<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
[X] SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
[ ] SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________to ______________
Commission file number : 000-28463
AROC Inc.
(Exact name of registrant as specified in its charter)
Delaware 73-2932492
(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or organization)
4200 East Skelly Drive, Suite 1000, Tulsa, Oklahoma 74135
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (918) 491-1100
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 Act of 1934 during the
preceding 12 months (or for such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
As of October 15, 2000, there were 55,278,837 shares of the Registrant's
common stock outstanding and 10,000,000 convertible restricted voting shares
outstanding of the Registrant.
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements Page
Consolidated Condensed Balance Sheets as of
September 30, 2000 and December 31, 1999 3
Consolidated Condensed Statements of Operations
for the three and nine months ended September 30, 2000 and 1999 4
Consolidated Condensed Statement of Stockholders' Equity (Deficit) and
Comprehensive Income (Loss) - Nine months ended September 30, 2000 5
Consolidated Condensed Statements of Cash Flows -
Nine months ended September 30, 2000 and 1999 6
Notes to Consolidated Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk 18
PART II - OTHER INFORMATION
The information called for by Item 1. Legal Proceedings, Item 2.
Changes in Securities, Item 3. Default Upon Senior Securities, Item 4.
Submission of Matters to a Vote of Security Holders, Item 5. Other
Information has been omitted as either inapplicable or because the
answer thereto is negative or has been described in the Form 8-K/A
filed October 27, 2000.
Item 6. Exhibit and Reports on Form 8-K 20
SIGNATURES 21
</TABLE>
Cautionary Statement Regarding Forward Looking Statements
In the interest of providing the Company's stockholders and potential investors
with certain information regarding the Company's future plans and operations,
certain statements set forth in this Form 10-Q relate to management's future
plans and objectives. Such statements are "forward-looking statements" within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Although any
forward-looking statements contained in this Form 10-Q or otherwise expressed by
or on behalf of the Company are, to the knowledge and in the judgment of the
officers and directors of the Company, expected to prove true and to come to
pass, management is not able to predict the future with absolute certainty.
Forward looking statements involve known and unknown risks and uncertainties
which may cause the Company's actual performance and financial results in future
periods to differ materially from any projection, estimate or forecasted result.
These risks and uncertainties include, among other things, volatility of oil and
gas prices, competition, risks inherent in the Company's oil and gas operations,
the inexact nature of interpretation of seismic and other geological and
geophysical data, imprecision of reserve estimates, the Company's ability to
replace and expand oil and gas reserves, and such other risks and uncertainties
described from time to time in the Company's periodic reports and filings with
the Securities and Exchange Commission. Accordingly, stockholders and potential
investors are cautioned that certain events or circumstances could cause actual
results to differ materially from those projected, estimated, or predicted.
2
<PAGE>
AROC INC. AND SUBSIDIARIES
(Formerly EnCap 1996 LP)
Consolidated Condensed Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
September 30 December 31
2000 1999
------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 567,063 $ 901,546
Accounts receivable - trade 6,050,068 923,813
Other current assets 1,217,042 -
Marketable equity securities - available for sale - 322,166
------------- ------------
Total current assets 7,834,173 2,147,525
------------- ------------
Property, plant, and equipment, at cost:
Oil and gas properties (using full cost method)
US properties 101,388,526 16,656,780
UK properties 18,222,631 -
Other depreciable assets 611,810 -
------------- ------------
120,222,967 16,656,780
Less accumulated depreciation, depletion and impairments (5,593,231) (3,094,393)
------------- ------------
Net property, plant and equipment 114,629,736 13,562,387
------------- ------------
Other assets:
Deposits and other assets 206,598 -
Deferred loan costs, less accumulated amortization 1,883,299 -
------------- ------------
Total other assets 2,089,897 -
------------- ------------
TOTAL ASSETS $ 124,553,806 $ 15,709,912
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 6,938,959 $ 486,676
Accrued expenses payable 1,085,558 -
Payable to affiliates - 78,872
------------- ------------
Total current liabilities 8,024,517 565,548
Long-term Liabilities:
Long-term debt (net of discount of $4,462,510
at September 30, 2000) 36,901,964 -
------------- ------------
Total Liabilities 44,926,481 565,548
------------- ------------
Redeemable preferred shares - par value $0.001, $50 per share redemption
value; 2,200,000 authorized; 1,780,303 issued and outstanding at
September 30, 2000 92,723,564 -
Stockholders' equity (deficit):
Common shares - par value $0.001; 100,000,000
authorized; 55,278,837 and 48,678,837 issued and
outstanding at September 30, 2000 and December 31, 1999,
respectively 55,279 48,679
Convertible shares - par value $0.001; 10,000,000
authorized; 10,000,000 issued and outstanding 10,000 10,000
Additional paid-in-capital 2,056,703 25,741,395
Unearned compensation - restricted stock (733,000) -
Accumulated other comprehensive loss - (213,123)
Accumulated deficit (14,485,221) (10,442,587)
------------- ------------
Total stockholders' equity (deficit) (13,096,239) 15,144,364
------------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 124,553,806 $ 15,709,912
============= ============
</TABLE>
See accompanying notes to consolidated condensed financial statements.
