<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 333-52263
MICHAEL PETROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
Texas 76-0510239
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
13101 Northwest Freeway
Suite 320
Houston, Texas 77040
(Address of principal executive offices including zip code)
(713) 895-0909
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [X*] No [ ]
* The registrant became subject to the reporting requirements of Section 13
of the Securities Exchange Act of 1934 (pursuant to Section 15(d) thereunder)
effective on July 22, 1998.
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
As of November 11, 1998, there were 10,000 shares of the Registrant's Common
Stock, par value $0.10 per share, outstanding.
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MICHAEL PETROLEUM CORPORATION
BALANCE SHEETS
(In thousands of dollars)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 9,044 $ 782
Accounts receivable 8,805 4,472
Prepaid expenses and other 4,604 1
--------- --------
Total current assets 22,453 5,255
Oil and gas properties, (successful efforts
method) at cost 143,838 34,977
Less: accumulated depreciation, depletion and
amortization (15,386) (6,966)
--------- --------
128,452 28,011
Other assets 5,883 351
--------- --------
TOTAL ASSETS $ 156,788 $ 33,617
--------- --------
--------- --------
LIABILITIES AND STOCKHOLDER'S DEFICIT
Current liabilities:
Accounts payable $ 8,924 $ 5,502
Accrued liabilities 11,897 298
Current portion of long-term debt 59 8,056
--------- --------
Total current liabilities 20,880 13,856
Long-term debt 140,793 19,885
Deferred income taxes 115 1,791
--------- --------
Total liabilities 161,788 35,532
Commitments and contingencies
Stockholder's deficit:
Preferred stock ($.10 par value,
50,000,000 shares authorized, no
shares issued)
Common stock ($.10 par value,
100,000,000 shares authorized,
10,000 shares issued) 1 1
Additional paid-in capital 610 610
Accumulated deficit (5,611) (2,526)
--------- --------
Total stockholder's deficit (5,000) (1,915)
--------- --------
TOTAL LIABILITIES AND STOCKHOLDER S DEFICIT $ 156,788 $ 33,617
--------- --------
--------- --------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
2
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MICHAEL PETROLEUM CORPORATION
STATEMENTS OF OPERATIONS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30,
------------------- -------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Oil and natural gas sales $ 6,749 $1,936 $16,446 $ 5,584
Operating expenses:
Production costs 1,233 557 2,833 1,474
Exploration 39 - 118 24
Depreciation, depletion and
amortization 3,921 847 8,420 2,558
General and administrative 294 244 811 544
------- ------ ------- ------
5,487 1,648 12,182 4,600
------- ------ ------- ------
Operating income 1,262 288 4,264 984
------- ------ ------- ------
Other income (expense):
Interest income and other 61 10 275 35
Interest expense (4,052) (575) (8,469) (1,350)
------- ------ ------- ------
(3,991) (565) (8,194) (1,315)
------- ------ ------- ------
Loss before income taxes and
extraordinary item (2,729) (277) (3,930) (331)
Benefit for income taxes before
extraordinary item 955 97 1,376 116
------- ------ ------- ------
------- ------ ------- ------
Loss before extraordinary item (1,774) (180) (2,554) (215)
------- ------ ------- ------
Extraordinary item -
extinguishment of T.E.P.
Financing, net of tax of $285 - - (531) -
------- ------ ------- ------
Net loss $(1,774) $ (180) $(3,085) $ (215)
------- ------ ------- ------
------- ------ ------- ------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
3
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MICHAEL PETROLEUM CORPORATION
STATEMENTS OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
----------------------
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (3,085) $ (215)
Adjustments to reconcile net loss to
Net cash provided by operating activities:
Depreciation, depletion and amortization 8,420 2,558
Gain on sale of oil and natural gas properties (50) -
Abandonment of oil and natural gas properties 35 -
Deferred income taxes (1,376) (116)
Extraordinary item - extinguishment of T.E.P.
