<PAGE> 1
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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997.
OR
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from .......... to ..........
Commission file number 0-9300
HARCOR ENERGY, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0234380
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4400 Post Oak Parkway, Suite 2220
Houston, TX 77027-3413
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (713) 961-1804
. . . . . . . . . . . . . . . .
(Former name, former address and former fiscal year,
if changed since last report)
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 number of shares of Registrant's Common Stock outstanding at
November 14, 1997 was 16,268,387.
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HARCOR ENERGY, INC.
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1997
------------------------------------
<TABLE>
<CAPTION>
Part I - Financial Information Page
------------------------------ ----
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 1997
(unaudited) and December 31, 1996 1
Consolidated Statements of Operations for the Three
Months Ended September 30, 1997 and 1996 (unaudited) 3
Consolidated Statements of Operations for the Nine
Months Ended September 30, 1997 and 1996 (unaudited) 4
Consolidated Statement of Stockholders' Equity
for the Nine Months Ended September 30, 1997 (unaudited) 5
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1997 and 1996 (unaudited) 6
Notes to Unaudited Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 17
Part II - Other Information
---------------------------
Item 6. Exhibits and Reports on Form 8-K 35
</TABLE>
<PAGE> 3
HARCOR ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1997 (UNAUDITED) AND DECEMBER 31, 1996
------------------------------------------------------
ASSETS
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------- -------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash investments ............................................ $ 2,484,807 $ 1,593,330
Accounts receivable .................................................. 4,069,804 8,894,240
Prepaids and other ................................................... 1,455,418 185,618
------------- -------------
Total current assets ................................................. 8,010,029 10,673,188
------------- -------------
PROPERTY AND EQUIPMENT, at cost, successful efforts method:
Unproved oil and gas properties ...................................... 4,367,212 4,079,779
Proved oil and gas properties:
Leasehold costs .................................................... 57,682,573 56,934,690
Plant, lease and well equipment .................................... 21,402,452 19,194,951
Intangible development costs ....................................... 30,761,914 28,918,323
Furniture and equipment .............................................. 395,644 373,772
------------- -------------
114,609,795 109,501,515
Less - accumulated depletion,
depreciation and amortization ...................................... (33,479,495) (28,876,525)
------------- -------------
Net property, plant and equipment .................................... 81,130,300 80,624,990
------------- -------------
OTHER ASSETS ........................................................... 2,895,560 3,328,364
------------- -------------
$ 92,035,889 $ 94,626,542
============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
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<PAGE> 4
HARCOR ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1997 (UNAUDITED) AND DECEMBER 31, 1996
------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------ ------------
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term
bank debt ................................. $ 397,500 $ 300,000
Other short-term debt ........................ -- 85,500
Accounts payable and
accrued liabilities ........................ 5,415,696 10,348,318
------------ ------------
Total current liabilities .................... 5,813,196 10,733,818
------------ ------------
LONG-TERM BANK DEBT,
net of current portion ....................... 4,902,500 1,700,000
------------ ------------
14-7/8% SENIOR SECURED NOTES ................... 52,578,232 52,400,131
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value -
1,500,000 shares authorized;
30,000 shares outstanding
at December 31, 1996 ....................... -- 300
Common stock, $.10 par value -
25,000,000 shares authorized;
16,268,387 and 15,110,836 shares outstanding
at September 30, 1997 and
December 31, 1996, respectively ............ 1,626,839 1,511,084
Additional paid-in capital ................... 51,115,109 49,891,612
Accumulated deficit .......................... (23,999,987) (21,610,403)
------------ ------------
Total stockholders' equity ................... 28,741,961 29,792,593
------------ ------------
$ 92,035,889 $ 94,626,542
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
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<PAGE> 5
HARCOR ENERGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996
(UNAUDITED)
------------------------------------
<TABLE>
<CAPTION>
Three Months Ended
September 30,
------------------------------
1997 1996
----------- -----------
<S> <C> <C>
REVENUES:
Oil and gas revenues ..................... $ 3,662,596 $ 5,115,231
Gas plant operating
and marketing revenues ................. 1,307,275 1,434,761
Interest income .......................... 11,772 80,228
Other .................................... 42,546 69,140
----------- -----------
5,024,189 6,699,360
----------- -----------
COSTS AND EXPENSES:
Production costs ......................... 971,005 1,200,392
Gas plant operating and marketing costs .. 1,124,546 765,111
Engineering and geological costs ......... 45,415 61,145
Depletion, depreciation and amortization . 1,378,851 1,510,881
General and administrative expenses ...... 496,542 655,886
Interest expense ......................... 2,317,020 2,491,667
Other .................................... -- 109,166
----------- -----------
6,333,379 6,794,248
----------- -----------
Loss before provision for income taxes
and extraordinary item ................ (1,309,190) (94,888)
Provision for income taxes ................. -- --
----------- -----------
Net operating loss before extraordinary item (1,309,190) (94,888)
EXTRAORDINARY ITEM - Loss on early
extinguishment of debt ................... -- (2,108,013)
----------- -----------
Net loss ................................. (1,309,190) (2,202,901)
Dividends on preferred stock ............... $ -- $ (132,500)
----------- -----------
NET LOSS APPLICABLE TO COMMON
STOCKHOLDERS ............................. $(1,309,190) $(2,335,401)
=========== ===========
NET LOSS PER COMMON SHARE BEFORE
EXTRAORDINARY ITEM ....................... $ (0.08) $ (0.02)
=========== ===========
NET LOSS PER COMMON SHARE AFTER
EXTRAORDINARY ITEM ....................... N/A $ (0.19)
===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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<PAGE> 6
HARCOR ENERGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996
(UNAUDITED)
------------------------------------
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
--------------------------------
1997 1996
------------ ------------
<S> <C> <C>
REVENUES:
Oil and gas revenues ....................... $ 12,588,419 $ 16,572,159
Gas plant operating
and marketing revenues ................... 4,133,980 4,849,677
Interest income ............................ 30,724 91,948
Other ...................................... 90,193 151,454
------------ ------------
16,843,316 21,665,238
------------ ------------
COSTS AND EXPENSES:
Production costs ........................... 3,062,945 3,874,081
Gas plant operating and marketing costs .... 2,872,073 2,751,581
Engineering and geological costs ........... 246,433 226,297
Depletion, depreciation and amortization ... 4,602,970 4,855,589
General and administrative expenses ........ 1,884,386 2,197,610
Interest expense ........................... 6,564,093 7,809,860
Other ...................................... -- 369,869
------------ ------------
19,232,900 22,084,887
------------ ------------
Loss before provision for income taxes
and extraordinary item ................... (2,389,584) (419,649)
Provision for income taxes ................. -- --
------------ ------------
Net operating loss before extraordinary item (2,389,584) (419,649)
EXTRAORDINARY ITEM - Loss on early
extinguishment of debt ..................... -- (2,108,013)
------------ ------------
Net loss ................................... (2,389,584) (2,527,662)
Dividends on preferred stock ................. $ (60,000) $ (397,500)
------------ ------------
NET LOSS APPLICABLE TO COMMON
STOCKHOLDERS ............................... $ (2,449,584) $ (2,925,162)
============ ============
NET LOSS PER COMMON SHARE BEFORE
EXTRAORDINARY ITEM ......................... $ (0.16) $ (0.08)
============ ============
NET LOSS PER COMMON SHARE AFTER
EXTRAORDINARY ITEM ......................... N/A $ (0.30)
============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
THESE CONSOLIDATED FINANCIAL STATEMENTS.
