of common stock, $.01 par value, for all JEDI
partnership interests in Michigan Gas Partners. Mercury did not receive
consideration for its partnership interests in Michigan Gas Partners.
Quicksilver issued 3,325,955 shares of common stock to Mercury in exchange for
certain Mercury oil and gas properties in Michigan and Wyoming, and Quicksilver
assumed debts related to the oil and gas properties transferred from Mercury.
Quicksilver also issued 3,030,860 shares of Quicksilver common stock to QELC in
exchange for all of QELC's oil and gas properties in Michigan and Wyoming. In
addition, Quicksilver assumed debts related to QELC's oil and gas producing
properties. Quicksilver issued 1,273,176 shares of common stock to individuals
for their interests in the assets of Mercury and QELC to be transferred to
Quicksilver in the business combination. Quicksilver satisfied debt owed to TCW
under a credit agreement dated November 14, 1996 between TCW and QELC, by
paying $17,075,000 in cash to TCW and by issuing 1,340,404 (13% of the
outstanding) shares of common stock to TCW in exchange for a $10,000,000 credit
on the debt.
The formation of Quicksilver was accounted for under provisions of
Accounting Principal Board Opinion Number 16 (APB 16) "Business Combinations".
Under APB 16, Mercury and QELC were considered companies under common control
and were accounted for at historical cost. The merger of Michigan Gas Partners
into Quicksilver was accounted for using the purchase method with a fair value
of $10 million. The fair value of Michigan Gas Partners was based on the
conversion of the $10,000,000 of debt of TCW for 13% of Quicksilver's common
shares which was the same percentage issued to the partners of Michigan Gas
Partners. Michigan Gas Partners' net book value was $8,884,000 at January 1,
1998. All of the valuation adjustment was assigned to oil and gas properties.
An amount of $1,116,000 was allocated to Michigan Gas Partners' book value of
producing oil and gas properties to complete the accounting.
Merger of MSR Exploration Ltd. with and Into Quicksilver
On March 4, 1999, Quicksilver completed a merger with MSR Exploration Ltd.
("MSR"). ABP 16, provides that exchanges or transfers of net assets between
companies under common control must be accounted for at
F-8
<PAGE>
QUICKSILVER RESOURCES INC.
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
historical cost in a manner similar to that of pooling of interest accounting.
Furthermore, APB 16 indicates that the purchase method of accounting should be
used if the effect of a transfer or exchange is to acquire all of the
outstanding shares held by minority interests. Prior to the merge, QELC,
Mercury, and the principal stockholders of Mercury, comprised of the Darden
family (the "Mercury Group"), controlled Quicksilver though their approximate
74% ownership of Quicksilver. The Mercury Group was considered to control MSR
because the Mercury Group and two other individuals affiliated with Mercury
own approximately 46.5% of the MSR common stock, controlled MSR's executive
committee of its board of directors, and held warrants to purchase 11 million
shares of MSR common stock. Accordingly, Quicksilver was considered the
"accounting acquiror" and transferred approximately 46.5% of MSR's net assets
to Quicksilver at historical cost. The remainder of MSR's net assets,
approximately 53.5% that relate to minority interests, will be valued and
recorded based on the purchase method of accounting in 1999. Although the
merger did not occur until 1999, MSR's financial statements have been combined
with the Company's as the entities were under common control. Also, a minority
interest has been reflected on the December 31, 1998, balance sheet and
statement of income since the merger occurred subsequent to year end.
2. Mergers and Acquisitions
On March 4, 1999, the Company completed the MSR merger. The merger
qualified as a tax-free exchange and was accounted for in part as a pooling of
interest for entities under common control, with the minority interest
accounted for under the purchase method. In connection with the merger, the
Company issued 2,577,700 shares of its common stock in exchange for all of the
outstanding common stock of MSR based on a conversion ratio of 1 share (the
merger exchange ratio) of the Company's common stock for ten (10) shares of
MSR common stock. MSR's outstanding common stock options and warrants were
converted into Quicksilver common stock options and warrants to purchase
approximately 24,857 shares and 1,133,750 shares, respectively. The minority
interest reflected on the Company's balance sheet and statement of income is
approximately 53.5% of MSR's net assets and results of operations for the
period.
The Company's financial statements have been restated for the period prior
to the business combination to include the combined financial results of the
Company and MSR. Total revenues, income (loss) before income taxes, and net
income for the year ended December 31, 1998, for the individual companies
prior to the merger are as follows in thousands:
<TABLE>
<CAPTION>
Quicksilver MSR
Resources Exploration
Inc. Ltd. Total
----------- ----------- -------
<S> <C> <C> <C>
Total Revenues.............................. $41,873 $ 3,814 $45,687
Income (loss) before income taxes........... $ 8,829 $(1,416) $ 7,413
Net income (loss)........................... $ 5,559 $ (674) $ 4,885
</TABLE>
There were no significant intercompany transactions between the Company and
MSR Exploration Ltd.
3. Significant Accounting Policies
The nature of operations and other significant accounting policies are as
follows:
Nature of Operations
Quicksilver Resources Inc. was formed to own various oil and gas properties
in the states of Michigan and Wyoming. Substantially all of the Company's
revenue is derived from the production and sale of natural gas, crude oil,
condensate, and plant products.
F-9
<PAGE>
QUICKSILVER RESOURCES INC.
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Accounts Receivable
The Company's customers are large oil and natural gas purchasers. The
Company does not require collateral, and receivables are generally due in 30-60
days. Management considers all accounts receivable current and collectible;
accordingly, no allowance for doubtful accounts has been established.
Major Customers
At December 31, 1998, three purchasers accounted for approximately 21%, 19%,
and 17%, respectively, of the Company's total consolidated oil and gas sales.
The Company does not anticipate that the loss of any of its present purchasers
would adversely effect the Company's consolidated business. The Company also
believes that, in the event of a loss of a present purchaser, other oil and gas
purchasers located in the Company's areas of production would offer competitive
prices for such production.
Inventories
Inventories are valued at the lower of cost (first-in, first-out method) or
market and consist of crude oil in tanks and well equipment spares and
supplies.
Properties, Plant, and Equipment
The Company follows the "full cost" method of accounting for oil and gas
properties whereby all costs associated with acquiring, exploring for, and
developing oil and gas reserves are capitalized and accumulated in cost centers
established on a country-by-country basis. Such costs include land acquisition
costs, geological and geophysical expenses, carrying charges on non-producing
properties, costs of drilling both productive and non-productive wells, and
overhead charges directly related to acquisition, exploration, and development
activities.
The capitalized costs related to each cost center, including the estimated
future costs to develop proved reserves and the costs of production equipment,
are amortized using the unit-of-production method based on the estimated net
proved reserves as determined by petroleum engineers. Investments in unproved
properties are not amortized until proven reserves associated with them can be
determined or until impairment occurs. Oil and natural gas reserves and
production are converted into equivalent units based upon estimated relative
energy content.
The capitalized costs less accumulated depletion and depreciation in each
cost center are limited to an amount equal to the estimated future net revenue
from proved reserves discounted at a 10% interest rate (based on prices and
costs at the balance sheet date) plus the lower of cost (net of impairments) or
fair market value of unproved properties.
Proceeds from the sale of oil and gas properties are applied against
capitalized costs, with no gain or loss recognized unless such a sale would
significantly alter the relationship between capitalized costs and proved
reserves of oil and gas, in which case the gain or loss is recognized in
income.
Other plant and equipment are depreciated on the straight-line basis as
follows:
Gas processing plants and gathering systems--over fifteen to twenty
years
Other equipment--over ten years
Building--over forty years
Potential impairment of producing properties and significant unproved
properties and other plant and equipment are assessed annually (unless economic
events warrant more frequent reviews). In addition, a
F-10
<PAGE>
QUICKSILVER RESOURCES INC.
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
quarterly impairment analysis of aggregated properties is performed by the
Company using discounted future net cash flows determined based upon current
prices and costs.
Revenue Recognition
The Company recognized revenue as quantities of oil and gas are sold or
volumes of gas are transported to the buyer, and utilizes the sales method of
accounting for oil and gas imbalances. The Company's net imbalance was
immaterial at December 31, 1998.
Environmental Compliance and Remediation
Environmental compliance costs, including on going maintenance and
monitoring, are expensed as incurred. Environmental remediation costs, which
improve the condition of a property, are capitalized.
Deferred Charges
Financing charges related to the acquisition of debt are deferred and
amortized on a straight line basis over the term of that debt.
Joint Venture Operations
Certain of the Company's exploration and development activities relating to
oil and gas are conducted jointly with others. The accompanying financial
statements reflect only the Company's proportionate interest in such
activities.
Income Taxes
Income taxes provide for the tax effects of transactions reported in the
financial statements and consist of taxes currently due plus deferred taxes
primarily related to differences between the basis of properties, plant, and
equipment for financial and income tax reporting. The deferred tax assets and
liabilities represent the future tax return consequences of those differences,
which will either be taxable or deductible when the assets and liabilities are
recovered or settled.
Cash Equivalents and Time Deposits
The Company considers all highly liquid investments purchased with a
maturity of three months or less to be cash equivalents. Investments with an
original maturity in excess of three months are considered to be time deposits.
Disclosure of Fair Value of Financial Instruments
The Company's financial instruments include cash, time deposits, accounts
receivable, and notes payable, accounts payable, and long-term debt. The fair
value of long-term debt is estimated at the present value of future cash flows
discounted at rates consistent with comparable maturities for credit risk. The
carrying amounts reflected in the balance sheet for financial assets classified
as current assets and the carrying amounts for financial liabilities classified
as current liabilities approximate fair value due to the short maturity of such
instruments.
F-11
<PAGE>
QUICKSILVER RESOURCES INC.
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Accounting Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Earnings per Share
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per share"
("EPS") which established new standards for computing and presenting EPS. SFAS
No. 128 replaced the presentation of primary EPS with a presentation of basic
EPS. Basic EPS excludes dilution and is computed by dividing income available
to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. Earnings per share amounts for 1998
have been presented to conform to the SFAS No. 128 requirements.
Recently Issued Accounting Standards
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting comprehensive income and its
components (revenues, expenses, gains, and losses) in a full set of general-
purpose statements. It requires (a) classification of items of other
comprehensive income by their nature in a financial statement and (b) display
of the accumulated balance of other comprehensive income separate from retained
earnings and additional paid-in surplus in the equity section of the statement
of financial position. The Company adopted SFAS No. 130 on January 1, 1998. Net
income and comprehensive income are the same.
SFAS 131, "Disclosures About Segments of an Enterprise and Related
Information," became effective for fiscal years beginning after December 15,
1997. This statement establishes standards for defining and reporting business
segments. The Company adopted SFAS No. 131 on January 1, 1998. As substantially
all of the Company's revenue is derived from the production and sale of natural
gas, crude oil, condensate and plant products, which are operated as one
segment, this standard did not have a significant impact on the Company's
financial statements.
The FASB has also issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which was originally effective for fiscal
years beginning after June 15, 1999. This statement establishes accounting and
reporting standards for derivative instruments and for hedging activities.
Management is currently evaluating the effect of adopting SFAS No. 133 on the
Company's financial statements.
Certain Reclassifications
Certain reclassifications have been made for presentation adopted in 1999.
Revenues have been restated to remove marketing and processing deductions which
are now reflected as operating expenses.
F-12
<PAGE>
QUICKSILVER RESOURCES INC.
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Properties, Plants, and Equipment
Capitalized costs are shown below in thousands.
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
----------------- -----------------
<S> <C> <C>
Proved oil and gas
properties............. $178,128 $166,843
Unproved oil and gas
interests.............. 3,584 3,216
Accumulated depletion
and depreciation....... (53,225) (41,217)
-------- --------
$128,487 $128,842
Other equipment......... 10,064 5,620
Accumulated
depreciation........... $ (3,741) $ (3,402)
-------- --------
$134,810 $131,060
======== ========
</TABLE>
5. Other Assets
Other assets, in thousands, consist of:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
----------------- -----------------
<S> <C> <C>
Deferred loan cost....................... $755 $118
Less accumulated amortization............ (91) (4)
---- ----
Net deferred loan costs.................. 664 114
Environmental escrow bonds............... 305 241
---- ----
$969 $355
==== ====
</TABLE>
6. Notes Payable and Long-Term Debt
Long-term debt, in thousands, consists of:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
----------------- -----------------
<S> <C> <C>
Notes payable to a bank
(7.1% at December 31, 1998)............ $84,841 $84,453
Various loans............................ 198 364
------- -------
85,039 84,817
Less current maturities................ (67) (161)
------- -------
$84,972 $84,656
======= =======
</TABLE>
Long-term debt maturities are as follows, in thousand of dollars:
<TABLE>
<CAPTION>
Periods Ending December 31, 1998
-------------- -----------------
<S> <C>
1998....................................................... $ -
1999....................................................... 67
2000....................................................... 20
2001....................................................... 20
2002....................................................... 4
2003....................................................... 4
Thereafter................................................. 84,924
-------
$85,039
=======
</TABLE>
As part of merger of the Company with MSR on March 4, 1999, the Company
entered into a new five year Credit Facility agreement. The existing debt of
$73,993,000 and $10,848,000 from Quicksilver and MSR was transferred into the
new Credit Facility. The Credit Facility permits the Company to obtain
revolving credit
F-13
<PAGE>
QUICKSILVER RESOURCES INC.
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
loans and to issue letters of credit for the account of the Company from time
to time in an aggregate amount not to exceed $200 million. The Borrowing Base
is currently $85 million and is subject to semi-annual determination and
certain other redeterminations based upon a variety of factors, including the
discounted present value of estimated future net cash flow from oil and gas
production. At the Company's option, loans may be prepaid, and revolving credit
commitments may be reduced, in whole or in part at any time in certain minimum
amounts. The Company can designate the interest rate on amounts outstanding at
either the London Interbank Offered Rate (LIBOR) + 1.65% or bank prime. On
March 4, 1999, the Company locked in its interest rate at 7.38% for the next
six months. The collateral for this loan agreement consists of substantially
all of the existing assets of the Company and any future reserves acquired. The
loan agreement contains certain dividend restrictions and restrictive
covenants, which, among other things, require the maintenance of a minimum
current ratio, net worth, and debt service ratio. The Company currently is in
compliance with all such restrictions.
7. Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets and liabilities as of December 31, 1998,
and December 31, 1997 are as follows, in thousands:
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
Deferred tax assets
Tax credit sale and unearned income....................... $ 3,811 $ 4,597
Net operating loss carryforwards.......................... 2,500 2,301
Investment tax credits.................................... - 171
------- -------
Total deferred tax assets............................... $ 6,311 $ 7,069
Deferred tax liabilities
Properties, plant, and equipment.......................... $18,264 $16,686
------- -------
Net deferred tax liabilities.......................... $11,953 $ 9,617
======= =======
</TABLE>
No valuation allowance is required because the deferred tax assets will be
utilized by the reversal of the deferred tax liabilities. As the deferred tax
liabilities reverse and create taxable income, the tax assets will offset this
tax liability.
The provisions for income taxes for the year ended December 31, 1998 are as
follows, in thousands:
<TABLE>
<S> <C>
United States Federal
Current............................................................. $ 950
Deferred............................................................ 2,336
------
$3,286
======
</TABLE>
A reconciliation of the statutory federal income tax rate and the effective
tax rate for the year ended December 31, 1998 is as follows:
<TABLE>
<S> <C>
U.S. federal statutory tax rate........................................ 34.0%
Statutory reduction of net operating loss carryforwards................ 6.2%
----
Effective income tax rate.............................................. 40.2%
====
</TABLE>
F-14
<PAGE>
QUICKSILVER RESOURCES INC.
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Under Internal Revenue Code Section 382, a change of ownership was deemed to
have occurred for MSR. Due to the limitations imposed by Section 382, a portion
of MSR's net operating losses could not be utilized. However, starting in 1999,
the Company has approximately $7,500,000 of net operating loss carryforwards
available from MSR to reduce future U.S. taxable income. These U.S. net
operating loss carryforwards will begin to expire in 2001.
8. Unearned Revenues
The Quicksilver Properties include certain properties which carry IRS code
Section 29 income tax benefits. Code Section 29 allows a credit against regular
federal income tax liability for certain eligible gas production. During 1997
these credits were conveyed through the sale of the working interests to a
bank. The agreement with the bank provided that the Company would receive cash,
payment for future production on the properties, and payment for a portion of
tax credits taken by the bank. The agreement included a fixed payment note
which provides for the Company to receive a minimum of approximately $7 million
plus interest for the future production on the properties. A portion of the
initial cash payment represented an advance payment for the first eighteen
months of tax benefits. As of December 31, 1998 and December 31, 1997, a
balance of $1,338,000 and $2,680,000 respectively, in unearned revenues existed
as a result of the cash consideration received in excess of the tax benefit
earned. At December 31, 1998 and December 31, 1997, $538,000 and $2,005,000
respectively, of the unearned revenues represented advance payments on tax
benefits, which will be recognized as earned through 1999. The balance of
$800,000 will remain unearned until the tax benefits of the IRS Code Section 29
expire at December 31, 2002.
9. Stockholders' Equity
The Company is authorized to issue 40 million shares of common stock with a
par value of one cent ($0.01) and 10 million shares of preferred stock with a
par value of one cent ($0.01). At December 31, 1998, the Company had 100,000
shares of common stock outstanding.
As part of the merger with MSR, the Company agreed to exchange one share of
its common stock for each 10 shares of MSR common stock. To effect the exchange
ratio, the present shareholders of the Company will be issued an additional
10,210,800 shares in the form of a stock dividend. Upon completion of the
merger the founding shareholders will own 10,310,800 (80%) of the shares of the
Company and former MSR shareholders will own approximately 2,577,700 (20%) of
the common shares of the Company. All references in the financial statements to
numbers of shares and per share amounts have been restated to reflect the stock
dividend.
The Company currently has 11,510,800 shares of common stock outstanding.
MSR's outstanding options and warrants were converted into options and warrants
to purchase Company common stock. As a result of the merger, the Company has
outstanding warrants to purchase common stock of 550,000 shares at $12.50 per
share, 550,000 shares at $20.00 per share, 28,000 shares at $33.75 per share,
and 5,750 shares at $0.10 per share and options to purchase 24,857 shares of
common stock at $8.75 per share.
Stock Option Plan
Pursuant to the merger agreement with MSR, the Company converted the
outstanding options of MSR into options to purchase Quicksilver common shares.
During 1997, an aggregate of 24,857 shares were granted
under MSR's plan at an exercise price of $8.75 per share. Options are totally
vested and must be exercised within five years of the date of grant. No
additional options will be granted under the plan.
F-15
<PAGE>
QUICKSILVER RESOURCES INC.
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Related Party Transactions
When the Company was formed on January 1, 1998, it entered into a Management
Agreement (the Management Agreement) for Mercury Exploration Company (Mercury)
to act as operator of the Company's oil and gas properties in Michigan, Wyoming
and Montana under a joint operating agreement. The Company has no operating
employees; Mercury performs all operations on behalf of the Company. In its
capacity as operator, Mercury pays all costs and expenses of operations and
distributes all net revenues associated with the Company's properties. The
Company reimburses Mercury for its actual cost for direct and indirect expenses
incurred by Mercury for the benefit of the Company and its properties. The
indirect expenses for which Mercury is reimbursed include employee
compensation, office rent, office supplies, and employee benefits. During 1998,
the Company paid Mercury a total of approximately $1.2 million under the
management agreement.
Mercury generally allocated its expenses among the Company and other
entities for which Mercury's services are provided by multiplying the aggregate
amount of indirect expenses incurred by Mercury by the time that the employees
of Mercury spend on managing Quicksilver properties and dividing by the
aggregate time that the employees of Mercury spend on all the entities for
which Mercury provides similar services. Management believes the allocated
method and amounts are reasonable.
Mercury owns 3,899,822 (30.3%) shares of the Company's common stock, and
three of Mercury's directors--Frank Darden, Thomas Darden, and Glenn Darden--
are also directors and officers of the Company.
11. Supplemental Information for Oil and Gas Producing Activities (Unaudited)
The Company's proved oil and gas reserves at December 31, 1998, have been
estimated by Holditch-Reservoir Technologies Consulting Services and at
December 31, 1997, by Citadel Engineering, Ltd. and Mercury in accordance with
guidelines established by the Securities and Exchange Commission ("SEC").
Accordingly, the following reserve estimates are based upon existing economic
and operating conditions.
There are numerous uncertainties inherent in establishing quantities of
proved reserves. The following reserve data represent estimates only and should
not be construed as being exact. In addition, the present values should not be
construed as the current market value of the Company's oil and gas properties
or the cost that would be incurred to obtain equivalent reserves.
F-16
<PAGE>
QUICKSILVER RESOURCES INC.
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Estimated Reserves
Changes in the estimated net quantities of crude oil and natural gas
reserves, all of which are located in the continental United States, are as
follows:
Reserve Quantities
<TABLE>
<CAPTION>
Oil Gas
------ -------
(Mbbl) (Mmcf)
<S> <C> <C>
Proved reserves
As of January 1, 1997..................................... 21,137 100,918
Purchase of reserves.................................... 3,646 50,701
Revisions of previous estimates......................... 686 332
Production for 1997..................................... (933) (13,117)
------ -------
As of January 1, 1998..................................... 24,536 138,834
Purchase of reserves.................................... - -
Revision of estimates................................... (5,886) -
Extensions and discoveries.............................. - 29,683
Production for 1998..................................... (667) (15,315)
------ -------
As of December 31, 1998................................... 17,983 153,202
====== =======
Proved Developed Reserves
As of January 1, 1997..................................... 5,335 91,729
As of January 1, 1998..................................... 8,932 119,669
As of December 31, 1998................................... 9,829 123,743
</TABLE>
Standardized Measure
The following tables present the Company's standardized measure of
discounted future net cash flows and changes therein relating to proved oil and
gas reserves and were computed using reserve valuations based on regulations
prescribed by the SEC. These regulations provide that the oil, condensate, and
gas price structure utilized to project future net cash flows reflects current
prices at each date presented and have been escalated only when known and
determinable price changes are provided by contract. Future production,
development, and net abandonment costs are based on current costs without
escalation. The resulting net future cash flows have been discounted to their
present values based on a 10% annual discount factor for the years ended
December 31, 1998 and 1997, in thousands of dollars.
