UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
MARK ONE
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-9579
HALLWOOD ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 84-1489099
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
4610 South Ulster Street
Suite 200
Denver, Colorado 80237
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (303) 850-7373
Securities Registered Pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
None None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
Series A Cumulative Preferred Stock, par value $.01 per share
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the common shares held by nonaffiliates of the
registrant as of March 6, 2000 was approximately $37,353.000.
Number of Shares outstanding as of March 6, 2000:
Common Stock 9,999,754
Series A Cumulative Preferred Stock 2,290,349
Documents Incorporated by Reference
The information called for by Part III of Form 10-K is incorporated by reference
to the definitive proxy statement for the annual meeting of stockholders of the
Company to be filed with the Securities and Exchange Commission not later than
120 days after December 31, 1999.
<PAGE>
PART I
ITEM 1 - BUSINESS
Hallwood Energy Corporation ("HEC" or the "Company") is a Delaware corporation
engaged in the development, exploration, acquisition and production of oil and
gas properties. HEC began operations June 8, 1999, in connection with the
consolidation ("Consolidation") of Hallwood Energy Partners, L.P. ("HEP") and
Hallwood Consolidated Resources Corporation ("HCRC") and the acquisition of the
direct energy interests of The Hallwood Group Incorporated ("Hallwood Group").
For accounting purposes, the Consolidation has been treated as a purchase by HEP
of the common stock of HCRC and the direct energy interests of Hallwood Group.
Accordingly, the assets and liabilities of HEP, including its 46% share of
assets and liabilities of HCRC owned prior to the Consolidation, have been
recorded at historical cost, and the remaining assets and liabilities of HCRC
and the direct energy interests of Hallwood Group have been recorded at
estimated fair values as of the date of purchase. All information presented for
periods prior to June 8, 1999 represents the historical information of HEP
because HEP was considered to be the acquiring entity for accounting purposes.
The financial statements for periods prior to June 8, 1999 have been
retroactively restated to reflect the corporate structure of HEC, and all share
and per share information assumes that the shares of HEC issued to HEP in
connection with the Consolidation were outstanding for all periods prior to June
8, 1999. The Company's properties are primarily located in the Rocky Mountain,
Greater Permian and Gulf Coast regions of the United States. On March 6, 2000,
HEC had 100 employees.
Marketing
The oil and gas produced from the properties owned by HEC has typically been
marketed through normal channels for such products. The Company generally sells
its oil at local field prices generally paid by the principal purchasers of
crude oil in the areas where the majority of producing properties are located.
In response to the volatility in the oil markets, HEC has entered into financial
contracts for hedging the price of between 12% and 54% of its estimated oil
production for 2000 through 2001.
All of HEC's natural gas production is sold on the spot market or in short-term
contracts and is transported in intrastate and interstate pipelines. HEC has
entered into financial contracts for hedging the price of between 34% and 43% of
its estimated gas production for 2000 through 2002.
The purpose of the hedges is to provide protection against price decreases and
to provide a measure of stability in the volatile environment of oil and natural
gas spot pricing. The amounts received or paid upon settlement of these
contracts are recognized as an increase or decrease in oil or gas revenue at the
time the hedged volumes are sold.
Both oil and natural gas are purchased by refineries, major oil companies,
public utilities, industrial customers and other users and processors of
petroleum products. HEC is not confined to, nor dependent upon, any one
purchaser or small group of purchasers. Accordingly, the loss of a single
purchaser, or a few purchasers, would not materially affect HEC's business
because there are numerous other purchasers in the areas in which HEC sells its
production. However, for the years ended December 31, 1999, 1998 and 1997,
purchases by the following companies exceeded 10% of the total oil and gas
revenues of the Company:
1999 1998 1997
---- ---- ----
Conoco Inc. 19% 23% 20%
El Paso Field Services Company 14% 11% 11%
Plains All American Inc. 14%
Marathon Petroleum Company 16%
Factors, if they were to occur, which might adversely affect HEC include
decreases in oil and gas prices, the reduced availability of a market for
production, rising operational costs of producing oil and gas, compliance with,
and changes in, environmental control statutes and increasing costs of
transportation.
<PAGE>
Competition
HEC encounters competition from other oil and gas companies in all areas of its
operations, including the acquisition of exploratory prospects and proven
properties. The Company's competitors include major integrated oil and gas
companies and numerous independent oil and gas companies, individuals and
drilling and income programs. As described above under "Marketing," production
is sold on the spot market, thereby reducing sales competition; however, oil and
gas must compete with coal, atomic energy, hydro-electric power and other forms
of energy.
Regulation
Production and sale of oil and gas is subject to federal and state governmental
regulation in a variety of ways, including environmental regulations, labor
laws, interstate sales, excise taxes and federal and Indian lands royalty
payments. Failure to comply with these regulations may result in fines,
cancellation of licenses to do business and cancellation of federal, state or
Indian leases.
The production of oil and gas is subject to regulation by the state regulatory
agencies in the states in which HEC does business. These agencies make and
enforce regulations to prevent waste of oil and gas and to protect the rights of
owners to produce oil and gas from a common reservoir. The regulatory agencies
regulate the amount of oil and gas produced by assigning allowable production
rates to wells capable of producing oil and gas.
Title to Properties
The Company believes it has satisfactory title to all of its material producing
properties in accordance with standards generally accepted in the oil and gas
industry. As is customary in the industry in the case of undeveloped properties,
little investigation of record title is made at the time of acquisition.
Investigations, including a title opinion of legal counsel, generally are made
before commencement of drilling operations. To the extent title opinions or
other investigations reflect title defects, the Company, rather than the seller
of undeveloped property, typically is responsible to cure any such title defects
at the Company's expense. If the Company was unable to remedy or cure title
defects of a nature such that it would not be prudent to commence drilling
operations on the property, the Company could suffer a loss of its entire
investment in such property. The Company's properties are subject to customary
royalty, overriding royalty, carried, net profits, working and other similar
interests, liens incident to operating agreements, liens for current taxes and
other burdens. In addition, the Company's credit facility is secured by
approximately 80% in value of the oil and natural gas interests of the Company
and other assets of the Company.
Environmental Considerations
The exploration for, and development of, oil and gas involves the extraction,
production and transportation of materials which, under certain conditions, can
be hazardous or can cause environmental pollution problems. In light of the
current interest in environmental matters, the Company cannot predict what
effect possible future public or private action may have on the business of HEC.
The Company is continually taking actions it believes are necessary in its
operations to ensure conformity with applicable federal, state and local
environmental regulations. As of December 31, 1999, HEC has not been fined or
cited for any environmental violations which would have a material adverse
effect upon capital expenditures, earnings, cash flows or the competitive
position of HEC in the oil and gas industry.
Insurance Coverage
HEC is subject to all the risks inherent in the exploration for, and development
of, oil and gas, including blowouts, fires and other casualties. HEC maintains
insurance coverage as is customary for entities of a similar size engaged in
operations similar to that of HEC, but losses can occur from uninsurable risks
or in amounts in excess of existing insurance coverage. The occurrence of an
event which is not insured or not fully insured could have an adverse impact
upon HEC's earnings, cash flows and financial position.
<PAGE>
Year 2000
In prior years, the Company discussed the nature and progress of its plans to
become Year 2000 compliant. In late 1999, the Company completed its remediation
and testing of systems. As a result of those planning and implementation
efforts, the Company experienced no significant disruptions in it critical
information technology and non-information technology systems, and believes
those systems successfully responded to the Year 2000 date change.
The Company is not aware of any material problems resulting from Year 2000
issues, either with its products, its internal systems, or the products and
services of third parties. The Company will continue to monitor its computer
applications and those of its suppliers and vendors throughout the Year 2000 to
ensure that any latent Year 2000 matters that may arise are addressed properly.
Cautionary Statement Regarding Forward-Looking Statements
In the interest of providing the shareholders with certain information regarding
the Company's future plans and operations, certain statements set forth in this
Form 10-K relate to management's future plans and objectives. Such statements
are forward-looking statements within the meanings 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-K 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 come to pass, there can be no assurances that any of
these expectations will prove correct or that any of the actions that are
planned will be taken. 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 others:
Volatility of oil and gas prices. It is impossible to predict future oil and gas
price movements with certainty. Declines in oil and gas prices may materially
adversely affect HEC's financial condition, liquidity, ability to finance
planned capital expenditures and results of operations. Lower oil and gas prices
may also reduce the amount of oil and gas that HEC can produce economically.
HEC's revenues, profitability, future growth and ability to borrow funds or
obtain additional capital, as well as the carrying value of its properties, will
be substantially dependent upon prevailing prices of oil and gas. Historically,
the markets for oil and gas have been volatile, and they are likely to continue
to be volatile in the future. Prices for oil and gas are subject to wide
fluctuation in response to relatively minor changes in the supply of and demand
for oil and gas, market uncertainty and a variety of additional factors that are
beyond HEC's control.
Hedging arrangements may expose the Company to financial loss. In order to
reduce its exposure to short-term fluctuations in the prices of oil and gas, the
Company periodically enters into hedging arrangements. The hedging arrangements
apply to only a portion of its production and provide only partial price
protection against declines in oil and gas prices. Such hedging arrangements may
expose the Company to risk of financial loss in some circumstances, including
instances where production is less than expected or where the other party to any
hedging arrangement fails to perform. In addition, the hedging arrangements may
limit the benefit to the Company of increases in the prices of oil or gas.
Similarly, in order to reduce its exposure to short-term fluctuations in
interest rates and to provide a measure of predictability for a portion of its
interest payments under its debt facilities, the Company has entered into
contracts to hedge its interest payments on a portion of its variable rate debt.
These hedges provide only partial protection against increases in interest
rates. These hedging arrangements may expose the Company to risk of financial
loss in some circumstances, including instances where the other party to any
hedging arrangement fails to perform. In addition, the hedging arrangements may
limit the benefit to the Company of declines in interest rates.
<PAGE>
Competition from larger, more established oil and gas companies. HEC encounters
competition from other oil and gas companies in all areas of its operation,
including the acquisition of exploratory prospects and proven properties. HEC's
competitors include major integrated oil and gas companies and numerous
independent oil and gas companies, individuals and drilling and income programs.
Many of its competitors are large, well-established companies with substantially
larger operating staffs and greater capital resources than HEC's and, in many
instances, have been engaged in the oil and gas business for a much longer time
than HEC. Those companies may be able to pay more for exploratory prospects and
productive oil and gas properties, and may be able to define, evaluate, bid for
and purchase a greater number of properties and prospects than HEC's financial
or human resources permit. HEC's ability to explore for oil and gas prospects
and to acquire additional properties in the future will be dependent upon its
ability to conduct its operations, to evaluate and select suitable properties
and to consummate transactions in highly competitive environments.
Risks of drilling activities. HEC's success will be materially dependent upon
the continued success of its drilling program. HEC's future drilling activities
may not be successful and, if drilling activities are unsuccessful, such failure
will have an adverse effect on HEC's future results of operations and financial
condition. Oil and gas drilling involves numerous risks, including the risk that
no commercially productive oil or gas reservoirs will be encountered, even if
the reserves targeted are classified as proved. The cost of drilling, completing
and operating wells is often uncertain, and drilling operations may be
curtailed, delayed or canceled as a result of a variety of factors, including
unexpected drilling conditions, pressure or irregularities in formations,
equipment failures or accidents, adverse weather conditions, compliance with
governmental requirements and shortages or delays in the availability of
drilling rigs and the delivery of equipment. Although HEC has identified
numerous drilling prospects, there can be no assurance that such prospects will
be drilled or that oil or gas will be produced from any such identified
prospects or any other prospects.
Availability of capital is important to the Company's ability to grow. The
acquisition of reserves is capital intensive, and funding for the costs of
acquisition may be greater than the Company's cash flow can provide. As a
result, additional financing may be required, and the availability or terms of
any such additional financing cannot be assured. In the event sufficient capital
resources are not available to the Company, it may negatively affect the
Company's flexibility in planning for and reacting to possible acquisition
activities.
Risks relating to the acquisition of oil and gas properties. The successful
acquisition of producing properties requires an assessment of recoverable
reserves, future oil and gas prices, operating costs, potential environmental
and other liabilities and other factors. Such assessments are necessarily
inexact and their accuracy inherently uncertain. In connection with such an
assessment, HEC will perform a review of the subject properties that it believes
to be generally consistent with industry practices. This usually includes
on-site inspections and the review of reports filed with various regulatory
entities. Such a review, however, will not reveal all existing or potential
problems, nor will it permit a buyer to become sufficiently familiar with the
properties to fully assess their deficiencies and capabilities. Inspections may
not always be performed on every well, and structural and environmental problems
are not necessarily observable even when an inspection is undertaken. Even when
problems are identified, the seller may be unwilling or unable to provide
effective contractual protection against all or part of these problems. There
can be no assurances that any acquisition of property interests by HEC will be
successful and, if an acquisition is unsuccessful, that the failure will not
have an adverse effect on HEC's future results of operations and financial
condition.
Hazards relating to well operations and lack of insurance. The oil and gas
business involves certain hazards such as well blowouts; craterings; explosions;
uncontrollable flows of oil, gas or well fluids; fires; formations with abnormal
pressures; pollution; and releases of toxic gas or other environmental hazards
and risks, any of which could result in substantial losses to HEC. In addition,
HEC may be liable for environmental damages caused by previous owners of
property purchased or leased by HEC. As a result, substantial liabilities to
third parties or governmental entities may be incurred, the payment of which
could reduce or eliminate the funds available for exploration, development or
acquisitions or result in the loss of HEC's properties. While HEC believes that
it maintains all types of insurance commonly maintained in the oil and gas
industry, it does not maintain business interruption insurance. In addition, HEC
cannot predict with certainty the circumstances under which an insurer might
deny coverage. The occurrence of an event not fully covered by insurance could
have a materially adverse effect on HEC's financial condition and results of
operations.
Future oil and gas production depends on continually replacing and expanding
reserves. In general, the volume of production from oil and gas properties
declines as reserves are depleted, with the rate of decline depending on
reservoir characteristics. HEC's future oil and gas production is, therefore,
highly dependent upon its ability to economically find, develop or acquire
additional reserves in commercial quantities. Except to the extent HEC acquires
properties containing proved reserves or conducts successful exploration and
development activities, or both, the proved reserves of HEC will decline as
reserves are produced. The business of exploring for, developing or acquiring
reserves is capital-intensive. To the extent cash flow from operations is
reduced, and external reserves of capital become limited or unavailable, HEC's
ability to make the necessary capital investments to maintain or expand its
asset base of oil and gas reserves would be impaired. In addition, there can be
no assurance that HEC's future exploration, development and acquisition
activities will result in additional proved reserves or that HEC will be able to
drill productive wells at acceptable costs. Furthermore, although HEC's revenues
could increase if prevailing prices for oil and gas increase significantly,
HEC's finding and development costs could also increase.