3
<PAGE>
AROC INC. AND SUBSIDIARIES
(Formerly EnCap 1996 LP)
Consolidated Condensed Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Three Nine Nine
Months Ended Months Ended Months Ended Months Ended
September 30 September 30 September 30 September 30
2000 1999 2000 1999
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
Oil and gas revenues $ 5,696,624 $ 957,075 $ 11,241,130 $ 2,335,317
Operating expenses:
Lease operating expense 2,740,656 560,326 5,148,040 1,607,135
Depreciation, depletion, and amortization 1,270,447 129,174 2,515,239 475,964
General and administrative expense 857,636 71,432 1,505,289 277,286
------------ ------------ ------------ -------------
Total operating expenses 4,868,739 760,932 9,168,568 2,360,385
------------ ------------ ------------ -------------
Income (loss) from operations 827,885 196,143 2,072,562 (25,068)
Other income (expense):
Impairment write-down and loss on sale of
marketable equity securities - (1,902,076) (262,689) (6,060,891)
Interest income 2,751 485 27,837 1,094
Interest expense (1,295,224) - (2,076,041) -
Miscellaneous income/(expense) (63,427) - (95,339) -
Equity in net losses of affiliate - - - (4,251,961)
------------ ------------ ------------ -------------
Net loss (528,015) (1,705,448) (333,670) (10,336,826)
Preferred stock dividend requirements 2,225,378 - 3,708,964 -
------------ ------------ ------------ -------------
Net loss attributable to common stockholders $ (2,753,393) $ (1,705,448) $ (4,042,634) $ (10,336,826)
============ ============ ============ =============
Basic loss per share $ (0.05) $ (0.03) $ (0.08) $ (0.19)
============ ============ ============ =============
Weighted average number of common shares outstanding 53,678,837 53,678,837 53,678,837 53,678,837
============ ============ ============ =============
</TABLE>
See accompanying notes to consolidated condensed financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
AROC INC. AND SUBSIDIARIES
(Formerly EnCap 1996 LP)
Consolidated Condensed Statement of Stockholders' Equity (Deficit) and Comprehensive Income/(Loss)
Nine Months Ended September 30, 2000
(Unaudited)
Unearned Accumulated
Compensation Other
Common Convertible Additional Restricted Comprehensive
Shares Shares Paid-in-Capital Stock Loss
-------- ----------- --------------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1999 $ 48,679 $ 10,000 $ 25,741,395 $ - $ (213,123)
Contributions - - 88,366 - -
Distributions - - (1,125,698) - -
Issuance of preferred stock - - (28,243,708) - -
Warrants issued to lender - - 4,744,948 - -
Issuance of restricted stock 6,600 - 851,400 (858,000) -
Preferred stock dividends - - - - -
Vesting of restricted stock -
compensation expense - - - 125,000 -
Comprehensive loss:
Net loss - - - - -
Change in net unrealized loss
of investments - - - - 213,123
Total comprehensive income
-------- ----------- --------------- ------------ -------------
Balance at September 30, 2000 $ 55,279 $ 10,000 $ 2,056,703 $ (733,000) $ -
======== =========== =============== ============ =============
Accumulated
Deficit Total
------------ ------------
Balance at December 31, 1999 $(10,442,587) $ 15,144,364
Contributions - 88,366
Distributions - (1,125,698)
Issuance of preferred stock - (28,243,708)
Warrants issued to lender - 4,744,948
Issuance of restricted stock - -
Preferred stock dividends (3,708,964) (3,708,964)
Vesting of restricted stock -
compensation expense - 125,000
Comprehensive loss:
Net loss (333,670) (333,670)
Change in net unrealized loss
of investments - 213,123
------------
Total comprehensive income (120,547)
------------ ------------
Balance at September 30, 2000 $(14,485,221) $(13,096,239)
============ ============
See accompanying notes to consolidated condensed financial statements.
</TABLE>
5
<PAGE>
AROC INC. AND SUBSIDIARIES
(Formerly EnCap 1996 LP)
Consolidated Condensed Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Nine Months
Ended Ended
September 30 September 30
2000 1999
------------ ------------
<S> <C> <C>
Cash flows from operating activites:
Net loss $ (333,670) $(10,336,826)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activites:
Depreciation, depletion and amortization 2,515,239 475,964
Impairment writedown and loss on sale of marketable securities 262,688 6,060,891
Compensation expense 125,000 -
Interest expense and defered loan amortization 1,309,362 -
Equity in net losses in affiliate - 4,251,961
Changes in assets and liabilities, net effects from acquisitions
Accounts receivable (2,579,756) (234,649)
Other assets (1,108,766) -
Accounts payable and accrued expenses (2,692,361) (15,971)
------------ ------------
Net cash provided by (used in) operating activities (2,502,264) 201,370
------------ ------------
Cash flows from investing activities:
Proceeds from sale of oil and gas properties 139,541 2,989,315
Additions of property and equipment (6,497,709) (1,180,736)
Proceeds from sale of marketable securities available for sale - 2,794,729
Acquisition of AROC 578,839 -
------------ ------------
Net cash provided by (used in) investing activities (5,779,329) 4,603,308
------------ ------------
Cash flows from financing activities:
Deferred loan costs (1,145,357) -
Payments of long-term debt (40,345,951) -
Proceeds from issuance of preferred stock 2,703,150 -
Proceeds from issuance of long-term debt 47,500,000 -
Contributions 88,366 1,682,958
Distributions (853,098) (5,612,312)
------------ ------------
Net cash provided by (used in) financing activities 7,947,110 (3,929,354)
------------ ------------
Net increase (decrease) in cash (334,483) 875,324
Cash and cash equivalents at beginning of period 901,546 396,822
------------ ------------
Cash and cash equivalents at end of period $ 567,063 $ 1,272,146
============ ============
Supplemental disclosures of cash flow information -
Cash paid during the period for interest $ 477,000 $ -
============ ============
Supplemental disclosures of noncash investing and financing activities:
Distribution of stock $ 272,601 $ -
Preferred shares issued for banking fees 962,000 -
Preferred shares issued to refinance debt 35,299,439 -
Preferred shares to purchase oil and gas properties
and acquisition of old AROC 21,805,304 -
Change to stockholders' equity for issuance of preferred stock 28,243,708 -
</TABLE>
See accompanying notes to consolidated condensed financial statements
6
<PAGE>
AROC Inc.