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<PAGE> 7
HARCOR ENERGY, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
(UNAUDITED)
------------------------------------------------
<TABLE>
<CAPTION>
Preferred Stock Common Stock Additional
------------------------ -------------------------- Paid-in Accumulated
Shares Amount Shares Amount Capital Deficit
------- ------------ ---------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 30,000 $ 300 15,110,836 $ 1,511,084 $ 49,891,612 $(21,610,403)
Issuance of common stock
pursuant to warrant exercises -- -- 388,351 38,835 1,376,235 --
Preferred stock conversions (30,000) (300) 769,200 76,920 (92,738) --
Preferred stock dividends -- -- -- -- (60,000) --
Net loss for nine months
ended September 30, 1997 -- -- -- -- -- (2,389,584)
------- ------------ ---------- ------------ ------------ -------------
Balance, September 30, 1997 -- $ -- 16,268,387 $ 1,626,839 $ 51,115,109 $(23,999,987)
======= ============ ========== ============ ============ ============
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
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<PAGE> 8
HARCOR ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996
(UNAUDITED)
------------------------------------
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
--------------------------------
1997 1996
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss ................................. $ (2,389,584) $ (2,527,662)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depletion, depreciation and
amortization and impairment ............ 4,602,970 4,855,589
Amortization of deferred charges ....... 634,300 727,528
Engineering and geological costs ......... 246,433 226,297
Loss on early extinguishment of debt ..... -- 2,108,013
Other .................................... -- 369,869
------------ ------------
3,094,119 5,759,634
Changes in working capital, net of
effects of non-cash transactions ....... (2,127,342) (2,961,466)
------------ ------------
Net cash provided by operating activities 966,777 2,798,168
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Engineering and geological costs ......... (246,433) (226,297)
Proceeds from sale of oil & gas properties 4,674,000 --
Additions to property and equipment ...... (9,032,608) (17,649,797)
------------ ------------
Net cash used in investing activities .... (4,605,041) (17,876,094)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in other assets ................. (23,395) (216,751)
Proceeds from long-term debt ............. 9,000,000 4,400,000
Repayment of bank debt ................... (5,700,000) (10,000,000)
Redemption of Senior Secured Notes ....... -- (3,644,000)
Decrease in other debt and liabilities ... (85,500) (363,099)
Issuance of common stock ................. 1,398,952 21,792,075
Dividends on preferred stock ............. (60,000) (397,500)
------------ ------------
Net cash provided by financing activities 4,530,057 11,570,725
------------ ------------
Net increase (decrease) in cash .......... 891,793 (3,507,201)
Cash at beginning of period .............. 1,593,330 12,204,460
------------ ------------
Cash at end of period .................... $ 2,485,123 $ 8,697,259
============ ============
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
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<PAGE> 9
HARCOR ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
(UNAUDITED)
--------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (ALL DOLLAR AMOUNTS
HAVE BEEN ROUNDED TO THE NEAREST THOUSAND) -
The Company made interest payments of $8,172,000 and $9,879,000 during
the nine months ended September 30, 1997 and 1996, respectively.
The Company received payment of $4,674,000 in January 1997 relating to
the sale of oil and gas properties effective December 1996. The proceeds from
this sale are reflected in investing activities in the current statement of cash
flows.
SUPPLEMENTAL INFORMATION REGARDING NON-CASH INVESTING AND FINANCING
ACTIVITIES - NINE MONTHS ENDED SEPTEMBER 30, 1997
Included in investing activities in the current period are payments of
$4,725,000 relating to drilling costs which were accrued but unpaid at December
31, 1996. At September 30, 1997, the Company had accrued capital costs of
$898,000 which are not reflected in investing activities.
SUPPLEMENTAL INFORMATION REGARDING NON-CASH INVESTING AND FINANCING
ACTIVITIES - NINE MONTHS ENDED SEPTEMBER 30, 1996
The Company incurred a non-cash charge of $370,000 in connection with
the write-off of a long-term investment which is not reflected in investing
activities.
The Company entered into agreements resulting in the issuance of 65,000
unregistered shares of its common stock in exchange for the cancellation of
options and warrants to purchase an aggregate of 376,000 of its common shares.
Additionally, a warrant to purchase 350,000 shares of the Company's common
stock, which was issued in connection with a prior financing, was returned to
the Company and canceled in exchange for the issuance of 99,750 new warrants.
These activities are not reflected in financing activities and did not result in
a gain or loss.
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<PAGE> 10
Included in investing activities in the period were payments of
$8,188,000 relating to drilling costs which were accrued but unpaid at December
31, 1995. At September 30, 1996, the Company had accrued capital costs of
$3,555,000 which are not reflected in investing activities.
The accompanying notes are an integral part
of these consolidated financial statements.
-8-
<PAGE> 11
HARCOR ENERGY, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION -
The accompanying consolidated financial statements for the nine months
ended September 30, 1997 include the accounts and results of HarCor Energy, Inc.
("HarCor"); and, for the nine months ended September 30, 1996, the results of
its wholly-owned subsidiaries, Warrior, Inc. ("Warrior") and HTAC Investments,
Inc. ("HTAC") (collectively, the "Company" or "HarCor" unless the context
specifies otherwise). Warrior and HTAC had no material operations and were
merged into HarCor in March 1996.
All significant intercompany accounts and transactions have been
eliminated in consolidation.
The consolidated financial statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. The Company believes, however, that it
has made adequate disclosures so that the information presented herein is not
misleading.
A summary of the Company's significant accounting policies is included
in the consolidated financial statements and notes thereto, contained in its
Annual Report on Form 10-K for the year ended December 31, 1996 (the "10-K").
The unaudited consolidated financial data presented herein should be read in
conjunction with the 10-K.
In the opinion of the Company, the unaudited consolidated financial
statements contained herein include all adjustments (consisting of normal
recurring accruals and the elimination of intercompany transactions) necessary
to present fairly the Company's consolidated results of operations, cash flows
and
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<PAGE> 12
changes in stockholders' equity for the nine-month periods ended September 30,
1997 and 1996.
The results of operations for an interim period are not necessarily
indicative of the results to be expected for a full year.
GAS BALANCING -
Natural gas revenues are recorded on the entitlement method based on
the Company's percentage ownership of current production. Each working interest
owner in a well generally has the right to a specific percentage of production,
although actual production sold may differ from an owner's ownership percentage.
Under entitlement accounting, a receivable is recorded when underproduction
occurs and a payable is recorded when overproduction occurs.
CAPITALIZED INTEREST COSTS -
Interest costs of $288,000 for the nine months ended September 30, 1997
have been capitalized as part of the historical costs of unproved oil and gas
properties.
ACCOUNTS PAYABLE AND ACCRUED LIABILITIES -
Accounts payable and accrued liabilities at September 30, 1997
comprised the following (amounts in thousands):
<TABLE>
<S> <C>
Accrued development costs. . . . . . $ 900
Accrued interest payable . . . . . . 1,752
Trade accounts payable and other . . 2,764
-----
$5,416
======
</TABLE>
STOCK COMPENSATION PLANS -
The Company accounts for its Stock Compensation Plans by applying
provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees"; accordingly, no compensation expense has been
recognized for awards granted under these plans. The Company has elected not to
apply SFAS No. 123, "Accounting for Stock Based Compensation", which would
result in additional compensation expense in the statement of income for the
current period.
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<PAGE> 13
NET LOSS PER COMMON SHARE -
Net loss per common share was calculated by dividing the appropriate
net loss, after considering preferred stock dividends for applicable periods, by
the weighted average number of common shares outstanding during each period.
Outstanding stock options, warrants and convertible preferred shares were not
included in the calculations, since their effect was antidilutive. The weighted
average number of outstanding common shares utilized in the calculations was
16,232,000 and 12,216,000 for the three months ended September 30, 1997 and
1996, respectively; and 15,796,000 and 9,874,000 for the nine months ended
September 30, 1997 and 1996, respectively.
CHANGES IN ACCOUNTING PRINCIPLES -
In October 1996, the American Institute of Certified Public Accountants
issued Statement of Position No. 96-1, "Environmental Remediation Liabilities,"
which establishes new accounting and reporting standards for the recognition and
disclosure of environmental remediation liabilities. The provisions of the
statement are effective for fiscal years beginning after December 15, 1996. The
Company does not believe that the impact of this new standard had any
significant effect on the Company's financial position or results of operations
during the current period.
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128 - "Earnings
per Share" effective for interim and annual periods after December 15, 1997.