Estimates of reserves and future cash flows are imprecise. Reservoir engineering
is a subjective process of estimating underground accumulations of oil and gas
that cannot be measured in an exact manner. Estimates of economically
recoverable oil and gas reserves and of future net cash flows necessarily depend
upon a number of variable factors and assumptions, such as historical production
from the area compared with production from other producing areas, the assumed
effects of regulations by governmental agencies, and assumptions concerning
future oil and gas prices, future operating costs, severance and excise taxes,
development costs and workover and remedial costs, all of which may in fact vary
considerably from actual results. For these reasons, estimates of the
economically recoverable quantities of oil and gas attributable to any
particular group of properties, classifications of such reserves based on risk
of recovery, and estimates of the future net cash flows expected from them
prepared by different engineers, or by the same engineers but at different
times, may vary substantially, and such reserve estimates may be subject to
downward or upward adjustment based upon such factors. In addition, the status
of the exploration and development program of any oil and gas company is
ever-changing. Consequently, reserve estimates also vary over time. Actual
production, revenues and expenditures with respect to HEC's reserves will likely
vary from estimates, and such variances may be material.
ITEM 2 - PROPERTIES
Exploration and Development Projects and Acquisitions
In 1999, HEC incurred $24,162,000 in direct property additions, development,
exploitation, and exploration costs. The costs were comprised of $11,093,000 for
property acquisitions and approximately $13,069,000 for domestic exploration and
development. HEC's 1999 capital program led to the replacement, including
revisions to prior year reserves, of 95% of 1999 production using year-end
prices of $24.32 per bbl and $2.00 per mcf. Excluded from these calculations are
the reserves of HCRC and the direct interests of Hallwood Group acquired in the
Consolidation. Also excluded from the calculations are sales of reserves in
place in 1999, which were approximately 9% of 1999 production.
Property Sales
During 1999, HEC received approximately $388,000 for the sale of approximately
420 non-strategic wells located principally in Texas but also included wells
located in Louisiana, Mississippi, North Dakota, New Mexico, Oklahoma, and Utah.
Regional Area Descriptions and 1999 Capital Budget
The following discussion of HEC's properties and capital projects contains
forward-looking statements that are based on current expectations, estimates and
projections about the oil and gas industry, management's beliefs and assumptions
made by management. Words such as "projects," "believes," "expects,"
"anticipates," "estimates," "plans," "could," variations of such words and
similar expressions are intended to identify such forward-looking statements.
Please refer to the section entitled "Cautionary Statement Regarding
Forward-Looking Statements" under Item 1. for a discussion of factors which
could affect the outcome of the forward-looking statements.
Since HEP was considered the acquiring entity for accounting purposes, the
expenditures discussed below represent the costs incurred by HEP prior to June
8, 1999, plus the costs incurred on a consolidated basis after June 8, 1999.
Gulf Coast Region
HEC has significant interests in the Gulf Coast Region in Louisiana and South
and East Texas. The Louisiana interests are located in Lafayette Parish and
consist of 13 producing gas wells and the associated water handling and gas
treating facilities. The wells produce principally from the Bol Mex formation at
13,500 to 14,500 feet and seven are operated by HEC. In South and East Texas,
HEC has interests in approximately 151 producing wells, 45 of which are operated
by the Company and produce primarily from the Austin Chalk, Paluxy, Lower Frio
and Cotton Valley formations at depths from 7,000 to 13,000 feet. During 1999,
HEC expended approximately $16,251,000 (67%) of its capital budget in this
region. Of this amount, approximately $7,230,000 was for the Seisgen
Exploration, Inc. ("Seisgen") acquisition described below. The following
discussion relates to major 1999 capital projects within the region.
Seisgen Acquisition. In October 1999, HEC acquired from Seisgen, interests in 34
wells located principally in the Yoakum Gorge area of Lavaca County, Texas. The
proven reserves have a net present value, discounted at 10% of $5,182,000, using
non-escalated prices of $2.50 mcf of gas and $18.50 per barrel of oil. HEC also
acquired significant non-producing assets including drilling locations,
exploration acreage and 3-D seismic data. HEC believes that the acquisition has
significant upside potential value and expands opportunities in the Yoakum Gorge
area where HEC has been active since 1998. Specifically, in 1998 HEC
participated in a successful non-operated exploration discovery in the Wilcox
formation using proprietary 3-D seismic data. In 1999, HEC participated in five
additional non-operated directional wells testing the Wilcox Steven Sands. Three
of the wells are producing and two of the wells are drilling or are in the
process of being completed as of December 31, 1999. The average rate of the
producing wells at December 31, 1999 is approximately 12,775 gross mcf per well
per day. HEC owns an average 28% working interest in four of the producing wells
and 12.5% working interests in the remaining two wells. HEC's 1999 drilling
costs incurred are approximately $3,130,000. During 2000, HEC plans to drill at
least three additional development wells and three exploration wells.
Bell Project. During 1998, HEC drilled one successful well within the Bell
prospect located in Houston County, Texas. HEC owns a 60% working interest in
this operated well. In 1999, HEC sidetracked another well to test reserves in
the Buda and Georgetown formations using a stacked dual lateral well. Initial
tests of the Georgetown formation showed it water prone, but the Buda formation
is currently being tested and is producing oil. At December 31, 1999, HEC was
also drilling a dual lateral Buda formation development well which is currently
being completed. HEC owns 36% working interests in the wells drilling or being
completed. The horizontal lateral sections are between 4,000-8,000 feet, and the
total vertical depth of the wells range from 9,000-10,000 feet. HEC's costs in
1999 were approximately $1,446,000 for all drilling and prospect costs in the
area. During 2000, HEC plans to drill as many as five wells in the area.
Scott Field Area. During 1999, the two most significant wells in the Field, the
A.L. Boudreaux #1, and the G.S. Boudreaux Estate #1 went offline. The A.L.
Boudreaux #1 was successfully restored to commercial production of 11.7 mmcf per
day and 250 bopd following a workover, although post-workover reserves are less
than had been previously estimated. The G.S. Boudreaux well was lost, but an
alternate unit well began drilling in the fourth quarter of 1999 to recover
additional gas believed to be remaining in the fault block. Also drilling at
December 31, 1999, was a well in a fault block adjacent to the A. L. Boudreaux.
In February of 2000, based on the drilling results, this well was plugged and
abandoned. In 2000, HEC's plans include an exploration test of the deeper Klump
Sands productive in nearby fields.
Mirasoles Project. In 1999, HEC began completion of a 17,000-foot Frio Formation
exploration well located in Kenedy County, Texas. In 1998, eight prospective
horizons were identified while drilling this large structural prospect defined
by 63 miles of proprietary 3-D seismic data. Stimulation of the deepest and
highest potential zone was not possible due to mechanical problems. HEC then
tested three shallower Frio zones, but found only subcommercial oil production
rather than gas as anticipated. In 1999, HEC incurred approximately $1,473,000
related to this project. HEC operates the well and owns a 35% working interest.
The well is temporarily abandoned and HEC, as operator, is currently proposing
the abandonment of the well and project.
Boca Chica Project. In 1999, HEC incurred approximately $313,000 for seismic
data and all costs associated with its participation in an exploration well,
which was directionally drilled from the shore to a bottom hole location under
the waters of the Gulf of Mexico. This 10,000-foot exploration well in the Big
Hum formation tested wet, yet the exploration results were sufficiently
encouraging that working interest owners shot 3-D seismic over the area in the
third quarter of 1999. Though the 3-D seismic interpretation is still underway,
HEC anticipates that during 2000 another well will be drilled. HEC owns a 25%
working interest in the well.
Greater Permian Region
HEC has significant interests in the Greater Permian Region, which includes West
Texas and Southeast New Mexico. In this region, HEC has interests in 436
productive oil and gas wells (359 of which are operated), 30 shut-in oil and gas
wells (28 operated) and 13 operated salt water disposal wells or injection
wells. In 1999, HEC expended approximately $1,362,000 (6%) of its capital budget
on projects in this area. The following is a description of the significant
areas and 1999 capital projects within the Greater Permian Region.
Carlsbad/Catclaw Area. HEC's interests in the Carlsbad/Catclaw Area as of
December 31, 1999 consisted of 59 producing wells that produce primarily natural
gas and two shut-in wells. The wells are located on the northwestern edge of the
Delaware Basin in Lea, Eddy and Chaves Counties, New Mexico. The Company
operates 33 of these wells. The wells produce at depths ranging from
approximately 2,500 feet to 14,000 feet from the Delaware, Atoka, Bone Springs
and Morrow formations. In 1999, HEC spent approximately $475,000 recompleting or
drilling four producing development wells. HEC expects to continue operated
development drilling in Lea County.
Spraberry Area. HEC's interests in the Spraberry Area consist of 377 producing
wells, 13 salt-water disposal wells, and 28 shut-in wells in Dawson, Upton,
Reagan and Irion Counties, Texas. The Company operates 326 of the producing oil
and gas wells. Current production is predominately from the Upper and Lower
Spraberry, Clearfork Canyon, Dean, and Fusselman formations at depths ranging
from 5,000 feet to 9,000 feet. During 1999, HEC plugged 66 wells in the area and
anticipates an additional 10 wells will be plugged in 2000. The Spraberry area
is a mature operation where aggressive operating expense control and limited
development drilling typify the management of the area.
Rocky Mountain Region
HEC has significant interests in the Rocky Mountain Region, which include
producing properties in Colorado, Montana, North Dakota and Northwest New
Mexico. The Company has interests in 218 producing oil and gas wells, 176 of
which are operated by HEC, 22 shut-in wells, and five salt-water disposal wells.
HEC expended approximately $4,183,000 (17%) of its 1999 capital budget in this
area. A discussion of the major projects in the region follows.
Colorado Western Slope Project. HEC drilled and completed three 5,500-foot
Dakota Formation wells in 1999. The wells are located in Garfield County,
Colorado. HEC owns 100% working interests in the wells. Sales of production for
all three wells in November 1999 had combined rates of approximately 1,450 gross
mcf per day. HEC's total costs in 1999 for the three wells were approximately
$1,854,000. HEC has identified 13 additional development locations and in 2000,
plans to drill up to nine additional wells and to recomplete two wells.
Toole County Area. HEC's interests in the Toole County Area consist of 61
producing wells and 17 shut-in wells, 66 of which are operated by the Company.
The oil wells produce from the Nisku formation at depths of approximately 3,000
feet, and the gas wells produce from the Bow Island formation at depths of 900
to 1,200 feet. HEC plans to divest this area in 2000.
San Juan Basin Project - Colorado and New Mexico. HEC's interest in the San Juan
Basin consists of 80 producing gas wells (75 operated), 12 operated shut-in
wells and three operated salt water disposal wells located in San Juan County,
New Mexico and LaPlata County, Colorado. HEC operates 52 producing wells in New
Mexico, 31 of which produce from the Fruitland Coal formation at approximately
2,200 feet and 21 of which produce from the Picture Cliffs, Mesa Verde and
Dakota formations at 1,200 to 7,000 feet. HEC also operates 23 producing wells
in La Plata County, Colorado. The wells in Colorado produce from the Fruitland
Coal formation at depths of 1,800-2,200 feet. During 1999, $676,500 was spent
for the purchase of overriding royalty interests and working interests in 18
coal bed methane properties already operated by HEC, located in San Juan County,
New Mexico. Most of the interests purchased qualify for tax credits under
Section 29 of the Internal Revenue Code. In order to monetize these credits, the
majority of the acquired interests were sold to 44 Canyon LLC ("44 Canyon"), a
special purpose entity owned by a large East Coast financial institution, by
HEC, in exchange for cash, a production payment, and promissory notes. In 1999,
HEC along with some of its peers, petitioned the Colorado Oil & Gas Commission
to allow for optional infill drilling on 160 acre spacing in the Colorado
Fruitland Coal formation. If approved, additional drilling of as many as 17
wells would result in the area. Although no application for additional drilling
has been made in New Mexico, with regulatory approval, 14 new drilling
opportunities would be created in the area, as well. In addition, in 1999, HEC
installed an additional gas-gathering pipeline in LaPlata County, Colorado. HEC
anticipates that the additional line will help lower system pressures and will
increase production by 1,000 mcf per day. Additional water disposal capacity was
completed in the fourth quarter of 1999. HEC's costs incurred in 1999 for the
additional pipeline and water disposal facilities were approximately $395,000.
Other
At December 31, 1999, HEC owned various other interests in properties in Kansas,
Oklahoma, California, and South Central Texas. The remaining $2,366,000 (10%) of
HEC's capital expenditures incurred in 1999 were devoted to technical general
and administrative expenditures, delay rental costs, and for numerous other
projects which were completed or are underway and which are individually less
significant.
Future Plans
At December 31, 1999, HEC's plans were to sell its interests in approximately
500 non-strategic oil and gas wells in 2000. These sales are being made in an
effort to better focus the Company on its core areas of Colorado, Utah, New
Mexico, Texas, and Louisiana and at the same time reduce its level of debt and
administrative overhead. These wells represent approximately 34% of HEC's total
well count, approximately 16% of HEC's reserve value, and approximately 11% of
its operating cash flow based on five year average reserve pricing. Proceeds
from the sales will be used initially to reduce debt. Subsequent to December 31,
1999 and through March 6, 2000, approximately 145 of the non-strategic oil and
gas wells located in the Keystone, Merkle, and Weesatche areas of Texas, as well
as various oil and gas wells in Oklahoma, North Dakota and Montana have been
sold. As a result of successful sales negotiations, sales proceeds in four of
the five areas exceeded the net present value, discounted at 10%, recorded in
HEC's January 1, 2000, five year average price reserve report. Purchase and sale
agreements for properties located in Williston Basin, Montana, North Dakota and
Kansas are currently being negotiated. Efforts to sell the remainder of the
non-strategic oil and gas wells are ongoing.
For 2000, HEC's capital budget, which will be provided by cash generated from
operations and cash on hand has been set at $24,000,000. The Company expects to
allocate its capital budget for 2000 among its core areas as follows:
Gulf Coast Region $14,500,000
Greater Permian Region 500,000
Rocky Mountain Region 7,000,000
Other 2,000,000
-----------
$24,000,000
Company Reserves, Production and Discussion by Significant Regions
The following table presents the December 31, 1999 reserve data by significant
regions.