(Formerly EnCap 1996 LP)
Notes to Consolidated Condensed Statements
(Unaudited)
A. Summary of Significant Accounting Policies
Basis of Presentation
---------------------
These financial statements have been prepared by AROC Inc. (AROC or the Company)
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission, and reflect all adjustments which are, in the opinion of
management, necessary for a fair statement of the results for the interim
periods, on a basis consistent with the annual audited financial statements.
All such adjustments are of a normal, recurring nature. Certain information,
accounting policies, and footnote disclosure normally included in financial
statements prepared in accordance with generally accepted principles have been
omitted pursuant to such rules and regulations, although the Company believes
that the disclosures are adequate to make the information presented not
misleading. These financial statements should be read in conjunction with the
AROC, EnCap Acquisition and Pro Forma financial statements and the notes thereto
included in the Company's most recent Form 8-K.
Consolidation
-------------
The consolidated financial statements include the financial statements of the
Company and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
Loss Per Share
--------------
Basic loss per share has been computed by dividing the net loss attributable to
common stockholders by the weighted average number of common shares and
convertible shares (convertible at any time into a minimum of 5,000,000 common
shares) outstanding during the periods presented.
The effect of potential common shares (options, warrants and restricted stock)
is anti-dilutive. Accordingly, diluted loss per share is not presented.
Foreign Currency Translation
----------------------------
The financial statements of subsidiaries of the Company whose functional
currency is not U.S. dollars are translated for consolidation purposes at the
rate of exchange at the balance sheet date. Exchange differences arising on the
retranslation of net assets are reported as a component of stockholders' equity
(deficit) in accumulated other comprehensive loss. In the underlying financial
statements, transactions with third parties are translated into the functional
currency at the exchange rate prevailing at the date of each transaction.
Monetary assets and liabilities denominated in currencies other than the
functional currency are translated into U.S. dollars at the exchange rate
prevailing at the balance sheet date. Any exchange gain or loss is recorded in
the consolidated statements of operations. Translation and exchange gains or
losses for the periods presented were immaterial.
7
<PAGE>
AROC Inc.
(Formerly EnCap 1996 LP)
Notes to Consolidated Condensed Statements
(Unaudited)
Depreciation of Other Fixed Assets
----------------------------------
Other tangible fixed assets are stated at cost less accumulated depreciation.
Depreciation is provided on a straight line basis to write off the cost of
assets, net of estimated residual values, over their estimated useful lives as
follows:
Fixtures and equipment - 3 to 7 years
Buildings - 30 years
Deferred Taxation
-----------------
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in the consolidated statement of operations in
the period that includes the enactment date.
For the periods presented and at September 30, 2000, the Company had net
deferred tax assets reduced by a valuation allowance to zero because it was not
more likely than not such deferred tax assets will be realized.
Debt Issuance Costs
-------------------
Debt issuance costs are initially capitalized and are amortized (interest
method) over the term of the debt to which they relate.
Stock Option Plan
-----------------
The Company applies the intrinsic value-based method of accounting prescribed by
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations, in accounting for its fixed plan
stock options. As such, compensation expense would be recorded on the date of
grant only if the current market price of the underlying stock exceeded the
exercise price. Financial Accounting Standards Board Statement (FAS) 123,
"Accounting for Stock-Based Compensation," established accounting and disclosure
requirements using a fair value-based method of accounting for stock-based
employee compensation plans. As allowed by FAS 123, the Company has elected to
continue to apply the intrinsic value-based method of accounting described
above, and has adopted the disclosure requirements of FAS 123.
Business Segments
-----------------
The Company considers itself to be involved in one business activity and does
not meet the criteria established by Financial Accounting Standards Board
Statement FAS 131, "Segment Disclosures and Related Information".
8
<PAGE>
AROC Inc.
(Formerly EnCap 1996 LP)
Notes to Consolidated Condensed Statements
(Unaudited)
Revenues from operations from the United Kingdom (UK) production were $371,583
and $673,590 for the three and nine months ended September 30, 2000,
respectively. Loss from operations from the UK production were $332,748 and
$345,477 for the three and nine months ended September 30, 2000, respectively.