financing, net of taxes 470 -
Amortization of debt issuance costs 414 -
Amortization of deferred loss on early termination
of commodity swap agreement 464 -
Amortization of discount of debt 146 98
Changes in operating assets and liabilities:
Accounts receivable (4,333) (601)
Prepaid expenses and other (2,021) 90
Accounts payable 3,423 1,691
Accrued liabilities 7,855 (60)
--------- --------
Net cash provided by operating
Activities 10,362 3,445
--------- --------
Cash flows from investing activities:
Additions to oil and natural gas properties (99,002) (13,268)
Proceeds from sale of oil and natural gas properties 150 -
Prepaid natural gas contract as consideration for non-
producing oil and gas properties (9,994) -
--------- --------
Net cash used in investing activities (108,846) (13,268)
--------- --------
Cash flows from financing activities:
Proceeds from long-term debt 141,603 12,162
Payments on long-term debt (29,305) (2,068)
Additions to deferred loan costs (5,552) (26)
--------- --------
Net cash provided by financing activities 106,746 10,068
--------- --------
Net increase in cash and cash equivalents 8,262 245
Cash and cash equivalents, beginning of period 782 1,182
--------- --------
Cash and cash equivalents, end of period $ 9,044 $ 1,427
--------- --------
--------- --------
Non-cash transaction:
Non-producing properties acquired through
Delivery of natural gas $ 3,743 -
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
4
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MICHAEL PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
Michael Petroleum Corporation, a Texas corporation, (the "Company") is a
wholly owned subsidiary of Michael Holdings, Inc., a Texas corporation.
The financial statements included herein have been prepared by the Company
are unaudited, condensed and do not contain all information required by
generally accepted accounting principles to be included in a full set of
financial statements. In the opinion of management, all material
adjustments, consisting of normal recurring adjustments, necessary to
present fairly the results of operations have been included. Due to
seasonal fluctuations, the results of operations for the interim periods
are not necessarily indicative of operating results for the entire fiscal
year. The financial statements in this Form 10-Q should be read in
conjunction with the audited financial statements and notes thereto
included in the Company's Registration Statement on Form S-4, as amended
(Registration No. 333-52263) (the "Registration Statement").
2. OIL AND GAS PROPERTIES
On July 31, 1998, the Company acquired all of the capital stock of two
companies owning non-operating working interests in 132 productive wells on
approximately 17,000 gross (500 net) acres primarily in the Lobo Trend
located in Webb and Zapata Counties in Texas for $2.6 million. The working
interest percentages range from 0.5% to 15%, with an average working
interest of approximately 2.5% and an average net revenue interest of
approximately 2.0%.
The Company recorded impairment losses of $1,430,000 and $238,000 for the
nine months ended September 30, 1998 and 1997, respectively, which is
included in depreciation, depletion and amortization (DD&A). See "Item 2.
Management's Discussion and Analysis of Financial Condition and Results
of Operations."
3. LONG-TERM DEBT
On April 2, 1998, the Company completed a debt offering under Rule 144A of
$135 million of 11 1/2% Senior Notes, due 2005 (the "Series A Notes"). Net
proceeds from the sale were used to prepay outstanding borrowings under a
previous credit agreement (the "T.E.P. Financing") of approximately $28
million. Under the T.E.P. Financing, a 30% net profits interest in all of
the Company's oil and natural gas properties was granted to the lender. In
addition, a warrant to purchase up to 5% of the Company's common stock was
granted to the lender. The value of the net profits interest and the
warrant was recorded as a discount to the T.E.P. Financing. On April 2,
1998, the T.E.P. Financing Agreement was extinguished, and the unamortized
balance of the notes payable discount, the deferred debt issuance costs and
certain fees incurred at closing were written off and reflected in the
income statement as an extraordinary loss, net of taxes.
On July 22, 1998, the Securities and Exchange Commission ("SEC") declared
the Company's Registration Statement effective pursuant to Section 8(a) of
the Securities Act of 1933, as amended (the "Securities Act"). The
Company's Series A Notes had been offered and sold in a transaction exempt
from registration under the Securities Act, subject to contractual
registration rights. As of September 4, 1998, all of the Series A Notes
had been exchanged for Series B Notes (which were the subject of the
Registration Statement), the terms of which are substantially identical to
the terms of the Series A Notes.