F-17
<PAGE>
QUICKSILVER RESOURCES INC.
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Future cash flows....................................... $ 607,336 $ 629,499
Future production and development costs................. (331,599) (300,273)
Future income tax expense............................... (55,106) (46,733)
--------- ---------
Future net cash flows................................... 220,631 282,493
10% annual discount for estimated timing of cash flows.. (92,212) (134,848)
--------- ---------
Standardized measure of discounted future net cash
flows.................................................. $ 128,419 $ 147,645
========= =========
</TABLE>
Changes in Standardized Measure of Discounted Future Net Cash Flows
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Net changes in price and production costs................. $ 3,199 $ (5,362)
Development costs incurred................................ 8,283 3,303
Revision of estimates..................................... (21,708) 2,908
Changes in estimated future development costs............. (13,763) (1,654)
Purchases of reserves..................................... 1,715 32,247
Extensions, discoveries and improved recovery, net of
future production and development costs.................. 18,246 -
Net changes in income taxes............................... (7,871) 13,519
Sales of oil and gas net of production costs.............. (24,346) (28,013)
Accretion of discount..................................... 14,765 11,558
Other..................................................... 2,254 (10,217)
-------- --------
Net increase (decrease)................................... $(19,226) $ 18,289
======== ========
</TABLE>
Estimated future cash inflows are computed by applying year end prices of
oil and gas to year end quantities of proved developed reserves. Estimated
future development and production costs are determined by estimating the
expenditures to be incurred in developing and producing the proved oil and gas
reserves in future years, based on year end costs and assuming continuation of
existing economic conditions.
These estimates are furnished and calculated in accordance with requirements
of the Financial Accounting Standards Board and the SEC. Because of
unpredictable variances in expenses and capital forecasts, crude oil and
natural gas price changes, and the fact that the bases for such estimates vary
significantly, management believes the usefulness of these projections is
limited. Estimates of future net cash flows do not necessarily represent
management's assessment of future profitability or future cash flow to the
Company.
Costs incurred in oil and gas property acquisition, exploration, and
development activities for the year ended December 31, 1998, in thousands:
<TABLE>
<S> <C>
Acquisition of properties........................................... $ 1,715
Exploration costs................................................... 1,095
Development costs................................................... 8,283
-------
Total............................................................. $11,093
=======
</TABLE>
F-18
<PAGE>
QUICKSILVER RESOURCES INC.
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Capitalized cost for oil and gas properties at December 31, 1998 and 1997,
in thousands:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Proved oil and gas properties............................ $178,128 $166,843
Unproved oil and gas interests........................... 3,584 3,216
Accumulated depletion and depreciation................... (53,225) (41,217)
-------- --------
$128,487 $128,842
======== ========
</TABLE>
Results of operations from producing activities, for the year ended December
31, 1998, in thousands:
<TABLE>
<S> <C>
Oil and gas sales................................................ $ 38,923
Operating expenses............................................... (14,577)
Depletion and depreciation....................................... (12,198)
--------
12,148
Income taxes..................................................... (4,130)
--------
Results of operations from producing activities (excluding
corporate overhead and interests costs)......................... $ 8,018
========
</TABLE>
F-19
<PAGE>
QUICKSILVER RESOURCES INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
In thousands, except for share and per share amounts
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------ -----------------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents............... $ 3,174 $ 294
Accounts receivable, net of allowance
for doubtful accounts of $1,350 at
September 30, 1999..................... 11,382 7,776
Inventories and other current assets.... 807 751
-------- --------
Total current assets.................. 15,363 8,821
Investments in equity affiliates.......... 3,089 -
Properties, plant and equipment--net
("full cost")............................ 171,286 134,810
Other assets.............................. 1,582 969
-------- --------
$191,320 $144,600
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt....... $ 14 $ 67
Accounts payable........................ 9,457 5,772
Accrued liabilities..................... 2,687 1,691
-------- --------
Total current liabilities............. 12,158 7,530
Long-term debt............................ 117,060 84,972
Other long-term liabilities............... 2,800 1,338
Deferred income taxes..................... 15,466 11,953
Minority interest......................... 228 6,219
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01
Authorized 10,000,000 shares, issued
and outstanding--none................ - -
Common stock, $.01 par value
Authorized 40,000,000 shares, issued
and outstanding 12,877,692 and
11,510,800........................... 129 115
Paid in capital in excess of par value.. 37,904 27,574
Treasury stock of 10,808 shares......... (74) -
Retained earnings....................... 5,649 4,899
-------- --------
Total stockholders' equity............ 43,608 32,588
-------- --------
$191,320 $144,600
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-20
<PAGE>
QUICKSILVER RESOURCES INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Nine Months Ended September 30, 1999 and 1998
In thousands, except for per share data
<TABLE>
<CAPTION>
1999 1998
------- -------
(unaudited)
<S> <C> <C>
REVENUE
Gas sales................................................... $26,763 $27,360
Oil sales................................................... 6,708 5,222
Other income................................................ 3,247 2,281
------- -------
Total revenues............................................ 36,718 34,863
------- -------
EXPENSES
Operating expenses.......................................... 15,214 13,439
Depletion and depreciation.................................. 10,110 9,375
Provision for doubtful accounts............................. 1,350 -
General and administrative.................................. 2,733 1,075
Interest.................................................... 6,324 4,951
------- -------
Total expenses............................................ 35,731 28,840
------- -------
Income before income taxes and minority interest.............. 987 6,023
Minority interest in net loss of MSR Exploration Ltd.......... 141 583
------- -------
Income before income taxes.................................... 1,128 6,606
Income taxes.................................................. 378 2,062
------- -------
Net income.................................................... 750 $ 4,544
======= =======
Basic and diluted earnings per share.......................... $ 0.06 $ 0.39
======= =======
Basic and diluted weighted average number of shares
outstanding for the periods.................................. 12,578 11,511
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-21
<PAGE>
QUICKSILVER RESOURCES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 1999 and 1998
In thousands
<TABLE>
<CAPTION>
1999 1998
-------- --------
(unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net income........................................... $ 750 $ 4,544
Charges and credits to net income not affecting cash
Depletion and depreciation......................... 10,110 9,375
Deferred income taxes.............................. 378 2,412
Recognition of unearned revenue.................... (538) (994)
Minority interest in loss of subsidiary............ (141) (583)
Amortization of deferred loan costs................ 258 75
Provision for doubtful accounts.................... 1,350 -
Charges in assets and liabilities
Accounts receivable................................ (4,956) (5,591)
Inventory, prepaid expenses and other.............. (77) (48)
Accounts payable................................... 3,685 5,497
Accrued liabilities................................ 996 1,408
-------- --------
NET CASH FROM OPERATING ACTIVITIES..................... 11,815 16,095
-------- --------
INVESTING ACTIVITIES
Acquisition of properties and equipment.............. (36,659) (13,601)
Acquisition of pipeline and facilities............... (3,089) -
-------- --------
NET CASH USED FOR INVESTING ACTIVITIES................. (39,748) (13,601)
-------- --------
FINANCING ACTIVITIES
Notes payable, bank proceeds......................... 35,339 6,850
Principal payments on long-term debt................. (3,304) (8,731)
Payments to acquire treasury stock................... (74) -
Deferred financing costs............................. (800) (600)
Stock registration fees.............................. (348) -
-------- --------
NET CASH FROM (USED FOR) FINANCING ACTIVITIES.......... 30,813 (2,481)
-------- --------
NET INCREASE IN CASH................................... 2,880 13
CASH AT BEGINNING OF PERIOD............................ 294 643
-------- --------
CASH AT END OF PERIOD.................................. $ 3,174 $ 656
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash payments for interest expense................... $ 5,245 $ 3,503
======== ========
Cash payments for income taxes....................... $ - $ -
Common stock of 1,377,000 shares used for acquisition
of minority interest in MSR......................... $ 10,327 $ -
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-22
<PAGE>
QUICKSILVER RESOURCES INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
For the Nine Months ended September 30, 1999 and 1998
1. Accounting Policies and Disclosures
In the opinion of management of Quicksilver Resources Inc. (Quicksilver or
the "Company"), the Company's Condensed Consolidated Financial Statements
contain all adjustments (consisting of only normal, recurring accruals)
necessary to present fairly the financial position of the Company as of
September 30, 1999, and the results of operations and cash flows for the nine
months ended September 30, 1999, and September 30, 1998.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Form 10-K for the year ended December 31, 1998. The
results of operations for the nine months ended September 30, 1999, are not
necessarily indicative of the operating results to be expected for the full
fiscal year.
Certain reclassifications have been made for presentation adopted in 1999.
In June 1999, the Company reclassified marketing and operating costs to
operating expense. These costs were previously reported as deductions from
revenue. All prior periods have been reclassified.
2. Recent Developments
On October 18, 1999 the Company announced it had filed a registration
statement with the Securities and Exchange Commission relating to a public
offering of 7,000,000 shares of common stock to be sold by the Company, plus an
additional 1,050,000 shares that will be subject to an option granted by the
Company to the underwriters to cover any over-allotments. Proceeds from the
sale of common stock will be used to repay a portion of existing debt.
3. Mergers and Acquisitions
Merger of MSR Exploration Ltd. with and into Quicksilver
On March 4, 1999, Quicksilver completed a merger with MSR Exploration Ltd.
(the "MSR Merger"). Accounting Principles Board Opinion (APB) No. 16 provides
that exchanges or transfers of net assets between companies under common
control be accounted for at historical cost in a manner similar to that of
pooling of interest accounting. Furthermore, APB 16 indicates that the purchase
method of accounting should be used if the effect of a transfer or exchange is
to acquire all of the outstanding shares held by minority interests. Prior to
the merger Quicksilver Energy, L.C., Mercury Exploration Company, and the
principal stockholders of Mercury Exploration Company, comprised of the Darden
family (the "Mercury Group"), controlled Quicksilver through their approximate
74% ownership of Quicksilver. The Mercury Group was considered to control MSR
because the Mercury Group and two other individuals affiliated with Mercury
owned approximately 46.5% of MSR's common stock, controlled the executive
committee of MSR's board of directors, and held warrants to purchase 11 million
shares of MSR common stock. Accordingly, Quicksilver was considered the
"accounting acquirer" in the MSR Merger, and MSR was considered as having
transferred approximately 46.5% of MSR's net assets to Quicksilver at
historical cost. The remainder of MSR's net assets, the approximate 53.5%
related to minority interests, was valued and recorded by Quicksilver based on
the purchase method of accounting in March 1999. The minority interest
reflected on the Company's December 31, 1998 balance sheet and statements of
operations is approximately 53.5% of MSR's net assets and results of operations
for the periods prior to March 4, 1999. Although the merger did not occur until
1999, MSR's financial statements as of December 31, 1998, and September 30,
1998, have been combined with the Company's since the entities were under
common control.
F-23
<PAGE>
QUICKSILVER RESOURCES INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)--(Continued)
For the Nine Months ended September 30, 1999 and 1998
The MSR Merger qualified as a tax-free exchange. In connection with the
merger, the Company issued 2,577,700 shares of its common stock in exchange for
all of the outstanding common stock of MSR based on a conversion ratio of one
share of the Company's common stock for ten shares of MSR common stock (the
merger exchange ratio). MSR's outstanding common stock options and warrants
were converted into Quicksilver common stock options and warrants to purchase
approximately 24,857 shares and 1,133,750 shares, respectively.
Unocal Property Acquisition
On May 17, 1999, the Company and Union Oil Company of California ("Unocal")
completed the previously announced purchase by the Company from Unocal of
substantially all of Unocal's natural gas and crude oil assets in Michigan.
The assets purchased, consisting of ownership interests in the Garfield unit
and the Beaver Creek unit, include approximately 20,000 net leasehold acres and
about 13,000 Mcfe production per day. Quicksilver's ownership in Garfield
increased to 99% from 54%.
The purchase price for the Unocal acquisition consisted of $27 million in
cash, subject to certain adjustments, which resulted in a final purchase price
of $25.8 million cash and 404,381 unregistered shares of the Company's common
stock. The stock component of the purchase price was placed in escrow and will
be distributed to Unocal over a three-year period, subject to downward
adjustment in correlation to certain costs, expenses, and liabilities which may
be incurred during this period. The purchase price was determined in an arms
length negotiation with Unocal following a competitive bid process. The Company
financed the cash portion of the purchase price with borrowings under a bank
credit facility, which permits the Company to obtain revolving credit loans and
to issue letters of credit from time to time in an aggregate amount not to
exceed the lesser of a borrowing base limitation or $200 million. Lenders under
the bank credit facility include Bank of America, Frost National Bank, and
Paribas.
Beaver Creek Pipeline Acquisition
On June 23, 1999 the Company together with Mercury Michigan, Inc., an
affiliate of the Company's largest stockholder, formed Beaver Creek Pipeline,
L.L.C. to acquire the Beaver Creek Pipeline, a 125-mile natural gas pipeline
extending from the Beaver Creek field in northern Michigan to Midland,
Michigan. The Company invested $2,644,000 for its 50% interest in Beaver Creek
Pipeline, L.L.C.
MGV Energy Acquisition
On August 26, 1999 the Company purchased an 89.5% interest in MGV Energy,
Inc., which is a Calgary-based natural gas production company, for $1.6
million. MGV is involved in a joint venture relationship with Pan Canadian, one
of the largest independent oil and gas companies in Canada. Under the
arrangement, MGV identifies acquisition and development prospects for Pan
Canadian within a 36,000 square mile area of mutual interest in southern
Alberta. Should Pan Canadian decide to acquire a submitted prospect, MGV has a
right to participate in the acquisition at up to a 20% level. MGV is free to
pursue on its own any prospects outside of the area of mutual interest and also
may take 100% of any prospect within the area of mutual interest which Pan
Canadian rejects. MGV recently made its first acquisition of an interest in 375
existing wells in southern Alberta, Canada, incurring approximately $2.1
million of debt to finance its purchase. MGV acquired daily net production of
1.2 Mmcf of natural gas and 10.1 Bcf of proved reserves.
F-24
<PAGE>
QUICKSILVER RESOURCES INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)--(Continued)
For the Nine Months ended September 30, 1999 and 1998
4. Long-Term Debt
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------ -----------------
(unaudited)
<S> <C> <C>
Long-term debt, in thousands,
consists of:
Notes payable to banks
(8.315% at September 30, 1999 and
7.1% at December 31, 1998)......... $ 84,850 $84,841
(7.515% at September 30, 1999...... 28,000 -
(8.25% at September 30, 1999....... 2,000 -
(7.0% at September 30, 1999)....... 2,108 -
Various loans........................ 116 198
-------- -------
117,074 85,039
Less current maturities.............. (14) (67)
-------- -------
$117,060 $84,972
======== =======
</TABLE>
Long-term debt maturities are as follows, in thousands of dollars:
<TABLE>
<CAPTION>
Periods Ending September 30, 1999 December 31, 1998
-------------- ------------------ -----------------
(unaudited)
<S> <C> <C>
1999.................................... $ 6 $ 67
2000.................................... 8 20
2001.................................... - 20
2002.................................... - 4
2003.................................... - 4
Thereafter.............................. 117,060 84,924
-------- -------
$117,074 $85,039
======== =======
</TABLE>
As part of the merger of the Company with MSR on March 4, 1999, the Company
entered into a new five year credit facility agreement ("Credit Facility"). The
existing debt of $73,993,000 and $10,848,000 from, respectively, Quicksilver
and MSR was transferred into the new Credit Facility. The Credit Facility
permits the Company to obtain revolving credit loans and to issue letters of
credit for the account of the Company from time to time in an aggregate amount
not to exceed the lesser of $200 million on the Borrowing Base. Under an
amendment to the Credit Facility dated May 17, 1999 the Borrowing Base is $115
million at September 30, 1999 and is subject to semi-annual determination and
certain other redeterminations based upon a variety of factors, including the
discounted present value of estimated future net cash flow from the Company's
natural gas and crude oil production. On December 1, 1999 the Borrowing Base
will be revised and the Company could be required to repay up to $20,000,000 of
the outstanding balance. As of September 30, 1999, $114,850,000 was outstanding
under the Credit Facility. At the Company's option, loans may be prepaid, and
revolving credit commitments may be reduced in whole or in part at any time in
certain minimum amounts. The Company can designate the interest rate on amounts
outstanding at either the London Interbank Offered Rate (LIBOR) + 2.375%, or at
bank prime rate. On September 7, 1999 the Company designated its interest rate
for six months at 8.315% for $84,850,000 of the debt. An additional $28,000,000
was designated in at 7.515% through November 16, 1999. The collateral for the
Credit Facility consists of substantially all of the existing assets of the
Company and any future reserves acquired. The loan agreement contains certain
dividend restrictions and restrictive covenants, which, among other things,
require the maintenance of a minimum current ratio. The Company currently is in
compliance with all such restrictions.
F-25
<PAGE>
QUICKSILVER RESOURCES INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)--(Continued)
For the Nine Months ended September 30, 1999 and 1998
MGV (see note 3) incurred US$2,108,000 in debt in the acquisition of the
Monogram Unit in August 1999. The interest rate is 0.75% over Canadian Imperial
Bank of Commerce ("CIBC") prime.
5. Unearned Revenues
The Quicksilver properties include certain properties which carry IRS code
Section 29 income tax benefits. Code Section 29 allows a credit against regular
federal income tax liability for certain eligible natural gas production.
During 1997, these credits were conveyed through the sale of the working
interests to a bank. The agreement with the bank provided that the Company
would receive cash payment for future production on the properties and payment
for a portion of the tax credits taken by the bank. The agreement included a
fixed payment note which provides for the Company to receive a minimum of
approximately $7 million plus interest for the future production on the
properties. A portion of the initial cash payment represented an advance
payment for the first eighteen months of tax benefits. As of September 30,
1999, and December 31, 1998, a balance of $800,000 and $1,338,000,
respectively, in unearned revenues existed as a result of the cash
consideration received in excess of the tax benefit earned. Such amounts are
included in other long-term liabilities.
6. Stockholders' Equity
The Company is authorized to issue 40 million shares of common stock with a
par value of one cent ($0.01) and 10 million shares of preferred stock with a
par value of one cent ($0.01).
As part of the merger with MSR, the Company agreed to exchange one share of
its common stock for each ten shares of MSR common stock. To provide for the
desired percentage ownership in the Company by the former MSR stockholders, the
founding stockholders of the Company were issued an additional 10,210,800
shares, prior to the merger, in the form of a stock dividend. Upon completion
of the merger, the founding stockholders owned 10,310,800 (80%) of the shares
of the Company and former MSR stockholders owned approximately 2,577,700 (20%)
of the common shares of the Company. A total of 1,200,000 shares of MSR common
stock were held under common control, and 1,377,700 shares were held by
minority stockholders. All references to numbers of shares and per share
amounts in the financial statements dated prior to the effective date of the
merger, March 4, 1999, have been restated to reflect the stock dividend plus
1,200,000 shares held under common control or a total of 11,510,800 common
shares.
The Company now has 12,877,692 shares of common stock outstanding. As part
of the Unocal Property addition, the Company placed 404,381 unregistered shares
in escrow (see note 2 and 7). Outstanding options and warrants for MSR stock
were converted into options and warrants to purchase Company common stock as
part of the MSR Merger. As a result of the merger, the Company has outstanding
warrants to purchase common stock of 550,000 shares at $12.50 per share,
550,000 shares at $20.00 per share, 28,000 shares at $33.75 per share, and
5,750 shares at $0.10 per share, and options to purchase 24,857 shares of
common stock at $8.75 per share. The warrant to acquire 5,750 shares at $0.10
per share expires on October 31, 2002 and is exercisable only after the closing
price per share of the Company's common stock on the American Stock Exchange
reaches $10.00. Such options and warrants are anti-dilutive at September 30,
1999 and therefore are not included in earnings per share.
7. Contingencies
The Company's customers are large natural gas and crude oil purchasers. The
Company does not generally require collateral, and receivables are usually due
and collected in 30 to 60 days. On March 10, 1999, one of
F-26
<PAGE>
QUICKSILVER RESOURCES INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)--(Continued)
For the Nine Months ended September 30, 1999 and 1998
the Company's natural gas purchasers filed for protection under Chapter 11 of
the Federal Bankruptcy Code. Management considers a portion of the
approximately $2,450,000 account receivable associated with this purchaser to
be uncollectible; accordingly, an allowance for doubtful accounts of $1,350,000
was established in the first quarter and remains in place at September 30,
1999. All contracts with that purchaser have been terminated, and the gas has
been recontracted with a credit-worthy purchaser. The Company believes that
based on information currently available regarding the bankruptcy proceeding,
the net receivable will be recovered.
In connection with the purchase of certain properties from Unocal (see note
2), the Company placed 404,381 unregistered shares of Company common stock in
escrow. These shares will be distributed to Unocal over a three-year period,
subject to downward adjustment pending the resolution of certain contingencies.
Such shares, which are not considered outstanding at September 30, 1999, will
become outstanding as they are distributed following the resolution of the
contingencies.