This statement replaces primary earnings per share ("EPS") with a newly defined
basic EPS and modifies the computation of diluted EPS. The Company's basic and
diluted EPS computed using the requirements of SFAS 128 are the same as the
Company's currently disclosed primary EPS.
In February 1997, the FASB issued SFAS No. 129 - "Disclosures of
Information about Capital Structures" which is applicable to all entities that
issue securities other than ordinary common stock and is effective for all
periods ending after December 15, 1997. The Company believes there are no
additional disclosures required of it at this time relating to the issuance of
SFAS No. 129.
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<PAGE> 14
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 reported
periods. Actual results could differ from those estimates. Significant estimates
with regard to these financial statements include the estimate of proved oil and
gas reserve volumes and the related present value of estimated future net
revenues therefrom.
(2) LONG-TERM DEBT
Availability under the Company's current credit facility, entered into
in July 1995 (the "Credit Agreement"), is limited to a "borrowing base" amount
which is determined semi-annually by ING Capital, at its sole discretion, and
may be established at an amount up to $15 million. The borrowing base was $15
million at September 30, 1997. Availability under the Credit Agreement, as
amended in August 1997, will terminate on June 30, 1998, and amounts outstanding
will convert to a term loan on July 31, 1998, with a set amortization schedule
of a percentage of the outstanding principal balance continuing through December
31, 2001. Amounts advanced under this facility bear interest at an adjusted
Eurodollar rate plus 2.50% or Prime Rate (as determined by ING Capital) plus
0.5% at the Company's option. There was $5.3 million outstanding under the
Credit Agreement at September 30, 1997, with an effective interest rate of 8.24%
at that date.
The Credit Agreement contains certain customary and usual covenants and
restrictions which impose limitations on the Company with respect to, among
other things, dividends, financial condition and ratios, use of borrowings and
additional debt incurrence. All indebtedness of the Company under the Credit
Agreement is secured by a first lien upon substantially all of the Company's oil
and gas properties as well as by a pledge of all of the accounts receivable,
inventory, general intangibles, machinery and equipment and other assets of the
Company. All assets not subject to a lien in favor of the lender are subject to
a negative pledge, with certain exceptions.
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<PAGE> 15
(3) SENIOR SECURED NOTES
THE NOTES -
The Company's 14-7/8% Senior Secured Notes, which were issued in July
1995 (the "Notes"), bear interest at the rate of 14-7/8% per annum and are
payable semi-annually on January 15 and July 15 of each year. The Notes are
redeemable, in whole or in part, at the option of the Company at any time on or
after July 15, 1999, at the following redemption prices (expressed as
percentages of the principal amount) if redeemed during the twelve-month period
commencing on July 15 of the year set forth below plus, in each case, accrued
interest thereon to the date of redemption:
<TABLE>
<CAPTION>
Year Percentage
<S> <C>
1999................................................. 110%
2000................................................. 107%
2001 and thereafter.................................. 100%
</TABLE>
The Notes were issued pursuant to an indenture, dated July 24, 1995,
between the Company and Texas Commerce Bank National Association, as Trustee
(the "Indenture"). All of the obligations of the Company under the Notes and the
Indenture are secured by a second priority lien on substantially all of the
assets of the Company securing its bank debt.
There were a total of $53.7 million Notes outstanding (face value) at
September 30, 1997. The difference between the face value of the Notes and the
balance sheet amount recorded herein is the result of an initial allocation to
paid-in capital of the value ascribed to the warrants at the close of the Note
Offering. This amount is being amortized through interest expense over the life
of the Notes.
EXCESS CASH FLOW OFFER -
In the event that the Company has excess cash flow (as defined) in
excess of $2 million in any fiscal year, beginning with the fiscal year ended
December 31, 1996, the Company will be required to make an offer to purchase
Notes from all Holders in an amount equal to 50% of all such excess cash flow
for such fiscal year (not just the amount in excess of $2 million) at a purchase
price equal to 101% of the principal amount thereof, plus accrued
-13-
<PAGE> 16
and unpaid interest thereon ("Excess Cash Flow Offer"). The Company may
credit the principal amount of Notes acquired in the open market and retired
prior to the Excess Cash Flow Offer against such required Excess Cash Flow
Offer, provided that each Note may only be so credited once. Excess cash flow
for this purpose is generally defined as net cash flow provided by operations
less capital expenditures and payments on scheduled indebtedness. No Excess Cash
Flow Offer has been made in the current period ended.
(4) COMMITMENTS AND CONTINGENCIES
RISK MANAGEMENT AND HEDGING ACTIVITIES -
The Company utilizes financial instruments as a hedging strategy to
protect against the effects of volatility in crude oil and natural gas commodity
prices. Upon consummation of an acquisition, the Company will usually enter into
commodity derivative contracts (hedges) such as futures, swaps or collars or
forward contracts which cover a substantial portion of the existing production
of the acquired property. Over time, as production increases, the Company will
continue to utilize hedging techniques to ensure that a substantial portion of
its production remains effectively hedged. Gains or losses under the hedging
agreements are recognized in oil and gas production revenues in periods in which
the hedged production occurs with such agreements settling on a monthly basis.
As of September 30, 1997, the Company was a party to various gas
contracts covering volumes of approximately 0.7 Bcf and 0.3 Bcf for 1997 and
1998, respectively, at fixed prices ranging from $1.68/MMBtu to $2.07/MMBtu or
indexed prices; and oil hedges covering notional volumes of approximately 62
MBOE and 74 MBOE for 1997 and 1998, respectively, at fixed prices ranging from
$17.25/Bbl to $18.51/Bbl or indexed prices.
EMPLOYEE SEVERANCE OBLIGATION -
Concurrent with the Company's engagement of investment bankers to
pursue its potential sale, the Company's Board of Directors approved in March
1997 a severance arrangement for all of the Company's employees. The purpose of
this severance arrangement is to maximize shareholder value in any potential
sale process and retain personnel necessary to effect an orderly transition in
the event of sale. The severance arrangement would
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<PAGE> 17
be effected only in the event the Company is sold or a change of
control occurs. The total financial impact of this severance arrangement, if
effected, would result in a decrement of approximately $0.10 per common share to
any potential sales proceeds on a fully-diluted basis. (See Note 6.)
(5) STOCKHOLDERS' EQUITY
COMMON STOCK GRANTS -
In February 1997 the Company granted an aggregate of 60,000 restricted
shares of common stock on behalf of certain of its directors as deferred
compensation. These shares were subsequently canceled pursuant to NASDAQ
regulations requiring shareholder approval for such transactions and are not
reflected in shares outstanding at September 30, 1997.
WARRANT EXERCISE -
In May 1997 a warrant to purchase 256,351 shares of the Company's
common stock at $3.57 per share was exercised. Additionally, in July and August
1997 warrants to purchase an aggregate of 132,000 shares of the Company's common
stock at $3.85 per share were exercised. Total net cash proceeds to the Company
was approximately $1.4 million as a result of these warrant exercises.
CONVERSION OF PREFERRED STOCK -
Effective April 1997 the remaining 20,000 shares of the Company's
Series B 8% Convertible Preferred Stock were converted into 512,800 shares of
the Company's common stock on an exchange basis equivalent to 25.64 shares of
common to each share of preferred. Effective April 1997 all of the 10,000 shares
of the Company's Series C 8% Convertible Preferred Stock were converted into
256,400 shares of the Company's common stock on an exchange basis equivalent to
the Series B 8% Convertible Preferred Stock.
-15-
<PAGE> 18
PREFERRED STOCK DIVIDENDS -
The Company paid cash dividends on preferred stock for the periods
indicated as follows:
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
---------------------
1997 1996
------- --------
<S> <C> <C>
8% Convertible (Series A, B, C) . . . $60,000 $195,000
9% Convertible (Series E) . . . . . . - 202,500
------- --------
$60,000 $397,500
======= ========
</TABLE>
The Series A Preferred Stock and the Series E Preferred Stock were
converted into shares of common stock of the Company during the fourth quarter
of 1996 and the holders thereof received no dividends during the current year.