Capital expenditures were $1,311,766 for the three months and $1,680,766 for the
nine months ended September 30, 2000. The UK oil and gas properties were
acquired in May 2, 2000 in connection with the old AROC reverse acquisition (see
note B).
B. Significant Events
As a result of the May 2, 2000 transactions described below, EnCap Equity
1996 Limited Partnership (EnCap 1996 LP) became the largest stockholder
(approximately 39%) of AROC Inc. (old AROC). Although old AROC is the legal
acquirer, EnCap 1996 LP is treated as having acquired old AROC for accounting
purposes. Accordingly, the transactions have been accounted for as a reverse
acquisition and EnCap 1996 LP is now referred to as AROC or the Company. The
historical financial statements are those of EnCap 1996 LP, which have been
restated for the equivalent number of shares received in the transactions. The
results of operations of AROC (Legal Acquirer) will be included in the financial
statements of the combined AROC and EnCap 1996 LP financial statements from May
2, 2000 (Acquisition Date).
On May 2, 2000, pursuant to four separate Purchase and Sale agreements by and
between old AROC and (i) EnCap Equity 1994 Limited Partnership (EnCap 1994 LP),
(ii) Energy Capital Investment Company PLC (ECIC) and ECIC Corporation, (iii)
EnCap 1996 LP, and (iv) Mountaineer Limited Partnership (together the Sellers),
old AROC acquired direct or indirect ownership of oil and gas properties located
in Texas, Louisiana, New Mexico and Wyoming (the EnCap Acquisition). The
properties were acquired in exchange for the issuance to the Sellers of an
aggregate of 930,140 shares of the Company's newly created redeemable Series A
Preferred Stock (Preferred Stock).
Also, on May 2, 2000, old AROC sold to Bank of America, EnCap 1996 LP, ECIC, El
Paso Capital Investments, L.L.C. (El Paso), EF-II Holdings, LLC (EF-II), Picosa
Creek Limited Partnership (Picosa) and EnCap Investments, L.L.C. (EnCap
Investments) 850,163 shares of the Company's Preferred Stock for a total
consideration of approximately $42.5 million, received in satisfaction of
outstanding obligations to those parties and in consideration of cash
(approximately $2,700,000) and the purchase of an oil and gas property interest
(valued at approximately $2,000,000).
The Preferred Stock accrues cumulative dividends at the rate of $5.00 per share
per year, payable semiannually. Until May 1, 2002, dividends are payable in
kind through the issuance of additional shares of Preferred Stock at a price
equal to the fair market value of the Preferred Stock at the time of the
payment. The Preferred Stock has a liquidation preference of $50.00 per share
and may be redeemable at $50.00 per share at either AROC's or the holder's
option upon the occurrence of certain events. Each share of Preferred Stock is
convertible at any time into 384.6 shares of AROC's common stock and has the
right to vote in all matters on the same basis as if the Preferred Stock had
been converted into common stock. The terms of the Preferred Stock prohibit
AROC from taking certain actions without the consent of the holders of the
Preferred Stock. Upon the first to occur of (1) an event of default, as
defined, or (2) May 1, 2005, each holder of a share of Preferred Stock shall be
entitled to require that AROC redeem all
9
<PAGE>
AROC Inc.
(Formerly EnCap 1996 LP)
Notes to Consolidated Condensed Statements
(Unaudited)
of the Preferred Stock held by such holder by paying in cash the redemption
price ($50.00 per share plus unpaid dividends). The charge to stockholders'
equity of $28,243,708 for the issuance of Preferred Stock represents the
difference between fair value ($50 per share) of Preferred Stock issued by old
AROC to acquire oil and gas properties from EnCap 1996 LP and the historical
cost of those oil and gas properties as EnCap 1996 LP is the accounting
acquirer.
Pursuant to a Credit Agreement dated as of May 2, 2000, among AROC, Toronto
Dominion (Texas), Inc., individually and as Agent, and the lenders named in that
agreement (the "Credit Agreement"), the Company obtained a new $35,000,000
credit facility. The credit facility is secured by a first lien on
substantially all of the Company's assets. The credit facility imposes certain
restrictions on the Company's activities, including the payment of dividends and
purchases of stock. The credit facility provides for a revolving line of credit
for three years. Borrowings under the credit facility bear interest at either
the LIBOR rate plus from 1.75% to 3.0% or the agent's prime rate plus from .25%
to 1.5%, at the Company's election. Interest is payable quarterly beginning
July 31, 2000. Principal is payable in full on the third anniversary of the
closing of the credit facility. The borrowing base for the credit facility will
typically be redetermined semiannually, although the lenders and borrowers have
the right to make a redetermination at any time.
In addition, on May 2, 2000, old AROC entered into a purchase agreement
providing for the sale to EnCap 1996 LP, ECIC and El Paso of a total of
$17,000,000 in subordinated notes in exchange for cash in that amount. The
subordinated notes bear interest at the rate of 12% per year, payable
semiannually. Principal is due May 1, 2007. Until May 1, 2002, interest is
payable in kind by increasing the principal amount of the debt. Additionally,
old AROC also issued to EnCap 1996 LP, ECIC and El Paso warrants to purchase a
total of 39,541,233 shares of AROC's common stock at a price of $0.01 per share
at any time until April 30, 2007 pursuant to such purchase agreement. The fair
value of the warrants ($4,744,948) relating to the subordinated notes has been
treated as a discount.