F-27
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
MSR Exploration Ltd. and Subsidiaries
Fort Worth, Texas
We have audited the accompanying consolidated balance sheet of MSR
Exploration Ltd. and subsidiaries (the Company) as of December 31, 1997, and
the related consolidated statement of operations, stockholders' equity and cash
flows for the period from inception March 7, 1997 to December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit 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 misstatement. 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 audit provides a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of the Company as of December 31,
1997, and the results of its operations and its cash flows for the period from
inception March 7, 1997 to December 31, 1997, in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Fort Worth, Texas
March 25, 1998
(December 18, 1998 as to Note 12)
F-28
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31, 1997
<TABLE>
<S> <C>
ASSETS
Cash and cash equivalents....................................... $ 528,000
Time deposits................................................... 59,000
Accounts receivable............................................. 507,000
Inventories..................................................... 248,000
Prepaid expenses................................................ 32,000
-----------
Total current assets.......................................... 1,374,000
PROPERTIES, PLANT AND EQUIPMENT--NET ("full cost")................ 24,234,000
OTHER ASSETS...................................................... 355,000
-----------
LIABILITIES AND STOCKHOLDERS' EQUITY $25,963,000
===========
CURRENT LIABILITIES
Current portion of long-term debt............................... $ 88,000
Accounts payable................................................ 652,000
Accrued liabilities............................................. 592,000
-----------
Total current liabilities..................................... 1,332,000
-----------
LONG-TERM DEBT.................................................... 10,560,000
-----------
DEFERRED INCOME TAXES............................................. 1,001,000
STOCKHOLDERS' EQUITY
Common stock, $0.01 par value
Authorized 50,000,000 shares, issued and outstanding
25,777,014................................................... 258,000
Paid in capital in excess of par value.......................... 12,812,000
Foreign currency translation adjustment......................... (30,000)
Retained earnings............................................... 30,000
-----------
13,070,000
-----------
$25,963,000
===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-29
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
For the Period from Inception, March 7, 1997 to
December 31, 1997
<TABLE>
<S> <C>
REVENUE
Oil sales...................................................... $ 257,000
Gas sales...................................................... 570,000
Interest and other income...................................... 27,000
-----------
Total revenues............................................... 854,000
-----------
EXPENSES
Operating expenses............................................. 228,000
Production taxes............................................... 68,000
Depletion and depreciation..................................... 220,000
General and administrative..................................... 146,000
Interest....................................................... 147,000
-----------
Total expenses............................................... 809,000
-----------
Income before income taxes....................................... 45,000
Income tax (expense) benefit..................................... (15,000)
-----------
Net income..................................................... $ 30,000
===========
Basic and diluted earnings per share............................. $ -
===========
Basic weighted average number of shares outstanding for the
period.......................................................... 14,801,000
===========
Diluted weighted average number of shares outstanding for the
period.......................................................... 14,838,000
===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-30
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the Period from Inception, March 7, 1997 to
December 31, 1997
<TABLE>
<CAPTION>
Cumulative
Paid in Foreign Total
Common Stock Capital Currency Stock-
------------------- in Excess Translation Retained holders'
Shares Amount of Par Adjustment Earnings Equity
---------- -------- ----------- ----------- -------- -----------
<S> <C> <C> <C> <C> <C> <C>
Inception March 7, 1997
Issuance of shares in
exchange for oil and
gas properties....... 12,000,000 $120,000 $ 337,000 $ - $ - $ 457,000
Merger--Issuance of
shares in exchange for
Old MSR shares (Note
1)..................... 13,777,014 138,000 12,400,000 12,538,000
Warrants payable--60,000
warrants issued in
payment of bank
commitment fee......... 75,000 75,000
Translation
adjustments............ (30,000) (30,000)
Net income.............. 30,000 30,000
---------- -------- ----------- -------- ------- -----------
Balance at December 31,
1997................... 25,777,014 $258,000 $12,812,000 $(30,000) $30,000 $13,070,000
========== ======== =========== ======== ======= ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-31
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Period from Inception, March 7, 1997 to December 31, 1997
<TABLE>
<S> <C>
OPERATING ACTIVITIES
Net income....................................................... $ 30,000
Charges and credits to net loss not affecting cash
Depletion and depreciation..................................... 220,000
Deferred income taxes.......................................... 15,000
Changes in assets and liabilities
Receivables.................................................... 236,000
Inventories and prepaid expenses............................... (22,000)
Accounts payable and accrued liabilities....................... (153,000)
-----------
NET CASH FROM (USED FOR) OPERATING ACTIVITIES...................... 326,000
-----------
INVESTING ACTIVITIES
Property, plant and equipment expenditures....................... (592,000)
Cash received in merger.......................................... 350,000
Change in cumulative foreign currency translation................ (30,000)
-----------
NET CASH FROM (USED FOR) INVESTING ACTIVITIES...................... (272,000)
-----------
FINANCING ACTIVITIES
Principal payments on long-term debt............................. 10,575,000
Proceeds from debt borrowings.................................... (10,040,000)
Payment of financing costs....................................... (61,000)
-----------
NET CASH FROM (USED FOR) FINANCING ACTIVITIES...................... 474,000
-----------
CASH AT END OF PERIOD.............................................. $ 528,000
===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-32
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
MSR Exploration Ltd. (the Company), and its wholly owned subsidiaries. The
Company's consolidated financial statements include the operations of the
Company from its inception on March 7, 1997 and Old MSR's operations since
October 31, 1997, the effective date of the Merger. All significant inter-
company transactions and balances have been eliminated in consolidation.
Principal Business Activity and Merger
MSR Exploration Ltd. ( "the Company"), formerly Mercury Montana, Inc., was
organized on March 7, 1997, under the laws of the State of Delaware for the
purpose of acquiring from Mercury Exploration Company (Mercury) and thereafter
exploring, developing and operating all of the Company's oil and natural gas
properties located in Montana (the "Mercury Properties"). Upon formation of the
Company, Mercury conveyed to the Company the Mercury Properties and associated
debt in exchange for a majority of the then outstanding Company common stock
and warrants to purchase additional shares of Company common stock. Certain
directors, officers and agents of Mercury also conveyed to the Company certain
contractual rights in the Mercury Properties in exchange for shares of Company
common stock and warrants. The Mercury Properties included approximately 75
crude oil producing wells which were subject to a prior production payment,
forward-sale agreement between Mercury and a third party covering a period from
October 1996 through December 1997. The agreement was the obligation of
Mercury; consequently the oil revenue and associated expenses from these
properties belonged to Mercury through December 31, 1997, and started accruing
to the Company on January 1, 1998.
On March 26, 1997, MSR Exploration Ltd., ("Old MSR") , an Alberta, Canada
corporation, entered into an agreement with the Company, then known as Mercury
Montana, Inc. and its majority shareholder at that time, Mercury, both of Fort
Worth, Texas, to combine all of the Company's oil and gas assets in Montana
with all the oil and gas assets of Old MSR by way of a merger of the Company
and Old MSR. The Company was the surviving corporation in the merger and
changed its name to MSR Exploration Ltd. after the merger was effective. The
merger was accounted for under the purchase method of accounting.
At a combined Annual, General and Special Meeting of Shareholders of the Old
MSR held on October 30, 1997, the shareholders elected directors and approved
the domestication or continuance of Old MSR from Alberta, Canada to Delaware,
U.S.A. The domestication of Old MSR into Delaware was required for the merger
to become effective. The merger was subsequently approved on October 31, 1997,
by written consent of the stockholders of Old MSR.
As part of the merger, the Company issued to Old MSR shareholders one share
of common stock of the Company for each of the 13,777,014 outstanding shares of
Old MSR common stock. Each of the 12,000,000 shares of common stock of the
Company outstanding prior to the merger remained outstanding. The combined
total number of outstanding shares is 25,777,014. All such shares are listed
for trading on the American Stock Exchange. In addition, the Company paid $4
million of Mercury Exploration Company bank debt. Outstanding warrants to
purchase 5.5 million shares of common stock of the Company at $1.25 per share
and 5.5 million shares at $2.00 per share also remained outstanding after the
merger, as did Company stock options to purchase an aggregate of 228,570 shares
of Company common stock at $0.875 per share granted in lieu of salaries. An
outstanding warrant to purchase 280,000 shares of common stock of the Old MSR
at $3.375 per share was converted to an equivalent right to acquire shares of
the Company.
F-33
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Three members of Old MSR's Board of Directors, Otto J. Buis, Patrick M.
Montalban and Steven M. Morris, together with two independent directors, D.
Randall Kent and W. Yandell Rogers, III, were elected to the Board of Directors
of Old MSR at its October 30, 1997 meeting. With the completion of the merger,
Messrs. Buis, Montalban, Morris, Kent and Rogers became directors of the
Company joined by Frank Darden, Thomas F. Darden and Glenn M. Darden, the
directors of the Company prior to the merger and also directors of Mercury.
On October 31, 1997, the Company restructured the Old MSR's revolving credit
facility and entered into a new credit agreement with a bank. The closing of
the loan was subject to the successful completion of the Company's merger with
Old MSR. The new agreement is for a $25,000,000 senior secured revolving credit
facility with an initial borrowing base of $12,000,000, which matures in five
years.
U.S. Dollar Reporting
The majority of the Company's business is transacted in U.S. dollars and,
accordingly, the consolidated financial statements are expressed in that
currency.
Accounts Receivable
The Company's customers are large oil and natural gas purchasers. The
Company does not require collateral, and receivables are generally due in 30-60
days. Management considers all accounts receivable current and collectible;
accordingly, no allowance for doubtful accounts has been established.
Major Customers
For the period from inception March 7, 1997 to December 31, 1997, three
purchasers, Rio Vista Energy, Ltd., Montana Power Company, and J.N. Petroleum
Marketing, Inc., accounted for approximately 42%, 22% and 11%, respectively of
the Company's total consolidated oil and gas sales. The Company has a contract
with Montana Power Company which expires January 1, 2004 to sell all gas
processed through one of the company's gas plants. Gas prices are re-determined
each January during the contract term. The Company does not anticipate that the
loss of any of its present purchasers would adversely effect the Company's
consolidated business. The Company also believes that, in the event of a loss
of a present purchaser, other oil and gas purchasers located in the Company's
areas of production would offer competitive prices for such production.
Inventories
Inventories are valued at the lower of cost (first-in, first-out method) or
market and consist of crude oil in tanks and well equipment spares and
supplies.
Properties, Plant and Equipment
The Company follows the "full cost" method of accounting for oil and gas
properties whereby all costs associated with acquiring, exploring for, and
developing oil and gas reserves are capitalized and accumulated in cost centers
established on a country-by-country basis. Such costs include land acquisition
costs, geological and geophysical expenses, carrying charges on non-producing
properties, costs of drilling both productive and non-productive wells, and
overhead charges directly related to acquisition, exploration and development
activities.
The capitalized costs related to each cost center, including the estimated
future costs to develop proved reserves and the costs of production equipment,
are amortized using the unit-of-production method based on the estimated net
proved reserves as determined by independent petroleum engineers. Investments
in unproved
F-34
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
properties are not amortized until proven reserves associated with them can be
determined or until impairment occurs. Oil and natural gas reserves and
production are converted into equivalent units based upon estimated relative
energy content.
The capitalized costs less accumulated depletion and depreciation in each
cost center are limited to an amount equal to the estimated future net revenue
from proved reserves discounted at a 10% interest rate (based on prices and
costs at the balance sheet date) plus the lower of cost (net of impairments) or
fair market value of unproved properties.
Proceeds from the sale of oil and gas properties are applied against
capitalized costs, with no gain or loss recognized, unless such a sale would
significantly alter the relationship between capitalized costs and proved
reserves of oil and gas, in which case the gain or loss is recognized in
income.
Other plant and equipment are depreciated on the straight-line basis as
follows:
Gas processing plants and gathering systems--over eight years
Other equipment--over three to seven years
Potential impairment of producing properties and significant unproved
properties and other plant and equipment are assessed annually (unless economic
events warrant more frequent reviews). In addition, a quarterly impairment
analysis of aggregated properties is performed by the Company using discounted
future net cash flows determined based upon current prices and costs.
Revenue Recognition
The Company recognizes revenue as quantities of oil and gas sold or volumes
of gas transported, and utilizes the entitlement method of accounting for oil
and gas imbalances. Under this method, the Company recognizes revenue for its
proportionate share of volumes sold. Any over-produced amount is recorded as
deferred revenue and any under-produced amount is recorded as current revenue
and revenue receivable. The Company had no significant over or under-produced
positions as of December 31, 1997.
Environmental Compliance and Remediation
Environmental compliance costs, including on going maintenance and
monitoring, are expensed as incurred. Environmental remediation costs, which
improve the condition of a property, are capitalized.
Deferred Charges
Financing charges related to the acquisition of debt are deferred and
amortized over the term of that debt using the effective interest method.
Foreign Currency Translation
The functional currency for the Company's foreign operations is the
applicable local currency; therefore, translation is performed for balance
sheet accounts using current exchange rates in effect at the balance sheet
date, and for revenue and expense accounts using a weighted average exchange
rate for the year.
F-35
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Joint Venture Operations
Certain of the Company's exploration and development activities relating to
oil and gas are conducted jointly with others. The accompanying financial
statements reflect only the Company's proportionate interest in such
activities.
Income Taxes
Income taxes provide for the tax effects of transactions reported in the
financial statements and consist of taxes currently due plus deferred taxes
related primarily to differences between the basis of properties, plant and
equipment for financial and income tax reporting. The deferred tax assets and
liabilities represent the future tax return consequences of those differences,
which will either be taxable or deductible when the assets and liabilities are
recovered or settled.
Earnings per Share
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share"
("EPS") which established new standards for computing and presenting EPS. SFAS
No. 128 replaced the presentation of primary EPS with a presentation of basic
EPS. Basic EPS excludes dilution and is computed by dividing income available
to common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. The diluted weighted average number
of shares outstanding includes 16,000 shares for the period attributable to the
assumed exercise of dilutive common stock options. Earnings per share amounts
for 1997 have been presented to conform to the SFAS No. 128 requirements.
Cash Equivalents and Time Deposits
The Company considers all highly liquid investments purchased with a
maturity of three months or less to be cash equivalents. Investments with an
original maturity in excess of three months are considered to be time deposits.
Stock-Based Compensation
Compensation expense is recorded with respect to stock option grants to
employees using the intrinsic value method prescribed by Accounting Principles
Board Opinion No. 25. The Company has not elected the fair value method of
accounting for stock-based compensation encouraged, but not required, by
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-
Based Compensation."
Disclosure of Fair Value of Financial Instruments
The Company's financial instruments include cash, time deposits, accounts
receivable, notes payable, accounts payable and long-term debt. The Company
estimates that the carrying amount of these items is a reasonable estimate of
their fair value.
Accounting Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-36
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Recently Issued Accounting Standards
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of general
purpose statements. It requires (a) classification of items of other
comprehensive income by their nature in a financial statement and (b) display
of the accumulated balance of other comprehensive income separate from retained
earnings and additional paid-in surplus in the equity section of the statement
of financial position. The Company plans to adopt SFAS No. 130 for the quarter
ended March 31, 1998.
2. Production Payment/Forward Sale of Oil
The Mercury Properties contributed to the Company by Mercury, upon its
inception, were subject to a production payment. Mercury and Supply Development
Group, Inc. (SDG) entered into a Production Payment Agreement in October 1996.
Pursuant to the agreement SDG was entitled to an aggregate of 320,000 barrels
of oil produced from certain properties of Mercury, including the Mercury
Properties. Mercury could satisfy this obligation by delivering to SDG proceeds
from the sale of oil produced rather than delivering the oil "in kind", unless
SDG elected to take oil "in kind". Pursuant to the Merger Agreement among the
Company, Old MSR, and Mercury dated as of March 26, 1997, as amended, Mercury
was entitled to all of the oil revenue and income attributable to the Mercury
Properties until the Production Payment Amount had been delivered to SDG;
provided that Mercury must reimburse the Company for all costs and expenses of
oil production. Mercury's obligation to SDG was satisfied on December 31, 1997.
No amounts associated with the Production Payment Agreement are reflected in
the Company's financial statements, as the Production Payment Agreement was an
obligation of Mercury.
3. Pro Forma Condensed Consolidated Data
The following pro forma condensed consolidated data for the years ended
December 31, 1997 and 1996 are presented as if the merger of the Company with
Old MSR had been consummated on January 1, 1996, which includes adjustments to
Old MSR. The Company's revenue and expenses subject to a prior forward sale
were excluded from the Company's statements of operations and from this pro
forma data. Oil revenues and direct operating expenses subject to the forward
sale for 1997 were approximately $2,180,000 and $1,536,000 respectively, and
for 1996 were approximately $689,000 of revenues and $308,000 of associated
expenses. For 1996 the oil revenues and associated expenses subject to the
forward sale relate to the final three months of 1996. Revenues and expenses
associated with the forward sale began to accrue to the Company on January 1,
1998.
F-37
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In thousands except for per share amounts
<TABLE>
<CAPTION>
January 1
To From Inception
March 6 March 7 to
Predecessor December 31 Pro Forma
1997 Historical Historical Unaudited
- ---- ----------- -------------- ---------
<S> <C> <C> <C>
Revenue.................................. $ 57 $ 854 $4,454
Expenses................................. 31 824 4,604
------ ------ ------
Net income (loss)........................ $ 26 $ 30 $ (150)
====== ====== ======
Basic and diluted earnings (loss) per
share................................... $ - $ - $(0.01)
====== ====== ======
Weighted average number of shares
outstanding............................. 12,000 12,000 25,777
====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
Predecessor Pro Forma
1996 Historical Unaudited
- ---- ----------- ---------
<S> <C> <C>
Revenue................................................... $ 2,070 $6,446
Expenses.................................................. 1,188 6,512
------- ------
Net income (loss)....................................... $ 882 $ (66)
======= ======
Basic and diluted earnings (loss) per share............... $ -
=======
Weighted average number of shares outstanding............. $12,000
=======
</TABLE>
4. Bankruptcy
On February 2, 1992, Old MSR filed for bankruptcy protection under Chapter
11 of the U.S. Bankruptcy Code. Old MSR elected to voluntarily file for
bankruptcy primarily due to its substantial net losses and its inability to
negotiate an agreeable restructuring of indebtedness with its then primary
lender.
On September 12, 1992, Old MSR filed a plan of reorganization with the
Bankruptcy Court which was subsequently amended on December 11, 1992 and March
2, 1993, to reflect agreements between Old MSR and its creditors. As of
December 31, 1997, the remaining amounts due to these creditors totaled
$150,500.
5. Properties Plant and Equipment
Capitalized costs at December 31, 1997, are shown below in thousands.
<TABLE>
<S> <C>
Proved oil and gas properties....................................... $39,930
Unproved oil and gas interests...................................... 847
Accumulated depletion and depreciation.............................. (17,917)
-------
22,860
-------
Gas processing plants and gathering systems......................... 3,851
Other equipment..................................................... 830
Accumulated depreciation............................................ (3,307)
-------
1,374
-------
$24,234
=======
</TABLE>
F-38
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Other Assets
Other assets included deferred charges related to the acquisition of long-
term debt (amortized over the life of that debt using the effective interest
method) and restricted cash (held in a letter of credit in lieu of a plugging
and abandonment bond required by the U.S. Environmental Protection Agency).
Amounts presented in thousands.
<TABLE>
<CAPTION>
1997
----
<S> <C>
Deferred loan cost..................................................... $118
Less accumulated amortization.......................................... (4)
----
Net deferred loan cost................................................. 114
Restricted cash........................................................ 241
----
Total other assets................................................... $355
====
</TABLE>
7. Note Payable and Long-Term Debt
<TABLE>
<CAPTION>
1997
-------
<S> <C>
Long-term debt, in thousands, consists of:
Note payable to a bank (7.6% at December 31, 1997)................. $10,498
Various pre-petition claims at interest rates ranging from 6% to
10%, due in monthly, quarterly and annual installments, including
interest.......................................................... 150
-------
10,648
Less current maturities............................................ (88)
-------
$10,560
=======
</TABLE>
Long-term debt maturities are as follows, in thousands of dollars:
<TABLE>
<CAPTION>
Years Ending December 31, Amount
------------------------- -------
<S> <C>
1998................................................................ $ 88
1999................................................................ 62
2000................................................................ -
2001................................................................ -
2002................................................................ 10,498
Thereafter.......................................................... -
-------
$10,648
=======
</TABLE>
As part of the formation of the Company on March 7, 1997, the Company agreed
to guarantee the repayment of $4.0 million of debt owed by Mercury Exploration
Company to a bank. On October 31, 1997, the Company restructured the Old MSR
revolving credit facility and entered into a new credit agreement with a bank.
Proceeds from the new facility were used to repay the $4.0 million of debt
guarantee by the Company and repay $6.0 million of debt owed by Old MSR. The
closing of the loan was subject to the successful completion of the Company's
merger with Old MSR. The new agreement is for a $25,000,000 senior secured
revolving credit facility with an initial borrowing base of $12,000,000, which
matures in five years. The Company can designate the interest rate on amounts
outstanding at either the London Interbank Offered Rate (LIBOR) + 1.75%, or
bank prime plus 1%. The collateral for this loan agreement consists of
substantially all of the existing assets of the Company and any future reserves
acquired. The loan agreement contains certain restrictive covenants, which,
among other things, require the maintenance of a minimum current ratio, net
worth, debt service ratio and contains certain dividend restrictions.
F-39
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets and liabilities as of December 31, 1997
are as follows in thousands:
<TABLE>
<CAPTION>
1997
------
<S> <C>
Deferred tax assets:
Operating loss carryforwards....................................... $2,301
Investment tax credits............................................. 171
------
Total deferred tax assets........................................ 2,472
Deferred tax liabilities:
Properties, plant and equipment.................................... 3,473
------
Total deferred tax liabilities................................... 3,473
------
Net deferred tax liabilities................................... $1,001
======
</TABLE>
The income tax expense for the period from inception March 7, 1997 to
December 31, 1997 was $15,000. This amount represents a deferred provision as
no current tax provision or benefit was realized. No valuation allowance is
required because the deferred tax assets will be used up by the reversal of the
deferred tax liabilities. As the deferred tax liabilities reverse and create
taxable income, the tax assets will offset this tax liability.
The Company has U.S. net operating loss carryforwards of approximately
$6,500,000 available to reduce future U.S. taxable income subject to certain
limitations. These U.S. net operating loss carryforwards begin to expire in
2001. The Company also has Canadian expense carryforwards totaling
approximately $2,000,000 available to reduce future Canadian taxable income.
These Canadian expense carryforwards have no expiration date. Use of these U.S.
and Canadian carryforwards is dependent on future taxable income.
9. Stockholders' Equity
The Company is authorized to issue 50,000,000 of common stock with a par
value of one cent ($0.01) and 10,000,000 shares of preferred stock with a par
value of one cent ($0.01). The Company currently has outstanding 25,777,014
shares of common stock, warrants to purchase additional shares of common stock,
5,500,000 shares at $1.25 per share, 5,500,000 shares at $2.00 per share, and
options to purchase 248,570 shares of common stock at $0.875 per share, and
common stock warrants for 280,000 shares at $3.375 per share, and 57,500 shares
at $0.01 per share.