No further dividends are currently required to be paid as all of the preferred
stock of the Company has been either redeemed or converted to common stock as of
April 1997.
(6) STRATEGIC ALTERNATIVES
In March 1997 the Company announced that it had engaged a group of
investment bankers to pursue the potential sale of the Company. The Company is
continuing to review proposals for a sale of the Company or its assets; however,
there can be no assurances that this process will result in the sale of the
Company. In the event the Company is sold, there can be no assurances as to
either the amount or form of consideration that the Company's shareholders would
receive in such a transaction. (See STRATEGIC ALTERNATIVES UPDATE in ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS included herein.)
-16-
<PAGE> 19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
All dollar amounts and volume information referenced in this Item 2.
have been rounded to the nearest thousand.
RESULTS OF OPERATIONS
COMPARISON OF RESULTS FOR THE THREE MONTHS
ENDED SEPTEMBER 30, 1997 AND 1996
REVENUES - The Company's total revenues decreased $1,675,000 (25%) from
$6,699,000 in third quarter 1996 to $5,024,000 in the current period.
Oil and gas revenues decreased $1,452,000 (28%) from $5,115,000 in the
third quarter of 1996 to $3,663,000 in the current period due to decreased
production levels and lower commodity prices. Oil and gas production volumes
were lower in the current period as compared to third quarter 1996 as a result
of the following factors: (i) lost production from the sale of the majority of
the Company's Permian Basin properties in December 1996; (ii) normal production
rate declines on the initial Bakersfield development wells; (iii) third quarter
1996 included the effect of higher initial production rates from the drilling of
17 development wells on the Bakersfield Properties during second and third
quarters of 1996; (iv) the conversion of 17 producing wells to water injection
wells beginning in the latter part of 1996 and continuing through third quarter
1997 as part of the Ellis waterflood project on the Bakersfield Properties; and
(v) continuing development drilling on the Bakersfield Properties was delayed
pending repressurization of the Ellis waterflood. Development drilling on the
Ellis waterflood and the Truman and Tisdale shale leases was also delayed
pending the outcome of the Company's announced sale process.
Oil revenues decreased $962,000 (43%) from $2,235,000 in third quarter
1996 to $1,273,000 in the current period due to lower production volumes and
prices. Oil production decreased 43,000 barrels (36%) from 119,000 barrels in
the third quarter of 1996 to 76,000 barrels in the current period. A decrease of
25,000 barrels was attributable to the Bakersfield Properties due to the factors
described above while oil production from the Company's other properties
decreased 18,000 barrels in the
-17-
<PAGE> 20
aggregate due principally to the sale of most of its producing Permian Basin
properties in December 1996. Lower unit prices also negatively impacted oil
revenues in the current quarter. The average unit price received for oil (net of
the effects of hedging) was $17.23 per barrel during third quarter 1997 as
compared to $20.42 per barrel in third quarter 1996. Hedging activities had no
material effect on oil revenues in the current quarter.
Gas revenues decreased $490,000 (17%) from $2,880,000 in the third
quarter of 1996 to $2,390,000 in the current period due to decreased production
volumes. Gas production decreased 327,000 Mcf (23%) from 1,398,000 Mcf in third
quarter 1996 to 1,071,000 Mcf in third quarter 1997 due principally to decreased
production from the Company's Bakersfield Properties as discussed previously.
Gas production from the Company's other properties declined slightly in the
aggregate from period to period. Average prices received for gas were increased
slightly to $2.23 per Mcf in third quarter 1997 as compared to $2.06 per Mcf in
the third quarter of 1996.
During the current quarter, the Company realized revenues of $1,308,000
from its natural gas processing plant and gas marketing activities. Gas plant
revenues consisted of $703,000 from the sale of processed natural gas liquids
("NGLs"; 40,000 barrels at an average composite price of $17.58 per barrel),
$561,000 from the resale of natural gas purchased from third parties, and
$44,000 in gas processing fees. During the third quarter of 1996, the Company
realized revenues of $1,435,000 from its gas plant and marketing activities
consisting of $1,038,000 from the sale of natural gas liquids (59,000 barrels at
an average composite price of $17.59 per barrel), $367,000 from the resale of
natural gas purchased from third parties, and $30,000 in processing fees. The
decrease in revenues from the sale of NGLs in the current quarter was due to
reduced gas inlet production volumes from the Company's Bakersfield Properties
as discussed previously.
The Company realized total interest and other income of $53,000 in the
third quarter of 1997 as compared to $149,000 during the third quarter of 1996.
COSTS AND EXPENSES - Total costs and expenses decreased $461,000 (7%)
from $6,794,000 in third quarter 1996 to $6,333,000 in the current period.
-18-
<PAGE> 21
Oil and gas production costs for the third quarter 1997 were $971,000
as compared to $1,200,000 in third quarter 1996 representing a decrease of
$229,000 (19%) in the current period. The current period decrease reflects
reduced production volumes and adjustments to lease operating expenses on
certain of the Company's properties for prior periods.
During the third quarter of 1997, the Company incurred costs of
$1,125,000 from gas plant and gas marketing activities, which consisted of
$812,000 from the purchase of natural gas for processing and resale and $313,000
of direct operating expenses. During the third quarter of 1996, the Company
incurred costs of $765,000 in gas plant and marketing activities which consisted
of $410,000 for the purchase of natural gas for resale and $355,000 of direct
operating expenses. The increase in purchases of third party gas in the current
quarter was required to fulfill certain gas marketing arrangements which the
Company was otherwise unable to meet as a result of decreased production volumes
on its Bakersfield Properties.
The Company incurred engineering and geological expenses of $45,000 and
$61,000 for the quarters ended September 30, 1997 and 1996, respectively.
Depletion, depreciation and amortization ("DD&A") expense decreased
$132,000 (9%) from $1,511,000 in third quarter 1996 to $1,379,000 in the third
quarter of 1997 due to decreased levels of oil and gas production in the current
period as discussed in REVENUES.
General and administrative expenses were $496,000 and $656,000 for the
quarters ended September 30, 1997 and 1996, respectively, representing a
decrease of $160,000 (24%) in the current period.
Interest expense decreased $175,000 (7%) from $2,492,000 in third quarter 1996
to $2,317,000 in third quarter 1997. This was due to the retirement of $11.3
million of the Company's 14-7/8% Senior Secured Notes in the third quarter of
1996. There were no dividends on preferred stock in the third quarter of 1997
due to the conversion of the Company's remaining preferred stock into common
stock. The Company paid $132,000 in preferred stock dividends in third quarter
1996.
-19-
<PAGE> 22
NET LOSS - For the three months ended September 30, 1997, the Company
had a net loss of $1,309,000, or $0.08 per share. During the three months ended
September 30, 1996, the Company had a net loss attributable to common
stockholders of $2,335,000 ($.19 per common share) after extraordinary charge
and preferred dividends. The extraordinary charge in 1996 was due to early
retirement of debt as a result of the redemption of a portion of the Company's
14-7/8% Senior Secured Notes.
COMPARISON OF RESULTS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1997 AND 1996
REVENUES - The Company's total revenues decreased $4,822,000 (22%) from
$21,665,000 during the first nine months of 1996 to $16,843,000 in the current
period.
Oil and gas revenues decreased $3,984,000 (24%) from $16,572,000 in the
first nine months of 1996 to $12,588,000 in the current period due to decreased
production levels. Oil and gas production volumes were lower in the first nine
months of 1997 as compared to the same period in 1996 as a result of the
following factors: (i) lost production from the sale of the majority of the
Company's Permian Basin properties in December 1996; (ii) normal production rate
declines on the initial Bakersfield development wells; (iii) the first half of
1996 included the continued effect of higher initial production rates resulting
from the second phase of the Company's development drilling program on the
Bakersfield Properties conducted in the latter half of 1995; and second and
third quarters of 1996 included initial production rates from the drilling of 17
development wells during that period; (iv) the conversion of 17 producing
wells to water injection wells during the second half of 1996 and continuing
through third quarter 1997 as part of the Ellis waterflood project on the
Bakersfield Properties; and (v) continuing development drilling on the
Bakersfield Properties was delayed pending repressurization of the Ellis
waterflood; and Development drilling on the Ellis waterflood and the Truman and
Tisdale shale leases was also delayed pending the outcome of the Company's
announced sale process.