5
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4. PRO FORMA RESULTS
In March and April 1998, the Company acquired oil and gas properties for
approximately $89.3 million. Accordingly, revenues and expenses from the
properties have been included in the Company's statement of operations from
the date of purchase. The unaudited pro forma results of the Company's
operations, assuming the properties were acquired as of January 1 of each
respective year is as follows (in thousands):
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
----------------------
1998 1997
-------- --------
<S> <C> <C>
Pro Forma (Unaudited):
Revenues $ 20,341 $ 21,584
Net loss before extraordinary item (3,218) (1,839)
Net loss (3,749) (1,839)
</TABLE>
5. STOCK OPTION PLAN
On July 1, 1998, the shareholders of Michael Holdings, Inc. ("MHI"), the
parent company and owner of all of the outstanding common stock of the
Company, approved the Michael Holdings, Inc. 1998 Stock Option Plan. The
Stock Option Plan is available for grants to substantially all employees
and directors of MHI. The Stock Option Plan is administered by the
Compensation Committee of the Board of Directors of MHI. A maximum of
194,000 shares of MHI common stock is available for grant under the
Stock Option Plan. As of September 30, 1998, the Company granted, at
exercise prices equal to the fair market value per share, options
covering a total of 71,150 shares to twenty employees and directors
of MHI.
6. YEAR 2000 COMPLIANCE
The Company has begun making necessary modifications to its computer
systems in preparation for the year 2000. As of September 30, 1998, the
Company has incurred a total cost of less than $10,000, which has been
expensed. The impact of failing to identify and correct this problem could
be significant to the Company's ability to operate and report results, as
well as potentially exposing the Company to third party litigation. See
Item 2. "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Year 2000 Compliance".
7. SUBSEQUENT EVENTS
On November 4, 1998, the Company entered into a costless collar contract
with a third party which provides a floor price of $2.15 per MMbtu and
ceiling price of $2.38 per MMbtu. The collar hedges a monthly volume of
300,000 MMbtu from May 1, 1999 through April 30, 2000. Any gas revenues
over $2.38 per MMbtu will be paid by the Company to the third party.
Conversely, the third party agreed to pay the Company all revenues below
$2.15 per MMbtu.
On November 4, 1998, in a separate transaction with another third party,
the Company entered into a costless collar contract which provides a floor
price of $2.15 per MMbtu and ceiling price of $2.36 per MMbtu. The collar
hedges a monthly volume of 150,000 MMbtu from May 1, 1999 through Arpil 30,
2000. Any gas revenues over $2.36 per MMbtu will be paid by the Company to
the third party. Conversely, the third party agreed to pay the Company all
revenues below $2.15 per MMbtu.
6
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is management's discussion and analysis of certain
significant factors that have affected certain aspects of the Company's
financial position and operating results during the periods included in the
accompanying unaudited condensed financial statements. For supplemental
information, it is suggested that this Item 2. "Management's Discussion and
Analysis of Financial Condition and Results of Operations" be read in
conjunction with the corresponding section included in the Company's
Amendment No. 2 to Form S-4 (the "Form S-4") filed with the Securities and
Exchange Commission on July 20, 1998. The Form S-4 includes the Company's
Audited Financial Statements and the Notes thereto for certain prior periods,
as well as other relevant financial and operating information.
GENERAL
The Company is an independent energy company engaged in the acquisition,
development and production of oil and natural gas, principally in the Lobo
Trend of South Texas. The Company began operations in 1983, and, since its
inception, has increased its reserves and production as a result of
acquisitions and development of its oil and natural gas properties. In
August 1996, the Company consummated an acquisition of approximately 21,000
gross acres (12,700 net acres) in the Lobo Trend for a purchase price of
approximately $15.3 million. In 1997, the Company participated in the
drilling of 19 natural gas wells, completing 15 capable of commercial
production (a success rate of 79%). In March and April 1998, the Company
completed acquisitions adding approximately 51,000 gross acres (48,400 net
acres) in the Lobo Trend for an aggregate purchase price of approximately
$89.3 million. For the nine months ended September 30, 1998, the Company
participated in the drilling of 19 gross (14 net) natural gas wells, 15 gross
(10 net) of which were completed as productive wells.
From October 1, 1998 through November 11, 1998, the Company participated
in the drilling of 5 gross (4 net) natural gas wells of which one has been
completed, three are in the process of being completed, and one was a dry hole.
The Company utilizes the "successful efforts" method of accounting for
its oil and natural gas activities as described in Note 1 of the Financial
Statements in the Registration Statement.