As a result of the merger of Old MSR with and into the Company on October
31, 1997 pursuant to the terms of the Agreement and Plan of Merger, dated as of
March 26, 1997, as amended, among Old MSR, the Company and Mercury Exploration
Company, each outstanding share of common stock, no par value per share, of Old
MSR outstanding immediately prior to the effective time of the Merger, was
converted into the right to receive one share of common stock, par value $0.01
per share, of the Company. In accordance with Rule 12g-3(a) of the Securities
Exchange Act of 1934, as amended, the Company has succeeded to the obligations
of Old MSR under the Exchange Act and will continue to file reports with the
Securities and Exchange Commission using the Commission File Number (No. 1-
8523) utilized by its predecessor. In connection with the Merger, the Company
changed its name from Mercury Montana, Inc. to MSR Exploration Ltd.
F-40
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock Option Plan
The 1997 Stock Option Plan of the Company (the "Plan") was adopted by the
Board of Directors of the Company and approved by its shareholders and became
effective as of March 7, 1997. The Plan permits the granting of options to
purchase shares of the Company's common stock. All employees and directors of
the Company are eligible to participate in the Plan. An aggregate of 250,000
shares of the Company's common stock have been authorized and reserved for
issuance under the Plan. The Company's Board of Directors has increased the
authorized share to a total of 500,000 shares, subject to shareholder approval.
As of December 31, 1997, options to purchase an aggregate of 248,570 shares of
the Company's common stock have been granted under the Plan at an exercise
price of $0.875 per share. Options are totally vested when granted and must be
exercised within five years of the date of grant. The Company's Compensation
Committee of the Board of Directors determines who shall be granted options
under the Plan and the terms thereof, and administers the Plan. No options may
be granted under the Plan after March 7, 2007.
No compensation cost has been recognized at date of grant of the stock
options because the exercise price at date of grant was equal to the fair value
of the common stock at date of grant. Had compensation cost for the Company's
stock option plan been determined based on the fair value at the grant date for
awards under the plan, the Company's net income would have been reduced by
$62,000 for the period ended December 31, 1997. The fair value of the options
were calculated in accordance with the Black-Scholes option pricing model using
an expected volatility of 26%, expected option term of five years and a risk-
free rate of return of 6%. Pro forma basic and diluted earnings per share were
$0.00.
10. Related Party Transactions
On October 31, 1997, the Company and Mercury Exploration Company (Mercury)
have entered into a Management Agreement. Pursuant to the Agreement, Mercury
will be managing all of the operations of the Company's various oil and gas
properties and gas gathering and compression facilities located in Montana and
Texas. Mercury will also provide accounting, administrative, and advisory
services.
The Company agreed to reimburse Mercury for its costs and expenses incurred
in connection with managing such operations and pay a management fee equal to
10% of such costs and expenses. The term of the Management Agreement is for two
years and thereafter for successive one-year terms. At December 31, 1997 the
Company owed Mercury approximately $52,000 for payment of costs incurred on
behalf of the Company . No management fee has been paid or accrued for the
period ended December 31, 1997.
Mercury owns 6,480,000 shares of the Company's common stock and three of
Mercury's directors and officers--Frank Darden, Thomas Darden, and Glenn
Darden--are also directors and officers of the Company.
F-41
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
11. Supplemental Cash Flow Information
For the period from inception, March 7, 1997, to December 31, 1997, in
thousands:
<TABLE>
<CAPTION>
1997
-------
<S> <C>
Cash paid during the year:
Interest............................................................. $ 134
=======
Income taxes......................................................... $ -
=======
Non-cash financing activities
Purchase of the net assets of Old MSR by issuance of 13,777,014
shares of common stock. Amount includes assets totaling $20,034,000,
including cash of $350,000, and liabilities totaling $8,496,000,
including long-term debt of $6,114,000.............................. $12,538
=======
Consideration for financing costs by issuance of common stock
warrants............................................................ $ 75
=======
</TABLE>
12. Statements of Revenue and Direct Operating Expenses
<TABLE>
<CAPTION>
For the Period Twelve Months
From January 1 Ended
to March 6, December 31,
1997 1996
-------------- -------------
(in thousands)
<S> <C> <C>
Revenues
Oil sales...................................... $ - $1,855
Gas sales...................................... 57 215
--- ------
Total........................................ 57 2,070
--- ------
Direct operating expenses
Operating expenses............................. - 989
Production taxes............................... 7 199
--- ------
Total........................................ 7 1,188
--- ------
Excess of revenues over direct operating
expenses........................................ $50 $ 882
=== ======
</TABLE>
a. Basis of Presentation
Historical financial statements reflecting financial position, results of
operations and cash flows required by generally accepted accounting principles
are not presented for the period for January 1 to March 6, 1997, and for the
year ended December 31, 1996, as such information is neither readily available
on an individual property basis nor meaningful for the properties included in
the Merger. Accordingly, this statement of revenues and direct operating
expenses is presented in lieu of the financial statements required under Rule
3-05 of Securities and Exchange Commission Regulation S-X.
The accompanying statement of revenues and direct operating expenses
represent the Company's pre-Merger net ownership interest in the properties
included in the Merger and are presented on the full cost accrual basis of
accounting. Depreciation, depletion, and amortization, allocated general and
administrative expenses, interest expense, and income taxes have been excluded
because the property interests included in the Merger were from a newly formed
business, and the expenses incurred would not necessarily be indicative of the
expenses to be incurred by the Company after the Merger.
F-42
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
b. Forward Sale of Oil Revenues
The Mercury Properties were subject to a Production Payment Agreement
entered into in October 1996 between Mercury and a third party. The Agreement
was the obligation of Mercury and was for the period from October 1, 1996 to
December 31, 1997. The Company's oil revenues and associated operating expenses
included in the statements of revenues and direct operating expenses do not
include any amounts which were subject to the Agreement. The oil revenues and
associated expenses relating to the production payment forward sale started
accruing to the Company on January 1, 1998.
The oil revenues and associated expenses dedicated to the production payment
forward sale from October 1, 1996, through December 31, 1996 were excluded from
the Statement of Revenues and Direct Operating Expenses. Such amounts were also
excluded from the Company's statement of operations for the period from
Inception, March 7, 1997, to December 31, 1997. To provide information about
the Company for 1998 and beyond, revenues subject to the forward sales
agreement amounted to $689,000 for 1996. Direct operating expenses subject to
the sale were $308,000 for 1996.
DISCLOSURES ABOUT OIL AND GAS PRODUCING ACTIVITIES
(Unaudited)
The following information about the Company's oil and gas producing
activities has been prepared in accordance with Statement of Financial
Standards No. 69, Disclosures about Oil and Gas Producing Activities.
The Company believes that the valuation method prescribed by Statement of
Financial Standards No. 69 does not provide the best estimate of current
economic value of its oil and gas reserves as unproved reserves are not
attributed any economic value and the use of year end price assumptions and a
10% discount rate are arbitrary. The pro forma amounts for 1996 are presented
as if the Company had been in existence, owned the Mercury Properties, and had
been combined with Old MSR since January 1, 1996.
F-43
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Proved Oil and Gas Quantities
The following information summarizes the Company's estimated net quantities
of proved and proved-developed oil and gas reserves. The December 31, 1997 and
1996 end of year reserves are based on estimates of Citadel Engineering Ltd.,
petroleum consultants.
Year Ended December 31, 1997
<TABLE>
<CAPTION>
Oil Gas
------ ------
(Mbbl) (Mmcf)
<S> <C> <C>
Proved reserved
Beginning of year--pro forma............................... 5,281 1,339
Revisions of previous estimates............................ 686 332
Purchase of reserves in place--Old MSR..................... 3,646 19,870
Production................................................. (143) (322)
----- ------
End of year................................................ 9,470 21,219
===== ======
Proved developed reserves
Beginning of year--pro forma............................... 1,628 1,339
===== ======
End of year................................................ 4,412 16,484
===== ======
Year ended December 31, 1996--pro forma
<CAPTION>
Oil Gas
------ ------
(Mbbl) (Mmcf)
<S> <C> <C>
Proved reserves
Beginning of year.......................................... 5,291 1,401
Revisions of previous estimates............................ 120 25
Production................................................. (130) (87)
----- ------
End of year................................................ 5,281 1,339
===== ======
Proved developed reserves
Beginning of year.......................................... 1,638 1,401
===== ======
End of year................................................ 1,628 1,339
===== ======
</TABLE>
DISCLOSURES ABOUT OIL AND GAS PRODUCING ACTIVITIES
(Unaudited)
The following standardized measure of discounted future net cash flows
relating to proved oil and gas reserves has been computed using year end
prices, except where contractual arrangements in place at year end provide for
future price changes and costs, in thousands.
<TABLE>
<CAPTION>
As of December 31,
--------------------
1997 1996
--------- ---------
Pro Forma
<S> <C> <C>
Future cash flows...................................... $ 178,672 $ 119,585
Future production and development costs................ (70,242) (71,893)
Future income tax expense.............................. (25,474) (10,200)
--------- ---------
82,956 37,492
10% annual discount for timing of cash flows........... (44,581) (20,445)
--------- ---------
Standardized measure of discounted cash flows.......... $ 38,375 $ 17,047
========= =========
</TABLE>
F-44
<PAGE>
MSR EXPLORATION LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The standardized measure of discounted cash flows does not include any
value relating to the Company's gathering, processing, and transmission of gas
reserves owned by other companies. The following table sets out in aggregate
the principle source of change in the standardized measure of discounted
future net cash flows for the year ended December 31, 1997, in thousands.
<TABLE>
<CAPTION>
1997
-------
<S> <C>
Sales of oil and gas produced, net of production costs............. $ (531)
Net changes in price and production costs.......................... (5,628)
Purchase of reserves in place...................................... 20,817
Revisions of previous quantity estimates........................... 2,908
Development costs incurred during the year......................... 62
Accretion of discount.............................................. 1,705
Net change in income taxes......................................... 1,234
Other.............................................................. 761
-------
Net increase (decrease)............................................ 21,328
Balance at beginning of year--pro forma............................ 17,047
-------
Balance at end of year............................................. $38,375
=======
</TABLE>
Costs incurred in oil and gas property acquisition, exploration and
development activities, in thousands:
<TABLE>
<CAPTION>
Inception-
March 7, 1997 to Year Ended
December 31, December 31,
1997 1996
---------------- ------------
<S> <C> <C>
Property acquisition costs..................... $19,583 $ -
======= ===
Exploration costs.............................. $ 530 $ -
======= ===
Development costs.............................. $ 62 $84
======= ===
</TABLE>
Results of operations from producing activities, in thousands:
<TABLE>
<CAPTION>
Inception-
March 7, 1997 to Year Ended
December 31, December 31,
1997 1996
---------------- ------------
<S> <C> <C>
Oil and gas sales............................. $ 827 $ 2,070
Operating expenses............................ (228) (1,054)
Production taxes.............................. (68) (199)
Depletion and depreciation.................... (220) (273)
----- -------
311 544
Income taxes.................................. (106) (185)
----- -------
Results of operations from producing
activities (excluding corporate overhead and
interest costs).............................. $ 205 $ 359
===== =======
</TABLE>
F-45
<PAGE>
SELECTED QUARTERLY FINANCIAL DATA
(Unaudited)
The following table summarizes selected quarterly financial data for the
fourth quarter ended December 31, 1997.
<TABLE>
<CAPTION>
December 31,
1997
--------------
(in thousands)
<S> <C>
Revenue....................................................... $729
----
Net income (loss)............................................. $(19)
====
Basic and diluted earnings (loss) per share................... -
====
</TABLE>
F-46
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Stockholders
Mercury Exploration Company
Fort Worth, Texas
We have audited the accompanying consolidated balance sheets of Mercury
Exploration Company as of September 30, 1997 and 1996 and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended September 30, 1997. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements 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 misstatement. 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 Mercury
Exploration Company as of September 30, 1997 and 1996, and the results of its
operations and its cash flows for each of the three years in the period ended
September 30, 1997, in conformity with generally accepted accounting
principles.
As described in Note 13, the Company has changed its accounting policy for
accounting for oil and gas properties from the successful efforts method to the
full cost method.
Weaver and Tidwell, L.L.P.
Fort Worth, Texas
October 26, 1998
F-47
<PAGE>
MERCURY EXPLORATION COMPANY
CONSOLIDATED BALANCE SHEETS
September 30, 1997 and 1996
(in thousands)
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash........................................................ $ 4,530 $ 2,958
Securities available for sale............................... 30 40
Trade accounts receivable................................... 9,226 6,494
Other accounts receivable................................... 110 -
Inventory, at lower of average cost or market............... 754 887
Notes receivable--current portion........................... 27 40
-------- -------
Total current assets.................................... 14,677 10,419
Investment in partnerships.................................... 6,937 6,200
PROPERTY AND EQUIPMENT
Oil and gas properties ("full cost")
Proven.................................................... 85,665 25,979
Unproven.................................................. 1,305 1,710
Land, buildings and leasehold improvements.................. 1,579 1,174
Furniture and equipment..................................... 594 478
Transportation equipment.................................... 582 502
-------- -------
89,725 29,843
Less accumulated depreciation and depletion................. 8,621 2,720
-------- -------
81,104 27,123
Other assets
Drilling bonds.............................................. 162 274
Deposit on property acquisition............................. - 6,170
-------- -------
162 6,444
-------- -------
Total assets............................................ $102,880 50,186
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt........................ $ 13,534 $ 3,415
Accounts payable............................................ 6,055 4,655
Accrued liabilities......................................... 1,698 3,635
Advances payable............................................ 2,360 2,839
Royalties payable........................................... 1,984 1,483
Accounts payable--related partnerships...................... 107 168
Income taxes payable........................................ - 37
Unearned income............................................. 2,072 -
-------- -------
Total current liabilities............................... 27,810 16,232
Deferred income taxes......................................... 6,650 3,939
LONG-TERM LIABILITIES
Long-term debt.............................................. 47,174 19,560
Minority interest in subsidiaries............................. 5,930 28
STOCKHOLDERS' EQUITY
Common shares, no par value, 1,000,000 shares authorized;
250,950 shares issued and outstanding...................... 1,087 1,087
Retained earnings........................................... 14,229 9,340
-------- -------
15,316 10,427
-------- -------
Total liabilities and stockholders' equity.............. $102,880 $50,186
======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-48
<PAGE>
MERCURY EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended September 30, 1997, 1996 and 1995
(in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
OIL AND GAS REVENUE.............................. $ 41,328 $ 17,388 $ 6,703
COSTS AND EXPENSES
Production..................................... 16,454 11,907 3,849
General and administrative expenses............ 1,784 1,372 1,234
Depreciation, depletion and amortization....... 5,918 986 349
-------- -------- --------
Income from operations....................... 17,172 3,123 1,271
OTHER INCOME (EXPENSE)
Gain on sale of assets......................... - - 5
Interest expense............................... (5,414) (1,620) (324)
Interest income................................ 196 200 239
Equity in partnership income................... 731 1,010 884
Management fee income.......................... 204 176 162
Rental income.................................. 221 189 99
Miscellaneous income (expense)................. 386 417 (189)
-------- -------- --------
Income before minority interest and income
taxes....................................... 13,496 3,495 2,147
MINORITY INTEREST IN INCOME OF SUBSIDIARIES...... 5,687 28 -
-------- -------- --------
Income before income taxes................... 7,809 3,467 2,147
INCOME TAXES..................................... 2,694 1,219 684
-------- -------- --------
NET INCOME....................................... $ 5,115 $ 2,248 $ 1,463
======== ======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING.............. 250,950 250,950 250,950
======== ======== ========
EARNINGS PER SHARE............................... $ 20.38 $ 8.96 $ 5.83
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-49
<PAGE>
MERCURY EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Years ended September 30, 1997, 1996 and 1995
(in thousands)
<TABLE>
<CAPTION>
Common Retained
Shares Earnings Total
------ -------- -------
<S> <C> <C> <C>
BALANCE,
September 30, 1994.................................. 1,087 $ 5,629 $ 6,716
Net income.......................................... - 1,463 1,463
----- ------- -------
BALANCE,
September 30, 1995.................................. 1,087 7,092 8,179
Net income.......................................... - 2,248 2,248
----- ------- -------
BALANCE,
September 30, 1996.................................. 1,087 9,340 10,427
Distribution to shareholders........................ - (226) (226)
Net income.......................................... - 5,115 5,115
----- ------- -------
BALANCE,
September 30, 1997.................................. 1,087 $14,229 $15,316
===== ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-50
<PAGE>
MERCURY EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
September 30, 1997, 1996 and 1995
(in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers.................... $ 39,687 $ 15,568 $ 7,111
Rent received................................... 221 188 99
Interest received............................... 196 200 239
Cash paid to suppliers and employees............ (19,204) (10,290) (5,002)
Interest paid................................... (5,414) (1,620) (295)
Income tax paid................................. (130) (95) (49)
-------- -------- -------
Net cash provided by operating activities..... 15,356 3,951 2,103
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of marketable equity
securities..................................... 14 3 9
Proceeds from sale of assets.................... 586 560 -
Redemption of bonds............................. 112 - 58
Repayment of advance from affiliates............ - 313 854
Distribution received from partnerships......... 1,194 1,192 225
Purchases of bonds.............................. - (71) 90
Payments received on notes receivable........... 12 60 (156)
Advance from affiliates......................... (61) - (16)
Purchases of marketable equity securities....... (4) (14) (27)
Deposits paid on property acquisitions.......... - (4,370) (1,800)
Investments in partnerships..................... (1,200) - (2,838)
Capital expenditures............................ (54,231) (19,779) (2,227)
-------- -------- -------
Net cash used in investing activities......... (53,578) (22,106) (5,828)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable..................... 89,052 17,888 5,950
Payment on advance from stockholders............ - - (47)
Proceeds from production loans.................. 5,271 - -
Payments on production loans.................... (3,199) - -
Distributions to minority interest.............. (11) - -
Principal paid on long-term debt................ (51,319) (1,093) (52)
-------- -------- -------
Net cash provided by financing activities..... 39,794 16,795 5,851
-------- -------- -------
Net increase (decrease) in cash............... 1,572 (1,360) 2,126
CASH, beginning of period......................... 2,958 4,318 2,192
-------- -------- -------
CASH, end of period............................... $ 4,530 $ 2,958 $ 4,318
======== ======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-51
<PAGE>
MERCURY EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years ended September 30, 1997, 1996 and 1995
(in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY
OPERATING ACTIVITIES:
Net income........................................ $ 5,115 $ 2,248 $ 1,463
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and depletion...................... 5,918 986 349
Minority interest in income..................... 5,687 28 -
Gain on sale of assets.......................... - - (5)
Partnership income.............................. (731) (1,010) (884)
Deferred income taxes........................... 2,710 1,114 622
Changes in operating assets and liabilities
Accounts receivable........................... (2,732) 2,322 (731)
Inventory..................................... 134 (499) (388)
Prepaid expenses.............................. - - 2,094
Accounts payable.............................. 1,400 261 931
Accrued liabilities........................... (1,937) 2,434 (87)
Advances payable.............................. (479) 891 (3,440)
Royalties payable............................. 501 (4,735) 1,866
Income taxes payable.......................... (147) 10 12
Other......................................... (83) (99) 301
------- ------- -------
Net cash provided by operating activities........ $15,356 $ 3,951 $ 2,103
======= ======= =======
</TABLE>
SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During 1997, notes payables were issued in exchange for assets of
approximately $152,000.
In 1997, stockholders' equity was reduced by approximately $226,000 as a
result of transfer of property to shareholders.
The accompanying notes are an integral part of these financial statements.
F-52
<PAGE>
MERCURY EXPLORATION COMPANY
Note 1. Summary of Significant Accounting Policies
The nature of operations and significant accounting policies are as follows:
Nature of Operations
Mercury Exploration Company's (the Company) operations consist primarily of
oil and gas development and production in Texas, New Mexico, Montana, Wyoming,
Michigan, Indiana, Kansas, Oklahoma, Kentucky and North Dakota.
Consolidation Policy
The accompanying consolidated financial statements include the accounts of
the Company, its wholly-owned subsidiary, Mercury Michigan, Inc., Quicksilver
Pipeline, L.L.C. (organized in 1996) of which the Company owns 52%, Quicksilver
Energy, L.C. (organized in 1996) of which the Company owns 52%, and Mercury
Montana, Inc. (organized in 1997) of which the Company owns 54%. As a result of
the consolidation, intercompany transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Financial Instruments
Financial instruments of the Company consist of cash, marketable equity
securities, accounts receivable, notes receivable, investments in partnerships,
accounts payable and debt. Recorded values of cash, accounts receivable, notes
receivable and accounts payable approximate fair values due to the short
maturities of the instruments. Investments in partnerships consist of ownership
interests in privately held entities with no quoted market prices. An estimate
of fair value cannot be made without incurring excessive costs. Investments in
marketable equity securities were determined by quoted prices. Recorded values
of notes payable approximate fair values based upon current interest rates.
Inventory
Inventory consists of oil and gas equipment available for use in production.
Oil and Gas Property and Equipment
The Company follows the "full cost" method of accounting for oil and gas
properties whereby all costs associated with acquiring, exploring for, and
developing oil and gas reserves are capitalized and accumulated in cost centers
established on a country-by-country basis. Such costs include land acquisition
costs, geological and geophysical expenses, carrying charges on non-producing
properties, costs of drilling both productive and non-productive wells, and
overhead charges directly related to acquisition, exploration and development
activities.
The capitalized costs related to each cost center, including the estimated
future costs to develop proved reserves and the costs of production equipment,
are amortized using the unit-of-production method based on the estimated net
proved reserves as determined by independent petroleum engineers. Investments
in unproved properties are not amortized until proven reserves associated with
them can be determined or until impairment occurs. Oil and natural gas reserves
and production are converted into equivalent units based upon estimated
relative energy content.
F-53
<PAGE>
MERCURY EXPLORATION COMPANY
The capitalized costs less accumulated depletion and depreciation in each
cost center are limited to an amount equal to the estimated future net revenue
from proved reserves discounted at a 10% interest rate (based on prices and
costs at the balance sheet date) plus the lower of cost (net of impairments) or
fair market value of unproved properties.
Proceeds from the sale of oil and gas properties are applied against
capitalized costs, with no gain or loss recognized, unless such a sale would
significantly alter the relationship between capitalized costs and proved
reserves of oil and gas, in which case the gain or loss is recognized in
income.