Oil revenues decreased $2,689,000 (36%) from $7,429,000 in first nine
months of 1996 to $4,740,000 in the current period due to lower production
volumes. Oil production decreased 149,000
-20-
<PAGE> 23
barrels (36%) from 409,000 barrels in the first nine months of 1996 to
260,000 barrels in the current period. A decrease of 92,000 barrels was
attributable to the Bakersfield Properties due to the factors described above
while oil production from the Company's other properties decreased 58,000
barrels in the aggregate due principally to the sale of most of the Company's
Permian Basin properties in December 1996. The average unit price received for
oil (net of hedging activities) was $19.36 per barrel during first nine months
of 1997 as compared to $19.33 per barrel for the same period in 1996. Hedging
activities had no material effect on oil revenues in the current period.
Gas revenues decreased $1,295,000 (14%) from $9,143,000 in the first
nine months of 1996 to $7,848,000 in the current period also due to decreased
production volumes. Gas production decreased 1,085,000 Mcf (23%) from 4,655,000
Mcf in first nine months of 1996 to 3,570,000 Mcf in the current period. This
was primarily the result of decreased production from the Company's Bakersfield
Properties as described previously. Gas production from the Company's other
properties declined slightly in the aggregate from period to period. Average
prices received for gas increased to $2.20 per Mcf for the first nine months
1997 as compared to $1.96 per Mcf in the first nine months of 1996.
During the first nine months of 1997, the Company realized revenues of
$4,134,000 from its natural gas processing plant and gas marketing activities.
Gas plant revenues consisted of $2,697,000 from the sale of natural gas liquids
(140,000 barrels at an average composite price of $19.26 per barrel), $1,321,000
from the resale of natural gas purchased from third parties, and $116,000 in gas
processing fees. During the first half of 1996, the Company realized revenues of
$4,850,000 from its gas plant and marketing activities consisting of $3,211,000
from the sale of natural gas liquids (181,000 barrels at an average composite
price of $17.74 per barrel), $1,539,000 from the resale of natural gas purchased
from third parties, and $100,000 in processing fees. The decrease in revenues
from sale of NGLs in the current period was due to reduced gas inlet production
volumes from the Company's Bakersfield Properties as previously discussed.
The Company realized total interest and other income of approximately
$121,000 in the first nine months of 1997 as compared to $243,000 during the
same period in 1996.
-21-
<PAGE> 24
COSTS AND EXPENSES - Total costs and expenses decreased $2,852,000
(13%) from $22,085,000 in first nine months of 1996 to $19,233,000 in the
current period.
Oil and gas production costs for the first nine months of 1997 were
$3,063,000 as compared to $3,874,000 in the first nine months of 1996
representing a decrease of $811,000 (21%) in the current period. The current
period decrease reflects reduced production volumes and adjustments to lease
operating expenses on certain of the Company's properties for prior periods. The
Company's total aggregate production cost per barrel of oil equivalent ("BOE")
was $3.58 per BOE year-to-date as compared to $3.27 per BOE for the first nine
months of 1996.
During the first nine months of 1997, the Company incurred costs of
$2,872,000 from gas plant and gas marketing activities, which consisted of
$1,789,000 from the purchase of natural gas for processing and resale and
$1,083,000 of direct operating expenses. During the first nine months of 1996,
the Company incurred costs of $2,752,000 resulting from its gas plant and
marketing activities which consisted of $1,405,000 from the purchase of natural
gas for processing and resale and $1,347,000 of direct operating expenses. The
increase in purchases of third party gas in the current period was required to
fulfill certain gas marketing arrangements which the Company was otherwise
unable to meet as a result of decreased production volumes on its Bakersfield
Properties.
The Company incurred engineering and geological expenses of $247,000
and $226,000 for the nine months ended September 30, 1997 and 1996,
respectively.
DD&A expense decreased $253,000 (5%) from $4,856,000 in first nine
months of 1996 to $4,603,000 in the first nine months of 1997 due to decreased
levels of oil and gas production in the current period as discussed in REVENUES.
The DD&A rate per BOE for oil and gas reserves was estimated at $4.94 for the
first nine months of 1997 as compared to an estimated $3.85 per BOE during the
first nine months of 1996. The increase in DD&A rate per BOE in the current
period is due to incremental capital costs incurred in the continuing
development of the Company's undeveloped reserves in California.
General and administrative expenses were $1,884,000 and $2,197,000 for
the nine months ended September 30, 1997 and 1996,
-22-
<PAGE> 25
respectively, representing a decrease of $313,000 (14%) in the current period.
Interest expense decreased $1,246,000 (16%) from $7,810,000 in first
nine months 1996 to $6,564,000 in first nine months 1997. This was primarily due
to the retirement of $11.3 million of the Company's 14-7/8% Senior Secured Notes
in the third quarter of 1996. The Company paid $60,000 in preferred dividends in
the first nine months of 1997 as compared to $397,000 during the same period of
1996. The decrease in dividends in 1997 is due to the conversion of the
Company's preferred stock into common stock.
NET LOSS - The Company's net loss attributable to common stockholders
for the nine months ended September 30, 1997 was $2,450,000 ($.16 per common
share). During the nine months ended September 30, 1996, the Company had a net
loss attributable to common stockholders after extraordinary charge and
preferred dividends of $2,925,000 ($.30 per common share). The extra-ordinary
charge in 1996 was due to early retirement of debt as a result of the redemption
of a portion of the Company's 14-7/8% Senior Secured Notes.
LIQUIDITY AND CAPITAL RESOURCES
SUMMARY - The Company's sources of working capital have primarily been
cash flow from operations and a combination of debt and equity financings as
needs for capital and opportunities to improve its capital structure have
arisen. During the nine months ended September 30, 1997, the Company generated
net cash from operating activities of approximately $1 million as compared to
$2.8 million during the same period in 1996. The Company realized net proceeds
of $4.5 million from financing activities during the current period as compared
to $11.6 million in financing activities during the same period in 1996. The
Company utilized a net of $4.6 million in investing activities in the current
period as compared to $17.9 million expended on investing activities for the
nine months ended September 30, 1996.
WORKING CAPITAL - The Company had net working capital of $2,197,000
with a current ratio of 1.38:1 at September 30, 1997 as compared to a working
capital deficit of $61,000 and a current ratio of 0.99:1 at December 31, 1996.
-23-
<PAGE> 26
OPERATING ACTIVITIES
CASH FLOWS - Discretionary cash flow is a measure of performance which
is useful for evaluating exploration and production companies. It is derived by
adjusting net income or loss to eliminate the non-cash effects of exploration
expenses, DD&A and non-recurring charges, if applicable. The effects of non-cash
working capital changes are not taken into account. This measure reflects an
amount that is available for capital expenditures, debt service and dividend
payments.
During the nine months ended September 30, 1997, the Company generated
discretionary cash flow of $3.1 million (before an decrease resulting from
changes in other working capital of $2.1 million. This compares to discretionary
cash flow generated by operations of $5.8 million (before a decrease resulting
from changes in other working capital of $3 million) during the same period in
1996.
The decrease in the current period's discretionary cash flow as
compared to 1996 was primarily due to decreased oil and gas production volumes
which was a result of the following factors: (i) lost production from the sale
of the Company's Permian Basin properties; (ii) normal production rate
declines; (iii) 1996 included the effects of higher initial production rates
resulting from the Company's development drilling program on its Bakersfield
Properties during that period; (iv) the conversion of 17 producing wells to
water injection wells as part of the Ellis waterflood project; and (v) certain
delays of the projected development drilling program on the Bakersfield
Properties. These factors resulted in a 28% decrease in production levels in
1997 on a year-to-year comparison basis with 1996. Production for third quarter
1997, however, was 14% below the prior two quarters of 1997. (See RESULTS OF
OPERATIONS - REVENUES.)