RESULTS OF OPERATIONS
The following table summarizes production volumes, average sale prices
and operating revenues for the Company's oil and natural gas operations for
the three and nine-month periods ended September 30, 1998 and 1997:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30,
------------------ -------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Production volumes:
Oil and condensate (MBlbs) 18 3 53 20
Natural gas (Mmcf) 3,186 895 7,583 2,383
Average sales prices:
Oil and condensate (per Bbl) $ 10.73 $ 19.69 $ 11.89 $ 18.68
Natural gas (per Mcf) 2.06 2.09 2.09 2.18
Operating revenues ($ 000's):
Oil and condensate $ 193 $ 68 $ 630 $ 382
Natural gas 6,556 1,868 15,816 5,202
------- ------- -------- -------
Total $ 6,749 $ 1,936 $ 16,446 $ 5,584
------- ------- -------- -------
------- ------- -------- -------
</TABLE>
7
<PAGE>
COMPARISON OF THREE MONTH PERIODS ENDED SEPTEMBER 30, 1998 AND 1997
Oil and natural gas revenues for the three months ended September 30,
1998 increased 248% to $6.75 million from $1.94 million for the three months
ended September 30, 1997. Production volumes for natural gas for the third
quarter ended September 30, 1998 increased 256% to 3,186 MMcf from 895 MMcf
for the third quarter of 1997. Average natural gas prices decreased 1% to
$2.06 per Mcf for 1998 from $2.09 per Mcf for 1997. The increase in natural
gas production was a result of the Company's 1998 acquisitions and new wells
on line resulting from the Company's drilling program.
Oil and natural gas production costs for the three months ended
September 30, 1998 increased 121% to $1,233,000 from $557,000 for the three
months ended September 30, 1997 primarily due to the increase in production.
However, production costs per equivalent unit decreased to $0.37 per Mcfe for
the three-months ended September 30, 1998 from $0.61 per Mcfe for the three
months September 30, 1997. The decrease on an equivalent basis was due to a
reduction in workover costs and increased efficiencies in the Lobo Trend
properties as a result of increased production and acquisition activities.
Depreciation, depletion and amortization ("DD&A") expense for the three
months ended September 30, 1998 increased 364% to $3.92 million from $847,000
for the same period in 1997. The increase was due to increased production
during 1998 resulting from the acquisitions and the new wells completed in
1998. In addition, a $725,000 impairment charge was taken in the three months
ended September 30, 1998 with no corresponding charge in the same period in
1997. The impairment charges in 1998 were primarily due to development dry holes
drilled on oil and gas leases that incurred a reduction in the estimated proven
reserves.
General and administrative expenses for the three months ended September
30, 1998 increased 21% to $294,000 from $244,000 for the three months ended
September 30, 1997 due to salaries and related benefits for six new
employees, plus increases in legal and professional fees in connection with
the Senior Notes offerings.
Interest expense, net of capitalized interest, for the three months
ended September 30, 1998 increased 604% to $4.05 million from $575,000 for
the same period in 1997. The increase was due to the higher level of
outstanding debt for the three months ended September 30, 1998 compared to
the same period of 1997.
The net loss for the three months ended September 30, 1998 was $1.77
million compared to net loss of $180,000 for the three months ended September
30, 1997, primarily as a result of the factors discussed above.
COMPARISON OF NINE MONTH PERIODS ENDED SEPTEMBER 30, 1998 AND 1997
Oil and natural gas revenues for the nine months ended September 30,
1998 increased 195% to $16.45 million from $5.58 million for the nine months
ended September 30, 1997. Production volumes for natural gas for the nine
months ended September 30, 1998 increased 218% to 7,583 MMcf from 2,383 MMcf
for the first nine months of 1997. Average natural gas prices decreased 4%
to $2.09 per Mcf for nine months ended September 30, 1998 from $2.18 per Mcf
for the same period in 1997. The increase in natural gas production was due
to the Company's 1998 acquisitions and new wells on line resulting from the
Company's drilling program.
Oil and natural gas production costs for the nine months ended September
30, 1998 increased 93% to $2.83 million from $1.47 million for the nine
months ended September 30, 1997 primarily due to the increase in production
and acquisition activities. However, production costs per equivalent unit
decreased to $.36 per Mcfe for the nine months ended September 30, 1998 from
$.59 per Mcfe for the nine months ended September 30, 1997. The decrease on
an equivalent basis was due to a reduction in workover costs and increased
efficiencies in the Lobo Trend properties as a result of increased
production.