Other Property and Equipment
Property and equipment is stated at cost. Depreciation is provided for using
the straight-line and accelerated methods. Depreciation methods are designed to
amortize the cost of assets over their estimated useful lives. Estimated useful
lives of major categories of property and equipment are as follows:
<TABLE>
<S> <C>
Land, buildings and leasehold improvements........................ 40 years
Furniture and equipment........................................... 5-10 years
Transportation equipment.......................................... 5 years
</TABLE>
Maintenance, repairs, renewals and betterments, which do not enhance the
value or increase the basic productive capacity of assets are charged to
expense as incurred.
Investments in Securities
The Company has adopted Statement No. 115, ACCOUNTING FOR CERTAIN
INVESTMENTS IN DEBT AND EQUITY SECURITIES, issued by the Financial Accounting
Standards Board. In accordance with Statement No. 115, the Company's
investments in securities are classified as follows:
TRADING SECURITIES--Investments in debt and equity securities held
principally for resale in the near term are classified as trading securities
and recorded at their fair values. Unrealized gains and losses on trading
securities are included in other income. The Company does not, nor does it
intend to, trade investments that it owns.
SECURITIES TO BE HELD TO MATURITY--Debt securities for which the Company has
the positive intent and ability to hold to maturity are reported at cost,
adjusted for amortization of premiums and accretion of discounts which are
recognized in interest income using the interest method over the period to
maturity.
SECURITIES AVAILABLE FOR SALE--Securities available for sale consist of its
debt and equity securities not classified as trading securities nor as
securities to be held to maturity.
Unrealized holding gains and losses on securities available for sale if
material, are reported as a net amount in a separate component of stockholders'
equity until realized.
Gains and losses on the sale of securities available for sale are determined
using the specific identification method.
Accounts Receivable
The Company has not provided an allowance for doubtful accounts. All
receivables considered doubtful have been charged to current operations, and it
is management's opinion that no additional material amounts are doubtful of
collection.
F-54
<PAGE>
MERCURY EXPLORATION COMPANY
Cash Flow Presentation
For purposes of the statement of cash flows, time deposits that mature in
three months or less, certificates of deposit and restricted cash are
considered cash and cash equivalents.
Earnings Per Common Share
The Company has adopted Statement No. 128, Earnings Per Share, issued by the
Financial Standards Accounting Board. Adoption of Statement No. 128 had no
effect upon 1997, 1996 or 1995 earnings per share computations.
Basic earnings per common share was computed based on the weighted average
number of common shares outstanding for the period. Diluted earnings per share
have not been presented since the Company has no outstanding options or
warrants to purchase its common stock.
Concentration of Credit Risk
The Company regularly maintains cash in bank deposit accounts, which exceed
FDIC insured limits. The Company has not experienced any losses in such
accounts and believes it is not exposed to any significant credit risk on cash
and cash equivalents.
Accounting Changes
The Financial Accounting Standards Board has issued the following Statements
of Financial Accounting Standards effective for fiscal years beginning after
December 15, 1997:
No. 130--Reporting Comprehensive Income
Requires that all items are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements.
No. 131--Disclosures About Segments of an Enterprise and Related Information
Requires disclosure of operating segments based upon information used
internally for evaluating segment performance and allocating resources.
No. 132--Employers' Disclosures About Pensions and other Post-retirement
Benefits
Revises employers' disclosures about pensions and other post-retirement
plans.
The Company will adopt the above standards effective January 1, 1998.
Adoption is not expected to have a significant effect upon current financial
statements.
Note 2. Securities Available For Sale
Securities available for sale consist of equity securities and are carried
at cost, which approximates market at September 30, 1997 and 1996. Market value
was determined by quoted prices.
Included in net income for the years ended September 30, 1997 and 1996 is a
$241 gain and $161 loss, respectively, from sales of marketable equity
securities. The cost of the securities sold was determined by the specific
identity method.
F-55
<PAGE>
MERCURY EXPLORATION COMPANY
Note 3. Trade Accounts Receivable
Trade accounts receivable at September 30 consist of the following:
<TABLE>
<CAPTION>
1997 1996
------- -------
(in thousands)
<S> <C> <C>
Oil and gas revenue receivable.............................. $ 8,235 $ 6,188
Joint interest billings receivable.......................... 991 306
------- -------
$ 9,226 $ 6,494
======= =======
</TABLE>
Note 4. Investment In Partnerships
Investment in partnerships is stated at cost plus the proportionate share of
invested accumulated income. The Company's investment in partnerships consists
of a 10% interest in Michigan Gas Partners, Ltd., a 6% interest in Frederic HOF
Limited Partnership, and a 50% interest in Wilderness Energy, L.C. None of
these entities individually is considered a significant subsidiary of the
Company. The following is a summary of the combined financial position and
combined results of operations of the Company's investments in partnerships as
of and for the years ended September 30:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Current assets...................................... $ 5,127 $ 7,311 $ 8,085
Property, plant and equipment....................... 40,102 44,392 45,916
Other assets........................................ 25 274 299
------- ------- -------
Total assets...................................... $45,254 $51,977 $54,300
======= ======= =======
Current liabilities................................. $ 200 $ 3,502 $ 4,358
Partnership equity.................................. 45,054 48,475 49,942
------- ------- -------
Total liabilities and partnership equity.......... $45,254 $51,977 $54,300
======= ======= =======
Oil and gas revenue................................. $ 9,830 $ 9,973 $ 8,116
======= ======= =======
Net income.......................................... $ 2,857 $ 3,840 $ 3,889
======= ======= =======
Company's investment................................ $ 6,937 $ 6,200 $ 6,285
======= ======= =======
</TABLE>
F-56
<PAGE>
MERCURY EXPLORATION COMPANY
Note 5. Long-Term Debt
Long-term debt at September 30 consists of the following:
<TABLE>
<CAPTION>
1997 1996
------- -------
(in thousands)
<S> <C> <C>
Note payable to bank with interest at prime, due in monthly
payments of $82,750, with final payment due on December 31,
2002, retired in 1997, secured by investment in Wilderness
Energy, L.C. and Frederic HOF Limited Partnership............ $ - $ 3,000
Notes payable to various entities, due in monthly payments
ranging from $186 to $3,895, including interest ranging from
7% to 10.63%, secured by land, buildings and equipment....... 673 615
Note payable to bank, interest at 8.75%, unsecured, due on
October 17, 1998, retired in 1997............................ - 8,800
Note payable to bank, due in monthly installments of $210,000
in 1997, including interest at 8.18%, secured by the assets
of Mercury Exploration, Inc. in Wyoming and Montana, retired
in 1997...................................................... - 10,560
Note payable to bank, due in monthly payments ranging from
$165,000 to $88,333, including interest at 7.655%, secured by
producing oil and gas properties............................. 8,680 -
Line of credit to bank, due on January 1, 2002, including
interest at Libor + 1.125%, secured by producing oil and gas
properties................................................... 4,900 -
Note payable to bank, due in monthly payments of $82,750, with
interest at prime + .25%, with final payment due January 1,
2003, secured by oil and gas producing properties............ 4,255 -
Note payable to bank, due in monthly payments of $866,667,
including interest at 7.59% (based on rate swap), with final
payment due on December 27, 2000, secured by oil and gas
producing properties and investment in Quicksilver Energy,
L.C.......................................................... 15,200 -
Note payable to bank, due in quarterly payments ranging from
$1,400,000 to $600,000, beginning in August 1999, including
interest at 9%, with final payment due on March 31, 2007,
secured by oil and gas producing properties and investment in
Quicksilver Energy, L.C...................................... 27,000 -
------- -------
60,708 22,975
------- -------
Less current maturities....................................... 13,534 3,415
------- -------
$47,174 $19,560
======= =======
</TABLE>
Aggregate maturities of long-term debt are as follows:
<TABLE>
<S> <C>
1998................................................................. $13,534
1999................................................................. 10,335
2000................................................................. 7,170
2001................................................................. 6,220
2002................................................................. 10,353
Thereafter........................................................... 13,096
-------
$60,708
=======
</TABLE>
F-57
<PAGE>
MERCURY EXPLORATION COMPANY
Note 6. Income Taxes
The Company provides for deferred income taxes resulting from temporary
differences between the tax basis of assets and liabilities and their reported
amounts in the financial statements that will result in taxable or deductible
amounts in future years. Temporary differences result primarily from intangible
development costs being capitalized and amortized for financial reporting
purposes but expensed for tax reporting purposes and different income
recognition criteria for debt extinguishments. Also included in income taxes is
the portion of state taxes based on income.
The Company's income tax provision is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ----
(in thousands)
<S> <C> <C> <C>
Current.................................................. $ (16) $ 105 $ 62
Deferred................................................. 2,710 1,114 622
------ ------ ----
$2,694 $1,219 $684
====== ====== ====
</TABLE>
The tax effects of net operating loss carryforwards and temporary
differences at September 30, 1997 and 1996 that give rise to significant
portions of deferred tax assets and deferred tax liabilities are as follows:
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Deferred tax assets
Net operating loss carryforwards............................ $ 539 $ 128
Tax credit carryforwards.................................... 253 322
------ ------
$ 792 $ 450
------ ------
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Deferred tax liabilities
Property and equipment...................................... $5,458 $2,114
Long term debt.............................................. 1,198 1,559
Investments................................................. 786 716
------ ------
7,442 4,389
------ ------
Total deferred taxes, net................................. $6,650 $3,939
====== ======
</TABLE>
There is no material difference between the statutory tax rate and the
provision for taxes used in the accompanying financial statements.
The Company has U.S. net operating loss carryforwards of approximately
$1,600,000 available to reduce future U.S. taxable income subject to certain
limitations. These U.S. net operating loss carryforwards will expire in 2012.
Note 7. Profit Sharing and Savings Plan
The Company sponsors a defined contribution pension plan. All full-time
employees are eligible for participation upon completion of one year's service.
Employee contributions to the plan for the year ended September 30, 1997, 1996
and 1995 were $199,000, $162,000 and $106,000, respectively. The Company made
contributions of $200,000, $117,000 and $78,000 in 1997, 1996 and 1995,
respectively.
F-58
<PAGE>
MERCURY EXPLORATION COMPANY
Note 8. Operating Leases
The Company's leasing operations consist principally of the leasing of
automobiles under operating leases that expire over the next three years.
The future minimum annual rentals on noncancellable leases in effect at
September 30, 1997, which have initial or remaining terms of more than one
year, are as follows:
<TABLE>
<S> <C>
1998................................................................. $87,000
1999................................................................. 70,000
2000................................................................. 17,000
</TABLE>
Total rental expense under operating leases was $129,000, $115,000 and
$162,000 in 1997, 1996 and 1995, respectively.
Note 9. Futures Contract
There were no significant realized or unrealized gains or losses on this
agreement at September 30, 1997. The Company has entered into this agreement as
a hedge against any downward movement in the commodity price of oil through
December 31, 1997. The agreement terminates at December 31, 1997. The Company
has received a cash payment in advance of the delivery of the oil at a fixed
price of approximately $17.48 per barrel. The market price for oil at September
30, 1997, was less than this price.
Note 10. Contingencies
The Company is a defendant in a lawsuit filed by a former employee with
potential exposure of $500,000. The Company believes the lawsuit is without
merit and is vigorously defending its position, and does not expect the
ultimate outcome to materially affect the Company's financial position.
Note 11. Subsequent Events
The Company settled a lawsuit in December of 1997, which resulted in a gain
of approximately $2,781,000.
In October 1997, Mercury Montana, Inc. merged with MSR Exploration, Ltd. As
a result of the merger, Mercury Exploration Company obtained an approximate 25%
ownership interest in MSR Exploration, Ltd.
Effective January 1, 1998, Mercury transferred substantially all producing
oil and gas properties to a newly formed related company, Quicksilver Resources
Inc., in exchange for common stock in Quicksilver.
Subsequently on September 1, 1998, Quicksilver Resources Inc. entered into a
merger agreement with MSR Exploration Ltd.
Note 12. Acquisitions
On November 14, 1996, Quicksilver Energy L.C., a 52% owned subsidiary of
Mercury, consummated the acquisition of certain property interests from Shell
Western Exploration & Production, Inc. (the Shell Properties). Such interests
are primarily located in Michigan and, as of January 1, 1998, had combined
proved reserves of approximately 42.5 Bcfe. The aggregate purchase price for
the interests was approximately $57.7 million, which was paid in cash
principally with bank debt.
F-59
<PAGE>
MERCURY EXPLORATION COMPANY
The following unaudited pro forma summary presents the consolidated results
of operations of Mercury for the years ended September 30, 1997, 1996 and 1995
as if the acquisition had occurred at the beginning of each fiscal year.
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
September 30, 1997 September 30, 1996 September 30, 1995
------------------ ------------------ ------------------
(in thousands, except for per share data)
<S> <C> <C> <C>
Revenues........... $44,599 $47,802 $26,783
Net income......... 5,457 10,227 5,832
Earnings per
share............. 21.74 40.75 23.39
</TABLE>
On October 9, 1997, Mercury consummated the acquisition of certain property
interests from ECT Enocene Enterprises II (the Destec Properties). Such
interests are primarily located in Michigan and, as of January 1, 1998, had
combined proved reserves of approximately 25.4 Bcfe. The aggregate purchase
price for the interests was approximately $23.5 million, which was paid in cash
principally with debt from Mercury's credit facility.
The following unaudited pro forma summary presents the consolidated results
of operations of Mercury for the years ended September 30, 1997 and 1996 as if
the acquisition had occurred at the beginning of each fiscal year. The 1996 pro
forma amounts also give effect to the Shell Properties acquisition discussed
above.
<TABLE>
<CAPTION>
Year Ended Year Ended
September 30, 1997 September 30, 1996
-------------------- --------------------
(in thousands, except for per share data)
<S> <C> <C>
Revenues................ $ 51,856 $ 54,026
Net income.............. 8,330 12,646
Earnings per share...... 33.19 50.38
</TABLE>
Note 13. Change in Method of Accounting for Oil and Gas Properties
Pursuant to the merger agreement with MSR Exploration Ltd. dated September
1, 1998, the Company has changed its accounting policy for oil and gas
properties from the successful efforts method to the full cost method.
Accordingly, the Company's financial statements have been restated to apply the
change retroactively. The effect of the accounting change on income as
previously reported for 1997, 1996 and 1995 is:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ -----
(in thousands)
<S> <C> <C> <C>
Effect on:
Income before extraordinary item and net income....... $4,219 $1,169 $ 200
Earnings per common share............................. $16.81 $ 4.66 $0.80
</TABLE>
Adoption of the full cost method of accounting for oil and gas properties
was mandated in the September 1998 merger agreement with MSR and is consistent
with the accounting policy of MSR previously disclosed to its shareholders and
the general public. In addition, the Company believes the full cost method of
accounting for oil and gas properties more accurately reflects management's
exploration objectives and results by including all costs incurred in oil and
gas producing activities as integral to the acquisition, discovery and
development of whatever reserves ultimately result from its efforts as a whole.
F-60
<PAGE>
MERCURY EXPLORATION COMPANY
Note 14. Supplemental Oil and Gas Reserve Data (Unaudited)
The Company's proved oil and gas reserves at September 30, 1997 have been
estimated by the Company's petroleum engineers in accordance with guidelines
established by the Securities and Exchange Commission ("SEC"). Accordingly, the
following reserve estimates are based upon existing economic and operating
conditions.
There are numerous uncertainties inherent in establishing quantities of
proved reserves. The following reserve data represent estimates only and should
not be construed as being exact. In addition, the present values should not be
construed as the current market value of the Company's oil and gas properties
or the cost that would be incurred to obtain equivalent reserves.
Estimated Reserves
Changes in the estimated net quantities of crude oil and natural gas
reserves, all of which are located in the continental United States, are as
follows:
Reserve Quantities
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Proved reserves:
Crude Oil (Mbbls)
Beginning of period....................... 20,473 980 997
Revisions of previous estimates........... - 450 -
Purchase of reserves in place............. 1,436 19,608 -
Production................................ (835) (565) (17)
-------- -------- --------
End of period............................. 21,074 20,473 980
======== ======== ========
Minority interest end of period........... 374 - -
======== ======== ========
Natural Gas (Mmcf):
Beginning of period....................... 20,571 22,523 23,127
Revisions of previous estimates........... (881) (3,041) -
Purchase of reserves in place............. 66,114 2,029 -
Production................................ (7,852) (940) (604)
-------- -------- --------
End of period............................. 77,952 20,571 22,523
======== ======== ========
Minority interest end of period........... 21,401 - -
======== ======== ========
Proved developed reserves:
Crude Oil (Mbbls)
Beginning of period....................... 5,955 113 130
End of period............................. 6,873 5,955 113
Minority interest end of period........... 374 - -
Natural Gas (Mmcf):
Beginning of period....................... 18,542 19,295 19,899
End of period............................. 69,883 18,542 19,295
Minority interest end of period........... 21,401 - -
Company's proportional interest in proved
reserves of investee's accounted for by the
equity method--end of year................... 1,352 1,701 2,641
</TABLE>
F-61
<PAGE>
MERCURY EXPLORATION COMPANY
Standardized Measure
The following tables present the Company's standardized measure of
discounted future net cash flows and changes therein relating to proved oil and
gas reserves and were computed using reserve valuations based on regulations
prescribed by the SEC. These regulations provide that the oil, condensate and
gas price structure utilized to project future net cash flows reflects current
prices at each date presented and have been escalated only when known and
determinable price changes are provided by contract. Future production,
development and net abandonment costs are based on current costs without
escalation. The resulting net future cash flows have been discounted to their
present values based on a 10% annual discount factor.
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------
Standardized Measure (in thousands): 1997 1996 1995
------------------------------------ --------- --------- --------
<S> <C> <C> <C>
Future cash flows........................... $ 457,196 $ 375,012 $ 56,067
Future production and development costs..... (255,999) (231,817) (30,418)
Future income tax expense................... (48,301) (41,985) (6,675)
--------- --------- --------
152,896 101,210 18,974
10% annual discount for timing of cash
flows...................................... (70,805) (51,810) (10,556)
--------- --------- --------
Standardized measure of discounted cash
flows...................................... $ 82,091 $ 49,400 $ 8,418
========= ========= ========
Company's share of equity method investee's
standardized measure of discounted future
net cash flows............................. $ 1,101 $ 1,048 $ 1,189
========= ========= ========
Primary changes in standardized measure of discounted future net cash flows
(in thousands):
<CAPTION>
1997 1996 1995
--------- --------- --------
<S> <C> <C> <C>
Net changes in prices and production costs.. $ (2,176) $ (2,201) $ 2,845
Development costs incurred.................. (1,755) (2,832) (405)
Changes in estimated future development
costs...................................... (1,654) (4,395) -
Purchases of reserves-in-place.............. 62,355 71,115 -
Net change in income taxes.................. (5,932) (17,531) (994)
Sales of oil and gas, net of production
costs...................................... (21,923) (5,482) (2,854)
Accretion of discount....................... 4,940 842 614
Other....................................... (1,164) 1,466 458
--------- --------- --------
$ 32,691 $ 40,982 $ (336)
========= ========= ========
</TABLE>
Estimated future cash inflows are computed by applying year end prices of
oil and gas to year end quantities of proved developed reserves. Estimated
future development and production costs are determined by estimating the
expenditures to be incurred in developing and producing the proved oil and gas
reserves in future years, based on year end costs and assuming continuation of
existing economic conditions.
These estimates are furnished and calculated in accordance with requirements
of the Financial Accounting Standard Board and the SEC. Because of
unpredictable variances in expenses and capital forecasts, crude oil and
natural gas price changes, and the fact that the bases for such estimates vary
significantly, management believes the usefulness of these projections is
limited. Estimates of future net cash flows do not necessarily represent
management's assessment of future profitability or future cash flow to Mercury.
F-62
<PAGE>
MERCURY EXPLORATION COMPANY
Costs incurred in oil and gas property acquisition, exploration and
development activities (in thousands):
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Property acquisition costs........................ $ 53,162 $ 14,631 $ -
Exploration costs................................. $ 3,027 $ 778 $ 550
Development costs................................. $ - $ - $ 2,095
Company's share of equity method investee's costs
of property acquisition, exploration and
development...................................... $ - $ 120 $ 511
</TABLE>
Results of operations from producing activities (in thousands):
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------
1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
Oil and gas sales.............................. $ 34,440 $ 12,169 $ 2,106
Operating expenses............................. (17,312) (11,945) (4,321)
Production taxes............................... (2,169) (739) (78)
Depletion and depreciation..................... (5,361) (796) (271)
-------- -------- -------
9,598 (1,311) (2,564)
Income taxes................................... (3,263) - -
-------- -------- -------
Results of operations from producing activities
(excluding corporate overhead and internal
costs)........................................ $ 6,335 $ (1,311) $(2,564)
======== ======== =======
Minority interest in results of operations..... $ (5,667) $ - $ -
======== ======== =======
Company's share of equity method investee's
results of operations from producing
activities.................................... $ (81) $ 85 $ 7
======== ======== =======
</TABLE>
Note 15. Capitalized Costs Relating to Oil and Gas Producing Activities
For the Years Ended September 30, 1997, 1996 and 1995
(in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- ------
<S> <C> <C> <C>
Unproved oil and gas properties..................... $ 1,305 $ 1,710 $1,003
Proved oil and gas properties....................... 85,665 25,979 7,986
------- ------- ------
86,970 27,689 8,989
Less accumulated depreciation and depletion......... 6,729 1,067 271
------- ------- ------
Net capitalized costs............................... $80,241 $26,622 $8,718
======= ======= ======
Company's share of equity method investee's net
capitalized costs.................................. $ 911 $ 1,005 $1,189
======= ======= ======
</TABLE>
F-63
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Stockholders
Mercury Exploration Company
Fort Worth, Texas
We have audited the accompanying consolidated balance sheet of Mercury
Exploration Company as of December 31, 1997 and the related consolidated
statements of income, stockholders' equity and cash flows for the three months
then ended. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.
We conducted our audit 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 misstatement. 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 audit provides 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 Mercury
Exploration Company as of December 31, 1997, and the results of its operations
and its cash flows for the three months then ended in conformity with generally
accepted accounting principles.
Weaver and Tidwell, L.L.P.