The effect of the current period's decline in production volumes was
partially mitigated by (i) lower operating costs and expenses; (ii) interest
expense savings as a result of the retirement of a portion of the Company's
14-7/8% Senior Secured Notes; and (iii) reduced dividend payments resulting from
the conversion of the Company's remaining preferred stock into common stock.
(See RESULTS OF OPERATIONS - COSTS AND EXPENSES.)
Production during the remainder of 1997 will continue to be negatively
impacted by normal production declines and production
-24-
<PAGE> 27
losses resulting from the conversion of additional producing wells to water
injector wells on the Ellis lease waterflood project. Plans for the fourth
quarter of 1997 provide for the conversion of an additional 13 producing wells
to injection for a total of 32 injectors by year-end 1997. The Company will also
continue to be negatively impacted in 1997 on a year-to-year comparison basis
with 1996 as a result of the sale of its Permian Basin properties in December
1996.
The Company hopes that the above negative factors will be mitigated by
resumed drilling and development activities on the Bakersfield Properties which
were resumed in the latter part of 1997. Also, effects of water injection on the
Ellis waterflood initiated in 1996 have been observed, and an increase in
production response has resulted in portions of the waterflood area in the
fourth quarter. (See DEVELOPMENTAL DRILLING ACTIVITIES which follows.)
RESULTS OF HEDGING ACTIVITIES - The Company's hedging activities during
the nine months ended September 30, 1997 have not had a material effect on the
Company's liquidity or results of operations. (See Note 4 of "Unaudited Notes to
Consolidated Financial Statements" included herein.)
CAPITAL EXPENDITURES AND INVESTING ACTIVITIES
DEVELOPMENTAL DRILLING ACTIVITIES - The Company expended a total of
$9.3 million in investing activities in the current period which consisted of
$4.7 million for drilling costs accrued at December 31, 1996 and $4.6 million
($5.5 million accrual basis) relating to current period developmental drilling
and 3-D activities. This compares to $17.9 million expenditures for the nine
months ended September 30, 1996 which consisted of $8.2 million for drilling
costs accrued at December 31, 1995 and $9.7 million ($13.2 million accrual
basis) relating to developmental drilling and 3-D activities for that period.
The Company also realized cash proceeds of $4.7 million in the current period
relating to the sale of certain of its Permian Basin oil and gas properties in
December 1996.
The Company had originally planned to spend approximately $14 million
during 1997 on the development of its Bakersfield Properties. However, a portion
of those expenditures for drilling new wells will be delayed until 1998 pending
progress of repressuring of the Diatomite zone on the Ellis lease by water
-25-
<PAGE> 28
injection. During July, 1996 water injection was initiated in four
wells in the waterflood pilot project area with four additional producing wells
converted to injection in December 1996. Expansion of the waterflood project has
continued in 1997 with the number of injection wells being increased to 12 in
the first quarter and further increased to 19 in the fourth quarter of 1997.
Plans are to convert 13 more wells to injection in the fourth quarter which will
result in a total of 32 active injection wells by year-end. Completion of the
installation of the entire waterflood project is anticipated by early 1999.
The effect of water injection has been observed in a total of 22 wells
to date. The Company has recently drilled three Diatomite wells on the Ellis
lease to evaluate the repressuring progress. Based on favorable pressure data
observed, one of the three new wells has recently been completed in the
Diatomite zone and has averaged 33 barrels of oil per day during the first ten
days of testing. In addition to the three new Diatomite wells drilled on the
Ellis lease in the third quarter of 1997, 12 wells previously drilled which were
completed in only the deeper shale zone are also available for completion in the
Diatomite zone pending repressuring of the waterflood area. The timing of
completion of these wells and the drilling of additional wells is contingent on
the pressure information indicating that the reservoir has been sufficiently
repressured, although it is anticipated that at least three of these wells will
be completed in the Diatomite in the fourth quarter 1997.
Active development of the shale zones on the Truman and Tisdale leases
previously had been delayed as a primary focus was the exploitation of the Ellis
lease through development drilling and installation of the Diatomite zone
waterflood project. A deep shale well drilled on the Truman lease in January
1997 has continued to show favorable performance with average rates of 63
barrels of oil per day and 280 Mcfd during October 1997. In October the Company
commenced the drilling of a four-well shale development program on the Truman
lease for the fourth quarter. Additional shale development is also projected for
1998. These estimates may vary as the Company further evaluates the results of
drilling activities, water injection, and results of future operations.
There can be no assurances that the Company will be successful in the
continued development of the Bakersfield
-26-
<PAGE> 29
Properties nor that it will experience increased production response from the
Ellis waterflood project.
The Company is also involved in a small waterflood project on its
Permian Basin properties and has approximately $2 million in capital
expenditures planned in this area during the next two years.
EXPLORATION ACTIVITIES - During 1996 the Company participated in the
shooting of 339 square miles of 3-D seismic data and the reprocessing of 1,000
miles of 2-D seismic data in four project areas covering approximately 217,000
acres. The Company has a 22.7% working interest in its McMullen County, Texas
project (Hostetter Area), 12.5 % working interest in the Terrebone Parish,
Louisiana project (Lapeyrouse), 7.5% working interest in the Reeves County,
Texas project (Permian Basin) and a 43% working interest in its South Texas Frio
program (Gulf Coast Frio). The processing and interpretation of the seismic data
has continued in 1997 with drilling currently underway in two of the areas. The
Company anticipates spending approximately $2 million to $4 million during the
next eighteen months on 3-D generated drilling activities, depending upon
initial results. A summary of activity in each area follows.
HOSTETTER: The Texaco 64-1 is the first test well in this project and
is presently being completed in one of the shallower Slick-Luling objectives.
A potentially significant interval has been logged in the second test well,
the Stella Penn #8, and it is expected that this well will be completed
in the Slick-Luling interval and flowing into the sales line by early December.
The Company plans to participate in two additional wells during the fourth
quarter in this project area.
LAPEYROUSE: The Company is presently reviewing three well proposals for
drilling in early 1998. The seismic interpretation of the 3-D data in this
project area has been completed and the company is in the process of finalizing
the necessary permitting for the drilling of two test wells in late January
1998. A third well should commence drilling in second quarter 1998.
PERMIAN BASIN: The Oatman #1 test well is presently being completed
and has logged 276' of gross potential pay in multiple-zone intervals in the
Delaware, Wolfcamp and Atoka formations. The Company anticipates having the
well completed and flowing to sales by early December. The Kirk #1 well was
recompleted and has
-27-
<PAGE> 30
logged 40ft. of gross pay. The well is currently flowing 1500 MCF/D to sales.
In addition, the TXL "1" #1 well is currently being drilled and has logged 89
feet of gross potential pay in shallower intervals. Total depth (projected at
22,000 feet) and the primary Silvro-Devonian formation objective is expected to
be reached by December 1997. The Company expects that two drilling rigs will
continue running in 1998 in the project area on exploration wells. In addition,
a third drilling rig is anticipated to be brought into the project area in 1998
to continue with follow-up development wells to the Oatman #1 well. The Company
also expects the Hammond #1 and the Youngblood #1 exploratory wells in the
prospect area to commence drilling in January. The partners in the project are
currently evaluating proposals to shoot an additional 130 square miles of 3-D
data in the project area.
GULF COAST FRIO: The Company anticipates participation in the
drilling of up to six shallow Frio prospects by the end of January 1998 in the
South Texas Frio trend. These prospects are "AVO" (amplitude versus offset)
bright spot anomalies with an average total depth of 4500' test.
FINANCING ACTIVITIES
SUMMARY - The Company realized net proceeds of $4.5 million from its
financing activities during the first nine months of 1997 which consisted of (i)
$1.4 million in cash proceeds from the issuance of common stock pursuant to a
warrant exercise; (ii) net borrowings of $3.3 million on the Company's revolving
credit facility with ING; and (iii) $168,000 for the payment of preferred stock
dividends and other debt and miscellaneous. Effective April 1997 all of the
Company's preferred stock had been either redeemed or converted to common stock
and no further dividend payments are required in future periods.