Depreciation, depletion and amortization ("DD&A") expense for the nine
months ended September 30, 1998 increased 229% to $8.42 million from $2.56
million for the same period in 1997. The increase was due to increased
production during 1998 and acquisition activities, partially offset by
$1,430,000 of impairment charges taken in the nine months ended September 30,
1998 compared to a $238,000 impairment charge taken in the same period in
1997. The impairment charges in 1998 were primarily due to development dry holes
drilled on oil and gas leases that incurred a reduction in the estimated proven
reserves.
8
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General and administrative expenses increased 49% to $811,000 from $544,000
for the nine months ended September 30, 1997 due to the addition of salaries and
related benefits for six new employees, plus increases in legal and professional
fees.
Interest expense, net of capitalized interest, for the nine months ended
September 30, 1998 increased 527% to $8.47 million from $1.35 million for the
same period in 1997. The increase was due to the higher level of outstanding
debt for the nine months ended September 30, 1998 compared to the same period
of 1997.
The extraordinary loss of $531,000 (net of the income tax benefit of
$285,000) for the nine months ended September 30, 1998 was due to an
extinguishment of the T.E.P. Financing. No extraordinary items occurred in
the nine months ended September 30, 1997.
The net loss for the nine months ended September 30, 1998 was $3.09
million compared to a loss of $215,000 for the nine months ended September
30, 1997, primarily as a result of the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
In April 1998, the Company completed the Senior Notes offering of $135
million. Approximately $28 million of the net proceeds from the sale of the
Series A Notes were used to repay indebtedness incurred under the T.E.P.
Financing. Approximately $89.3 million of the net proceeds were used to fund
acquisitions and the remaining balance to provide additional working capital
for general corporate purposes. In May 1998, the Company entered into a new
credit facility with Christiania Bank og KreditKasse as described under
"Financing Arrangements" below. As of September 30, 1998 and November 10,
1998, $8 million and $10 million, respectfully, had been drawn on the new
credit facility. The large majority of the Company's current indebtedness
exists as a result of the Senior Notes outstanding.
The Company had cash and cash equivalents at September 30, 1998 of $9.04
million, consisting primarily of short-term money market investments,
compared to $782,000 at December 31, 1997. Working capital was $1.57 million
at September 30, 1998 compared to a working capital deficit of $8.60 million
at December 31, 1997.
Cash flows provided by operating activities from the Company's
operations were approximately $10.36 million and $3.45 million for the nine
months ended September 30, 1998 and 1997, respectively. The increase in
operating cash flows for the nine months ended September 30, 1998 over the
same period in 1997 was primarily due to increased production, revenue and
operating income as a result of 1998 acquisitions and the Company's drilling
program.
Cash flows used in investing activities by the Company were $108.85
million and $13.27 million for the nine months ended September 30, 1998 and
1997, respectively. Property additions resulted primarily from the 1998
acquisitions and drilling and development activities described above.
Cash flows provided by financing activities were $106.75 million and
$10.07 million for the nine months ended September 30, 1998 and 1997,
respectively. The increase in the amount of cash flows provided by financing
activities for the nine months ended September 30, 1998 was primarily due to
the net proceeds received from the $135 million offering of the Series A
Notes, offset by the repayment of the indebtedness under the T.E.P Financing.
CAPITAL EXPENDITURES
Capital expenditures for the first nine months of 1998 totaled $108.85
million compared to $13.27 million in 1997.
The Company has experienced and expects to continue to experience
substantial working capital requirements due to the Company's development
program. Capital expenditures for 1998 are estimated to be $25.0 million,
exclusive of acquisitions discussed above. Substantially all of the capital
expenditures will be used to fund drilling activities, property acquisitions
and 3-D seismic surveys in the Company's project areas. The Company
anticipates drilling 34 gross (22 net) wells in 1998. While the net proceeds
from the offering of the Senior Notes,
9
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cash flows from operations and borrowings under the new credit facility
should allow the Company to implement its present development drilling
strategy, additional financing may be required in the future to fund the
Company's further growth through acquisitions of additional properties. In
addition, the Company's indebtedness contains certain negative and financial
covenants which may limit the Company's capital expenditures. See "Financing
Arrangements". In the event such capital resources are not available to the
Company, future significant property acquisitions and development may be
limited.