Fort Worth, Texas
November 30, 1998
F-64
<PAGE>
MERCURY EXPLORATION COMPANY
CONSOLIDATED BALANCE SHEET
December 31, 1997
(in thousands)
<TABLE>
<S> <C>
ASSETS
CURRENT ASSETS
Cash................................................................ $ 6,844
Securities available for sale....................................... 27
Trade accounts receivable........................................... 9,635
Inventory, at lower of average cost or market....................... 899
Notes receivable--current portion................................... 81
--------
Total current assets.............................................. 17,486
INVESTMENT IN MSR EXPLORATION, LTD.................................... 119
INVESTMENT IN PARTNERSHIPS............................................ 6,556
PROPERTY AND EQUIPMENT
Oil and gas properties................................................ 109,591
Land, buildings and leasehold improvements............................ 1,407
Furniture and equipment............................................... 683
Transportation equipment.............................................. 45
--------
112,426
--------
Less accumulated depreciation and depletion........................... 10,383
102,043
OTHER ASSETS.......................................................... 302
--------
TOTAL ASSETS...................................................... $126,506
========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt................................ $ 13,335
Accounts payable.................................................... 6,744
Accrued liabilities................................................. 826
Advances payable.................................................... 3,420
Royalties payable................................................... 1,631
Income taxes payable................................................ 854
--------
Total current liabilities......................................... 26,810
--------
UNEARNED REVENUES..................................................... 2,567
DEFERRED INCOME TAXES................................................. 7,070
LONG-TERM DEBT........................................................ 65,275
MINORITY INTEREST IN SUBSIDIARIES..................................... 7,114
STOCKHOLDERS' EQUITY
Capital Stock, No Par Value 1,000,000 shares authorized; 250,950
shares issued and outstanding...................................... 1,087
Retained earnings................................................... 6,583
--------
17,670
--------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........................ $126,506
========
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-65
<PAGE>
MERCURY EXPLORATION COMPANY
CONSOLIDATED STATEMENT OF INCOME
For The Three Months Ended December 31, 1997
(in thousands)
<TABLE>
<S> <C>
Oil and gas revenues.................................................. $ 11,049
Costs and expenses
Operating expenses.................................................... 4,736
Depletion and Depreciation............................................ 2,466
General and administrative............................................ 532
--------
Income from operations................................................ 3,315
--------
Other income (expense)................................................ (1,879)
Interest expense...................................................... 27
Interest income....................................................... 78
Equity in partnerships................................................ 78
Management fee income................................................. 54
Rental income......................................................... 32
Miscellaneous income.................................................. 461
Income from litigation settlement..................................... 2,781
--------
Income before income taxes and minority interest...................... 4,869
Minority interest in income of subsidiary............................. 1,277
--------
Income before income taxes............................................ 3,592
Income taxes.......................................................... 1,238
Net income............................................................ $ 2,354
========
Weighted average shares outstanding................................... 250,950
========
Earnings per share.................................................... $ 9.38
========
</TABLE>
F-66
<PAGE>
MERCURY EXPLORATION COMPANY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the Three Months Ended December 31, 1997
(in thousands)
<TABLE>
<CAPTION>
Common Shares Retained Earnings Total
------------- ----------------- -------
<S> <C> <C> <C>
BALANCE
September 30, 1997...................... $1,087 $14,229 $15,316
Net income.............................. - 2,354 2,354
------ ------- -------
BALANCE
December 31, 1997....................... $1,087 $16,583 $17,670
====== ======= =======
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-67
<PAGE>
MERCURY EXPLORATION COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS
For The Three Months Ended December 31, 1997
(in thousands)
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.......................................................... $ 2,354
Adjustments to reconcile net income to net cash provided by
operating activities...............................................
Depreciation and depletion.......................................... 2,466
Minority interest in undistributed subsidiary earnings.............. 1,277
Partnership income.................................................. (78)
Reduction of unearned revenues...................................... (1,593)
Deferred income taxes............................................... 273
Changes in operating assets and liabilities
Accounts Receivable............................................... (7)
Inventory......................................................... (223)
Accounts payable.................................................. 575
Accrued liabilities............................................... (859)
Advances payable.................................................. 1,060
Royalties payable................................................. (353)
Income taxes payable.............................................. 964
Other............................................................. (205)
-------
Net cash provided by operating activities........................... 5,651
-------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................................ (27,750)
Proceeds from sale of marketable equity securities.................. 4
Proceeds from bond maturities....................................... 65
Distribution received from partnerships............................. 458
Advances on notes receivable........................................ (15)
Investments in common stock not held for resale..................... (119)
-------
Net cash used in investing activities............................... (27,327)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable......................................... 25,435
Receipt of unearned revenues........................................ 2,088
Principal paid on long-term debt.................................... (3,533)
-------
Net cash provided by financing activities......................... 23,990
-------
Net increase (decrease) in cash................................... 2,314
Cash, beginning of period........................................... 4,530
-------
Cash, end of period................................................. $ 6,844
=======
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-68
<PAGE>
MERCURY EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
The nature of operations and significant accounting policies are as follows:
Nature of Operations
Mercury Exploration Company's (the Company) operations consist primarily of
oil and gas development and production in Texas, New Mexico, Wyoming, Michigan,
Indiana, Kansas, Oklahoma, Kentucky and North Dakota.
Consolidation Policy
The accompanying consolidated financial statements include the accounts of
the Company, its wholly-owned subsidiary, Mercury Michigan, Inc., Quicksilver
Pipeline, L.L.C. (organized in 1996) of which the Company owns 52%, and
Quicksilver Energy, L.C. (organized in 1996) of which the Company owns 52%. As
a result of the consolidation, intercompany transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Financial Instruments
Financial instruments of the Company consist of cash, marketable equity
securities, accounts receivable, notes receivable, investments in partnerships,
accounts payable and debt. Recorded values of cash, accounts receivable, notes
receivable and accounts payable approximate fair values due to the short
maturities of the instruments. Investments in partnerships consist of ownership
interests in privately held entities with no quoted market prices. An estimate
of fair value cannot be made without incurring excessive costs. Investments in
marketable equity securities were determined by quoted prices. Recorded values
of notes payable approximate fair values based upon current interest rates.
Inventory
Inventory consists of oil and gas equipment available for use in production.
Oil and Gas Property and Equipment
The Company follows the "full cost" method of accounting for oil and gas
properties whereby all costs associated with acquiring, exploring for and
developing oil and gas reserves are capitalized and accumulated in cost centers
established on a country-by-country basis. Such costs include land acquisition
costs, geological and geophysical expenses, carrying charges on non-producing
properties, costs of drilling both productive and non-productive wells, and
overhead charges directly related to acquisition, exploration and development
activities.
The capitalized costs related to each cost center, including the estimated
future costs to develop proved reserves and the costs of production equipment,
are amortized using the unit-of-production method based on the estimated net
proved reserves as determined by independent petroleum engineers. Investments
in unproved properties are not amortized until proven reserves associated with
them can be determined or until impairment occurs. Oil and natural gas reserves
and production are converted into equivalent units based upon estimated
relative energy content.
F-69
<PAGE>
MERCURY EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The capitalized costs less accumulated depletion and depreciation in each
cost center are limited to an amount equal to the estimated future net revenue
from proved reserves discounted at a 10% interest rate (based on prices and
costs at the balance sheet date) plus the lower of cost (net of impairments) or
fair market value of unproved properties.
Proceeds from the sale of oil and gas properties are applied against
capitalized costs, with no gain or loss recognized, unless such a sale would
significantly alter the relationship between capitalized costs and proved
reserves of oil and gas, in which case the gain or loss is recognized in
income.
Other Property and Equipment
Property and equipment is stated at cost. Depreciation is provided for using
the straight-line and accelerated methods. Depreciation methods are designed to
amortize the cost of assets over their estimated useful lives. Estimated useful
lives of major categories of property and equipment are as follows:
<TABLE>
<S> <C>
Land, buildings and leasehold improvements........................ 40 years
Furniture and equipment........................................... 5-10 years
Transportation equipment.......................................... 5 years
</TABLE>
Maintenance, repairs, renewals and betterments, which do not enhance the
value or increase the basic productive capacity of assets are charged to
expense as incurred.
Investments in Securities
The Company has adopted Statement No. 115, Accounting for Certain
Investments in Debt and Equity Securities, issued by the Financial Accounting
Standards Board. In accordance with Statement No. 115, the Company's
investments in securities are classified as follows:
TRADING SECURITIES--Investments in debt and equity securities held
principally for resale in the near term are classified as trading securities
and recorded at their fair values. Unrealized gains and losses on trading
securities are included in other income. The Company does not, nor does it
intend to, trade investments that it owns.
SECURITIES TO BE HELD TO MATURITY--Debt securities for which the Company has
the positive intent and ability to hold to maturity are reported at cost,
adjusted for amortization of premiums and accretion of discounts which are
recognized in interest income using the interest method over the period to
maturity.
SECURITIES AVAILABLE FOR SALE--Securities available for sale consist of its
debt and equity securities not classified as trading securities nor as
securities to be held to maturity.
Unrealized holding gains and losses on securities available for sale if
material, are reported as a net amount in a separate component of stockholders'
equity until realized.
Gains and losses on the sale of securities available for sale are determined
using the specific identification method.
Accounts Receivable
The Company has not provided an allowance for doubtful accounts. All
receivables considered doubtful have been charged to current operations, and it
is management's opinion that no additional material amounts are doubtful of
collection.
F-70
<PAGE>
MERCURY EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Cash Flow Presentation
For purposes of the statement of cash flows, time deposits that mature in
three months or less and certificates of deposit are considered cash and cash
equivalents.
Earnings per Common Share
The Company has adopted Statement No. 128, Earnings per Share, issued by the
Financial Standards Accounting Board. Adoption of Statement No. 128 had no
effect upon 1997 earnings per share computations.
Basic earnings per common share was computed based on the weighted average
number of common shares outstanding for the period. Diluted earnings per share
have not been presented since the Company has no outstanding options or
warrants to purchase its common stock.
Concentration of Credit Risk
The Company regularly maintains cash in bank deposit accounts, which exceed
FDIC insured limits. The Company has not experienced any losses in such
accounts and believes it is not exposed to any significant credit risk on cash
and cash equivalents.
Accounting Changes
The Financial Accounting Standards Board has issued the following Statements
of Financial Accounting Standards effective for fiscal years beginning after
December 15, 1997:
NO. 130--Reporting Comprehensive Income
Requires that all items are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements.
No. 131--Disclosures about Segments of an Enterprise and Related Information
Requires disclosure of operating segments based upon information used
internally for evaluating segment performance and allocating resources.
No. 132--Employers' Disclosures about Pensions and Other Post-Retirement
Benefits
Revises employers' disclosures about pensions and other post-retirement
plans.
The Company will adopt the above standards effective January 1, 1998.
Adoption is not expected to have a significant effect upon current financial
statements.
Note 2. Securities Available for Sale
Securities available for sale consist of equity securities and are carried
at cost, which approximates market at December 31, 1997. Market value was
determined by quoted prices.
Included in net income for the three months ended December 31, 1997 is a
$594 gain from sales of marketable equity securities. The cost of the
securities sold was determined by the specific identity method.
F-71
<PAGE>
MERCURY EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 3. Trade Accounts Receivable
Trade accounts receivable at December 31, 1997, consist of the following:
<TABLE>
<CAPTION>
(in thousands)
<S> <C>
Oil and gas revenue receivable................................ $8,023
Joint interest billings receivable............................ 1, 612
------
$9,635
======
</TABLE>
Note 4. Investment in Partnerships
Investment in partnerships is stated at cost plus the proportionate share of
invested accumulated income. The Company's investment in partnerships consists
of a 10% interest in Michigan Gas Partners, Ltd., a 6% interest in Frederic HOF
Limited Partnership, and a 50% interest in Wilderness Energy, L.C. The
following is a summary of the combined financial position and combined results
of operations of the Company's investments in partnerships as of and for the
three months ended December 31, 1997:
<TABLE>
<CAPTION>
(in thousands)
<S> <C>
Current assets................................................ $ 4,141
Property, plant and equipment................................. 37,831
-------
Total assets................................................ $41,972
=======
Current liabilities........................................... $ 674
Partnership equity............................................ 41,298
-------
Total liabilities and partnership equity.................... $41,972
=======
Oil and gas revenue........................................... $ 3,209
=======
Net income.................................................... $ 767
=======
Company's investment.......................................... $ 6,556
=======
</TABLE>
Note 5. Capitalized Costs Relating to Oil and Gas Producing Activities
<TABLE>
<CAPTION>
(in thousands)
<S> <C>
For December 31, 1997
Unproved oil and gas properties........................... $ 3,079
Proved and oil and gas properties......................... 106,512
--------
109,591
Less accumulated depreciation and depletion................. 9,127
--------
Net capitalized costs..................................... $100,464
========
Company's share of equity method investee's net capitalized
costs...................................................... $ 911
========
</TABLE>
F-72
<PAGE>
MERCURY EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 6. Long-Term Debt
Long-term debt at December 31, 1997 consists of the following:
<TABLE>
<CAPTION>
(in thousands)
--------------
<S> <C>
Notes payable to various entities, due in monthly payments
ranging from 7% to 10.63%, secured by land, buildings and
equipment.................................................. $ 645
Note payable to bank, due in monthly payments ranging from
$165,000 to $88,333, including interest at 7.655%, secured
by producing oil and gas properties........................ 8,020
Line of credit to bank, due on January 1, 2002, including
interest at Libor + 1.125%, secured by producing oil and
gas properties............................................. 26,335
Note payable to bank, due in monthly payments of $82,750,
with interest at prime + .25%, with final payment due
January 1, 2003, secured by oil and gas producing
properties................................................. 4,010
Note payable to bank, due in monthly payments of $866,667,
including interest at 7.59% (based on rate swap), with
final payment due on December 27, 2000, secured by oil and
gas producing properties and investment in Quicksilver
Energy, L.C................................................ 12,600
Note payable to bank, due in quarterly payments ranging from
$1,400,000 to $600,000, beginning in August 1999, including
interest at 9%, with final payment due on March 31, 2007,
secured by oil and gas producing properties and investment
in Quicksilver Energy, L.C................................. 27,000
-------
78,610
Less current maturities..................................... 13,335
-------
$65,275
=======
Aggregate maturities of long-term debt are as follows:
1999........................................................ $13,335
2000........................................................ 8,896
2001........................................................ 6,876
2002........................................................ 6,034
2003........................................................ 31,874
Thereafter.................................................. 11,595
-------
$78,610
=======
</TABLE>
Note 7. Income Taxes
The Company provides for deferred income taxes resulting from temporary
differences between the tax basis of assets and liabilities and their reported
amounts in the financial statements that will result in taxable or deductible
amounts in future years. Temporary differences result primarily from intangible
development costs being capitalized and amortized for financial reporting
purposes but expensed for tax reporting purposes and different income
recognition criteria for debt extinguishments. Also included in income taxes is
the portion of state taxes based on income.
The Company's income tax provision at December 31, 1997, is as follows:
<TABLE>
<CAPTION>
(in thousands)
--------------
<S> <C>
Current....................................................... $ 965
Deferred...................................................... 273
------
$1,238
======
</TABLE>
F-73
<PAGE>
MERCURY EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The tax effects temporary differences at December 31, 1997, that give rise
to significant portions of deferred tax assets and deferred tax liabilities
are as follows:
<TABLE>
<CAPTION>
(in thousands)
<S> <C>
Deferred tax assets
Tax credit carryforwards.................................... $ 738
------
738
------
Deferred tax liabilities
Property and equipment...................................... 5,992
Long term debt.............................................. 1,187
Investments................................................. 629
------
$7,808
======
Total deferred taxes, net................................. $7,070
======
</TABLE>
There is no material difference between the statutory tax rate and the
provision for taxes used in the accompanying financial statements.
The Company has tax credit carryforwards available to offset regular
federal income taxes of approximately $738,000 due to expire in 2002.
Note 8. Profit Sharing and Savings Plan
The Company sponsors a defined contribution pension plan. All full-time
employees are eligible for participation upon completion of one year's
service. Employee contributions to the plan for the three months ended
December 31, 1997 were $61,500. The Company made no contributions for the
three months ended December 31, 1997.
Note 9. Operating Leases
The Company's leasing operations consist principally of the leasing of
automobiles under operating leases that expire over the next three years.
The future minimum annual rentals on noncancellable leases in effect at
December 31, 1997, which have initial or remaining terms of more than one
year, are as follows:
<TABLE>
<S> <C>
1998................................................................ $108,000
1999................................................................ 81,000
2000................................................................ 33,000
</TABLE>
Total rental expense under operating leases was $26,000, for the three
months ended December 31, 1997.
Note 10. Futures Contract
The Company has entered into an agreement for the future delivery of
approximately 41,800 barrels of oil. The contract qualifies as a hedge for
financial reporting purposes. Accordingly, changes in the value of the
contract are recognized in income when the effects of changes in oil prices
are recognized. There were no significant realized or unrealized gains or
losses on this agreement at September 30, 1997. The Company has entered into
this agreement as a hedge against any downward movement in the commodity price
of oil through December 31, 1997. The agreement terminates at December 31,
1997. The Company has received a cash payment in advance of the delivery of
the oil at a fixed price of approximately $17.48 per barrel. The market price
for oil at September 30, 1997, was less than this price.
F-74
<PAGE>
MERCURY EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 11. Tax Credit Sale
In December 1997, the Company transferred certain properties, which carry
IRS Code Section 29 income tax benefits, to an unrelated party and received
consideration as follows:
a. Initial payment of $2,553,000
b. Fixed payment of $5,093,000
c. Credit payment note
d. Production payment
Code Section 29 allows a credit against regular federal income tax liability
for certain eligible gas production. A portion of the initial cash payment
represented an advance payment for the first eighteen months of tax benefits.
As of December 31, 1997, a balance of $2,448,000 in unearned revenues existed
as a result of cash consideration received in excess of the tax benefit earned.
For accounting purposes, the transfer does not qualify for sale or gain
recognition. Accordingly, the accompanying financial statements continue to
include the Company's costs, revenues and expenses associated with the assets
transferred.
Note 12. Supplemental Cash Flow Information
In October 1998, the Company exchanged its 54% interest in a subsidiary,
Mercury Montana, Inc., for a 25% interest in MSR Exploration Ltd. The
investment in MSR Exploration Ltd. is being accounted for under the equity
method of accounting. Assets and liabilities of Mercury Montana, Inc. at the
date of exchange were as follows:
Non-Cash Investing and Financing Activities
<TABLE>
<CAPTION>
(in thousands)
<S> <C>
Assets
Inventory..................................................... $ 78
Oil and gas properties, net................................... 4,345
Other assets.................................................. 50
------
Total Assets................................................ $4,473
======
Liabilities
Accounts payable.............................................. 395
Accrued liabilities........................................... 13
Deferred income taxes......................................... (147)
Long-term debt................................................ 4,000
Minority interest in subsidiaries............................. 93
------
Total Liabilities........................................... $4,354
======
Investment in MSR Exploration, Ltd............................ $ 119
======
</TABLE>
Note 13. Contingencies
The Company is a defendant in a lawsuit filed by a former employee with
potential exposure of $500,000. The Company believes the lawsuit is without
merit and is vigorously defending its position, and does not expect the
ultimate outcome to materially affect the Company's financial position.
F-75
<PAGE>
MERCURY EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 14. Subsequent Events
Effective January 1, 1998, Mercury transferred substantially all producing
oil and gas properties to a newly formed related company, Quicksilver Resources
Inc., in exchange for common stock in Quicksilver.
Subsequently on September 1, 1998, Quicksilver Resources Inc. entered into a
merger agreement with MSR Exploration Ltd.
Note 15. Supplemental Oil and Gas Reserve Data (Unaudited)
The Company's proved oil and gas reserves at December 31, 1997, have been
estimated by the Company's petroleum engineers in accordance with guidelines
established by the Securities and Exchange Commission ("SEC"). Accordingly, the
following reserve estimates are based upon existing economic and operating
conditions.
There are numerous uncertainties inherent in establishing quantities of
proved reserves. The following reserve data represent estimates only and should
not be construed as being exact. In addition, the present values should not be
construed as the current market value of the Company's oil and gas properties
or the cost that would be incurred to obtain equivalent reserves.
Estimated Reserves
Changes in the estimated net quantities of crude oil and natural gas
reserves, all of which are located in the continental United States, are as
follows:
Reserve Quantities December 31, 1997
<TABLE>
<CAPTION>
Petroleum Natural
Liquids Gas
(Bbls) Mmcf)
-------------- -------
(in thousands)
<S> <C> <C>
Reserves at September 30, 1997..................... 21,074 77,952
Purchases of reserves-in-place..................... - 30,831
Sale of reserves-in-place.......................... (5,840) (1,339)
Production......................................... (168) (3,339)
------ -------
Reserves at December 31, 1997...................... 15,066 104,105
====== =======
Total proved developed reserves at December 31,
1997.............................................. 4,520 90,585
====== =======
Company's proportional interest in reserves of
investee's accounted for by the equity method-end
of year........................................... - -
====== =======
</TABLE>
Standardized Measure
The following tables present the Company's standardized measure of
discounted future net cash flows and changes relating to proved oil and gas
reserves and were computed using reserve valuations based on regulations
prescribed by the SEC. These regulations provide that the oil, condensate and
gas price structure utilized to project future net cash flows reflects current
prices at each date presented and have been escalated only when known and
determinable price changes are provided by contract. Future production,
development and net abandonment costs are based on current costs without
escalation. The resulting net future cash flows have been discounted to their
present values based on a 10% annual discount factor.
F-76
<PAGE>
MERCURY EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Standardized Measure (in thousands): December 31, 1997
<TABLE>
<S> <C>
Future cash inflows............................................. $ 417,051
Future development and production costs......................... (213,408)
Future income tax expense....................................... (40,965)
---------
Future net cash flows........................................... 162,678
10% annual discount............................................. (71,774)
Standardized measure of discounted future cash flows............ $ 90,904
=========
Company's share of equity method
Investee's standardized measure of discounted future net cash
flows.......................................................... $ 1,101
=========
</TABLE>
Primary changes in standardized measure of discounted future net cash flows
(in thousands) for the three months ended December 31, 1997:
<TABLE>
<S> <C>
Net changes in prices and production costs......................... $ 1,708
Sale of reserves-in-place.......................................... (20,443)
Development costs incurred......................................... (1,486)
Changes in estimated future development costs...................... -
Purchase of reserves-in-place...................................... 32,247
Net change in income taxes......................................... 2,052
Sales of oil and gas, net of production costs...................... (6,313)
Accretion of discount.............................................. 2,052
Other.............................................................. (1,004)
--------
$ 8,813
========
</TABLE>
Estimated future cash inflows are computed by applying year end prices of
oil and gas to year end quantities of proved developed reserves. Estimated
future development and production costs are determined by estimating the
expenditures to be incurred in developing and producing the proved oil and gas
reserves in future years, based on year end costs and assuming continuation of
existing economic conditions.