After these transactions, AROC has outstanding 55,278,837 shares of common
stock, 10,000,000 convertible restricted voting shares, warrants to purchase
45,813,963 shares of common stock, and 1,780,303 shares of Series A Redeemable
Preferred Stock that are convertible into an aggregate of 684,731,923 shares of
common stock.
Old AROC had a fiscal year-end of April 30 while EnCap 1996 LP has a December 31
year-end. As a result of these transactions, the combined entity has adopted a
December 31 year-end.
The Company is engaged in the exploration, development, production and operation
of oil and gas properties. Operations are primarily conducted in Texas,
Louisiana, New Mexico, Wyoming, Oklahoma, Mississippi, Alabama, Arkansas and the
United Kingdom.
10
<PAGE>
AROC Inc.
(Formerly EnCap 1996 LP)
Notes to Consolidated Condensed Statements
(Unaudited)
The fair value of the assets and liabilities of the acquired businesses (EnCap
Acquisition and AROC) at May 2, 2000 is as follows (in thousands):
Cash $ 578
Other current assets 2,654
Other assets 145
Property, plant and equipment 97,224
Long-term debt (68,645)
Current liabilities (10,151)
----------
Net purchase price $ 21,805
==========
The net purchase price includes $21,097,000 for EnCap Acquisition (interests in
certain oil and gas properties) and $708,000 for old AROC. The EnCap Acquisition
properties were acquired in exchange for preferred stock as described above. The
old AROC acquisition represents the purchase step-up resulting from the reverse
acquisition (discussed in note A) of the remaining 80% of old AROC common stock
not already owned by EnCap Equity 1996 LP. The purchase price (step-up) was
based on the equivalent common stock value ($0.13 per share) of the Series A
Redeemable Preferred Stock discussed above. The net purchase price was allocated
to the acquired assets and liabilities based on their relative fair values.
The following summarized unaudited pro forma results of operations for the
nine months ended September 30, 2000 and 1999, assumes that the May 2, 2000: (i)
reverse acquisition of AROC Inc. (legal acquirer) by EnCap 1996 LP (accounting
acquirer), (ii) the acquisition of interests in oil and gas properties (EnCap
Acquisition) and (iii) the refinancing of AROC debt, all occurred as of January
1, 1999. The information is presented in thousands with the exception of the
per share information.
<TABLE>
<CAPTION>
Nine months ended Nine months ended
September 30, 2000 September 30, 1999
------------------- -------------------
<S> <C> <C>
Total oil and gas revenues $17,958 $ 9,963
=================== ===================
Net loss $(2,586) $(36,289)
=================== ===================
Net loss available for common shareholders $(9,262) $(42,965)
=================== ===================
Net loss per common share $ (0.17) $ (0.80)
=================== ===================
</TABLE>
11
<PAGE>
AROC Inc.
(Formerly EnCap 1996 LP)
Notes to Consolidated Condensed Statements
(Unaudited)
C. Stock Incentive Plan
In April, 2000, the Company adopted the 2000 Omnibus Stock and Incentive Plan
(the Stock Plan). This plan is intended to provide additional incentives
through the award of options, stock appreciation rights, shares of restricted
stock, and performance awards to directors, officers, key employees and
consultants. None were issued during the period ended September 30, 2000.
In April, 2000, the Company granted 6,600,000 shares of restricted stock to the
directors, officers and certain key employees. Under the Stock Plan, the shares
vest in equal increments in April 2001, 2002, and 2003 or upon a change in
control of the Company as defined in the Stock Plan. The estimated market value
of shares awarded was $858,000. This amount was recorded as unearned
compensation-restricted stock and is shown as a separate component of
stockholders' equity. Unearned compensation will be amortized to expense over
the three year vesting period.
D. Warrants
The following is a summary of warrants outstanding as of September 30, 2000:
Warrant series Strike price Last date for exercise Shares
Series "D" $0.86 March 31, 2001 287,119
Series "E" $0.86 October 31, 2001 30,953
Series "F" $1.38 December 16, 2002 275,139
Series "G" $1.60 April 30, 2007 1,210,938
Series "H" $0.01 October 30, 2008 3,275,000
Series "I" $0.01 April 30, 2007 1,193,581
Series "J" $0.01 April 30, 2007 39,541,233
-----------
Total Warrants 45,813,963
===========
E. Contingencies and Commitments
The Company is a named defendant in lawsuits, and is subject to claims of third
parties from time to time arising in the ordinary course of business. While the
outcome of lawsuits or other proceedings and claims against the Company cannot
be predicted with certainty, management does not believe the outcome of these
lawsuits will have material adverse effect on the financial position, results of
operations or liquidity of the Company.