-28-
<PAGE> 31
During the first nine months of 1996, the Company realized net proceeds
of $11.6 million from financing activities. This consisted of (i) $21.8 million
net proceeds realized from the sale of common stock in a public equity offering;
(ii) net repayment of $5.4 million in bank borrowings; (iii) the redemption of
$3.6 million (cash basis) of 14-7/8% Senior Secured Notes; and (iv) an aggregate
$1.2 million used for the payment of preferred stock dividends and other
miscellaneous financing activities.
CREDIT AGREEMENT - Availability under the Company's Credit Agreement is
limited to a "borrowing base" amount which is determined semi-annually by ING
Capital, at its sole discretion, and may be established at an amount up to $15
million. The borrowing base was $15 million at September 30, 1997 and there was
$5.3 million outstanding under the Credit Agreement at that date. Availability
under the Credit Agreement, as amended in August 1997, will terminate on June
30, 1998, at which time amounts outstanding will convert to a term loan on July
31, 1998, with a set amortization schedule of a percentage of the outstanding
principal balance continuing through December 31, 2001. Amounts advanced under
this facility bear interest at an adjusted Eurodollar rate plus 2.50% or Prime
Rate (as determined by ING Capital) plus 0.5% at the Company's option.
The Credit Agreement contains restrictive covenants which impose
limitations on the Company and its subsidiaries with respect to, among other
things, certain financial ratios or limitations, incurrence of indebtedness, the
sale of the Company's oil and gas properties and other assets, hedging
transactions, payment of dividends, mergers or consolidations and investments
outside the ordinary course of business. The Credit Agreement also contains
customary default provisions. The Company believes that it was in compliance
with all of the covenant provisions under the Credit Agreement at September 30,
1997.
14-7/8% SENIOR SECURED NOTES - The Company's $53.7 million (face value)
of 14-7/8% Senior Secured Notes (the "Notes") bear interest at the rate of
14-7/8% per annum and is payable semi-annually on January 15 and July 15 of each
year. The Notes are redeemable, in whole or in part, at the option of the
Company at any time on or after July 15, 1999, at the following redemption
prices (expressed as percentages of the principal amount) if
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<PAGE> 32
redeemed during the 12-month period commencing on July 15 of the year set forth
below plus, in each case, accrued interest thereon to the date of redemption:
<TABLE>
<CAPTION>
Year Percentage
---- ----------
<S> <C>
1999 . . . . . . . . . . 110%
2000 . . . . . . . . . . 107%
2001 and thereafter. . . 100%
</TABLE>
In the event that the Company has excess cash flow (as defined) in
excess of $2 million in any fiscal year, beginning with the fiscal year ending
December 31, 1996, the Company will be required to make an offer to purchase
Notes from all holders thereof in an amount equal to 50% of all such excess cash
flow for such fiscal year (not just the amount in excess of $2 million) at a
purchase price equal to 101% of the principal amount thereof, plus accrued and
unpaid interest thereon. The Company does not anticipate making such an offer in
the current fiscal year.
All of the obligations of the Company under the Notes and related
indenture are secured by a second priority lien on substantially all of the
assets of the Company, which are also collateralized under its Credit Agreement.
FINANCIAL COMMITMENTS - The Company expects that its available cash and
expected cash flow from operating activities will be sufficient to meet its
financial obligations and fund its planned developmental drilling on the
Bakersfield Properties for the foreseeable future, provided that (i) there are
no significant decreases in oil and gas prices; (ii) there are no significant
declines in oil and gas production from existing properties other than declines
in production currently anticipated based on engineering estimates of the
decline curves associated with such properties; (iii) drilling costs for
development wells with respect to the Bakersfield Properties do not increase
significantly from the drilling costs recently experienced by the operator in
such areas with respect to similar wells; and (iv) the operator continues its
development program with respect to the Bakersfield Properties on the schedule
currently contemplated.
The Company also expects that its current liquidity condition and
availability under its Credit Agreement will enable it to fund its 3-D seismic
and exploration activities for the
-30-
<PAGE> 33
next eighteen months. Further exploration and resulting development drilling of
these projects will depend on the measure of success of these initial
activities.
In the event operating cash flow and available liquidity are not
sufficient to fund debt and development and exploration costs, or results from
developmental drilling and exploration are not as successful as anticipated, the
Company will either (i) curtail its developmental drilling and/or exploration
activities or (ii) seek alternative financing to assist in these activities.
STRATEGIC ALTERNATIVES UPDATE
In March, 1997 the Company announced that it had engaged a group of
investment bankers to pursue a possible sale of the Company in order to maximize
shareholder returns. Following the circulation of certain confidential
information to an initial group of potential suitors, indications of interest
were received which suggested that the Company would probably receive more value
for the Company's non-California assets if they were offered to a separate group
of buyers because of the non-operated nature of these properties, and the
relatively high level of future capital expenditures and reserve potential
associated with the Company's various 3-D projects.
The Company subsequently bifurcated the sales process during the second
quarter and solicited interest from potential buyers for its California and
non-California assets as separate packages. As a result of this effort the
Company has now received offers and indications of interest on its
non-California assets from several potential buyers which appear to reflect a
more acceptable level of consideration. However, the Company believes that
recent drilling success in its 3-D program could represent additional value for
this package and it is circulating this new data to its potential non-California
asset buyers.
With respect to its California assets, early indications of interest
appeared to be influenced by the lack of evidentiary support at that time for
waterflood production response and associated proven undeveloped reserve
economics on the Company's Ellis lease waterflood project in the Lost Hills
field. Water injection at the Ellis lease had been initiated on a limited basis
in July, 1996 with only four injectors. Consequently, there was little direct
evidence available in March, 1997 to support the effects of repressurization and
waterflood response.
-31-
<PAGE> 34
Since the Company received its initial indications of interest it has:
(1) converted an additional 11 wells to water injection (resulting in a total of
19 injection wells) and has documented an initial repressurization of that area
of the Ellis lease currently under waterflood; (2) seen an increase in oil
production from wells in the response area; and (3) most recently successfully
completed its first infill well on the Ellis lease since repressurization
commenced at an average flow rate of 33 BOPD. These production rates are
materially higher than those for the wells drilled in late 1996 in the same area
prior to repressurization. The Company is providing this data to its remaining
California suitors.
Additionally, a deep shale well drilled on the Truman lease in January,
1997 has continued to perform better than its offsetting wells. In October, 1997
the Company recommenced drilling on the Truman lease and has four wells
scheduled for completion during the fourth quarter. The Company believes that
this program will increase cash flow contribution from its California assets,
thereby enhancing the financeability of this package by prospective bidders.
Following the dissemination of the above recent information, the
Company has entered into preliminary discussions with potential suitors for the
entire Company including its non-California assets. The Company is continuing,
however, to entertain proposals for the purchase of the Company's California
assets and non-California assets in separate transactions.
There can be no assurances, however, that this process will result in
the sale of the Company. In the event the Company is sold, there can be no
assurances as to either the amount or form of consideration that the Company's
shareholders would receive in such a transaction.
UNCERTAINTIES INVOLVING FORWARD-LOOKING DISCLOSURE
Certain of the statements set forth above under LIQUIDITY AND CAPITAL
RESOURCES, OPERATING ACTIVITIES, CAPITAL EXPENDITURES AND INVESTING ACTIVITIES
and STRATEGIC ALTERNATIVES UPDATE, such as the statements regarding possible
increases in production amounts, anticipated favorable response from the Ellis
waterflood project, available cash and expected cash flows from operating
activities
-32-
<PAGE> 35
for 1997 and 1998, further development of the shale formation on the Truman
lease, estimated development costs and number of anticipated wells to be
drilled in 1997 and thereafter, estimates of potential hydrocarbon-bearing
zones resulting from initial 3-D exploration results in the planned 3-D seismic
program and the potential sale of the Company are forward-looking and are based
upon the Company's current belief as to the outcome and timing of such future
events. There are numerous uncertainties inherent in estimating quantities of
proved oil and gas reserves and in projecting future rates of production and
timing of development expenditures, including many factors beyond the control
of the Company. Reserve engineering is a subjective process of estimating
underground accumulations of oil and gas that cannot be measured in an exact
way, and the accuracy of any reserve estimate is a function of the quality of
available data and of engineering and geological interpretation and judgment.