FINANCING ARRANGEMENTS
CREDIT FACILITY
In May 1998, the Company entered into a five-year credit facility (the
"Credit Facility") with Christiania Bank og KreditKasse ("Christiania") which
provides maximum loan amounts totaling $50.0 million, subject to borrowing
base limitations. The borrowing base will be redetermined quarterly by
Christiania based on the Company's proved oil and natural gas reserves
beginning at March 31, 1999. Although the initial borrowing base was $30
million, effective November 9, 1998, the borrowing base was increased by $5
million to a total of $35 million. The maturity date of all indebtedness
under the Credit Facility is May 28, 2002.
The interest rate for borrowings under the Credit Facility are
determined at either (i) the ABR rate, or (ii) the Eurodollar Rate plus
1.75%, at the election of the Company. The "ABR" rate is the higher of (i)
Christiania Bank's prime rate then in effect, (ii) the secondary market rate
for three-month certificates of deposit plus 1% or (iii) the federal funds
rate then in effect plus 0.5%. Interest will generally be due on a quarterly
basis. The Credit Facility is secured by substantially all of the oil and
natural gas assets of the Company, including accounts receivable, equipment
and gathering systems. The proceeds of the Credit Facility may be used to
finance working capital needs and for general corporate purposes of the
Company in the ordinary course of its business.
The Credit Facility contains certain covenants by the Company, including
(i) limitations on additional indebtedness and on guaranties by the Company
except as permitted under the Credit Facility, (ii) limitations on additional
investments except those permitted under the Credit Facility and (iii)
restrictions on dividends or distributions on or repurchases or redemptions
of capital stock by the Company except for those involving repurchases of
Michael Holdings, Inc. capital stock which may not exceed $500,000 in any
fiscal year. In addition, the Credit Facility requires the Company to
maintain and comply with certain financial covenants and ratios, including a
minimum interest coverage ratio, a minimum current ratio and a covenant
requiring that the Company's general and administrative expenses may not
exceed 12.5% of the Company's gross revenues in a calendar year. As of
November 10, 1998, the Company had a total of $25 million available for
borrowing and $10 million outstanding indebtedness under the Credit Facility.
In addition, effective March 31, 1999, the borrowing base will be reduced by
$2.6 million per quarter. However, the borrowing base is subject to
retermination on a semi-annual basis, commencing effective as of October 31,
1998.
SENIOR NOTES
The indenture governing the Senior Notes (the "Indenture") contains
certain covenants that, among other things, limit the ability of the Company
to incur additional indebtedness, pay dividends, repurchase equity interests
or make other Restricted Payments (as defined in the Indenture), create
liens, enter into transactions with affiliates, sell assets or enter into
certain mergers and consolidations. In the event of certain asset
dispositions, the Company is required under certain circumstances to use the
excess proceeds from such a disposition to offer to repurchase the Senior
Notes (and other Senior Indebtedness for which an offer to repurchase is
required to be concurrently made) having an aggregate principal amount equal
to the excess proceeds at a purchase price equal to 100% of the principal
amount of the New Notes, together with accrued and unpaid interest and
Liquidated Damages (as defined in the Indenture), if any, to the date of
repurchase (a "Net Proceeds Offer"). For additional information regarding the
terms of the Senior Notes, see "Description of Notes" in the Registration
Statement.
10
<PAGE>
HEDGING ACTIVITIES
In an effort to achieve more predictable cash flows and earnings and
reduce the effects of volatility of the price of oil and natural gas on the
Company's operations, the Company has hedged in the past, and in the future
expects to hedge oil and natural gas prices through the use of swap
contracts, put options and costless collars. While the use of these hedging
arrangements limits the downside-risk of adverse price movements, it also
limits future gains from favorable movements. The Company accounts for these
transactions as hedging activities and, accordingly, gains and losses are
included in oil and natural gas revenues in the periods in which the related
production occurs. The Company does not engage in hedging arrangements in
which the production amounts are in excess of the Company's actual production.
On April 7, 1998, the Company entered into a costless collar contract
with a third party which provides a floor price of $2.25 per Mmbtu and
ceiling price of $2.99 per MMbtu. The collar hedges a monthly volume of
450,000 MMbtu from May 1, 1998 through April 30, 1999. Any gas revenues over
$2.99 per MMbtu will be paid by the Company to the third party. Conversely,
the third party agreed to pay the Company all revenues below $2.25 per MMbtu.