<TABLE>
<CAPTION>
Proved Reserve Quantities Present Value of Future Net Cash Flows
Proved Proved
Mcf of Gas Bbls of Oil Undeveloped Developed Total
---------- ----------- ----------- --------- -----
(In thousands)
<S> <C> <C> <C> <C> <C>
Gulf Coast Region 24,945 1,328 $11,743 $ 29,593 $ 41,336
Greater Permian Region 30,071 5,540 3,123 52,896 56,019
Rocky Mountain Region 93,838 1,322 1,415 89,590 91,005
Other 2,814 3,491 783 18,857 19,640
-------- ------- ------- -------- --------
151,668 11,681 $17,064 $190,936 $208,000
======= ====== ====== ======= =======
</TABLE>
The following table presents the oil and gas production for significant regions
for the periods indicated.
<TABLE>
<CAPTION>
Production for the Production for the
Year Ended December 31, 1999 Year Ended December 31, 1998
---------------------------- ----------------------------
Mcf of Gas Bbls of Oil Mcf Gas Bbls of Oil
---------- ----------- ------- -----------
(In thousands)
<S> <C> <C> <C> <C>
Gulf Coast Region 5,234 189 5,291 175
Greater Permian Region 2,758 437 2,893 401
Rocky Mountain Region 9,862 151 5,233 133
Other 409 148 620 78
-------- --- -------- -----
18,263 925 14,037 787
====== === ====== ====
</TABLE>
The following table presents the Company's extensions and discoveries by
significant regions.
<TABLE>
<CAPTION>
For the Year Ended December 31, 1999 For the Year Ended December 31, 1998
------------------------------------ ------------------------------------
Mcf of Gas Bbls of Oil Mcf of Gas Bbls of Oil
---------- ----------- ---------- -----------
(In thousands)
<S> <C> <C> <C> <C>
Gulf Coast Region 5,708 113 1,201 164
Greater Permian Region 291 58 217 167
Rocky Mountain Region 4,346 9 78 83
Other 584 46 1
-------- ------- -------- ------
10,929 180 1,542 415
====== === ===== ====
</TABLE>
Average Sales Prices and Production Costs
The following table presents the average oil and gas sales price and average
production costs per equivalent mcf of gas computed at the ratio of six mcf of
gas to one barrel of oil.
<TABLE>
<CAPTION>
1999 1998 1997
------ ------ -----
Oil and condensate -
<S> <C> <C> <C>
includes the effects of hedging (per bbl) $16.52 $13.65 $19.08
Natural gas -
includes the effects of hedging (per mcf) 1.90 2.02 2.31
Production costs (per equivalent mcf of gas) .72 .65 .67
</TABLE>
<PAGE>
Productive Oil and Gas Wells
The following table summarizes the productive oil and gas wells as of December
31, 1999 attributable to HEC's direct interests. Productive wells are producing
wells and wells capable of production. Gross wells are the total number of wells
in which HEC has an interest. Net wells are the sum of HEC's fractional
interests owned in the gross wells.
Gross Net
Productive Wells
Oil 826 526
Gas 435 228
------ ---
Total 1,261 754
===== ===
Oil and Gas Acreage
The following table sets forth the developed and undeveloped leasehold acreage
held directly by HEC as of December 31, 1999. Developed acres are acres which
are spaced or assignable to productive wells. Undeveloped acres are acres on
which wells have not been drilled or completed to a point that would permit the
production of commercial quantities of oil and gas, regardless of whether or not
such acreage contains proved reserves. Gross acres are the total number of acres
in which HEC has a working interest. Net acres are the sum of HEC's fractional
interests owned in the gross acres.
Gross Net
(in thousands)
Developed acreage 272 144
Undeveloped acreage 666 168
--- ---
Total 938 312
=== ===
At December 31, 1999, HEC held undeveloped acreage in Texas, Louisiana, Montana,
Utah, Oklahoma, New Mexico, Kansas, Colorado, North Dakota and California.
Drilling Activity
The following table sets forth the number of wells attributable to HEC's direct
interests drilled in the most recent three years.
<TABLE>
<CAPTION>
Year Ended December 31,
1999 1998 1997
------ ------ -----
Gross Net Gross Net Gross Net
----- --- ----- --- ----- ---
Development Wells:
<S> <C> <C> <C> <C> <C> <C>
Productive 1 .5 12 3.6 23 4.5
Dry 1 .5 5 1.5 5 .8
--- --- --- --- --- ----
Total 2 1 17 5.1 28 5.3
=== === == === == ===
Exploratory Wells:
Productive 11 4.1 17 4.3 14 2.2
Dry 8 2.4 17 3.0 22 5.4
--- --- -- --- -- ---
Total 19 6.5 34 7.3 36 7.6
=== === == === == ===
</TABLE>
<PAGE>
Office Space
HEC leases office space in Denver, Colorado, for approximately $600,000 per year
under a lease that terminates on December 31, 2006. HEC also sub-leases office
space in Houston, Texas for approximately $42,000 per year under a lease that
terminates on October 14, 2001.
ITEM 3 - LEGAL PROCEEDINGS
See Notes 12 and 13 to the financial statements included in Item 8 - Financial
Statements and Supplementary Data.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1999.
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
HEC's common stock began trading over the counter on NASDAQ National Market
System under the symbol "HECO" on June 9, 1999. HEC's Series A Preferred Stock
began trading on the NASDAQ under the symbol "HECOP" on June 11, 1999. As of
March 6, 2000, there were 18,808 registered holders of record of HEC's common
stock and 12,566 registered holders of record of HEC's Series A Preferred Stock.
The following table sets forth, for the periods indicated, the high and low
closing bid quotations for each class of stock as reported by the Nasdaq Stock
Market, Inc. and the dividends paid per Series A Preferred share for the
corresponding periods. No common stock dividends were paid during the periods
shown.
<TABLE>
<CAPTION>
Common Stock High Low Dividends
- ------------ ---- --- ---------
<S> <C> <C> <C>
Second quarter 1999 (from June 9, 1999) $8 3/8 $5 3/8
Third quarter 1999 7 3/4 5 1/8
Fourth quarter 1999 7 3 1/2
Series A Preferred Stock
Second quarter 1999 (from June 11, 1999) $8 3/4 $7 3/4 $ .25
Third quarter 1999 8 7/8 8 1/8 .25
Fourth quarter 1999 8 5/16 7 .25
----
$ .75
</TABLE>
<PAGE>
Prior to the Consolidation, HEP's Class A Units were traded on the American
Stock Exchange (the "Exchange") under the symbol "HEP" through June 8, 1999. The
following table sets forth, for the periods indicated, the high and low reported
sales prices for the Class A Units as reported on the Exchange and the
distributions paid per Class A Unit for the corresponding periods.
<TABLE>
<CAPTION>
Class A Units High Low Distributions
- ------------- ---- --- -------------
<S> <C> <C> <C>
First quarter 1998 $8 5/8 $6 3/8 $.13
Second quarter 1998 7 .13
6
Third quarter 1998 7 4 .13
11/16
Fourth quarter 1998 5 7/8 3 .13
---
$.52
First quarter 1999 $4 3/8 $3 $.13
Second quarter 1999 (through June 8, 1999) 4 3/8 3 1/2 --
----
$.13
</TABLE>
On January 17, 1996, HEP's Class C Units began trading on the Exchange under the
symbol "HEPC." On February 17, 1998, HEP closed its public offering of 1.8
million Class C Units which were priced at $10.00 per Unit. HEP's Class C Units
stopped trading on June 8, 1999. The following table sets forth, for the periods
indicated, the high and low reported sales prices for the Class C Units as
reported on the Exchange and distributions paid per Class C Unit for the
corresponding periods.
<TABLE>
<CAPTION>
Class C Units High Low Distributions
- ------------- ---- --- -------------
<S> <C> <C> <C>
First quarter 1998 $11 $9 1/8 $ .25
Second quarter 1998 9 13/16 8 3/8 .25
Third quarter 1998 8 1/2 6 3/4 .25
Fourth quarter 1998 7 15/16 5 7/8 .25
-----
$1.00
First quarter 1999 $ 8 1/2 $6 3/16 $ .25
Second quarter 1999 (through June 8, 1999) 8 9/16 7 3/16 --
------
$ .25
</TABLE>
HEC's debt agreements limit aggregate dividends paid by HEC in any twelve month
period to 50% of cash flow from operations before working capital changes and
50% of distributions received from affiliates, if the principal amount of debt
of HEC is 50% or more of the borrowing base. Aggregate dividends paid by HEC are
limited to 65% of cash flow from operations before working capital changes and
65% of distributions received from affiliates, if the principal amount of debt
is less than 50% of the borrowing base.
On February 18, 2000, HEC repurchased and retired 43,816 shares of Series A
Preferred Stock from its affiliate, Hallwood Group for $303,426. The shares were
repurchased for $6.925 per share which represented the average of the closing
prices of the stock during the five days prior to February 18, 2000.
<PAGE>
ITEM 6 - SELECTED FINANCIAL DATA
The following table sets forth selected financial data regarding HEC's financial
position and results of operations as of the dates indicated. All information
presented for periods prior to June 8, 1999 represents the historical
information of HEP because HEP was considered to be the acquiring entity for
accounting purposes. The financial information for periods prior to June 8, 1999
have been retroactively restated to reflect the corporate structure of HEC, and
all share and per share information assumes that the shares of HEC issued to HEP
in connection with the Consolidation were outstanding for all periods prior to
June 8, 1999.
<TABLE>
<CAPTION>
As of and For the Year Ended December 31,
-----------------------------------------
1999 1998 1997 1996 1995
------ ------ ------- ------ -----
(In thousands except per Share)
Summary of Operations
Oil and gas revenues and
<S> <C> <C> <C> <C> <C>
pipeline operations $ 56,523 $ 43,177 $ 44,707 $ 50,644 $ 43,454
Total revenue 56,881 43,586 45,103 51,066 43,780
Production operating expense 17,100 12,175 11,060 11,511 11,298
Depreciation, depletion and
amortization 21,027 15,720 11,961 13,500 15,827
Impairment 14,000 10,943
General and administrative
expense 7,395 5,045 5,333 4,540 5,580
Net income (loss) 2,880 (13,895) 12,803 15,726 (9,031)
Basic net income (loss) per share
.06 (2.92) 2.17 2.69 (1.61)
Diluted net income (loss) per
share .06 (2.92) 2.14 2.69 (1.61)
Dividends per common share .21 1.26 1.25 1.34 1.78
Dividends per preferred share 1.00 1.00 1.00 1.00
Balance Sheet
Working capital (deficit) $ 3,371 $ (8,722) $ (973) $ (1,355) $ (4,363)
Property, plant and equipment,
net 181,621 105,005 94,331 88,549 94,926
Total assets 212,774 139,091 131,603 122,792 125,152
Long-term debt 109,357 40,381 34,986 29,461 37,557
Long-term contract settlement
obligation 2,512 2,397
Deferred liability and other 1,066 1,050 1,180 1,533 1,718
Minority interest in affiliates 582 2,788 3,258 3,336 3,042
Stockholders' equity 75,387 62,632 69,064 64,215 57,572
</TABLE>
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, LIQUIDITY AND CAPITAL RESOURCES
Overview
HEC began operations on June 8, 1999, in connection with the Consolidation of
HEP and HCRC and the acquisition of the direct property interests of Hallwood
Group. For accounting purposes, the Consolidation has been treated as a purchase
by HEP of the common stock of HCRC and the direct energy interests of Hallwood
Group. Generally accepted accounting principles require reporting of results on
a basis that makes it difficult to compare to prior years. Therefore, this
Overview provides certain information on a pro forma basis to facilitate the
comparison with prior periods.
Pro Forma Results
The following pro forma information is prepared as if the Consolidation had been
completed on January 1, 1997.
For the Year Ended December 31,
-------------------------------
1999 1998 1997
---- ---- ----
(in thousands except prices)
Prices
Gas (per mcf) $1.88 $1.96 $2.25
Oil (per bbl) $15.84 $13.33 $19.01
Production
Gas (mcf) 22,360 22,291 17,786
Oil (bbl) 1,177 1,386 1,362
Gas revenue $42,111 $43,752 $40,095
Oil revenue 18,638 18,477 25,888
Lease operating expense 21,187 21,705 19,318
Liquidity and Capital Resources
Cash Flow
HEC generated $18,238,000 of cash flow from operating activities during 1999.
The other primary cash inflows were:
o Proceeds from long-term debt of $13,000,000;
o Distributions received from affiliate of $1,833,000;
o Proceeds from the sale of property of $388,000;
Cash was used primarily for:
o Additions to property, exploration and development costs of $24,162,000;
o Costs incurred in connection with the Consolidation of $2,933,000;
o Payments of long-term debt of $3,000,000 and,
o Dividends to shareholders of $4,061,000.
When combined with miscellaneous other cash activity during the year, the result
was a decrease of $1,394,000 in HEC's cash and cash equivalents from $11,874,000
at December 31, 1998 to $10,480,000 at December 31, 1999.
<PAGE>
Property Purchases, Sales and Capital Budget
In 1999, HEC incurred $24,162,000 in direct property additions, development,
exploitation, and exploration costs. The costs were comprised of $11,093,000 for
property acquisitions and approximately $13,069,000 for domestic exploration and
development. HEC's 1999 capital program led to the replacement, including
revisions to prior year reserves, of 95% of 1999 production using year-end
prices of $24.32 per bbl and $2.00 per mcf. Excluded from these calculations are
the reserves of HCRC and the direct interests of Hallwood Group acquired in the
Consolidation. Also excluded are sales of reserves in place in 1999, which were
approximately 9% of 1999 production.
Regional Area Descriptions and 1999 Capital Budget
Since HEP was considered the acquiring entity for accounting purposes, the
expenditures discussed below represent the costs incurred by HEP prior to June
8, 1999, plus the costs incurred on a consolidated basis after June 8, 1999.
In the Gulf Coast Region, HEC expended approximately $7,230,000 acquiring
interests in 34 wells and significant non-producing assets including drilling
locations, exploration acreage and 3-D seismic. Most of the assets are located
in Yoakum Gorge area of Lavaca County, Texas. In addition, in the Yoakum Gorge
area, HEC participated in a successful non-operated exploration discovery in
1998, and in 1999, HEC participated in five additional non-operated directional
wells testing the Wilcox Steven Sands. HEC's 1999 drilling costs incurred in the
Yoakum Gorge area were approximately $3,130,000. HEC drilled one successful well
and sidetracked two additional wells within the Bell prospect located in Houston
County, Texas. HEC's costs in 1999 were approximately $1,446,000 for all
drilling and prospect costs within the Bell area. HEC spent approximately
$1,473,000 for completion attempts on the Mirasoles exploration well located in
Kenedy County, Texas. In 1999, HEC incurred approximately $313,000 for seismic
and all costs associated with its participation in the Boca Chica exploration
well.
In the Greater Permian Region, HEC spent approximately $475,000 recompleting or
drilling four producing development wells.