-33-
<PAGE> 36
As a result, estimates made by different engineers often vary from one
another. In addition, results of drilling, testing and production subsequent to
the date of an estimate may justify revisions of such estimate and such
revisions, if significant, would change the schedule of any further production
and development drilling. Accordingly, reserve estimates are generally different
from the quantities of oil and gas that are ultimately recovered. Furthermore,
the estimated production amounts and numbers of wells to be drilled in the
remainder of 1997 and beyond are based upon recently experienced product prices
and costs (except for gas sold under contract, in which case the contract prices
were used), which will probably be different from the actual prices recognized
and costs incurred in 1997 and beyond. Additional factors which could materially
affect the Company's oil and gas production and development drilling program in
the future are general economic conditions; the impact of the activities of OPEC
and other competitors; the impact of possible geopolitical occurrences
world-wide; the results of financing efforts, risks under contract and swap
agreements; changes in laws and regulations; capacity, deliverability and supply
constraints or difficulties, unforeseen engineering and mechanical or
technological difficulties in drilling or working over wells; and other risks
described under "Risk Factors" in the Company's Prospectus dated July 25, 1996,
filed with the Securities and Exchange Commission, relating to the July 1996
Equity Offering. Because of the foregoing matters, the Company's actual results
for the remainder of 1997 and beyond and strategic alternatives could differ
materially from those expressed in the above-described forward-looking
statements.
-34-
<PAGE> 37
HARCOR ENERGY, INC.
PART II - OTHER INFORMATION
Item 6. - Exhibits and Reports on Form 8-K
(a) Exhibits - 27 Financial Data Schedule
*10.1 Form of Restated Severance Agreement dated as of April
9, 1997 among HarCor Energy, Inc. and the Company's
employees
10.2 Financial Services Agreement dated April 18, 1997
between Jefferies & Company, Inc. by David E.K.
Frischkorn, Jr., Managing Director, and HarCor Energy,
Inc.
(b) Reports on Form 8-K - None
* Management contract or compensatory plan or arrangement required to be filed
as an exhibit to this Form 10-Q.
-35-
<PAGE> 38
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.
HARCOR ENERGY, INC.
Registrant
Date: November 14, 1997 /s/ Francis H. Roth
--------------------------------------
Francis H. Roth
President and Chief
Operating Officer
Date: November 14, 1997 /s/ Gary S. Peck
--------------------------------------
Gary S. Peck
Vice President - Finance &
Administration, Chief Financial
Officer and Corporate Secretary
-36-
<PAGE> 39
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 10.1
RESTATED SEVERANCE AGREEMENT
This Severance Agreement (the "Agreement") is between HarCor Energy, Inc. ("the
Company") and __________________________ (the "Employee").
WHEREAS, pursuant to the authority granted by the Board of Directors in a
resolution dated March 17, 1997, the Company and the said Employee entered into
a Severance Agreement dated April 9, 1997, and it is the intention of the
parties hereto that this Agreement will restate and extend the said Severance
Agreement, and
WHEREAS, the Company is considering business transactions that could result in
the sale, a change of control and/or ownership of the Company; and
WHEREAS, the Company recognizes that the sale, a change of control and/or
ownership could result in the loss of the Employee's job; and
WHEREAS, the Company recognizes that the continued employment of the Employee is
critical to the maximization of shareholders' value in any contemplated sale or
change of control transaction; and
WHEREAS, the Company wishes to continue the employment of the Employee with the
Company until any contemplated sale, change of control or ownership is effected.
Now, therefore, in consideration of the mutual covenants and agreements
hereinafter set forth, these parties agree to the following:
I. EMPLOYEE OBLIGATIONS
The Employee agrees to the following:
A. To remain employed by the Company in the Employee's current position
or any position assigned by the Company from April 9, 1997, until (a) December
31, 1998, or until (b) the Effective Date (as defined herein), whichever date
first occurs.
B. To devote all of the Employee's working time to the Company and to
give the Employee's best effort to the business affairs of the Company, and to
the performance of the duties of the Employee's assigned position, and as may be
further required, from April 9, 1997, until (a) December 31, 1998, or until (b)
the Effective Date, whichever date first occurs.
II. COMPANY OBLIGATIONS
The Company agrees to the following:
A. To pay a special one-time lump sum severance payment to the Employee
at Houston, Texas, within ten (10) days after the Effective Date, equal to 1.5
times Total Cash Compensation (as defined herein) paid to the Employee for the
tax year 1996, provided that:
1. All Employee Obligations are met; and
<PAGE> 1
EXHIBIT 10.2
JEFFERIES & COMPANY, INC.
TWO HOUSTON CENTER, 909 FANNIN STREET, SUITE 3100, HOUSTON, TEXAS 77010
TELEPHONE (713) 658-1100 FAX (713) 650-8730
CORPORATE FINANCE
April 18, 1997
Mr. Mark Harrington
Chief Executive Officer
HARCOR ENERGY, INC.
5 Post Oak Park, Suite 2220
Houston, Texas 77027
Dear Mark:
1. Retention and Services to be Rendered. This letter (the
"Agreement") confirms that HARCOR ENERGY, INC. ("HarCor" or the "Company") has
engaged Jefferies & Company, Inc. ("Jefferies") as financial advisor to HarCor
in connection with various ongoing financial services ("Financial Services").
2. Information on the Company. In connection with Jefferies'
activities hereunder, you will furnish us and our counsel upon request with all
material and information regarding the business and financial condition of the
Company, all of which will be accurate and complete in all material respects as
of their respective dates (all such information so furnished being the
"Information"). The Company recognizes and confirms that Jefferies: (a) will
use and rely primarily on the Information and on information available from
generally recognized public sources in performing the services contemplated by
this Agreement without having independently verified the same; (b) does not
assume responsibility for the accuracy or completeness of the Information and
such other information; and (c) will not make any appraisals of any of the
Company's assets.
3. Use of Name. The Company agrees that any reference to Jefferies
in any release, communication, or material publicly distributed, is subject to
Jefferies' prior written approval.
4. Use of Advice. No advice rendered by Jefferies in connection with
the services performed by Jefferies pursuant to this Agreement will be quoted
by either party hereto, nor will any such advice be referred to, in any report,
document, release or other communication, whether written or oral, prepared,
issued or transmitted by such party or any person or corporation controlling,
controlled by or under common control with such party or any director, officer.
employee, agent or representative of any such party thereof, without the prior
written authorization of both parties hereto, except to the extent required by
law (in which case the
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JUL-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 2,484,807
<SECURITIES> 0
<RECEIVABLES> 4,069,804
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 8,010,029
<PP&E> 114,609,795
<DEPRECIATION> (33,479,495)
<TOTAL-ASSETS> 92,035,889
<CURRENT-LIABILITIES> 5,813,196
<BONDS> 52,578,232<F1>
0
0
<COMMON> 1,626,839
<OTHER-SE> 27,115,122
<TOTAL-LIABILITY-AND-EQUITY> 92,035,889
<SALES> 4,969,871
<TOTAL-REVENUES> 5,024,189
<CGS> 2,095,551<F2>
<TOTAL-COSTS> 2,095,551
<OTHER-EXPENSES> 1,920,808<F3>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,317,020
<INCOME-PRETAX> (1,309,190)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,309,190)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,309,190)
<EPS-PRIMARY> (0.08)
<EPS-DILUTED> (0.08)
<FN>
<F1>14 7/8% SENIOR SECURED NOTES DUE 2002
<F2>OIL & GAS PRODUCTION COSTS & GAS PLANT COSTS
<F3>EXPLORATION, DD&A, G&A
</FN>
</TABLE>