These estimates are furnished and calculated in accordance with requirements
of the Financial Accounting Standards Board and the SEC. Because of
unpredictable variances in expenses and capital forecasts, crude oil and
natural gas price changes, and the fact that the bases for such estimates vary
significantly, management believes the usefulness of these projections is
limited. Estimates of future net cash flows do not necessarily represent
management's assessment of future profitability or future cash flow to the
Company.
F-77
<PAGE>
MERCURY EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Costs incurred in oil and gas property acquisition, exploration and
development activities (in thousands):
For the three months ended December 31, 1997
<TABLE>
<S> <C>
Property acquisition costs........................................ $25,152
Exploration costs................................................. 32
Development costs................................................. 2,566
Company's share of equity
Method investee's costs of Property acquisition, Exploration and
development.................................................... $ -
Results of operations from producing activities (in thousands):
For the three months ended December 31, 1997
Oil and gas sales............................................... $ 9,456
Operating expenses.............................................. (2,661)
Production taxes................................................ (563)
Depletion and depreciation...................................... (2,442)
-------
$ 3,790
Income taxes...................................................... (1,289)
Results of operations from producing activities (excluding
corporate overhead and interests costs).......................... $ 2,501
=======
Minority interests in results of operations....................... $ 1,269
=======
Company's share of equity method investee's results of operations
for producing activities......................................... $ 12
=======
</TABLE>
F-78
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Partners
Michigan Gas Partners Limited Partnership
We have audited the accompanying balance sheets of Michigan Gas Partners
Limited Partnership as of December 31, 1997 and 1996 and the related statements
of operations, partners' capital and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Partnership's management. Our responsibility is to
express an opinion on these financial statements 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 misstatement. 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 financial statements referred to above present fairly,
in all material respects, the financial position of Michigan Gas Partners
Limited Partnership as of December 31, 1997 and 1996 and the results of its
operations and its cash flows for each of the three years ended December 31,
1997, in conformity with generally accepted accounting principles.
As described in Note 8, the Company has changed its accounting policy for
accounting for oil and gas properties from the successful efforts method to the
full cost method.
Weaver and Tidwell, L.L.P.
Fort Worth, Texas
October 26, 1998
F-79
<PAGE>
MICHIGAN GAS PARTNERS LIMITED PARTNERSHIP
BALANCE SHEET
December 31, 1997 and 1996
(in thousands)
<TABLE>
<CAPTION>
1997 1996
------ -------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents...................................... $ 56 $ 55
Oil and gas revenue receivable................................. 669 444
------ -------
Total current assets......................................... 725 499
PROPERTY AND EQUIPMENT
Producing oil and gas leases................................... 13,668 13,655
Less accumulated depletion, depreciation and amortization...... 4,558 3,603
------ -------
9,110 10,052
------ -------
TOTAL ASSETS................................................. $9,835 $10,551
====== =======
LIABILITIES AND PARTNERS' CAPITAL
CURRENT LIABILITIES
Accounts payable............................................... $ 150 $ 238
Deferred liabilities........................................... 232 -
------ -------
Total current liabilities.................................... 382 238
PARTNERS' CAPITAL................................................ 9,453 10,313
------ -------
TOTAL LIABILITIES AND PARTNERS' CAPITAL...................... $9,835 $10,551
====== =======
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-80
<PAGE>
MICHIGAN GAS PARTNERS LIMITED PARTNERSHIP
STATEMENT OF OPERATIONS
Years Ended December 31, 1997, 1996 and 1995
(in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
REVENUES
Oil and gas sales..................................... $2,894 $3,212 $1,732
Gas compressor reimbursement.......................... 110 156 198
Other income.......................................... 17 - -
------ ------ ------
Total revenues...................................... 3,021 3,368 1,930
COSTS AND EXPENSES
Lease Operating expenses.............................. 1,922 1,853 1,183
Production taxes...................................... 114 133 70
Depletion, depreciation and amortization.............. 955 1,067 839
Impairment of oil and gas properties.................. - 902 423
General and administrative............................ 11 30 28
------ ------ ------
Total costs and expenses............................ 3,002 3,985 2,543
------ ------ ------
NET INCOME (LOSS)....................................... $ 19 $ (617) $ (613)
====== ====== ======
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-81
<PAGE>
MICHIGAN GAS PARTNERS LIMITED PARTNERSHIP
STATEMENT OF PARTNERS' CAPITAL
Years Ended December 31, 1997, 1996 and 1995
(in thousands)
<TABLE>
<S> <C>
BALANCE, DECEMBER 31, 1994............................................. $ 8,482
Distributions........................................................ (494)
Capital contributed.................................................. 4,838
Net Loss............................................................. (613)
-------
BALANCE, DECEMBER 31, 1995............................................. 12,213
Distributions........................................................ (1,283)
Net loss............................................................. (617)
-------
BALANCE, DECEMBER 31, 1996............................................. 10,313
Distributions........................................................ (879)
Net income........................................................... 19
-------
BALANCE, DECEMBER 31, 1997............................................. $ 9,453
=======
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-82
<PAGE>
MICHIGAN GAS PARTNERS LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
Years Ended December 31, 1997, 1996 and 1995
(in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from oil and gas sales.............. $ 2,938 $ 3,211 $ 1,561
Cash received from gas compressor reimbursement... 90 74 173
Cash paid to suppliers and employees.............. (2,135) (1,913) (1,148)
------- ------- -------
Net cash provided by operating activities..... 893 1,372 586
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.............................. (13) (132) (4,837)
------- ------- -------
Net cash used in investing activities......... (13) (132) (4,837)
CASH FLOWS FROM FINANCING ACTIVITIES:
Partnership distributions......................... (879) (1,283) (494)
Capital contributions............................. - - 4,838
------- ------- -------
Net cash provided by (used in) financing
activities................................... (879) (1,283) 4,344
------- ------- -------
Net increase (decrease) in cash............... 1 (43) 93
Cash, beginning of period........................... 55 98 5
------- ------- -------
Cash, end of period................................. $ 56 $ 55 $ 98
======= ======= =======
RECONCILIATION OF NET INCOME (LOSS) TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Net income (loss)................................. $ 19 $ (617) $ (613)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation, depletion and amortization.......... 955 1,067 839
Impairment of oil and gas properties.............. - 902 423
Changes in operating assets and liabilities
Oil and gas revenue receivable.................. (225) (83) (196)
Accounts payable................................ (88) 103 133
Deferred liabilities............................ 232 - -
------- ------- -------
Net cash provided by operating activities..... $ 893 $ 1,372 $ 586
======= ======= =======
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-83
<PAGE>
MICHIGAN GAS PARTNERS LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies
The accounting policy relative to the carrying value of property and
equipment is indicated in the caption on the balance sheets. The nature of
operations and other significant accounting policies are as follows:
Nature of Operations
Michigan Gas Partners Limited Partnership was formed to own and operate
various oil and gas properties in the state of Michigan. Substantially all of
the Company's revenue is derived from the production and sale of natural gas.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Oil and Gas Property and Equipment
The Partnership follows the "full cost" method of accounting for oil and gas
properties whereby all costs associated with acquiring, exploring for, and
developing oil and gas reserves are capitalized and accumulated in cost centers
established on a country-by-country basis. Such costs include land acquisition
costs, geological and geophysical expenses, carrying charges on non-producing
properties, costs of drilling both productive and non-productive wells, and
overhead charges directly related to acquisition, exploration and development
activities.
The capitalized costs related to each cost center, including the estimated
future costs to develop proved reserves and the costs of production equipment,
are amortized using the unit-of-production method based on the estimated net
proved reserves as determined by independent petroleum engineers. Investments
in unproved properties are not amortized until proven reserves associated with
them can be determined or until impairment occurs. Oil and natural gas reserves
and production are converted into equivalent units based upon estimated
relative energy content.
The capitalized costs less accumulated depletion and depreciation in each
cost center are limited to an amount equal to the estimated future net revenue
from proved reserves discounted at a 10% interest rate (based on prices and
costs at the balance sheet date) plus the lower of cost (net of impairments) or
fair market value of unproved properties.
Proceeds from the sale of oil and gas properties are applied against
capitalized costs, with no gain or loss recognized, unless such a sale would
significantly alter the relationship between capitalized costs and proved
reserves of oil and gas, in which case the gain or loss is recognized in
income.
Statement of Cash Flows
For purposes of the statement of cash flows, the Partnership considers all
highly liquid investments with an original maturity of ninety days or less to
be cash equivalents.
F-84
<PAGE>
MICHIGAN GAS PARTNERS LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS--(Continued)
Federal Income Taxes
Federal income taxes are not recorded, as the results of operations are not
taxable to the Partnership, but are includable in the respective income tax
returns of the partners.
Note 2. Related Party Transactions
In accordance with the partnership agreement, the Partnership contracts with
a partner for all property exploration costs and continuing costs of
operations. In addition, approximately $220,000 and $209,000, respectively, of
oil and gas receivables at December 31, 1997 and 1996 are due from the partner
and substantially all accounts payable for 1997 and 1996 are due to the
partner.
Note 3. Sale of Properties
In December 1997, the Partnership transferred certain properties with a cost
of $6,195,000 to an unrelated party and received consideration as follows:
a. Initial payment of $232,000
b. Fixed payment note of $2,017,000
c. Credit payment note with a maximum amount of $4,000,000
d. Production payment
For accounting purposes, the transfer does not qualify for sale or gain
recognition. Accordingly, the accompanying financial statements continue to
include the partnership's costs, revenues and expenses associated with the
assets transferred. Any gain on the properties transferred will be recognized
based upon future production of the properties.
Note 4. Allocation of Net Income or Losses and Distribution of Cash Flows
Net income equal to adjusted federal taxable income, as defined, is
allocated to the partners' capital accounts to the extent of cash flows, so
distributable, as defined. Remaining net income and net loss, as defined, are
allocated to the partners' capital accounts in proportion to their prospective
capital accounts and partnership interests in a manner specified in the
partnership agreement.
Note 5. Impairment of Property and Equipment
In 1996 and 1995, the Partnership recognized an impairment loss for certain
oil and gas properties based upon revision of the properties' reserves by
independent petroleum engineers. The impairment loss recognized in the
accompanying 1996 and 1995 financial statements was measured as the amount by
which the carrying amount of the oil and gas properties exceeded their fair
value. Fair value was determined based upon estimated future cash flows for the
properties, discounted at a 10% annual rate.
Note 6. Subsequent Events
Effective January 1, 1998, the Michigan Gas Partners transferred
substantially all producing oil and gas properties to a newly formed related
company, Quicksilver Resources Inc., in exchange for common stock of
Quicksilver.
F-85
<PAGE>
MICHIGAN GAS PARTNERS LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS--(Continued)
Note 7. Supplementary Information Related to Oil and Gas Activities--Unaudited
Quantities of Oil and Gas Reserves
The following table presents estimates of the Partnership's proved reserves,
all of which have been prepared by the engineers of the Partnership's General
Partner. Substantially all of the Partnership's crude oil and natural gas
activities are conducted in the United States.
Reserve Quantities for the years ended December 31, 1997, 1996 and 1995.
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Proved reserves:
Natural Gas (Mmcf):
Beginning of period.............................. 17,014 26,405 30,487
Production....................................... (1,199) (1,306) (915)
Revisions of previous estimates.................. (2,288) (8,085) (3,167)
------ ------ ------
End of period.................................... 13,527 17,014 26,405
====== ====== ======
Proved developed reserves:
Natural Gas (Mmcf):
Beginning of year................................ 15,956 25,667 24,190
End of year...................................... 12,600 15,956 25,667
</TABLE>
The reduction in the reserves of Michigan Gas Partners from 1996 to 1997 is
due primarily to the decision not to spend $3.2 million for drilling and
development of existing leases. Michigan Gas Partners put its properties up for
sale in 1997 and elected not to spend the capital to develop its reserves.
Because no additional development was planned, the 1997 reserve report removed
those potential reserves from its report and increased the decline in
production. No reasonable sales price was received for the properties, and the
assets were eventually merged into Quicksilver in 1998.
Standardized Measure of Discounted Future Net Cash Flows and Changes Therein
Relating to Proved Reserves.
The following standardized measure of discounted future net cash flows was
computed in accordance with the rules and regulations of the Securities and
Exchange Commission and Financial Accounting Standards Board Statement No. 69
using year end prices and costs. No values are given to unproved properties or
to probable reserves that may be recovered from proved properties.
The inexactness associated with estimating reserve quantities, future
production and revenue streams and future development and production
expenditures, together with the assumptions applied in valuing future
production, substantially diminishes the reliability of this data. The values
so derived are not considered to be an estimate of fair market value. The
Partnership therefore cautions against its simplistic use.
F-86
<PAGE>
MICHIGAN GAS PARTNERS LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS--(Continued)
The following tabulation reflects the Partnership's estimated discounted
future cash flows from natural gas production:
For the years ended December 31, 1997, 1996 and 1995, in thousands.
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Future cash flows............................ $ 39,203 $ 42,342 $ 55,715
Future production and development costs...... (23,680) (27,266) (34,926)
Future income tax expense.................... - - -
-------- -------- --------
10% annual discount for timing of cash
flows....................................... 15,523 15,076 20,789
(4,509) (4,600) (8,900)
-------- -------- --------
Standardized measure of discounted cash
flows....................................... $ 11,014 $ 10,476 $ 11,889
======== ======== ========
</TABLE>
Primary changes in the standardized measure of discounted future net cash
flows, in thousands:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Sales of oil and gas produced, net of
production costs.............................. $ (858) $ (326) $ (479)
Net changes in price and production costs...... 3,164 1,848 (6,354)
Change in estimated future development costs... 468 445 5,539
Revisions of previous quantity estimates....... (2,254) (5,535) (1,648)
Development costs incurred during the year..... (13) (132) (4,837)
Accretion of discount.......................... 1,047 1,189 1,768
Other.......................................... (1,016) 1,098 217
------- ------- -------
Net increase (decrease)........................ 538 (1,413) (5,794)
Balance at beginning of year................... 10,476 11,889 17,683
------- ------- -------
Balance at end of year......................... $11,014 $10,476 $11,889
======= ======= =======
</TABLE>
Changes in the supply and demand for oil, natural gas liquids, hydrocarbon
price volatility, inflation, timing of production, reserve revisions and other
factors make these estimates inherently imprecise and subject to substantial
revision. As a result, these measures are not the Partnership's estimates for
future cash flows nor do these measures serve as an estimate of current market
value.
Note 8. Change in Method of Accounting for Oil and Gas Properties
Pursuant to the merger agreement with MSR Exploration Ltd. dated September
1, 1998, the partnership has changed its accounting policy for oil and gas
properties from the successful efforts method to the full cost method.
Accordingly, the Partnership's financial statements have been restated to apply
the change retroactively. The effect of the accounting change on income as
previously reported for 1997, 1996, and 1995 is:
<TABLE>
<CAPTION>
1997 1996 1995
------ ----- -----
(in thousands)
<S> <C> <C> <C>
Effect on:
Income before extraordinary item and net income...... $1,738 $(659) $(812)
</TABLE>
Adoption of the full cost method of accounting for oil and gas properties
was mandated in the September 1998 merger agreement with MSR and is consistent
with the accounting policy of MSR previously disclosed to its shareholders and
the general public. In addition, the Company believes the full cost method of
accounting for oil and gas properties more accurately reflects management's
exploration objectives and results by including all costs incurred in oil and
gas producing activities as integral to the acquisition, discovery and
development of whatever reserves ultimately result from its efforts as a whole.
F-87
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
Quicksilver Resources Inc.
Fort Worth, Texas
We have audited the accompanying statement of revenues and direct operating
expenses of the Unocal Corporation's Spirit Energy 76 unit interests, as
described in Note 1, for the year ended December 31, 1998. This financial
statement is the responsibility of management. Our responsibility is to express
an opinion on this financial statement based on our audit.
We conducted our audit 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 statement is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amount and disclosures in the financial statement. 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 audit provides a reasonable basis for our opinion.
The accompanying statement of revenues and direct operating expenses
reflects the revenues and direct operating expenses attributable to the Unocal
Corporation's Spirit Energy 76 unit interests, as described in Note 2, and is
not intended to be a complete presentation of the revenues and expenses of the
Unocal Corporation's Spirit Energy 76 unit interests.
In our opinion, the financial statement referred to above presents fairly,
in all material respects, the revenues and direct operating expenses of the
Unocal Corporation's Spirit Energy 76 unit interests, as described in Note 1,
for the year ended December 31, 1998, in conformity with generally accepted
accounting principles.
DELOITTE & TOUCHE LLP
Fort Worth, Texas
July 22, 1999
F-88
<PAGE>
SPIRIT ENERGY 76 UNIT INTERESTS
STATEMENT OF REVENUES AND DIRECT OPERATING EXPENSES
YEAR ENDED DECEMBER 31, 1998
(in thousands)
<TABLE>
<CAPTION>
1998
------
<S> <C>
REVENUES--Oil, gas and related product sales............................ $9,718
DIRECT OPERATING EXPENSES--Lease operating expenses..................... 2,670
------
EXCESS OF REVENUES OVER DIRECT OPERATING EXPENSES....................... $7,048
======
</TABLE>
See notes to statement of revenues and direct operating expenses.
F-89
<PAGE>
SPIRIT ENERGY 76 UNIT INTERESTS
NOTES TO STATEMENT OF REVENUES AND DIRECT OPERATING EXPENSES
FOR THE YEAR ENDED DECEMBER 31, 1998
1. The Properties
The accompanying statement represents the revenues and direct operating
expenses attributable to the net interest in Unocal Corporation's Spirit Energy
76 unit interests in producing wells and certain non-producing leases primarily
in the Garfield and Beaver Creek Fields sold to Quicksilver Resources Inc.
("Quicksilver"). The purchase price was $30 million, consisting of $27 million
in cash and 404,381 unregistered shares of Quicksilver's common stock. The
stock component of the purchase price was placed in escrow and will be
distributed to Unocal over a three-year period, subject to downward adjustment
for certain costs, expenses, and liabilities incurred during this period.
Quicksilver financed the cash portion of the purchase price with $27 million of
borrowings under a bank credit facility, which permits Quicksilver to obtain
revolving credit loans and to issue letters of credit from time to time in an
aggregate amount not to exceed the lesser of a borrowing base limitation or
$200 million. The properties are located in the state of Michigan. The
acquisition closed in May 1999. These acquired properties and their related
operations are included in Quicksilver's consolidated financial statements from
the date of closing.
2. Basis Of Presentation
The historical financial statements reflecting financial position, results
of operations and cash flows required by generally accepted accounting
principles, are not presented as such information is neither readily available
on an individual property basis nor meaningful for the properties acquired
because the entire acquisition cost is being assigned to oil and gas
properties. Accordingly, the statement of revenues and direct operating
expenses is presented in lieu of the financial statements required under Rule
3-05 of Securities and Exchange Commission Regulation S-X.
The accompanying statement of revenues and direct operating expenses
represents Unocal Corporation's net ownership interest in the properties
acquired by Quicksilver and is represented on the full cost accrual basis of
accounting. Depreciation, depletion and amortization; allocated general and
administrative expenses; interest expense and income; and income taxes have
been excluded because the property interest acquired represents only a portion
of a business and the expenses incurred are not necessarily indicative of the
expense to be incurred by Quicksilver.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of certain revenues for the
reported period. Estimates and assumptions are also required in the disclosure
of contingent assets and liabilities as of the date of the financial
statements. Actual results may differ from such estimates.
3. Contingent Liabilities
Given the nature of the properties acquired and as stipulated in the
purchase agreement, Quicksilver is subject to loss contingencies, if any,
pursuant to existing or expected environmental laws, regulations and leases
covering the acquired properties.
F-90
<PAGE>
SPIRIT ENERGY 76 UNIT INTERESTS
NOTES TO STATEMENT OF REVENUES AND DIRECT OPERATING EXPENSES--(Continued)
For the Year Ended December 31, 1998
4. Oil And Natural Gas Reserves Information (unaudited)
Unaudited reserve information related to the properties being acquired is
presented in the table below and is derived from the January 1, 1999 oil and
natural gas reserve report prepared by Quicksilver's independent petroleum
engineers and calculated as of January 1, 1998 by adding production for 1998 to
the January 1, 1999 amount.
<TABLE>
<CAPTION>
Oil
------
(Mbbl)
<S> <C>
Estimated Quantities of Proved Reserves:
January 1, 1998.................................................... 2,938
Production....................................................... (239)
-----
December 31, 1998.................................................. 2,699
=====
Proved Developed Reserves:
As of December 31, 1998.......................................... 621
=====
</TABLE>
Standardized Measure of Discounted Future Net Cash Flows and Changes Therein
Related to Oil and Natural Gas Reserves--The standardized measure of discounted
future net cash flows ("Standardized Measure") relating to oil and natural gas
reserves being acquired is calculated in accordance with Statement of Financial
Accounting Standards No. 69, "Disclosures About Oil And Gas Producing
Activities". The Standardized Measure has been prepared assuming year-end
selling prices adjusted for future fixed and determinable contractual price
changes, year-end development and production costs, and a 10% annual discount
rate. The reserves and the related Standardized Measure at December 31, 1998,
derived from the oil and natural gas reserve report prepared by Quicksilver's
independent petroleum engineers, were adjusted for production during 1998, and
in addition, the Standardized Measure was adjusted for price changes to derive
reserves and the Standardized Measure as of December 31, 1998. The Standardized
Measure is not a fair market value of the mineral interests purchased, and the
Standardized Measure presented for the proved oil and natural gas reserves does
not purport to present the fair market value of the oil and natural gas
properties. An estimate of such value should consider, among other factors,
anticipated future prices of oil and natural gas, the probability of recoveries
of existing proved reserves, the value of probable reserves and acreage
prospects, and, perhaps, different discount rates. It should be noted that
estimates of reserve quantities are inherently imprecise and subject to
substantial revision.