In the Rocky Mountain Region, HEC drilled and completed three wells located in
Garfield County, Colorado. Drilling costs were approximately $1,854,000. HEC
incurred $676,500 for the purchase of overriding royalty interests and working
interests in 18 coal bed methane properties already operated by HEC, located in
San Juan County, New Mexico. In the same area, HEC incurred approximately
$395,000 for additional pipeline and water disposal facilities.
See Item 2 - Properties, for further discussion of HEC's exploration and
development projects.
Long-lived assets, other than oil and gas properties, are evaluated for
impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. To date, the Company has not recognized
any impairment losses on long-lived assets other than oil and gas properties.
Dividends
On December 13, 1999, HEC declared a quarterly dividend of $.25 per Series A
Cumulative Preferred share, which was paid on February 15, 2000 to shareholders
of record on December 31, 1999. This amount was accrued as of the year-end.
The Series A Cumulative Preferred Stock has a dividend preference of $1.00 per
share per year. HEC may not declare or pay dividends to common shareholders
unless full cumulative dividends have been paid on the preferred stock.
<PAGE>
Stock Option Plans
On June 9, 1999, HEC granted options to purchase 600,000 shares of common stock
at an exercise price of $7.00 per share which was equal to the fair market value
on the date of grant. On November 22, 1999, HEC granted an additional 61,500
options to purchase common stock at an exercise price of $7.00 per share which
was greater than the fair market value of the common stock on the date of the
grant. The options expire on June 9, 2006, unless sooner terminated pursuant to
the provisions of the plan. One-third of the options vested on the grant date,
and the remainder vest one-third on June 8, 2000 and one-third on June 8, 2001.
On January 28, 2000, HEC granted options to purchase 238,500 shares of common
stock at an exercise price of $4.625 per share which was equal to the fair
market value of the common stock on the date of grant. The options expire on
January 28, 2007, unless sooner terminated pursuant to the provisions of the
plan. One-third of the options vested on the grant date and the remainder vest
one-third on January 28, 2001 and one-third on January 28, 2002.
Prior to the Consolidation, the following HEP options were outstanding. All of
these options were cancelled on June 8, 1999.
<TABLE>
<CAPTION>
Number of Options
Outstanding Exercisable Exercise Price
<S> <C> <C> <C>
Class A Unit Options 390,400 390,400 $ 5.75
Class A Unit Options 25,500 17,000 $ 6.625
Class C Unit Options 120,000 120,000 $10.00
</TABLE>
Financing
On June 8, 1999, HEC and its lenders entered into an Amended and Restated Credit
Agreement (as amended, the "Credit Agreement") to extend the term date of its
line of credit to May 31, 2002. The lenders are Morgan Guaranty Trust Company,
First Union National Bank and Bank of America. The terms of the Credit Agreement
were amended on October 15, 1999, to, among other matters, increase HEC's
borrowing base to $90,000,000. At December 31, 1999, HEC had amounts outstanding
of $86,200,000.
HEC's plans are to sell its interests in approximately 500 non-strategic oil and
gas wells during 2000. These property sales will enable HEC to better focus on
its core areas while at the same time reduce its level of outstanding debt.
Subsequent to December 31, 1999 and through March 6, 2000, approximately 145 oil
and gas properties have been sold and HEC has repaid $6,000,000 of its
borrowings under the Credit Agreement. On January 27, 2000, the Credit Agreement
was further amended to reduce HEC's borrowing base to reflect the property sales
made by the Company and to waive compliance with an asset sale covenant. On
February 9, 2000, HEC's borrowing base was further reduced to $84,479,000 to
reflect the most recent property sales, and therefore HEC's unused borrowing
base totaled $4,279,000 at March 6, 2000.
Borrowings against the Credit Agreement bear interest at the lower of the
Certificate of Deposit rate plus from 1.375% to 2.125%, prime plus 1/2% or the
Euro-Dollar rate plus from 1.25% to 2.0%. The applicable interest rate was 8.5%
at December 31, 1999. Interest is payable monthly. Quarterly principal payments
of $11,457,000 are calculated to include repayments of the borrowing made
subsequent to December 31, 1999 and commence May 31, 2002.
The borrowing base for the Credit Agreement is typically redetermined
semiannually, although the lenders have the right to make a redetermination at
anytime. The Credit Agreement is secured by a first lien on approximately 80% in
value of HEC's oil and gas properties. Additionally, aggregate dividends paid
and stock repurchased by HEC in any 12 month period are limited to 50% of cash
flow from operations before working capital changes and distributions received
from affiliates, if the principal amount of debt of HEC is 50% or more of the
borrowing base. Aggregate dividends paid and stock repurchased by HEC are
limited to 65% of cash flow from operations before working capital changes and
distributions received from affiliates, if the principal amount of debt is less
than 50% of the borrowing base.
At the time of the Consolidation, HCRC had $25,000,000 of 10.32% Senior
Subordinated Notes ("Subordinated Notes") due December 23, 2007 and warrants to
purchase common stock which were held by The Prudential Insurance Company of
America ("Prudential"). On June 8, 1999, the Amended and Restated Subordinated
Note and Warrant Purchase Agreement (the "Note Agreement") was amended to issue
warrants to Prudential to purchase 309,278 shares of HEC's Common Stock at an
exercise price of $7.00 per share. The terms of the Note Agreement were further
amended on October 15, 1999 to exclude certain hedging transactions of the
subsidiaries of HEC from the calculation of indebtedness. In connection with
this amendment, the Company received a written waiver under the Credit Agreement
of the restriction on amendments to the Note Agreement. The Subordinated Notes
bear interest at the rate of 10.32% per annum on the unpaid balance, payable
quarterly. Annual principal payments of $5,000,000 are due December 23, 2003
through December 23, 2007.
HEC recorded the Subordinated Notes and the warrants based upon the relative
fair values of the Subordinated Notes without the warrants and of the warrants
themselves at the time of Consolidation. The allocated value of the warrants of
$1,956,000 was recorded as additional paid-in-capital. The discount on the
Subordinated Notes is being amortized over the term of the Subordinated Notes
using the interest method of amortization.
As part of its risk management strategy, HEC enters into financial contracts to
hedge the interest rate payments under its Credit Agreement. HEC does not use
the hedges for trading purposes, but rather to protect against the volatility of
interest rates under its Credit Agreement, which has a floating interest rate.
The amounts received or paid upon settlement of these transactions are
recognized as interest expense at the time the interest payments are due.
All contracts are interest rate swaps with fixed rates. As of March 6, 2000, HEC
was a party to eight contracts with three different counterparties.
The following table provides a summary of HEC's financial contracts.
Average
Amount of Contract
Period Debt Hedged Floor Rate
2000 $45,000,000 5.65%
2001 36,000,000 5.23
2002 37,500,000 5.23
2003 37,500,000 5.23
2004 6,000,000 5.23
Gas Balancing
HEC uses the sales method for recording its gas balancing. Under this method,
HEC recognizes revenue on all of its sales of production, and any
over-production or under-production is recovered or repaid at a future date.
As of December 31, 1999, HEC had a net over-produced position of 496,000 mcf
($992,000 valued at year-end gas prices). The Company believes that this
imbalance can be made up from production on existing wells or from wells which
will be drilled as offsets to existing wells and that this imbalance will not
have a material effect on HEC's results of operations, liquidity and capital
resources. The reserves disclosed in Item 8 have been decreased by 496,000 mcf
in order to reflect HEC's gas balancing position.
Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives) and for hedging
activities. SFAS 133 requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as (a) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment, (b)
a hedge of the exposure to variable cash flows of a forecasted transaction, or
(c) a hedge of the foreign currency exposure of a net investment in a foreign
operation, an unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. The accounting for changes
in the fair value of a derivative (gains and losses) depends on the intended use
of the derivative and the resulting designation. The Company is required to
adopt SFAS 133 on January 1, 2001. The Company has not completed the process of
evaluating the impact that will result from adopting SFAS 133.
Forward Looking Statements
Please refer to the section entitled "Cautionary Statement Regarding Forward
Looking Statements under Item 1. for a discussion of factors which could affect
the outcome of forward looking statements used by the Company.
Inflation and Changing Prices
Prices obtained for oil and gas production depend upon numerous factors that are
beyond the control of HEC, including the extent of domestic and foreign
production, imports of foreign oil, market demand, domestic and worldwide
economic and political conditions, storage capacity and government regulations
and tax laws. Prices for both oil and gas fluctuated from 1997 through 1999,
with a distinct downward trend in both oil and gas prices occurring in the
calendar year 1998 through the first quarter of 1999. Prices began to rebound in
April 1999.
The following table presents the weighted average prices received per year by
HEC, and the effects of the hedging transactions discussed below.
<TABLE>
<CAPTION>
Oil Oil Gas Gas
(excluding effects (including effects (excluding effects (including effects
of hedging of hedging of hedging of hedging
transactions) transactions) transactions) transactions)
------------ ------------ ------------ ------------
(per bbl) (per bbl) (per mcf) (per mcf)
<S> <C> <C> <C> <C>
1999 $18.16 $16.52 $2.06 $1.90
1998 12.82 13.65 1.99 2.02
1997 19.35 19.08 2.54 2.31
</TABLE>
As part of its risk management strategy, HEC enters into financial contracts to
hedge the price of its oil and natural gas. The purpose of the hedges is to
provide protection against price decreases and to provide a measure of stability
in the volatile environment of oil and natural gas spot pricing. The amounts
received or paid upon settlement of hedge contracts are recognized as oil or gas
revenue at the time the hedged volumes are sold.
HEC's philosophy is to use derivatives to provide a measure of stability in the
volatile price environment of oil and gas, and to furnish an element of
predictability in the cash flow of the Company. In general, the Company expects
to hedge up to 50%, on a total equivalent volume basis, of its oil and gas
production for the next two forward years, and 30% for each of the three years
thereafter. The Company does not ordinarily intend to hedge more than 65% of any
one commodity. In addition, HEC will, in most cases, enter into transactions
with minimum fixed prices for the production subject to the contracts. This
philosophy may be modified as circumstances require.
The financial contracts used by HEC to hedge the price of its oil and natural
gas production are swaps, collars and participating hedges. Under the swap
contracts, HEC sells its oil and gas production at spot market prices and
receives or makes payments based on the differential between the contract price
and a floating price which is based on spot market indices. As of March 6, 2000,
HEC was a party to 16 financial contracts with three different counterparties.
<PAGE>
The following table provides a summary of HEC's financial contracts.
Oil
Percent of
Production Contract
Period Hedged Floor Price
------ ---------- -----------
(per bbl)
2000 54% $18.47
2001 12% 19.16
<PAGE>
Gas
Percent of
Production Contract
Period Hedged Floor Price
------ ---------- -----------
(per mcf)
2000 42% $1.97
2001 43% $1.99
2002 34% $1.95
Between 11% and 13% of the gas volumes hedged in each year are subject to a
collar agreement whereby HEC will receive the contract price if the spot price
is lower than the contract price, the cap price if the spot price is higher than
the cap price, and the spot price if that price is between the contract price
and the cap price. The cap prices range from $2.54 per mcf to $2.65 per mcf.
During the first quarter through March 6, 2000, the weighted average oil price
(for barrels not hedged) was approximately $26.50 per barrel, and the weighted
average price of natural gas (for mcf not hedged) was approximately $2.25 per
mcf.
Inflation
Inflation did not have a material impact on HEC in 1999, 1998 and 1997 and is
not anticipated to have a material impact in 2000.
Results of Operations
For accounting purposes, the Consolidation has been treated as a purchase by HEP
of the common stock of HCRC and the direct energy interests of Hallwood Group.
Accordingly, all information presented for periods prior to June 8, 1999
represents the historical information of HEP because HEP was considered to be
the acquiring entity for accounting purposes.
1999 Compared to 1998
The following table is presented to contrast HEC's oil and gas price and
production for discussion purposes. Significant fluctuations are discussed in
the accompanying narrative.
1999 1998
---- ----
Gas
Production (mcf) 18,263,000 14,037,000
Price (per mcf) $1.90 $2.02
Oil
Production (bbl) 925,000 787,000
Price (per bbl) $16.52 $13.65
<PAGE>
Gas Revenue
Gas revenue increased $6,373,000 during 1999 compared with 1998. The increase is
comprised of an increase in gas production from 14,037,000 mcf during 1998 to
18,263,000 mcf during 1999, partially offset by a decrease in the average gas
price from $2.02 per mcf in 1998 to $1.90 per mcf in 1999. The increase in
production is primarily due to the Consolidation which caused a 4,478,000 mcf
increase in gas production. This increase was partially offset by decreased
production resulting from a production decline on two significant wells in
Louisiana caused by increased rates of water production on the wells and normal
production declines.
The effect of HEC's hedging transactions as described under "Inflation and
Changing Prices" was to decrease HEC's average gas price from $2.06 per mcf to
$1.90 per mcf, representing a $2,922,000 decrease in gas revenues for 1999.
Oil Revenue
Oil revenue increased $4,539,000 during 1999 compared with 1998. The increase is
comprised of an increase in the average oil price from $13.65 per barrel in 1998
to $16.52 per barrel in 1999, combined with an increase in production, from
787,000 barrels in 1998 to 925,000 barrels in 1999. The Consolidation caused a
production increase of 242,000 barrels of oil which was partially offset by the
production decline on two wells in Louisiana, as discussed above, and normal
production declines.
The effect of HEC's hedging transactions was to decrease HEC's average oil price
from $18.16 per barrel to $16.52 per barrel, resulting in a $1,517,000 decrease
in oil revenue for 1999.
Pipeline and Other
Pipeline and other revenue consists primarily of facilities income from two
gathering systems located in New Mexico, revenues derived from salt water
disposal and incentive payments related to certain wells in San Juan County, New
Mexico and LaPlata County, Colorado. Pipeline facilities and other revenue
increased $2,434,000 during 1999 compared with 1998. The increase is comprised
of a $1,716,000 increase due to the Consolidation and a $718,000 increase
primarily due to an increase in incentive payment income resulting from HEC's
acquisition of a volumetric production payment during May 1998.
Interest Income
The decrease in interest income of $51,000 during 1999 compared with 1998
resulted from a lower average cash balance during 1999.
Production Operating Expense
Production operating expense increased $4,925,000 during 1999 compared with
1998. The increase is comprised of a $5,527,000 increase due to the
Consolidation, partially offset by a decrease of $602,000 primarily resulting
from cost savings measures implemented in Kansas and West Texas during 1999.
Facilities Operating Expense
Facilities operating expense represents operating expenses associated with
various smaller gathering systems operated by HEC. The increase in facilities
operating expense of $128,000 is primarily due to increased maintenance activity
during 1999 compared with 1998.