12
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
---------------------
Results of Operations
---------------------
Volume, sales price and expense information for the Company's oil and gas
production during the nine months ended September 30, 2000 and 1999 is
summarized in the following table:
2000 1999
US UK US UK
---------------- ----------------
Net Sales Volumes:
Oil (Mbbls) 311 - 117 -
Natural Gas (Mmcf) 926 359 276 -
Oil Equivalent (MBOE) 466 60 163 -
Average Sales Prices:
Oil (per Bbl) $23.29 - $15.08 -
Gas (per Mcf) $ 3.45 $ 1.88 $ 2.07 -
Operating Expenses per
BOE of Net Sales:
Lease operating $ 8.64 $10.18 $ 9.04 -
Severance tax $ 1.10 - $ 0.82 -
Depreciation, depletion,
and amortization $ 4.70 $ 4.80 $ 2.92 -
General and administrative $ 2.97 $ 2.01 $ 1.70 -
13
<PAGE>
Three Months Ended September 30, 2000 compared to the Three Months Ended
------------------------------------------------------------------------
September 30, 1999
------------------
Total revenues from the Company's operations for the quarter ended September 30,
2000 were $5,696,624 compared to $957,075 for the quarter ended September 30,
1999. Revenues increased significantly over the comparable period a year
earlier due principally to higher oil and gas prices and production from oil and
gas properties acquired in the May 2, 2000 transactions described earlier.
Total operating expenses increased to $4,868,739 for the quarter ended September
30, 2000 compared to $760,932 for the same period in 1999. This increase was
primarily due to increases in lease operating expense and depletion,
depreciation and amortization costs. Lease operating expenses were higher at
$2,740,656 for the three-month period ended September 30, 2000 compared to
$560,326 for the same period in 1999. This was due to increases in expenses
associated with properties acquired in the May 2, 2000 transaction described
earlier. Depletion, depreciation and amortization of oil and gas properties
amounted to $1,270,447 for the quarter ended September 30, 2000 compared to
$129,174 for the same period in 1999 due to a higher depletable base and
production from properties acquired in the May 2, 2000 transaction described
earlier.
As a result of the May 2, 2000 transactions, income from operations of $827,885
was realized for the quarter ended September 30, 2000 compared to a income from
operations of $196,143 for the same period in 1999.
Impairment write-down and loss on sale of marketable securities decreased to $0
for the quarter ended September 30, 2000 compared to $1,902,076 for the quarter
ended September 30, 1999. This was a result of a significant amount of shares
sold during the 1999 period at losses and a writedown resulting from a decline
in market value considered other than temporary.
Interest expense increased from $0 for the quarter ended September 30, 1999, to
$1,295,224 for the quarter ended September 30, 2000 as a result of the debt from
the May 2, 2000 transactions.
Preferred stock dividends were $2,225,378 for the quarter ended September 30,
2000. These dividends are associated with the preferred series of stock issued
in connection with the May 2, 2000 transactions described earlier.
In summary, due to the above factors, the net loss for the common stockholders
for the quarter ended September 30, 2000 increased to $2,753,393 ($0.05 per
share) compared to a net loss of $1,705,448 ($0.03 per share) for the same
period in 1999.
14
<PAGE>
Nine Months Ended September 30, 2000 compared to the Nine Months Ended
----------------------------------------------------------------------
September 30, 1999
------------------
Total revenue from the Company's operations for the nine months ended
September 30, 2000, was $11,241,130 compared to $2,335,317 for the nine months
ended September 30, 1999. Revenue increased significantly over the comparable
period a year earlier due principally to higher oil and gas prices and
production from oil and gas properties acquired in the May 2, 2000 transactions.
Total operating expenses increased to $9,168,568 for the nine months ended
September 30, 2000, compared to $2,360,385 for the same period in 1999. This
increase was primarily due to the increases in lease operating expense, and
depletion, depreciation and amortization costs. Lease operating expenses
increased to $5,148,040 in the 2000 period compared to $1,607,135 for the nine-
month period ended September 30, 1999. This was due to increases in expenses
associated with the properties acquired in the May 2, 2000 transaction described
earlier. Depletion, depreciation and amortization of oil and gas properties
amounted to $2,515,239 for the nine-month period ended September 30, 2000,
compared to $475,964 for the nine-month period ended September 30, 1999, due to
a higher depletable base and production from properties acquired in the May 2,
2000 transaction described earlier. As a result of the preceding, the income
from operations of $2,072,562 for the nine-month period ended September 30,
2000, reflects an increase over the loss from operations of $25,068 for the
nine-month period ended September 30, 1999.
Impairment write-down and loss on sale of marketable securities decreased to
$262,689 for the nine months ended September 30, 2000 compared to $6,060,891 for
the nine months ended September 30, 1999. This was a result of a significant
amount of shares sold during the 1999 period at losses and a writedown resulting
from a decline in market value considered other than temporary.
Interest expense increased from $0 for the nine months ended September 30, 1999
to $2,076,041 for the quarter ended September 30, 2000 as a result of debt from
the May 2, 2000 transactions.
Preferred stock dividends were $3,708,964 for the nine months ended September
30, 2000. These dividends are associated with the preferred series of stock
issued in connection with the May 2, 2000 transactions described earlier.
In summary, due to the above factors, the net loss for the common stockholders
for the nine months ended September 30, 2000 decreased to $4,042,634 ($0.08 per
share) compared to a net loss of $10,336,826 ($0.19 per share) which included
$4,251,961 equity in net losses of old AROC.