In addition, on April 7, 1998, in a separate transaction with another third
party, the Company purchased put options having a strike price of $2.25 per
MMbtu for approximately $230,000. The put options hedge a volume of 150,000
Mmbtu per month from May 1, 1998 to April 30, 1999. The fair value of the
put option and costless collar at September 30, 1998 was approximately $1.02
million. All prices are relative to the Houston Ship Channel Index.
Effective on November 4, 1998, the Company entered into a costless
collar contract with a third party which provides a floor price of $2.15 per
MMbtu and ceiling price of $2.38 per MMbtu. The collar hedges a monthly
volume of 300,000 MMbtu from May 1, 1999 through April 30, 2000. Any gas
revenues over $2.38 per MMbtu will be paid by the Company to the third party.
Conversely, the third party agreed to pay the Company all revenues equal to
the difference between $2.15 per MMbtu, and any revenues under $2.15 per
MMbtu will be paid to the Company. In addition, in a separate transaction
with another third party, effective November 4, 1998, the Company entered
into a costless collar contract which provides a floor price of $2.15 per
MMbtu and ceiling price of $2.36 per MMbtu. The collar hedges a monthly
volume of 150,000 MMbtu from May 1, 1999 through April 30, 2000. Any gas
revenues over $2.36 per MMbtu will be paid by the Company to the third party.
Conversely, the third party agreed to pay the Company all revenues below
$2.15 per MMbtu.
CAUTIONARY STATEMENT FOR PURPOSES OF FORWARD LOOKING STATEMENTS
Item 2. "Management's Discussion and Analysis of Financial Condition
and Results of Operations" of this Quarterly Report on Form 10-Q contains
projections and other forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934. These statements can be
identified by the use of forward-looking terminology, such as "believes,"
"expects," "may," "should" or "anticipates" or the negative thereof or
comparable terminology, or by discussions of strategy that involve risks and
uncertainties. In addition, all statements other than statements of
historical facts included in this Quarterly Report, including, without
limitation, statements regarding the Company's business strategy, future
governmental regulation, oil and natural gas reserves, future drilling and
development opportunities and operations, future acquisitions, future
production of oil and natural gas (and the prices thereof and the costs
therefor), anticipated results of hedging activities, future capital
expenditures, and Year 2000 compliance issues, and future net cash flows, are
forward-looking statements and may contain certain information concerning
financial results, economic conditions, trends and known uncertainties. Such
statements reflect the Company's current views with respect to future events
and financial performance, and involve risks and uncertainties. Actual
results could differ materially from those projected in the forward-looking
statements as a result of these various risks and uncertainties, including,
without limitation, (i) factors such as natural gas price fluctuations and
markets, uncertainties of estimates of reserves and future net revenues,
competition in the oil and natural gas industry, risks associated with oil
and natural gas operations, risks associated with future acquisitions, risks
associated with the Company's future capital requirements and the
availability of sources of capital and regulatory and environmental risks,
(ii) adverse changes to the properties and leases acquired in 1998 or the
failure of the Company to achieve the anticipated benefits of such
acquisitions, (iii) the extent of "Year 2000" compliance by the Company's
suppliers and customers and the Company's information and embedded
technologies, and (iv) adverse changes in the market for the Company's oil and
natural gas production. For a more detailed description of these and certain
11
<PAGE>
other risks associated with the Company's operations, see "Risk Factors" in
the Registration Statement.
YEAR 2000 COMPLIANCE
Many computer systems have been designed using software that processes
transactions using two digits to represent the year. This type of software
will generally require modifications to function properly with dates after
December 31, 1999. The same issue applies to microprocessors embedded in
machinery and equipment, such as gas compressors and pipeline meters. The
impact of failing to identify and correct this problem could be significant
to the Company's ability to operate and report results, as well as
potentially exposing the Company to third party liability.
The Company has begun making necessary modifications to its internal
information computer system in preparation for the Year 2000. The Company
estimates that its Year 2000 project will be completed by March 1999, and
currently believes that the total related costs will be approximately
$30,000, funded by cash from operations or short term borrowings, when
completed in March 1999. Actual costs to date are less than $10,000.