General and Administrative Expense
General and administrative expense includes costs incurred for direct
administrative services such as legal, audit and reserve reports, as well as
allocated internal overhead incurred by the operating company on behalf of HEC.
These expenses increased $2,350,000 during 1999 compared with 1998 primarily due
to the Consolidation.
<PAGE>
Depreciation, Depletion and Amortization Expense
Depreciation, depletion and amortization expense increased $5,307,000 during
1999 compared with 1998. The increase is due to as higher capitalized costs
during 1999 primarily due to the Consolidation and property acquisitions during
1999.
Impairment of Oil and Gas Properties
Impairment of oil and gas properties during 1998 represents the property
impairments recorded during 1998 because capitalized costs exceeded the present
value (discounted at 10%) of estimated future net revenues from proved oil and
gas reserves at June 30, 1998, September 30, 1998 and December 31, 1998, based
on prices of $13.00 per barrel of oil and $2.00 per mcf of gas, $12.80 per bbl
of oil and $1.90 per mcf of gas and $10.00 per bbl of oil and $1.90 per mcf of
gas, respectively.
Interest Expense
Interest expense increased $4,018 during 1999 as compared with 1998. The
increase is due to a higher average outstanding debt balance during 1999
resulting from the Consolidation and additional borrowings.
Equity in Earnings (Loss) of HCRC
Equity in earnings (loss) of HCRC represents HEC's share of its equity
investment in HCRC prior to the Consolidation. HEC's equity in loss of HCRC
during 1998 represents twelve months of activity whereas the 1999 balance
represents activity until June 8, 1999. Additionally, the 1998 balance includes
HEC's share of the property impairments recorded by HCRC.
Minority Interest in Net Income of Affiliates
Minority interest in net income of affiliates represents unaffiliated partners'
interest in the net income of the May Partnerships. The decrease of $647,000
during 1999 compared with 1998 is primarily due to the liquidation of three of
the six May Partnerships on March 31, 1999.
Litigation
Litigation income during 1999 represents insurance proceeds received by HEC
which reimbursed costs previously paid in connection with a property related
claim partially offset by costs accrued for the settlement of a take-or-pay
related claim. Litigation expense during 1998 includes the settlement of the
Ellender lawsuit described in Item 8, Note 13, and the costs related to the
Arcadia arbitration described in Item 8, Note 12.
1998 Compared to 1997
The following table is presented to contrast HEC's oil and gas price and
production for discussion purposes. Significant fluctuations are discussed in
the accompanying narrative.
1998 1997
---- ----
Gas
Production (mcf) 14,037,000 11,774,000
Price (per mcf) $2.02 $2.31
Oil
Production (bbl) 787,000 770,000
Price (per bbl) $13.65 $19.08
<PAGE>
Gas Revenue
Gas revenue increased $1,146,000 during 1998 compared with 1997. The increase is
comprised of an increase in gas production from 11,774,000 mcf during 1997 to
14,037,000 mcf during 1998, partially offset by a decrease in the average gas
price from $2.31 per mcf in 1997 to $2.02 per mcf in 1998. Production increased
because two temporarily shut-in wells were back on line. The two wells were
temporarily shut-in during the second quarter of 1997 while workover procedures
were performed. The increase in gas production is also due to an expansion of
the gathering system in San Juan County, New Mexico during 1998.
The effect of HEC's hedging transactions was to increase HEC's average gas price
from $1.99 per mcf to $2.02 per mcf, representing a $421,000 increase in gas
revenues for 1998.
Oil Revenue
Oil revenue decreased $3,949,000 during 1998 compared with 1997. The decrease is
comprised of a decrease in the average oil price from $19.08 per barrel in 1997
to $13.65 per barrel in 1998, partially offset by an increase in production,
from 770,000 barrels in 1997 to 787,000 barrels in 1998. Production increased
slightly because two temporarily shut-in wells were back on line. The two wells
were temporarily shut-in during the second quarter of 1997 while workover
procedures were performed. The production increase was partially offset by
normal production declines.
The effect of HEC's hedging transactions was to increase HEC's average oil price
from $12.82 per barrel to $13.65 per barrel, resulting in a $653,000 increase in
oil revenue for 1998.
Pipeline and Other
Pipeline facilities and other revenue increased $1,273,000 during 1998 compared
with 1997 primarily due to an increase in incentive payment income resulting
from HEC's acquisition of a volumetric production payment during May 1998.
Interest Income
The increase in interest income of $13,000 during 1998 compared with 1997
resulted from a higher average cash balance during 1998 compared with 1997.
Production Operating Expense
Production operating expense increased $1,115,000 during 1998 compared with
1997. The increase is due to increased operating costs resulting from the
drilling projects completed during 1997 as well as the additional operating
expenses related to the properties acquired in the Arcadia acquisition during
October 1998.
Facilities Operating Expense
The decrease in facilities operating expense of $143,000 is primarily due to
decreased maintenance activity during 1998 compared with 1997.
General and Administrative Expense
General and administrative expense decreased $288,000 during 1998 compared with
1997 primarily due to a decrease in performance based compensation during 1998.
Depreciation, Depletion and Amortization Expense
Depreciation, depletion and amortization expense increased $3,759,000 during
1998 compared with 1997. The increase is due to a higher depletion rate
resulting from the increased production discussed above as well as higher
capitalized costs during 1998.
Impairment of Oil and Gas Properties
Impairment of oil and gas properties during 1998 represents the property
impairments recorded during 1998 because capitalized costs exceeded the present
value (discounted at 10%) of estimated future net revenues from proved oil and
gas reserves at June 30, 1998, September 30, 1998 and December 31, 1998, based
on prices of $13.00 per barrel of oil and $2.00 per mcf of gas, $12.80 per bbl
of oil and $1.90 per mcf of gas and $10.00 per bbl of oil and $1.90 per mcf of
gas, respectively.
Interest Expense
Interest expense decreased $299,000 during 1998 compared with 1997. The decrease
is due to a lower average outstanding debt balance during 1998 as compared to
1997.
Equity in Earnings (Loss) of HCRC
HEC's equity in HCRC's earnings decreased $6,236,000 during 1998 as compared to
1997. The decrease is primarily the result of property impairments recorded by
HCRC during 1998.
Minority Interest in Net Income of Affiliates
Minority interest in net income of affiliates decreased $821,000 during 1998
compared with 1997 due to a decrease in the net income of the May Partnerships
resulting primarily from lower oil and gas prices and decreased production from
their properties.
Litigation
Litigation expense during 1998 includes the settlement of the Ellender lawsuit
described in Item 8, Note 13 and the costs related to the Arcadia arbitration
described in Item 8, Note 12. Litigation income during 1997 is comprised of
insurance proceeds which reimbursed a portion of expense incurred in a prior
period to settle certain litigation.
<PAGE>
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
HEC's primary market risks relate to changes in interest rates and in the prices
received from sales of oil and natural gas. HEC's primary risk management
strategy is to partially mitigate the risk of adverse changes in its cash flows
caused by increases in interest rates on its variable rate debt and decreases in
oil and natural gas prices, by entering into derivative financial and commodity
instruments, including swaps, collars and participating commodity hedges. By
hedging only a portion of its market risk exposures, HEC is able to participate
in the increased earnings and cash flows associated with decreases in interest
rates and increases in oil and natural gas prices; however, it is exposed to
risk on the unhedged portion of its variable rate debt and oil and natural gas
production.
Historically, HEC has attempted to hedge the exposure related to its variable
rate debt and its forecasted oil and natural gas production in amounts which it
believes are prudent based on the prices of available derivatives and, in the
case of production hedges, the Company's deliverable volumes. HEC attempts to
manage the exposure to adverse changes in the fair value of its fixed rate debt
agreements by issuing fixed rate debt only when business conditions and market
conditions are favorable.
HEC does not use or hold derivative instruments for trading purposes nor does it
use derivative instruments with leveraged features. HEC's derivative instruments
are designated and effective as hedges against its identified risks, and do not
of themselves expose HEC to market risk because any adverse change in the cash
flows associated with the derivative instrument is accompanied by an offsetting
change in the cash flows of the hedged transaction.
Notes 1, 4 and 6 to the financial statements provide further disclosure with
respect to derivatives and related accounting policies.
All derivative activity is carried out by personnel who have appropriate skills,
experience and supervision. The personnel involved in derivative activity must
follow prescribed trading limits and parameters that are regularly reviewed by
the Board of Directors and by senior management. HEC uses only well-known,
conventional derivative instruments and attempts to manage its credit risk by
entering into financial contracts with reputable financial institutions.
Following are disclosures regarding HEC's market risk sensitive instruments by
major category. Investors and other users are cautioned to avoid simplistic use
of these disclosures. Users should realize that the actual impact of future
interest rate and commodity price movements will likely differ from the amounts
disclosed below due to ongoing changes in risk exposure levels and concurrent
adjustments to hedging positions. It is not possible to accurately predict
future movements in interest rates and oil and natural gas prices.
Interest Rate Risks (non trading) - HEC uses both fixed and variable rate debt
to partially finance operations and capital expenditures. As of December 31,
1999, HEC's debt consists of $86,200,000 in borrowings under its Credit
Agreement which bears interest at a variable rate, and $25,000,000 in borrowings
under its 10.32% Senior Subordinated Notes which bear interest at a fixed rate.
HEC hedges a portion of the risk associated with this variable rate debt through
derivative instruments, which consist of interest rate swaps and collars. Under
the swap contracts, HEC makes interest payments on its Credit Agreement as
scheduled and receives or makes payments based on the differential between the
fixed rate of the swap and a floating rate plus a defined differential. These
instruments reduce HEC's exposure to increases in interest rates on the hedged
portion of its debt by enabling it to effectively pay a fixed rate of interest
or a rate which only fluctuates within a predetermined ceiling and floor. A
hypothetical increase in interest rates of two percentage points would cause a
loss in income and cash flows of $1,724,000 during 2000, assuming that
outstanding borrowings under the Credit Agreement remain at current levels. This
loss in income and cash flows would be offset by a $900,000 increase in income
and cash flows associated with the interest rate swap and collar agreements that
are in effect for 2000.
A hypothetical decrease in interest rates of two percentage points would cause
an increase in the fair market value of $1,989,000 in HEC's Senior Subordinated
Notes from their fair value at December 31, 1999.
<PAGE>
Commodity Price Risk (non trading) - HEC hedges a portion of the price risk
associated with the sale of its oil and natural gas production through the use
of derivative commodity instruments, which consist of swaps and collars. These
instruments reduce HEC's exposure to decreases in oil and natural gas prices on
the hedged portion of its production by enabling it to effectively receive a
fixed price on its oil and gas sales or a price that only fluctuates between a
predetermined floor and ceiling. As of March 6, 2000, HEC has entered into
derivative commodity hedges covering an aggregate of 445,000 barrels of oil and
21,243,000 mcf of gas that extend through 2002. Under these contracts, HEC sells
its oil and natural gas production at spot market prices and receives or makes
payments based on the differential between the contract price and a floating
price which is based on spot market indices. The amount received or paid upon
settlement of these contracts is recognized as oil or natural gas revenues at
the time the hedged volumes are sold. A hypothetical decrease in oil and natural
gas prices of 10% from the prices in effect as of December 31, 1999 would cause
a loss in income and cash flows of $5,999,000 during 2000, assuming that oil and
gas production remain at 1999 levels. This loss in income and cash flows would
be offset by a $2,914,000 increase in income and cash flows associated with the
oil and natural gas derivative contracts that are in effect for 2000.
<PAGE>
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page No.