15
<PAGE>
Capital Resources and Liquidity
-------------------------------
Net Cash Used in Operating Activities - AROC's net cash used in operating
activities during the first nine months of 2000 totaled $2,502,264, primarily
due to payment of a portion of the old AROC liabilities assumed in the May 2,
2000 reverse acquisition described earlier.
Credit Facility - On May 2, 2000, old AROC entered into a purchase
agreement providing for the sale to EnCap 1996 LP, ECIC and El Paso (together
EnCap) of a total of $17,000,000 in subordinated notes in exchange for cash in
that amount. The subordinated notes bear interest at the rate of 12% per year,
payable semiannually. Principal is due May 1, 2007. Until May 1, 2002, interest
is payable in kind by increasing the principal amount of the debt. Additionally,
old AROC also issued to EnCap warrants to purchase a total of 39,451,233 shares
of AROC's common stock at a price of $0.01 per share at any time until April 30,
2007 pursuant to such purchase agreement.
Pursuant to a Credit Agreement dated as of May 1, 2000, among AROC, Toronto
Dominion (Texas), Inc. individually and as Agent, and the lenders named in that
agreement (the TD Credit Agreement), AROC obtained a new $35,000,000 credit
facility. The credit facility provides for a revolving line of credit for three
years. Borrowings ($25,000,000 initial borrowing) under the credit facility
bear interest at either the LIBOR rate plus from 1.75% to 3.0% or the agent's
prime rate plus from .25% to 1.5%, at AROC's election. Interest is payable
quarterly beginning July 31, 2000. Principal is payable in full on the third
anniversary of the closing of the credit facility.
The new facility was used along with the subordinated notes, purchased by EnCap,
to retire the previous credit facility with Bank of America and to support
AROC's capital expenditure requirements.
Liquidity - AROC believes that cash on hand, net cash generated from operations,
and unused borrowing capacity under its credit facility will be adequate to
satisfy the Company's financial obligations and to meet future liquidity needs
for at least the next two fiscal years. As of September 30, 2000, AROC's
available borrowing capacity under its credit facility was $4.5 million.
Capital Expenditures. The timing of most of the Company's capital expenditures
--------------------
is discretionary. Currently, there are no material long-term commitments
associated with the Company's U.S. capital expenditure plans. Consequently, the
Company has a significant degree of flexibility to adjust the level of such
expenditures as circumstances warrant. The Company primarily uses internally
generated cash flow to fund U.S. capital expenditures, other than significant
acquisitions, and to fund its working capital deficit. If the Company's
internally generated cash flows should be insufficient to meet its banking or
other obligations, the Company may reduce the level of discretionary U.S.
capital expenditures or increase the sale of non-strategic oil and gas
properties in order to meet such obligations.
16
<PAGE>
The timing of the Company's U.K. capital expenditures is determined annually by
a budget prepared by Burlington Resources and approved by the Company. Any
commitments will be met by funds available under the Company's credit facility
and internally generated cash flow. The level of the Company's capital
expenditures will vary in future periods depending on energy market conditions
and other related economic factors. (This is a forward-looking statement; refer
to the Cautionary Statement Regarding Forward Looking Statements).
Inflation and Prices. In recent years, inflation has not had a significant
--------------------
impact on the operations or financial condition of the Company.
The Company engages in oil and gas hedging activities and intends to
consider various hedging arrangements to realize commodity prices which it
considers favorable. Currently, oil hedges (costless collars) for the last
quarter of 2000 cover 66 MBbls at an average NYMEX reference price of $19.00/bbl
for the floor and $28.14/bbl for the collar. Currently, gas hedges (costless
collars) for the last quarter of 2000 and continuing until October 2001 cover
1,300 MMcf at an average NYMEX reference price of $2.49/Mcf for the floor and
$3.85/Mcf for the collar. The following table reflects the barrels and Mcf
hedged and the corresponding weighted average NYMEX reference prices for the
hedged periods shown:
NYMEX Reference
Period Ending Barrels Price Per BBl
----------------------- ----------------------- ----------------------
(in thousands)
December 31, 2000 66 $19.00 Floor, $28.14 Collar
NYMEX Reference
Period Ending MMcf Price per Mcf
----------------------- ----------------------- ----------------------
(in thousands)
October 31, 2000 100 $2.43 Floor, $3.28 Collar
October 31, 2001 1,200 $2.50 Floor, $3.90 Collar
Average oil and gas prices received by the Company fluctuate generally with
changes in spot market prices, which may vary significantly by region. The
Company's U.S. average gas price for the first nine months of 2000 was 67%
higher than 1999's first nine months. The Company's U.S. average oil price for
the first nine months of 2000 was 54% higher than 1999's first nine months.
Relatively modest changes in either oil or gas prices significantly impact the
Company's results of operations and cash flow. However, the impact of changes
in the market prices for oil and gas on the Company's average realized prices
may be reduced from time to time based on the level of the Company's hedging
activities.