<TABLE>
<CAPTION>
December 31, 1998
-----------------
(in thousands)
<S> <C>
Future cash inflows...................................... $149,842
Future production and development costs.................. (65,499)
Future income tax expense................................ (19,497)
--------
Future net cash flows undiscounted....................... 64,846
10% annual discount for estimated timing of cash flows... (26,550)
--------
Standardized measure of discounted future net cash
flows................................................... $ 38,296
========
The following are principal sources of changes in the standardized measure of
discounted future net cash flows:
<CAPTION>
Year Ended
December 31, 1998
-----------------
(in thousands)
<S> <C>
Standardized measure of discounted future net cash flows
at beginning of period.................................. $ 39,028
Changes resulting from:
Net change in prices................................. (1,986)
Sales of oil and natural gas produced, net of
production costs.................................... (7,048)
Accretion of discount................................ 3,903
Net change in income taxes........................... 4,399
--------
Standardized measure of discounted future net cash flows
at end of period........................................ $ 38,296
========
</TABLE>
F-91
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Stockholders
Mercury Exploration Company
Fort Worth, Texas
We have audited the accompanying statements of revenues and direct operating
expenses/Shell Michigan properties acquired of Mercury Exploration Company for
the years ended September 30, 1996 and 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements 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 misstatement. 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.
The accompanying statements of revenues and direct operating expenses/Shell
Michigan properties acquired reflect the revenues and direct operating expenses
attributable to Mercury Exploration Company described in Note 2 to the
financial statements and is not intended to be a complete presentation of the
revenues and expenses of Mercury Exploration Company.
In our opinion, the accompany financial statements referred to above present
fairly, in all material respects, the revenues and direct operating
expenses/Shell Michigan properties acquired of Mercury Exploration Company for
the years ended September 30, 1996 and 1995 in conformity with generally
accepted accounting principles.
WEAVER AND TIDWELL, L.L.P.
Fort Worth, Texas
October 23, 1998
F-92
<PAGE>
MERCURY EXPLORATION COMPANY
STATEMENT OF REVENUES AND DIRECT OPERATING EXPENSES
SHELL MICHIGAN PROPERTIES ACQUIRED
YEARS ENDED SEPTEMBER 30, 1996 AND 1995
(in thousands)
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Revenues
Gas revenues................................................. $25,543 $16,539
Oil revenues................................................. 1,152 892
Condensate revenues.......................................... 3,719 2,649
------- -------
Total revenues............................................. 30,414 20,080
======= =======
Direct Operating Expenses
Operating expenses........................................... 3,147 2,902
Production taxes............................................. 1,648 1,390
------- -------
Total direct operating expenses............................ 4,795 4,292
------- -------
Excess of Revenues Over Direct Operating
Expenses/Shell Michigan Properties Acquired.................. $25,619 $15,788
======= =======
</TABLE>
F-93
<PAGE>
MERCURY EXPLORATION COMPANY
SHELL MICHIGAN PROPERTIES ACQUIRED
NOTES TO FINANCIAL STATEMENTS
Note 1. Business Combination
On November 14, 1996 Mercury Exploration Company consummated the Shell
acquisition from Shell Western E & P, Inc. The acquisition consisted of 64
wells located in Michigan with combined proved reserves of approximately 75
Bcfe at the effective date of July 1, 1996. The aggregate purchase price for
the interests was approximately $57.7 million, which was paid in cash with bank
debt.
Note 2. Basis Of Presentation
Historical financial statements reflecting financial position, results of
operations and cash flows required by generally accepted accounting principles
are not presented, as such information is neither readily available on an
individual property basis nor meaningful for the properties included in the
business combination. Accordingly, these statements of revenues and direct
operating expenses/properties acquired are presented in lieu of the financial
statements required under Rule 3-05 of Securities and Exchange Commission
Regulation S-X. The accompanying financial statements include the direct
revenues and expenses of properties acquired by Mercury Exploration Company in
the business combination referred to in Note 1. All of the statements and
disclosures are stated in U.S. dollars.
The accompanying statements of revenues and direct operating
expenses/properties acquired represent Mercury's net ownership interest in the
properties included in the business combination and are presented on the full
cost accrual basis of accounting. Depreciation, depletion and amortization,
allocated general and administrative expenses, interest expense, and income
taxes have been excluded because the property interests included in the
business combination are from a newly formed business and the expenses incurred
are not necessarily indicative of the expenses to be incurred by Mercury.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
Note 3. Disclosures About Oil And Gas Activities (Unaudited)
The changes in proved reserves for 1996 and 1995 were as follows:
<TABLE>
<CAPTION>
Petroleum Natural Gas
Liquids (Bbls) (Mmcf)
-------------- -----------
(in thousands)
<S> <C> <C>
Reserves at September 30, 1994.................... 1,944 83,542
Production...................................... (241) (6,760)
----- -------
Reserves at September 30, 1995.................... 1,703 76,782
Production...................................... (267) (10,668)
----- -------
Reserves at September 30, 1996.................... 1,436 $66,114
===== =======
Total proved developed reserves
September 30, 1997.............................. 644 18,291
===== =======
September 30, 1996.............................. 911 28,959
===== =======
</TABLE>
F-94
<PAGE>
MERCURY EXPLORATION COMPANY
SHELL MICHIGAN PROPERTIES ACQUIRED
NOTES TO FINANCIAL STATEMENTS--(Continued)
The standardized measure of discounted estimated future net cash flows, and
changes therein, related to proved oil and gas reserves (in thousands) for 1996
and 1995 are as follows:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Future cash inflows..................................... $138,460 $174,704
Future development and production costs................. (35,525) (43,198)
Future income tax expense............................... - -
-------- --------
Future net cash flows................................... 102,935 131,506
10% annual discount..................................... (40,580) (43,485)
-------- --------
Standardized measure of discounted future cash flows.... $ 62,355 $ 88,021
======== ========
</TABLE>
Primary changes in standardized measure of discounted future net cash flows
(in thousands):
<TABLE>
<CAPTION>
1996 1995
-------- -------
<S> <C> <C>
Net changes in prices and production costs............... $ (5,130) $(1,807)
Sales of oil and gas, net of production costs............ (25,619) (15,788)
Accretion of discount.................................... 8,036 8,296
Other.................................................... (2,953) 1,858
-------- -------
$(25,666) $(7,441)
======== =======
</TABLE>
Estimated future cash inflows are computed by applying year end prices of
oil and gas to year end quantities of proved developed reserves. Estimated
future development and production costs are determined by estimating the
expenditures to be incurred in developing and producing the proved oil and gas
reserves in future years, based on year end costs and assuming continuation of
existing economic conditions.
These estimates are furnished and calculated in accordance with requirements
of the Financial Accounting Standards Board and the Securities and Exchange
Commission. Because of unpredictable variances in expenses and capital
forecasts, crude oil and natural gas price changes, and the fact that the bases
for such estimates vary significantly, management believes the usefulness of
these projections is limited. Estimates of future net cash flows do not
necessarily represent management's assessment of future profitability or future
cash flow to the Company.
The accompanying notes are an integral part of these financial statements.
F-95
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Stockholders
Mercury Exploration Company
Fort Worth, Texas
We have audited the accompanying statements of revenues and direct operating
expenses/Destec Michigan Properties acquired of Mercury Exploration Company for
the years ended September 30, 1997 and 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements 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 misstatement. 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.
The accompanying statements of revenues and direct operating expenses/Destec
Michigan properties acquired reflect the revenues and direct operating expenses
attributable to Mercury Exploration Company described in Note 2 to the
financial statements and is not intended to be a complete presentation of the
revenues and expenses of Mercury Exploration Company.
In our opinion, the accompanying financial statements referred to above
present fairly, in all material respects, the revenues and direct operating
expenses/Destec Michigan properties acquired of Mercury Exploration Company for
the years ended September 30, 1997 and 1996 in conformity with generally
accepted accounting principles.
WEAVER AND TIDWELL, L.L.P.
Fort Worth, Texas
October 23, 1998
F-96
<PAGE>
MERCURY EXPLORATION COMPANY
STATEMENT OF REVENUES AND DIRECT OPERATING EXPENSES
DESTEC MICHIGAN PROPERTIES ACQUIRED
YEARS ENDED SEPTEMBER 30, 1997 AND 1996
(in thousands)
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Revenues
Gas revenues.................................................. $7,257 $6,224
------ ------
Total revenues.............................................. 7,257 6,224
------ ------
Direct Operating Expenses
Operating expenses............................................ 1,289 1,689
Production taxes.............................................. 303 262
------ ------
Total direct operating expenses............................. 1,592 1,951
------ ------
Excess of Revenues Over Direct Operating Expenses/Destec
Michigan Properties Acquired................................... $5,665 $4,273
====== ======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-97
<PAGE>
MERCURY EXPLORATION COMPANY
DESTEC MICHIGAN PROPERTIES ACQUIRED
NOTES TO FINANCIAL STATEMENTS
Note 1. Business Combination
On October 9, 1997 Mercury Exploration Company consummated the Destec
acquisition from ECT Enocene Enterprises II, Inc. Such properties consist of
143 wells located in Michigan with combined proved reserves of approximately
30.8 Bcfe as of the effective date of August 1, 1997. The aggregate purchase
price for the interests was approximately $23.5 million, which was paid in cash
with bank debt.
Note 2. Basis Of Presentation
Historical financial statements reflecting financial position, results of
operations and cash flows required by generally accepted accounting principles
are not presented, as such information is neither readily available on an
individual property basis nor meaningful for the properties included in the
business combination. Accordingly, these statements of revenues and direct
operating expenses/properties acquired are presented in lieu of the financial
statements required under Rule 3-05 of Securities and Exchange Commission
Regulation S-X. The accompanying financial statements include the direct
revenues and expenses of properties acquired by Mercury Exploration Company in
the business combination referred to in Note 1. All of the statements and
disclosures are stated in U.S. dollars.
The accompanying statements of revenues and direct operating expenses/
properties acquired represent Mercury's net ownership interest in the
properties included in the business combination and are presented on the full
cost accrual basis of accounting. Depreciation, depletion and amortization,
allocated general and administrative expenses, interest expense, and income
taxes have been excluded because the property interests included in the
business combination are from a newly formed business and the expenses incurred
are not necessarily indicative of the expenses to be incurred by Mercury.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
Note 3. Disclosures About Oil And Gas Activities (unaudited)
The changes in proved reserves for 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
Petroleum Natural Gas
Liquids (Bbls) (Mmcf)
-------------- -----------
(in thousands)
<S> <C> <C>
Reserves at September 30, 1995.................... - 36,781
Production...................................... - (3,042)
--- ------
Reserves at September 30, 1996.................... - 33,739
Production...................................... - (2,908)
--- ------
Reserves at September 30, 1997.................... - 30,831
--- ------
Total proved developed reserves
September 30, 1997.............................. - 26,755
--- ------
September 30, 1996.............................. - 29,663
=== ======
</TABLE>
F-98
<PAGE>
MERCURY EXPLORATION COMPANY
DESTEC MICHIGAN PROPERTIES ACQUIRED
NOTES TO FINANCIAL STATEMENTS--(Continued)
The standardized measure of discounted estimated future net cash flows, and
changes therein, related to proved oil and gas reserves (in thousands) for 1997
and 1996 are as follows:
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Future cash inflows........................................ $75,746 $58,031
Future development and production costs.................... (15,776) (12,440)
Future income tax expense.................................. - -
------- -------
Future net cash flows...................................... 59,970 45,591
10% annual discount........................................ (27,723) (23,305)
------- -------
Standardized measure of discounted future cash flows....... $32,247 $22,286
======= =======
</TABLE>
Primary changes in standardized measure of discounted future net cash flows
(in thousands):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Net changes in prices and production costs................ $10,861 $(1,369)
Sales of oil and gas, net of production costs............. (5,665) (4,273)
Accretion of discount..................................... 2,229 2,082
Other..................................................... (2,536) (643)
------- -------
$(9,961) $(1,465)
======= =======
</TABLE>
Estimated future cash inflows are computed by applying year end prices of
oil and gas to year end quantities of proved developed reserves. Estimated
future development and production costs are determined by estimating the
expenditures to be incurred in developing and producing the proved oil and gas
reserves in future years, based on year end costs and assuming continuation of
existing economic conditions.
These estimates are furnished and calculated in accordance with requirements
of the Financial Accounting Standards Board and the SEC. Because of
unpredictable variances in expenses and capital forecasts, crude oil and
natural gas price changes, and the fact that the bases for such estimates vary
significantly, management believes the usefulness of these projections is
limited. Estimates of future net cash flows do not necessarily represent
management's assessment of future profitability or future cash flow to the
Company.
F-99
<PAGE>
Holditch--Reservoir Technologies Consulting Services
Schlumberger
1310 Commerce Drive
Park Ridge 1
Pittsburgh, PA 15275-1011
Tel: 412-787-5403
Fax: 412-787-2906
15 October, 1999
Quicksilver Resources, Inc.
1619 Pennsylvania Avenue
Fort Worth, Texas 76104
Dear Gentlemen:
At the request of Quicksilver Resources, Inc. (QUICKSILVER), Holditch-
Reservoir Technologies Consulting Services (H-RT) has prepared a reserve and
economic audit of certain proved oil and gas interests as of September 1, 1999.
The 1998 year end reserve forecasts prepared by H-RT were reviewed with the
updated production and adjusted as necessary. Major changes from the 1998 year
end reserve report are the result of higher product prices, significant reserve
additions in Michigan and Canada as a result of the acquisitions of Spirit
Energy and the Monogram Unit respectively, and adjustments to the undeveloped
reserves in the South Central Cut Bank Sand Unit in Montana. The results of
this study are summarized in Table 1.
TABLE 1
ESTIMATED NET RESERVES & INCOME
CERTAIN OIL AND GAS INTERESTS AUDITED FOR
QUICKSILVER RESOURCES
AS OF SEPTEMBER 1, 1999
<TABLE>
<CAPTION>
Proved
Proved Non- Proved Total
Producing producing Undeveloped Proved
Reserves Reserves Reserves Reserves
----------- ----------- ----------- -------------
<S> <C> <C> <C> <C>
Remaining Net Reserves
Oil--Mbbls 7,904.640 7,275.210 9,303.210 24,483.060
Gas--MMscf 117,137.100 26,242.100 67,465.780 210,845.000
NGL--Mbbls 600.330 358.150 88.020 1,046.500
Income Data (M$)
Future Net Revenue 525,116.500 228,254.500 404,088.900 1,157,460.000
Deductions 288,857.471 62,807.730 184,914.090 536,579.270
Future Net Income (FNI) 236,259.100 165,446.700 219,174.700 620,880.600
Discounted PV @ 10% (M$) 144,834.700 101,095.200 102,636.800 348,566.700
</TABLE>
A-1
<PAGE>
Holditch-Reservoir Technologies Consulting Services Schlumberger
15 October, 1999
Page 2
RESERVES ESTIMATES
A combination of conventional decline curve analysis, reservoir simulation, and
type curves were used in the January 1, 1999 evaluation to estimate the
remaining reserves in the MI Antrim formation. The reservoir simulation was
conducted using SHALEGAS, H-RT's multi-phase reservoir simulator designed
specifically for evaluating fractured shale formations. For the September 1,
1999 audit we reviewed the total MI Antrim Proved Producing production plot and
determined that our original forecast as a whole was in excellent agreement.
Based on this, no MI Antrim forecasts were changed.
The MI Non-Antrim formations were evaluated using decline curve analysis,
volumetrics, and production data analysis. The production data analysis was
conducted using PROMAT, H-RT's production data analysis software. Volumetric
calculations were based on data and maps provided to us by QUICKSILVER. All
forecasts from the January 1, 1999 evaluation were reviewed and changed where
applicable.
The reserves in the remaining properties were evaluated using decline curve
analysis for the producing properties, and volumetrics, analogies, and
simulation results for the behind pipe and undeveloped properties. For
producing properties under waterflood, watercut versus cumulative oil plots
were used to aid in decline curve estimates.
Reserve estimates are strictly technical judgments. The accuracy of any reserve
estimate is a function of the quality of data available and of engineering and
geological interpretations. The reserve estimates presented in this report are
believed reasonable; however, they are estimates only and should be accepted
with the understanding that reservoir performance subsequent to the date of the
estimate may justify their revision.
RESERVES ADDITIONS & MODIFICATIONS
Acquisitions and development activity during the first half of 1999 have
impacted Quicksilver's reserves. Acquisition of Spirit Energy and the Monogram
Unit added significant reserves in Michigan and Canada. Development activity in
the South Central Cut Bank Sand Unit in Montana resulted in a reduction of the
undeveloped reserves in the Unit.
QUICKSILVER acquired several MI Spirit Energy properties in May of 1999. New
properties included the Beaver Creek UPdC, the Beaver Creek Richfield Unit, the
Beaver Creek Richfield Non-unit, and the Detroit River Sour. QUICKSILVER also
obtained additional working and net revenue interests in the Garfield 8 and
Garfield Richfield properties. The Spirit acquisition added 1,438 MBbls of oil,
28,378 MMscf of gas, and 66 MBbls of NGL to the proved net reserves.
Total proved reserves in Canada increased by 10,077 MMscf as the result of the
acquisition of the Monogram Unit in southern Alberta. Quicksilver acquired
controlling (89%) interest in MGV Energy (MGV), a Calgary-based natural gas
company, in August, 1999. The Monogram Unit is MGV's first acquisition.
Proved undeveloped reserves in the South Central Cut Bank Sand Unit (SCCBSU)
were reduced by 872 MBO (16%) from the 1998 Year End reserve report based on
the results of
A-2
<PAGE>
Holditch-Reservoir Technologies Consulting Services Schlumberger
15 October, 1999
Page 3
recent drilling. The reserves were part of the Lower Cretaceous infill drilling
and waterflood optimization project outlined for the Unit. During 1999 QRI
drilled five Lower Cretaceous zone wells in the SCCBSU with limited success.
The reduction in reserves relates to the locations in the channels adjacent to
the recent drilling where the high permeability sand is swept.
RESERVE CATEGORIES
Reserves were assigned to the proved producing (PDP), proved non-producing
(PDNP), and proved undeveloped (PUD) reserve categories. Oil and gas reserves
by definition fall into one of the following categories: proved, probable, and
possible. The proved category is further divided into: developed and
undeveloped. The developed reserve category is even further divided into the
appropriate reserve status subcategories: producing and non-producing. Non-
producing reserves include shut-in and behind-pipe reserves. Only proved
reserves were evaluated in this report and all reserve categories used in this
report conform to the Securities and Exchange Commission Regulation S-X, Rule
4-10 (a).
The reserves and income attributable to the various reserve categories included
in this report have not been adjusted to reflect the varying degrees of risk
associated with them.
ECONOMIC TERMS
Net revenue (sales) is defined as the total proceeds from the sale of oil,
condensate, natural gas liquids (NGL), and gas before any deductions. Future
net income (cashflow) is future net revenue less net lease operating,
transportation, processing, and marketing expenses, and state severance or
production taxes. Future net income (cashflow) includes only those deductions
for general and administrative expenses charged by the operator to each
particular well on a monthly basis. No provisions for State or Federal income
taxes are made in this evaluation. The present worth (discounted cashflow) at
various discount rates is calculated on a monthly basis.
PRICING AND ECONOMIC PARAMETERS
All product prices, costs, and economic parameters used in this report were
supplied by QUICKSILVER. Data from QUICKSILVER were accepted as presented. All
pricing and costs were held constant for the life of the projects (no
escalation). All economics were run to economic life or 40 years which ever
occurs first. All prices used in this report were based on current contracts or
8/31/99 NYMEX pricing plus or minus local differentials. The base NYMEX prices
used were $22.86/Bbl for oil and $2.825/MMBtu for gas. Quicksilver currently
has two oil price contracts that apply to the entire company oil volumes. The
first is for 1000 BOPD at $20.65/Bbl and expires 7/31/2000, the second is for
500 BOPD at $19.35/Bbl and expires 4/30/2004. The oil price used for this
report is a yearly weighted average price of the contract volumes and prices
and the remaining volumes at the 8/31/99 NYMEX price of $22.86/Bbl. Total
proved working interest volumes were used for the weighted average with a 12.5%
royalty burden applied to the net oil stream to calculate the working interest
volumes.
A-3
<PAGE>
Holditch-Reservoir Technologies Consulting Services Schlumberger
15 October, 1999
Page 4
OWNERSHIP
The leasehold interests were supplied by QUICKSILVER and were accepted as
presented. No attempt was made by the undersigned to verify the title or
ownership of the interests evaluated.
GENERAL
All data used in this study were obtained from QUICKSILVER, public industry
information sources, or the non-confidential files of H-RT. A field inspection
of the properties was not made in connection with the preparation of this
report.
The potential environmental liabilities attendant to ownership and/or operation
of the properties have not been addressed in this report. Abandonment and
clean-up costs and possible salvage value of the equipment were not considered
in this report.
In auditing the information at our disposal related to this report, we have
excluded from our consideration all matters which require a legal or accounting
interpretation, or any interpretation other than those of an engineering or
geological nature. In assessing the conclusions expressed in this report
pertaining to all aspects of oil and gas evaluations, especially pertaining to
reserve audits, there are uncertainties inherent in the interpretation of
engineering data, and such conclusions represent only informed professional
judgments.
Data and worksheets used in the preparation of this audit will be maintained in
our files in Pittsburgh and will be available for inspection by anyone having
proper authorization by QUICKSILVER.
This report was prepared solely for the use of the party to whom it is
addressed and any disclosure made of this report and/or the contents by said
party thereof shall be solely the responsibility of said party, and shall in no
way constitute any representation of any kind whatsoever of the undersigned
with respect to the matters being addressed.
We appreciate the opportunity to perform this audit and are available should
you need further assistance in this matter.
Sincerely yours,
<TABLE>
<S> <C>
/s/ Nelson R. Fairchild Jr. /s/ Joseph H. Frantz, Jr., P.E.
Nelson R. Fairchild Jr. Joseph H. Frantz, Jr., P.E.
Senior Petroleum Engineer Operations Manager
Eastern U.S.
</TABLE>
A-4
<PAGE>
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5,000,000 Shares
[QUICKSILVER RESOURCE LOGO APPEARS HERE]
Common Stock
----------------
PROSPECTUS
----------------
Bear, Stearns & Co. Inc.
Dain Rauscher Wessels
Morgan Keegan & Company, Inc.
November 16, 1999
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