FINANCIAL STATEMENTS:
Independent Auditors' Report 28
Consolidated Balance Sheets at December 31, 1999 and 1998 29-30
Consolidated Statements of Operations for the years ended
December 31, 1999, 1998 and 1997 31
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1999, 1998 and 1997 32
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997 33
Notes to Consolidated Financial Statements 34-51
SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED) 52-55
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Shareholders of Hallwood Energy Corporation:
We have audited the consolidated financial statements of Hallwood Energy
Corporation as of December 31, 1999 and 1998 and for each of the three years in
the period ended December 31, 1999, listed in the index at Item 8. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Hallwood Energy Corporation at
December 31, 1999 and 1998, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1999 in conformity
with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Denver, Colorado
March 6, 2000
<PAGE>
<TABLE>
<CAPTION>
HALLWOOD ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands)
December 31,
--------------
1999 1998
------ -----
CURRENT ASSETS
<S> <C> <C>
Cash and cash equivalents $ 10,480 $ 11,874
Accounts receivable:
Oil and gas revenues 12,442 5,911
Trade 4,918 4,040
Due from affiliates 704 119
Prepaid expenses and other current assets 1,209 1,338
Net working capital of affiliate 236
------------- ----------
Total 29,753 23,518
-------- --------
PROPERTY, PLANT AND EQUIPMENT, at cost
Oil and gas properties (full cost method):
Proved mineral interests 758,473 664,799
Unproved mineral interests 6,543 2,694
Furniture, fixtures and other 1,941 3,411
--------- ---------
Total 766,957 670,904
Less accumulated depreciation, depletion,
amortization and property impairment (585,336) (565,899)
------- -------
Total 181,621 105,005
------- -------
OTHER ASSETS
Investment in common stock of HCRC 10,160
Deferred expenses and other assets 1,400 408
--------- ----------
Total 1,400 10,568
--------- --------
TOTAL ASSETS $212,774 $139,091
======= =======
<FN>
(Continued on the following page)
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HALLWOOD ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except shares)
December 31,
------------
1999 1998
------ -----
CURRENT LIABILITIES
<S> <C> <C>
Accounts payable and accrued liabilities $ 26,382 $ 22,921
Current portion of long-term debt 9,319
------------- ---------
Total 26,382 32,240
-------- --------
NONCURRENT LIABILITIES
Long-term debt 109,357 40,381
Deferred revenue and other 1,066 1,050
--------- ---------
Total 110,423 41,431
------- --------
Total liabilities 136,805 73,671
------- --------
MINORITY INTEREST IN AFFILIATES 582 2,788
---------- ---------
COMMITMENTS AND CONTINGENCIES (NOTE 14)
STOCKHOLDERS' EQUITY
Series A Cumulative Preferred Stock; 5,000,000 shares authorized; 2,334,165
shares issued and outstanding in 1999
and 1998 21,386 21,386
Common Stock par value $.01 per share; 25,000,000 shares
authorized; 9,999,754 shares issued and outstanding in 1999
and 5,599,754 shares issued and outstanding in 1998 100 56
Additional paid-in capital 67,883 58,052
Accumulated deficit (13,982) (16,862)
-------- --------
Stockholders' equity - net 75,387 62,632
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $212,774 $139,091
======= =======
<FN>
The accompanying notes are an integral part of the consolidated
financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HALLWOOD ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands except per share data)
For the Year Ended December 31,
-------------------------------
1999 1998 1997
------ ------ -----
REVENUES:
<S> <C> <C> <C>
Gas revenue $ 34,739 $ 28,366 $ 27,220
Oil revenue 15,280 10,741 14,690
Pipeline, facilities and other 6,504 4,070 2,797
Interest 358 409 396
--------- --------- ---------
56,881 43,586 45,103
------- ------- -------
EXPENSES:
Production operating 17,100 12,175 11,060
Facilities operating 626 498 641
General and administrative 7,395 5,045 5,333
Depreciation, depletion and amortization 21,027 15,720 11,961
Impairment of oil and gas properties 14,000
Interest 6,815 2,797 3,096
-------- -------- --------
52,963 50,235 32,091
------- ------- -------
OTHER INCOME (EXPENSES):
Equity in earnings (loss) of HCRC (419) (4,888) 1,348
Minority interest in net income of affiliates (329) (976) (1,797)
Litigation 48 (1,382) 240
---------- -------- --------
(700) (7,246) (209)
--------- -------- --------
INCOME (LOSS) BEFORE INCOME TAXES 3,218 (13,895) 12,803
PROVISION FOR INCOME TAXES:
Current 338
--------- ------------
NET INCOME (LOSS) 2,880 (13,895) 12,803
PREFERRED DIVIDENDS 2,368 2,464 664
-------- -------- --------
NET INCOME (LOSS) ATTRIBUTABLE TO
COMMON SHAREHOLDERS $ 512 $ (16,359) $ 12,139
========= ======== ========
NET INCOME (LOSS) PER SHARE - BASIC $ .06 $ (2.92) $ 2.17
========== ========== =========
NET INCOME (LOSS) PER SHARE - DILUTED $ .06 $ (2.92) $ 2.14
========== ========== =========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 8,083 5,600 5,600
======== ======== ========
PRO FORMA INFORMATION ASSUMING PROVISION
FOR INCOME TAXES APPLIED RETROACTIVELY (NOTE 1)
Income (loss) before income taxes $ 3,218 $(13,895) $ 12,803
Provision for income taxes ------- -------- -------
Net income (loss) $ 3,218 $ (13,895) $ 12,803
======== ========== ========
Net income (loss) attributable to common shareholders $ 850 $ (16,359) $ 12,139
========== ======== =========
Net income (loss) per share - basic $ .11 $ (2.92) $ 2.17
===== =========== ===========
Net income (loss) per share - diluted $ .11 $ (2.92) $ 2.14
===== =========== ======
<FN>
The accompanying notes are an integral part of the consolidated
financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HALLWOOD ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
ries A Cumulative
Preferred Stock Common Additional Accumulated
Stock Paid-in-Capital Deficit Total
--------- --------------- -------------- --------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1996 $ 4,868 $ 56 $ 75,061 $ (15,770) $ 64,215
Dividends (7,676) (7,676)
Net income 12,803 12,803
Other (278) (278)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1997 4,868 56 67,107 (2,967) 69,064
Issuance of preferred stock, net of
syndication costs 16,518 16,518
Capital contribution 171 171
Exercise of stock options 199 199
Dividends (9,495) (9,495)
Net loss (13,895) (13,895)
Other 70 70
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1998 21,386 56 58,052 (16,862) 62,632
Issuance of common stock in the
Consolidation 44 13,892 13,936
Dividends (4,061) (4,061)
Net income 2,880 2,880
------------ ------------ ------------ --------- ---------
Balance, December 31, 1999 $ 21,386 $ 100 $ 67,883 $ (13,982) $ 75,387
======== ======== ======== ======== ========
<FN>
The accompanying notes are an integral part of the consolidated
financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HALLWOOD ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the Year Ended December 31,
---------------------------------
1999 1998 1997
------ ------ -----
OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net income (loss) $ 2,880 $ (13,895) $ 12,803
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation, depletion and amortization 21,027 15,720 11,961
Impairment of oil and gas properties 14,000
Depreciation charged to affiliates 220 249 221
Gain on asset disposals (188)
Amortization of deferred loan costs and debt discount 282 82 81
Noncash interest expense 15 241
Minority interest in net income 329 976 1,797
Recoupment of take-or-pay liability (416) (130) (126)
Equity in (earnings) loss of HCRC 419 4,888 (1,348)
Undistributed (earnings) loss of affiliates (1,177) (1,319) 197
Changes in operating assets and liabilities provided (used) cash net of
noncash activity:
Oil and gas revenues receivable (2,642) 2,861 633
Trade receivables (529) 1,029 (562)
Due from affiliates (3,992) (362) (2,948)
Prepaid expenses and other assets 385 (247) (163)
Deferred expenses and other assets 193 (408)
Accounts payable and accrued liabilities 1,259 3,006 4,730
Due to affiliates (133)
------------- ------------ ----------
Net cash provided by operating activities 18,238 26,277 27,384
-------- -------- --------
INVESTING ACTIVITIES:
Additions to property, plant and equipment (11,093) (28,756) (3,233)
Exploration and development costs incurred (13,069) (12,180) (12,983)
Costs incurred in connection with the Consolidation (2,933)
Proceeds from sales of property, plant and equipment 388 454 133
Distributions received from affiliate 1,833 1,583
Investment in affiliates (20) (76)
Other investing activities (29)
------------- ------------- -----------
Net cash used in investing activities (24,874) (38,919) (16,188)
-------- -------- --------
FINANCING ACTIVITIES:
Payments of long-term debt (3,000) (18,286) (7,285)
Proceeds from equity offering, net
of syndication costs 16,518
Proceeds from long-term debt 13,000 33,000 7,000
Dividends paid (4,061) (9,495) (7,676)
Distributions paid by consolidated affiliates
to minority interest (429) (1,446) (1,875)
Payment of contract settlement (2,767)
Exercise of options 199
Capital contribution 171
Debt issuance costs (268)
Other financing activities (278)
------------- ------------- ----------
Net cash provided by (used in) financing activities 5,242 17,894 (10,114)
--------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (1,394) 5,252 1,082
CASH AND CASH EQUIVALENTS:
BEGINNING OF YEAR 11,874 6,622 5,540
-------- --------- ---------
END OF YEAR $ 10,480 $ 11,874 $ 6,622
======== ======== =========
<FN>
The accompanying notes are an integral part of the consolidated
financial statements.
</FN>
</TABLE>
<PAGE>
HALLWOOD ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Hallwood Energy Corporation ("HEC" or the "Company") is a Delaware corporation
engaged in the development, exploration, acquisition and production of oil and
gas properties. HEC began operations June 8, 1999, in connection with the
consolidation ("Consolidation") of Hallwood Energy Partners, L.P. ("HEP") and
Hallwood Consolidated Resources Corporation ("HCRC") and the acquisition of the
direct energy interests of The Hallwood Group Incorporated ("Hallwood Group").
For accounting purposes, the Consolidation has been treated as a purchase by HEP
of the common stock of HCRC and the direct energy interests of Hallwood Group.
Accordingly, the assets and liabilities of HEP, including its 46% share of
assets and liabilities of HCRC owned prior to the Consolidation, have been
recorded at historical cost, and the remaining assets and liabilities of HCRC
and the direct energy interests of Hallwood Group have been recorded at
estimated fair values as of the date of purchase. All information presented for
periods prior to June 8, 1999 represents the historical information of HEP
because HEP was considered to be the acquiring entity for accounting purposes.
The financial statements for periods prior to June 8, 1999 have been
retroactively restated to reflect the corporate structure of HEC, and all share
and per share information assumes that the shares of HEC issued to HEP in
connection with the Consolidation were outstanding for all periods prior to June
8, 1999. The Company's properties are primarily located in the Rocky Mountain,
Mid-Continent, Greater Permian and Gulf Coast regions of the United States.
The following pro forma information presents the financial information of HEP,
HCRC and the direct property interests of Hallwood Group as if the Consolidation
had taken place on January 1 of each year presented. Any additional provision or
benefit for income taxes is excluded because of the Company's net operating loss
carryforwards and related valuation allowance.
<TABLE>
<CAPTION>
For the Year Ended December 31,
1999 1998
-------------------------------------------- ------------------------
As Acquired As Acquired
Reported Interests Pro Forma Reported Interests Pro Forma
-------- ---------- --------- -------- --------- ---------
(In thousands except per Share data)
<S> <C> <C> <C> <C> <C> <C>
Revenues $56,881 $11,874 $68,755 $ 43,586 $ 25,181 $ 68,767
Net income (loss) 2,880 (1,163) 1,717 (13,895) (21,597) (35,492)
Net income (loss)
attributable to
common
shareholders 512 (1,163) (651) (16,359) (21,597) (37,956)
Net income (loss)
per share - basic $ .06 $ (.08) $ (2.92) $ (6.78)
======== ========= ========= ==========
Net income (loss)
per share - diluted $ .06 $ (.08) $ (2.92) $ (6.78)
======== ========= ========= ==========
</TABLE>
<PAGE>
Accounting Policies
Consolidation
HEC fully consolidates entities in which it owns a greater than 50% equity
interest and reflects a minority interest in the consolidated financial
statements. The accompanying financial statements include the majority owned
affiliates, the May Limited Partnerships 1984-1, 1984-2 and 1984-3 for all
periods and the May Limited Partnerships 1983-1, 1983-2 and 1983-3 through March
31, 1999 when they were liquidated.
Pro Forma Information
The pro forma information included in the statements of operations has been
presented to reflect the provision for income taxes, using statutory rates, as
though the Company had been a taxable corporation for all periods presented.
Because of the Company's net operating loss carryforwards and its recent
operating losses, it is assumed that the Company would have had a full valuation
allowance. Accordingly, no provision or benefit for income taxes has been
recorded in any period.
Derivatives
As of March 6, 2000, HEC was a party to 16 financial contracts to hedge the
price of its oil and natural gas. The purpose of the hedges is to protect
against price decreases and to provide a measure of stability in the volatile
environment of oil and natural gas spot pricing. The amounts received or paid
upon settlement of these contracts are recognized as oil or gas revenue at the
time the hedged volumes are sold.
As of March 6, 2000, HEC was a party to eight financial contracts to hedge the
interest payments under its Credit Agreement. The purpose of the hedges is to
protect against the variability of the interest rates under its Credit Agreement
which has a floating interest rate. The amounts received or paid upon settlement
of these transactions are recognized as interest expense at the time the
interest payments are due.
Gas Balancing
HEC uses the sales method for recording its gas balancing. Under this method,
HEC recognizes revenue on all of its sales of production, and any
over-production or under-production is recovered at a future date.
As of December 31, 1999, HEC had a net over-produced position of 496,000 mcf
($992,000 valued at year-end gas prices). The Company believes that this
imbalance can be made up with production on existing wells or from wells which
will be drilled as offsets to existing wells and that this imbalance will not
have a material effect on HEC's results of operations, liquidity and capital
resources. HEC's oil and gas reserves as of December 31, 1999 have been
decreased by 496,000 mcf in order to reflect HEC's gas balancing position.
Property, Plant and Equipment
HEC follows the full cost method of accounting whereby all costs related to the
acquisition and development of oil and gas properties are capitalized in a
single cost center ("full cost pool") and are amortized over the productive life
of the underlying proved reserves using the units of production method. Proceeds
from property sales are generally credited to the full cost pool.
<PAGE>
Capitalized costs of oil and gas properties may not exceed an amount equal to
the present value, discounted at 10%, of estimated future net revenues from
proved oil and gas reserves plus the cost, or estimated fair market value, if
lower, of unproved properties. Should capitalized costs exceed this ceiling, an
impairment is recognized. The present value of estimated future net revenues is
computed by applying current prices of oil and gas to estimated future
production of proved oil and gas reserves as of year-end, less estimated future
expenditures to be incurred in developing and producing the proved reserves
assuming continuation of existing economic conditions. During the second, third
and fourth quarters of 1998, using oil and gas prices of $13.00 per barrel of
oil and $2.00 per mcf of gas, $12.80 per barrel of oil and $1.90 per mcf of gas
and $10.00 per barrel of oil and $1.90 per mcf of gas, respectively, HEC
recorded oil and gas property impairments totaling $14,000,000. HEC did not
record any property impairments during 1999 or 1997.
HEC does not accrue costs for future site restoration, dismantlement and
abandonment costs related to proved oil and gas properties because the Company
estimates that such costs will be offset by the salvage value of the equipment
sold upon abandonment of such properties. The Company's estimates are based upon
its historical experience and upon review of current properties and restoration
obligations.
Unproved properties are withheld from the amortization base until such time as
they are either developed or abandoned. The properties are evaluated
periodically for impairment.
Long-lived assets, other than oil and gas properties which are evaluated for
impairment as described above, are evaluated for impairment whenever events or
changes in circumstances indicate that the carrying amount may not be
recoverable. To date, HEC has not recognized any impairment losses on long-lived
assets other than oil and gas properties.
Dividends
On December 13, 1999, HEC declared a quarterly dividend of $.25 per Series A
Cumulative Preferred share, which was paid on February 15, 2000 to shareholders
of record on December 31, 1999. This amount was accrued as of year-end.
The Series A Cumulative Preferred Stock has a dividend preference of $1.00 per
share per year. HEC may not declare or pay dividends to common shareholders
unless full cumulative dividends have been paid on the preferred stock.
Cash and Cash Equivalents
All highly liquid investments purchased with an original maturity of three
months or less are considered to be cash equivalents.
Computation of Net Income (Loss) Per Share
Basic income (loss) per share is computed by dividing net income (loss)
attributable to the common shareholders by the weighted average number of common
shares outstanding during the periods. Diluted income per common share includes
the potential dilution that could occur upon exercise of the options or warrants
to acquire common stock computed using the treasury stock method which assumes
that the increase in the number of shares is reduced by the number of shares
which could have been repurchased by the Company with the proceeds from the
exercise of the options or warrants (which were assumed to have been made at the
average market price of the common shares during the reporting period). The
warrants described in Note 6 have been ignored in the computation of diluted net
income (loss) per share in all periods and the stock options described in Note 9
have been ignored in the computation of diluted income (loss) per share in 1999
and 1998 because their inclusion would be anti-dilutive.
<PAGE>
The following table reconciles the number of shares outstanding used in the
calculation of basic and diluted income (loss) per share.
<TABLE>
<CAPTION>
Income
(Loss) Shares Per Share
------ ------ ---------
(In thousands except per Share data)
For the Year Ended December 31, 1999
<S> <C> <C> <C>
Net income per share - basic $ 512 8,083 $ .06
---------- ------ ======
Net income per share - diluted $ 512 8,083 $ .06
========== ====== ======
For the Year Ended December 31, 1998
Net loss per share - basic $(16,359) 5,600 $(2.92)
------ ----- =====
Net loss per share - diluted $(16,359) 5,600 $(2.92)
====== ===== =====
For the Year Ended December 31, 1997
Net income per share - basic $ 12,139 5,600 $ 2.17
=====
Effect of options 83
------------- -------
Net income per share - diluted $ 12,139 5,683 $ 2.14
======= ===== =====
</TABLE>
Use of Estimates
The preparation of the financial statements for the Company in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.