17
<PAGE>
New Accounting Pronouncements
-----------------------------
Statement of Financial Accounting Standards No. 133, Accounting for Derivatives
Instruments and Hedging Activities (Statement 133) was issued by the FASB in
September 1998. Statement 133 standardizes the accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts. Under the standard, entities are required to carry all derivative
instruments in the balance sheet at fair value. The accounting for changes in
the fair value of a derivative instrument depends on whether it has been
designated and qualifies as part of a hedging relationship and, if so, on the
reason for holding it. If certain conditions are met, entities may elect to
designate a derivative instrument as a hedge of exposures to changes in fair
values, cash flows, or foreign currencies. If the hedge exposure is a fair
value exposure, the gain or loss on the derivative instrument is recognized in
earnings in the period of change together with the offsetting loss or gain on
the hedged item attributable to the risk being hedged. If the hedged exposure
is a cash flow exposure, the effective portion of the gain or loss on the
derivative instrument is reported initially as a component of other
comprehensive income (outside earnings) and subsequently reclassified into
earnings when the forecasted transaction affects earnings. Any amounts excluded
from the assessment of hedge effectiveness as well as the ineffective portion of
the gain or loss is reported in earnings immediately. Statement 133 was amended
by Statement No. 137 in June 1999, which delayed implementation until fiscal
years beginning after June 15, 2000, with early adoption permitted.
At September 30, 2000 the Company has certain oil and gas price collar
derivatives. The oil collar expires December 31, 2000 and the gas collars expire
October 31, 2000 and October 31, 2001. The fair value of the gas collar that
expires October 31, 2001 was $1.3 million (unrealized loss) at September 30,
2000. The Company has not completed its analysis to determine whether the gas
collar that expires October 31, 2001 will be treated as a cash flow type hedge.
The effect of adopting Statement 133 from the gas collar that expires October
31, 2001 at September 30, 2000 would be a $1.3 million balance sheet liability
and a charge to comprehensive income. If this gas collar meets the Statement 133
hedge accounting requirements the amount recorded in accumulated other
comprehensive income upon adoption of Statement 133 will be recognized in
earnings in the same periods during which production revenues are recorded. The
Company is still in process of identifying all derivatives including embedded
derivatives, if any, to determine the impact of adopting Statement 133.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
------------------------------------------------------------------
The Company's operations are exposed to market risks primarily as a result
of changes in commodity prices, interest rates and foreign currency exchange
rates. The Company does not use derivative financial instruments for speculative
or trading purposes.
Commodity Price Risk
--------------------
The Company produces and sells crude oil, natural gas, condensate and
natural gas liquids. As a result, the Company's financial results can be
significantly impacted as these commodity prices fluctuate widely in response to
changing market forces. The Company engages in oil and gas hedging activities
and intends to continue to consider various hedging arrangements to realize
commodity prices which it considers favorable.
18
<PAGE>
Currently, the Company has entered into various hedging instruments
(costless collars) for a total of 66 MBbls at a weighted price of $19.00/Bbl for
a floor and $28.14/Bbl for a collar, and for a total of 1,300 MMcf at a weighted
price of $2.49/Mcf for a floor and $3.85/Mcf for a collar (NYMEX reference
prices), for the last quarter of 2000 and continuing until October 2001. The
fair value of the commodity hedge agreements is the amount at which they could
be settled, based on quoted market prices. At September 30, 2000, the Company
would have been required to pay approximately $1.7 million to terminate its oil
and gas hedging agreements then in place. The Company continues to monitor oil
and gas prices and may enter into additional oil and gas hedges in the future.
Interest Rate Risk
-------------------
The Company's interest rate risk exposure results primarily from short-term
rates, mainly LIBOR based borrowings from its credit facility with Toronto-
Dominion. To reduce the impact of fluctuations in interest rates the Company
maintains a portion of its total debt portfolio in fixed rate debt. At
September 30, 2000, the amount of the Company's fixed rate debt was
approximately 43% of total debt. The Company may consider financial instruments
such as interest rate swaps to manage the impact of changes in interest rates
based on management's assessment of future interest rates, volatility of the
yield curve and the Company's ability to access the capital markets in a timely
manner.
Foreign Currency and Operations Risk
-------------------------------------
International investments represent a significant portion of the Company's
total assets. The Company has international operations in the United Kingdom.
As a result of the significant foreign operation, the Company's financial
results could be affected by factors such as changes in foreign currency
exchange rates, weak economic conditions or changes in the political climate in
the United Kingdom. The Company believes the United Kingdom offers a relatively
stable political environment and does not anticipate any significant changes in
the near future. To date, the currency risk associated with its foreign
operations has not had a material impact on the Company's financial position or
results of operations. In the past, the Company has entered into a financial
instrument to address this risk; however, there are no current instruments in
place. It may consider these instruments again to manage the impact of changes
in exchange rates based on management's assessment of future exchange rate
volatility. Economic conditions in the United Kingdom are currently in a
favorable position for continued investment and management believes this will
continue without any significant change in the near future.
19
<PAGE>
PART II - OTHER INFORMATION
---------------------------
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
SEC
Exhibit
No. Description of Exhibits
------- -----------------------
(27) Financial Data Schedule
-----------------------
*27.1 Financial Data Schedule of AROC Inc.
*Filed Herewith.
(b) Reports on Form 8-K
-------------------
None
20
<PAGE>
SIGNATURES
----------
Pursuant to the requirements 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.
AROC Inc.
/s/ R. SCHULTE
----------------------------------------
Robert Schulte - Chief Financial Officer
Date: November 14, 2000
21