The Company anticipates it will begin reviewing the Year 2000
compliance status of field equipment, including compressor stations, gas
control systems and data logging equipment, during the fourth quarter of 1998
and expects to complete this review by March 1999.
Additionally, the Company is in the process of contacting its
significant customers and suppliers in order to determine the Company's
exposure to their potential failure to become Year 2000 compliant. Although
the Company is not aware of any Year 2000 compliance problems with any of its
customers or suppliers, there can be no guarantee that the systems of these
companies will operate without interruption in the new millennium.
The Company has designated personnel responsible to not only identify
and respond to these issues, but also to develop a contingency plan in the
event that a problem arises after the turn of the century. Management
expects the contingency plan to be substantially complete by mid 1999. At
this time, while no assurances can be given, the Company does not anticipate
that the arrival of the Year 2000 will materially impact its financial
position results of operations, or cash flows.
Project costs and timetable for Year 2000 compliance are based on
management's best estimates. In developing these estimates, assumptions were
made regarding future events including, among other things, the availability
of certain resources and the continued cooperation of the Company's customers
and suppliers. Actual costs and timing may differ from management's
estimates due to unexpected difficulties in obtaining trained personnel,
locating and correcting relevant computer code and other factors.
EFFECTS OF INFLATION AND CHANGES IN PRICE
The Company's results of operations and cash flows are affected by
changes in oil and natural gas prices. If the price of oil and natural gas
increases (decreases), there could be a corresponding increase (decrease) in
the operating costs that the Company is required to bear for operations, as
well as an increase (decrease) in revenues. Inflation has had only a minimal
effect on the Company.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has in the past and expects in the future to enter into
swap contracts, put options and costless collars in an effort to hedge oil
and natural gas prices. For a description of the Company's hedging
activities, see Item 2. "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Hedging Activities."
Because the Company is not yet required to provide disclosures
otherwise mandated under Item 305 of Regulation S-K promulgated by the
Securities and Exchange Commission, the foregoing disclosures under this Item
3 do not and are not intended to comply with Item 305.
12
<PAGE>
PART II - OTHER INFORMATION
<TABLE>
<CAPTION>
<S> <C> <C>
Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . Not Applicable
Item 2. Changes in Securities and Use of Proceeds. . . . . . Not Applicable
Item 3. Defaults upon Senior Securities. . . . . . . . . . . Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders. Not Applicable
Item 5. Other Information. . . . . . . . . . . . . . . . . . Not Applicable
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . Not Applicable
</TABLE>
(A) EXHIBITS. The following exhibits are filed as part of
this report:
<TABLE>
<CAPTION>
EXHIBIT NO.
- -----------
<S> <C>
27.1* Financial Data Schedule.
</TABLE>
- ----------
* Filed herewith
(B) Reports on Form 8-K during the quarter ended
September 30, 1998 . . . . . . . . . . . . . . . . . None
13
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
MICHAEL PETROLEUM CORPORATION
(REGISTRANT)
Date By
----------------- ----------------------------
Glenn D. Hart
Chief Executive Officer and
Chairman of the Board
Date By
----------------- ----------------------------
Michael G. Farmar
President and Chief Operating
Officer
Date By
----------------- ----------------------------
Robert L. Swanson
Vice President, Finance
Date By
----------------- ----------------------------
Scott R. Sampsell
Vice President, Controller and
Treasurer
14
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 9,044
<SECURITIES> 0
<RECEIVABLES> 8,805
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 22,453
<PP&E> 143,838
<DEPRECIATION> (15,386)
<TOTAL-ASSETS> 156,788
<CURRENT-LIABILITIES> 20,880
<BONDS> 140,852
0
0
<COMMON> 1
<OTHER-SE> (5,001)
<TOTAL-LIABILITY-AND-EQUITY> 156,788
<SALES> 0
<TOTAL-REVENUES> 16,446
<CGS> 0
<TOTAL-COSTS> 12,182
<OTHER-EXPENSES> (275)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8,469
<INCOME-PRETAX> (3,930)
<INCOME-TAX> (1,376)
<INCOME-CONTINUING> (2,554)
<DISCONTINUED> 0
<EXTRAORDINARY> (531)
<CHANGES> 0
<NET-INCOME> (3,085)
<EPS-PRIMARY> 0.00
<EPS-DILUTED> 0.00
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