Significant Customers
Although the Company sells the majority of its oil and gas production to a few
purchasers, there are numerous other purchasers in the area in which HEC sells
its production; therefore, the loss of its significant customers would not
adversely affect HEC's operations. For the years ended December 31, 1999, 1998
and 1997, purchases by the following companies exceeded 10% of the total oil and
gas revenues of the Company:
<PAGE>
1999 1998 1997
---- ---- ----
Conoco Inc. 19% 23% 20%
El Paso Field Services Company 14% 11% 11%
Plains All American Inc. 14%
Marathon Petroleum Company 16%
Environmental Concerns
HEC is continually taking actions it believes are necessary in its operations to
ensure conformity with applicable federal, state and local environmental
regulations. As of December 31, 1999, HEC has not been fined or cited for any
environmental violations which would have a material adverse effect upon capital
expenditures, earnings or the competitive position of HEC in the oil and gas
industry.
Other Comprehensive Income
The Company does not have any items of other comprehensive income for the years
ended December 31, 1999, 1998 and 1997. Therefore, total comprehensive income
(loss) is the same as net income (loss) for those periods.
<PAGE>
Segments
The Company engages in the development, production and sale of oil and gas, and
the acquisition, exploration, development and operation of oil and gas
properties in the continental United States. In addition, the Company's
activities exhibit similar economic characteristics and involve the same
products, production processes, class of customers, and methods of distribution.
Management of the Company evaluates its performance as a whole rather than by
product or geographically. As a result, HEC's operations consist of one
reportable segment.
Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives) and for hedging
activities. SFAS 133 requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as (a) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment, (b)
a hedge of the exposure to variable cash flows of a forecasted transaction, or
(c) a hedge of the foreign currency exposure of a net investment in a foreign
operation, an unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. The accounting for changes
in the fair value of a derivative (gains and losses) depends on the intended use
of the derivative and the resulting designation. The Company is required to
adopt SFAS 133 on January 1, 2001. The Company has not completed the process of
evaluating the impact that will result from adopting SFAS 133.
Reclassifications
Certain reclassifications have been made to prior years' amounts to conform to
the classifications used in the current year.
NOTE 2 - OIL AND GAS PROPERTIES
The following table summarizes cost information related to HEC's oil and gas
activities:
For the Year Ended December 31,
-------------------------------
1999 1998 1997
---- ---- ----
(In thousands)
Property acquisition costs:
Proved $ 85,235 $28,397 $ 1,942
Unproved 3,849 379 1,071
Development costs 7,302 8,087 7,607
Exploration costs 5,767 6,043 6,950
--------- ------- -------
Total $102,153 $42,906 $17,570
======= ====== ======
Depreciation, depletion, amortization and impairment expense related to proved
oil and gas properties per equivalent mcf of production for the years ended
December 31, 1999, 1998 and 1997, was $.88, $1.58 and $.73, respectively.
<PAGE>
At December 31, unproved properties consist of the following:
1999 1998
---- ----
(In thousands)
Texas $4,898 $1,857
North Dakota 1,009 499
Other 636 338
------ ------
$6,543 $2,694
===== =====
NOTE 3 - PRINCIPAL ACQUISITIONS AND SALES
On October 20, 1999, HEC acquired oil and gas properties located principally in
the Yoakum Gorge area of Lavaca County, Texas for $7,230,000 and future
contingent consideration. The acquisition was comprised of interests in 34
wells, drilling locations, exploration acreage and 3-D seismic data.
As a result of the arbitration discussed in Note 12, HEC completed an $8,200,000
acquisition of properties located primarily in Texas during October 1998. The
acquisition included interests in 570 wells, numerous proven and unproven
drilling locations, exploration acreage and 3-D seismic data.
In July 1996, HEC and its affiliate, HCRC, acquired interests in 38 wells
located primarily in LaPlata County, Colorado. An unaffiliated large East Coast
financial institution formed an entity to utilize the tax credits generated from
the wells. The project was financed by an affiliate of Enron Corp. through a
volumetric production payment. During May 1998, a limited liability company
owned equally by HEC and HCRC purchased the volumetric production payment from
the affiliate of Enron Corp. HEC funded its $17,257,000 share of the acquisition
price from operating cash flow and borrowings under its Credit Agreement.
During 1997, HEC had no individually significant property acquisitions or sales.
Subsequent to December 31, 1999 and through March 6, 2000, HEC sold
approximately 145 oil and gas properties located in Texas, Oklahoma and North
Dakota for approximately $7,100,000. HEC used $6,000,000 of the sales proceeds
to pay down its outstanding debt and the remainder was used for general
operations and capital projects.
NOTE 4 - DERIVATIVES
As part of its risk management strategy, HEC enters into financial contracts to
hedge the price of its oil and natural gas. HEC does not use these hedges for
trading purposes, but rather for the purpose of providing protection against
price decreases and to provide a measure of stability in the volatile
environment of oil and natural gas spot pricing. The amounts received or paid
upon settlement of these contracts is recognized as oil or gas revenue at the
time the hedged volumes are sold.
The financial contracts used by HEC to hedge the price of its oil and natural
gas production are swaps, collars and participating hedges. Under the swap
contracts, HEC sells its oil and gas production at spot market prices and
receives or makes payments based on the differential between the contract price
and a floating price which is based on spot market indices. As of March 6, 2000,
HEC was a party to 16 financial contracts with three different counterparties.
<PAGE>
The following table provides a summary of HEC's financial contracts:
Oil
Quantity of Production
Period Hedged Contract Floor Price
------ ---------------- --------------------
(bbls) (per bbl)
1997 346,000 $17.78
1998 175,000 16.62
1999 325,000 15.43
2000 372,000 18.47
2001 73,000 19.16
<PAGE>
Gas
Quantity of Production
Period Hedged Contract Floor Price
------ ---------------- --------------------
(mcf) (per mcf)
1997 5,386,000 $1.97
1998 7,101,000 2.09
1999 15,574,000 1.85
2000 9,040,000 1.97
2001 7,355,000 1.99
2002 4,848,000 1.95
From 1999 forward, between 11% and 13% of the gas volumes hedged in each year
are subject to a collar agreement whereby HEC will receive the contract price if
the spot price is lower than the contract price, the cap price if the spot price
is higher than the cap price, and the spot price if that price is between the
contract price and the cap price. The cap price ranges from $2.54 per mcf to
$2.65 per mcf.
In the event of nonperformance by the counterparties to the financial contracts,
HEC is exposed to credit loss, but has no off-balance sheet risk of accounting
loss. The Company anticipates that the counterparties will be able to satisfy
their obligations under the contracts because the counterparties consist of
well-established banking and financial institutions which have been in operation
for many years. Certain of HEC's hedges are secured by the lien on HEC's oil and
gas properties which also secures HEC's Credit Agreement described in Note 6.
NOTE 5 - INVESTMENT IN AFFILIATED CORPORATION
During 1998 and 1997, HEC accounted for its approximate 46% interest in HCRC
using the equity method of accounting. As a result of the Consolidation, HEC's
investment in HCRC was eliminated. The following presents summarized financial
information for HCRC at December 31, 1998 and 1997.
1998 1997
---- ----
(In thousands)
Current assets $12,566 $15,145
Noncurrent assets 88,601 77,226
Current liabilities 18,262 11,007
Noncurrent liabilities 53,316 32,678
Revenue 32,410 32,411
Net income (loss) (20,279) 5,585
No other individual entity in which HEC owns an interest comprises in excess of
10% of the revenues, net income or assets of HEC.
<PAGE>
The following amounts represent HEC's share of the property related costs and
reserve quantities and values of its equity investee HCRC as of December 31,
1998 and 1997, prior to its elimination on June 8, 1999 (in thousands):
Capitalized Costs Relating to Oil and Gas Activities:
As of December 31,
1998 1997
---- ----
Unproved properties $ 1,286 $ 1,040
Proved properties 147,600 118,966
Accumulated depreciation, depletion,
amortization and property impairment (100,890) (92,511)
------- -------
Net property $ 47,996 $ 27,495
======= =======
Costs Incurred in Oil and Gas Activities:
For the Year Ended December 31,
1998 1997
---- ----
Acquisition costs $ 12,879 $ 1,303
Development costs 2,636 2,060
Exploration costs 2,606 2,851
-------- ------
Total $ 18,121 $ 6,214
======= ======
<PAGE>
For the Year Ended December 31,
1998 1997
---- ----
Oil and gas revenue $ 10,372 $10,889
Production operating expense (4,272) (3,746)
Depreciation, depletion, amortization
and property impairment expense (13,773) (3,336)
Income tax benefit (expense) (761)
--------- --------
Net income (loss) from oil and gas activities $ (7,673) $ 3,046
======== =======
Proved Oil and Gas Reserve Quantities:
Gas Oil
Mcf Bbl
(unaudited)
Balance, December 31, 1998 32,000 1,470
====== =====
Balance, December 31, 1997 27,268 2,065
====== =====
Standardized Measure of Discounted Future Net Cash Flows:
(unaudited)
December 31, 1998 $30,134
======
December 31, 1997 $31,245
======
<PAGE>
NOTE 6 - DEBT
HEC's long-term debt at December 31, 1999 and 1998 consisted of the following:
1999 1998
---- ----
(In thousands)
Credit Agreement $ 86,200 $ 49,700
Note Agreement 25,000
Debt discount (1,843)
--------- -------
Total debt 109,357 49,700
Less current maturities (9,319)
------------- ---------
Long-term debt $109,357 $ 40,381
======= ========
On June 8, 1999, HEC and its lenders entered into an Amended and Restated Credit
Agreement (as amended, the "Credit Agreement") to extend the term date of its
line of credit to May 31, 2002. The lenders are Morgan Guaranty Trust Company,
First Union National Bank and Bank of America. The terms of the Credit Agreement
were amended on October 15, 1999, to, among other matters, increase HEC's
borrowing base to $90,000,000. At December 31, 1999, HEC had amounts outstanding
of $86,200,000.
HEC's plans are to sell its interests in approximately 500 non-strategic oil and
gas wells during 2000. These property sales will enable HEC to better focus on
its core areas while at the same time reduce its level of outstanding debt.
Subsequent to December 31, 1999 and through March 6, 2000, approximately 145 oil
and gas properties have been sold and HEC has repaid $6,000,000 of its
borrowings under the Credit Agreement. On January 27, 2000, the Credit Agreement
was further amended to reduce HEC's borrowing base to reflect the property sales
made by the Company and to waive compliance with an asset sale covenant. On
February 9, 2000, HEC's borrowing base was further reduced to $84,479,000 to
reflect the most recent property sales, and therefore HEC's unused borrowing
base totaled $4,279,000 at March 6, 2000.
Borrowings against the Credit Agreement bear interest at the lower of the
Certificate of Deposit rate plus from 1.375% to 2.125%, prime plus 1/2% or the
Euro-Dollar rate plus from 1.25% to 2.0%. The applicable interest rate was 8.5%
at December 31, 1999. Interest is payable monthly. Quarterly principal payments
of $11,457,000 are calculated to include the repayments of the borrowing made
subsequent to December 31, 1999 and commence May 31, 2002.
The borrowing base for the Credit Agreement is typically redetermined
semiannually, although the lenders have the right to make a redetermination at
anytime. The Credit Agreement is secured by a first lien on approximately 80% in
value of HEC's oil and gas properties. Additionally, aggregate dividends paid
and stock repurchased by HEC in any 12 month period are limited to 50% of cash
flow from operations before working capital changes and distributions received
from affiliates, if the principal amount of debt of HEC is 50% or more of the
borrowing base. Aggregate dividends paid and stock repurchased by HEC are
limited to 65% of cash flow from operations before working capital changes and
distributions received from affiliates, if the principal amount of debt is less
than 50% of the borrowing base.
At the time of the Consolidation, HCRC had $25,000,000 of 10.32% Senior
Subordinated Notes ("Subordinated Notes") due December 23, 2007 and warrants to
purchase common stock which were held by The Prudential Insurance Company of
America ("Prudential"). On June 8, 1999, the Amended and Restated Subordinated
Note and Warrant Purchase Agreement (the "Note Agreement") was amended to issue
warrants to Prudential to purchase 309,278 shares of HEC's Common Stock at an
exercise price of $7.00 per share. The terms of the Note Agreement were further
amended on October 15, 1999 to exclude certain hedging transactions of the
subsidiaries of HEC from the calculation of indebtedness. In connection with
this amendment, the Company received a written waiver under the Credit Agreement
of the restriction on amendment to the Note Agreement. The Subordinated Notes
bear interest at the rate of 10.32% per annum on the unpaid balance, payable
quarterly. Annual principal payments of $5,000,000 are due December 23, 2003
through December 23, 2007.
<PAGE>
HEC recorded the Subordinated Notes and the warrants based upon the relative
fair values of the Subordinated Notes without the warrants and of the warrants
themselves at the time of Consolidation. The allocated value of the warrants of
$1,956,000 was recorded as additional paid-in-capital. The discount on the
Subordinated Notes is being amortized over the term of the Subordinated Notes
using the interest method of amortization.
At December 31, 1999, HEC's debt maturity schedule is as follows.
(In thousands)
2000 $ --
2001 --
2002 36,943
2003 54,257
2004 5,000
Thereafter 13,157
--------
Total $109,357
=======
As part of its risk management strategy, HEC enters into financial contracts to
hedge the interest rate payments under its Credit Agreement. HEC does not use
the hedges for trading purposes, but rather to protect against the volatility of
the cash flows under its Credit Agreement, which has a floating interest rate.
The amounts received or paid upon settlement of these transactions are
recognized as interest expense at the time the interest payments are due.
All contracts are interest rate swaps with fixed rates. As of March 6, 2000, HEC
was a party to eight contracts with three different counterparties.
The following table provides a summary of HEC's financial contracts.
Average
Amount of Contract
Period Debt Hedged Floor Rate
1997 $15,000,000 6.56%
1998 15,000,000 6.84%
1999 40,000,000 5.70%
2000 45,000,000 5.65%
2001 36,000,000 5.23%
2002 37,500,000 5.23%
2003 37,500,000 5.23%
2004 6,000,000 5.23%
NOTE 7 - STOCKHOLDERS' EQUITY
HEC's stock trades on the NASDAQ under the symbol "HECO" for Common Stock and
"HECOP" for Series A Cumulative Preferred Stock.
Common Stock
Under its charter, HEC is authorized to issue up to 25,000,000 shares of HEC
common stock with a par value of $.01 per share. The common shareholders are
entitled to one vote per share on all matters voted on by shareholders. After
giving effect to any preferential rights of any series of preferred stock
outstanding, the holders of HEC common stock are entitled to participate in
dividends, if any, as may be declared from time to time by the board of
directors of HEC. Upon liquidation, the common shareholders are entitled to
receive a pro rata share of all of the assets of HEC that are available for
distribution to such holders. The holders of HEC common stock have no preemptive
rights with respect to future issuances of HEC common stock.
Preferred Stock
HEC is authorized to issue up to 5,000,000 shares of preferred stock from time
to time, in one or more series, without shareholder approval and to fix the
designation, preferences, conversion or other rights, voting powers,
restrictions, limitations as to dividends, qualifications and terms and
conditions of redemption of any series that may be established by the HEC Board
of Directors.
In connection with the Consolidation, the Board of Directors of HEC has
authorized the issuance of 2,334,165 shares of Series A cumulative preferred
stock. Each share of preferred stock is entitled to one vote on all matters on
which shareholders may vote. The preferred shareholders vote together with the
common shareholders in the election of directors and vote as a separate class on
all other matters.
Preferred shareholders are entitled to receive cumulative cash dividends at the
rate of $1.00 per share per year, if declared by the HEC Board of Directors.
Dividends are paid quarterly in arrears commencing on June 30, 1999. The
dividends are fully cumulative and accumulate, whether or not earned or declared
and whether or not HEC has funds legally available to pay them, without interest
on a daily basis. HEC may not declare or pay dividends to common shareholders
unless full cumulative dividends have been paid on the preferred stock.
Upon liquidation or dissolution of HEC, all accrued dividends must be paid to
the preferred shareholders before any assets may be distributed to the common
shareholders. Once all accrued preferred dividends are paid, the preferred
shareholders are entitled to participate equally with the common shareholders in
the distribution of the remaining assets of HEC in a liquidation or dissolution.
The HEC preferred stock is redeemable at the option of HEC after December 31,
2003. After that date, HEC may redeem shares of preferred stock in whole or in
part at any time at a redemption price of $10.00 per share, plus accrued
dividends which are unpaid on the redemption date. Preferred stock may not be
redeemed in part if full cumulative dividends have not been paid or set aside
for payment with respect to all prior dividend periods.
Rights Plan
During the second quarter of 1999, the board of directors of HEC approved the
adoption of a rights plan designed to protect shareholders in the event of a
takeover action that would otherwise deny them the full value of their
investment.
Under the terms of the rights plan, one right was distributed for each common
share of HEC to holders of record at the close of business on June 8, 1999. The
rights trade with the common stock. The rights will become exercisable only in
the event, with certain exceptions, that an acquiring party accumulates 15% or
more of HEC's outstanding common stock. The rights will expire on June 7, 2009.
HEC will generally be entitled to redeem the rights at one cent per right at any
time until the tenth day following the acquisition of a 15% position in its
common shares.
Issuance of HEP Units
On February 17, 1998, HEP closed its public offering of 1.8 million Class C
Units, priced at $10.00 per Unit. Proceeds to HEP, net of underwriting expenses,
were approximately $16,518,000. HEP used $14,000,000 of the net proceeds to
repay borrowings under its Credit Agreement and applied the remaining proceeds
toward the repayment of HEP's outstanding contract settlement obligation.
<PAGE>
NOTE 8 - INCOME TAXES
The following is a summary of the income tax provision for the year ended
December 31, 1999 (in thousands). HEC was not a taxable entity prior to the
Consolidation on June 8, 1999:
State $338
Federal - Current
Deferred
Total $338
===
Reconciliation of the expected tax at the statutory tax rate to the effective
tax is as follows for the year ended December 31, 1999 (in thousands):
Expected tax expense at the
statutory rate $1,094
State taxes net of federal benefit 223
Taxes on income prior to June 8, 1999 (440)
Change in valuation allowance (789)
Other 250
------
Effective tax expense $ 338
======
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amount used for income tax purposes. The tax effects of
significant items comprising the Company's deferred tax assets and liabilities
as of December 31, 1999 (in thousands) are as follows:
Deferred tax assets and (liabilities):
Net operating loss carryforward $ 7,758
Capital loss carryforward 1,458
Minimum tax credit carryforward 534
Temporary differences between
book and tax basis of property (215)
--------
Total 9,535
Valuation allowance (9,535)
------
Net deferred tax asset $ -0-
=========
The Company's net operating loss carryforwards expire between 2008 and 2019, the
capital loss carryforward expires in 2001 and the minimum tax credit
carryforward has no expiration date.
NOTE 9 - EMPLOYEE INCENTIVE PLANS
Every year beginning in 1992, the Boards of Directors of HEP and HCRC have
adopted an incentive plan. Each year the Boards of Directors determine the
percentage of each entities interest in the cash flow from certain wells
drilled, recompleted or enhanced during the year allocated to the incentive plan
for that year. The specified percentage was 2.80% for 1999, 2.75% for 1998, and
2.40% for 1997. The specified percentage of cash flow is then allocated among
certain key employees who are designated by the boards as participants in the
plan for that year. Each award under the plan (with regard to domestic
properties) represents the right to receive for five years a portion of the
specified share of the cash award, at the conclusion of which the participants
are each paid a share of an amount equal to a specified percentage (80% for
1999, 1998 and 1997) of the remaining net present value of the qualifying wells,
and the award for that year terminates. The expenses attributable to the plans
were $220,000 in 1999, $125,000 in 1998 and $277,000 in 1997 and are included in
general and administrative expense in the accompanying financial statements.
On June 9, 1999, the Compensation Committee of HEC adopted an incentive plan
that is substantially the same as the incentive plan of HEP and HCRC, and
specified that the percentage of cash flow allocated to the new plan for the
remainder of 1999 be 2.80%, the same as was allocated for the 1999 plan by HEP
and HCRC.
On June 9, 1999, the Compensation Committee of HEC granted options to purchase
600,000 shares of common stock at an exercise price of $7.00 per share which was
equal to the fair market value on the date of grant. On November 22, 1999, HEC
granted an additional 61,500 options to purchase common stock at an exercise
price of $7.00 per share which was greater than the fair market value of the
common stock on the date of the grant. The options expire on June 9, 2006,
unless sooner terminated pursuant to the provisions of the plan. One-third of
the options vested on the grant date, and the remainder vest one-third on June
8, 2000 and one-third on June 8, 2001.
On January 28, 2000, the Compensation Committee of HEC granted options to
purchase 238,500 shares of common stock at an exercise price of $4.625 per share
which was equal to the fair market value of the common stock on the date of
grant. The options expire on January 28, 2007, unless sooner terminated pursuant
to the provisions of the plan. One-third of the options vested on the grant date
and the remainder vest one-third on January 28, 2001 and one-third on January
28, 2002.
Prior to the Consolidation, the following HEP options were outstanding. All of
these options were cancelled on June 8, 1999.
Number of Options
Outstanding Exercisable Exercise Price
Class A Unit Options 390,400 390,400 $ 5.75
Class A Unit Options 25,500 17,000 $ 6.625
Class C Unit Options 120,000 120,000 $10.00
A summary of options granted to purchase HEC common stock and the changes
therein during the year-ended December 31, 1999 is presented below:
Weighted
Average
Exercise
Shares Price
Outstanding at beginning of year -- $ --
Granted 661,500 7.00
------- ----
Outstanding at end of year 661,500 $7.00
======= ====
Options exercisable 220,500 $7.00
======= ====
<PAGE>
A summary of options granted to purchase Class A Units and the changes therein
during the years-ended December 31, 1999, 1998, and 1997 is presented below:
<PAGE>
<TABLE>
<CAPTION>
1999 1998 1997
------ ------ -----
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Units Price Units Price Units Price
----- ----- ----- ----- ----- -----
Outstanding at beginning
<S> <C> <C> <C> <C> <C> <C>
of year 415,900 $ 5.80 425,000 $5.75 425,000 $5.75
Granted 25,500 6.625
Exercised (34,600) 5.75
Cancelled (415,900) $ 5.80
------- ------ ------------- -------- -------------
Outstanding at end of year -- $ -- 415,900 $5.80 425,000 $5.75
============= ========= ======= ==== ======= ====
Options exercisable at year-end -- $ -- 398,900 $5.80 425,000 $5.75
============= ========= ======= ==== ======= ====
</TABLE>
A summary of options granted to purchase Class C Unit Options and the changes
therein during the year ended December 31, 1999 and 1998 is presented below:
<TABLE>
<CAPTION>
1999 1998
---- ----
Weighted Weighted
Average Exercise Average Exercise
Price Price
Units Units
<S> <C> <C> <C> <C>
Outstanding at beginning of year 120,000 $10.00 -- $ --
Granted 120,000 10.00
Cancelled (120,000) 10.00
------- ----- --------------
Outstanding at end of year -- $ -- 120,000 $10.00
============= ========= ======= =====
Options exercisable at year-end -- $ -- 60,000 $10.00
============= ========= ======== =====
</TABLE>
The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"). Accordingly, no compensation cost has been recognized for the options
granted. Had compensation expense for options granted been determined based on
the fair value at the grant date for the options, consistent with the provisions
of SFAS 123, HEC's net income (loss) and net income (loss) per share would have
been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Net income(loss): as reported $2,880,000 $(13,895,000) $12,803,000
pro forma 930,000 (14,022,000) 12,730,000
Net income (loss) per share - basic:
as reported $ .06 $(2.92) $2.17
pro forma $(.18) $(2.94) $2.15
Net income (loss) per share - diluted:
as reported $ .06 $(2.92) $2.14
pro forma $(.18) $(2.94) $2.12
</TABLE>
<PAGE>
The fair value of the common stock options granted during 1999, for disclosure
purposes was estimated on the dates of grant using the Black-Scholes Model using
the following assumptions.
<TABLE>
<CAPTION>
Common Stock Options
Granted Granted
June 9, 1999 November 22, 1999
------------ -----------------
<S> <C> <C>
Expected dividend yield -- --
Expected price volatility 68% 68%
Risk-free interest rate 5.8% 6.4%
Expected life of options 7 years 7 years
</TABLE>
The fair value of the unit options granted during 1998 and 1995, for disclosure
purposes was estimated on the dates of grant using the Binomial Option Pricing
Model using the following assumptions:
1995 Class A 1998 Class A 1998 Class C
Options Options Options
Expected dividend yield 6% 8% 11%
Expected price volatility 28% 27% 29%
Risk-free interest rate 7.6% 6.4% 6.4%
Expected life of options 10 years 10 years 10 years
NOTE 10 - RELATED PARTY TRANSACTIONS
The Company manages and operates certain oil and gas properties on behalf of
independent joint interest owners and its affiliates. In such capacity, the
Company pays all costs and expenses of operations and distributes all revenues
associated with such properties. HEC has receivables from affiliates of $704,000
and $119,000 at December 31, 1999 and 1998, respectively, which represent net
revenues net of operating costs and expenses. The balances with affiliates are
settled monthly.
During the years ended December 31, 1999, 1998 and 1997, HEC incurred
approximately $124,000, $274,000 and $275,000, respectively, of consulting fees
under a consulting agreement with Hallwood Group. The consulting agreement was
terminated effective June 8, 1999 in connection with the Consolidation. HEC also
incurred $195,000, $317,000 and $301,000 in 1999, 1998 and 1997, respectively,
representing costs incurred by Hallwood Group and its affiliates on behalf of
the Company.
On February 18, 2000, HEC repurchased and retired 43,816 shares of Series A
Preferred Stock from it affiliate, Hallwood Group for $303,426. The shares were
repurchased for $6.925 per share which represented the average of the closing
prices of the stock during the five days prior to February 18, 2000.
<PAGE>
NOTE 11 - STATEMENT OF CASH FLOWS
In connection with the Consolidation, the purchase of the common stock of HCRC
and the direct energy interests of Hallwood Group was recorded through the
issuance of approximately 2,600,000 shares of HEC common stock to HCRC and
1,800,000 shares of HEC common stock to Hallwood Group based on the estimated
fair value of the assets acquired and the liabilities assumed as of the date of
purchase. This noncash investing activity is summarized as follows:
Fair Value of
Acquired Interest
-----------------
(In thousands)
Current assets $ 4,823
Oil and gas properties 81,348
Other assets 1,140
Current liabilities (2,606)
Long-term debt (49,544)
Other noncurrent liabilities (62)
Cash paid during 1999, 1998 and 1997 for interest totaled $6,583,000, $2,700,000
and $2,775,000, respectively. Cash paid for income taxes during 1999 was
$375,000. There was no cash paid for income taxes during 1998 and 1997 as HEC
was not a tax paying entity.
NOTE 12 - ARBITRATION
In connection with the Demand for Arbitration filed by Arcadia Exploration and
Production Company ("Arcadia") with the American Arbitration Association against
Hallwood Energy Partners, L.P., Hallwood Consolidated Resources Corporation,
E.M. Nominee Partnership Company and Hallwood Consolidated Partners, L.P.
(collectively referred to as "Hallwood"), the arbitrators ruled that the
original agreement entered into in August 1997 to purchase oil and gas
properties for $16,400,000 should proceed, with a reduction in the total
purchase price of approximately $2,500,000 for title defects. The arbitrators
also ruled that Arcadia was not entitled to enforce its claim that Hallwood was
required to purchase an additional $8,000,000 in properties and denied Arcadia's
claim for attorneys fees. The arbitrators granted Arcadia prejudgment interest
on the adjusted purchase price, in the amount of $904,000 of which HEC's share
was $452,000. That amount was accrued in the December 31, 1998 financial
statements of the Company and was paid during the second quarter of 1999.
In October 1998, HEC closed the acquisition of oil and gas properties from
Arcadia pursuant to the ruling which included interests in approximately 570
wells, numerous proven and unproven drilling locations, exploration acreage, and
3-D seismic data. HEC's share of the purchase price was $8,200,000.
NOTE 13 - LEGAL SETTLEMENTS
In connection with the Consolidation, HEC assumed the liability for two lawsuits
filed against Hallwood Group and certain individuals and related to the direct
energy interests acquired from Hallwood Group. These lawsuits, both filed in
federal court in Denver, Colorado, have been settled. HEC was obligated to pay
approximately $673,000 in connection with these lawsuits, and that amount was
accrued as a liability on the Company's balance sheet in connection with the
Consolidation. The court gave its final approval for the settlement during
January 2000 and the settlement amount was paid by HEC during February 2000.
<PAGE>
Concise Oil and Gas Partnership ("Concise"), a wholly owned subsidiary of HEC
was a defendant in a lawsuit styled Dr. Allen J. Ellender, Jr. et al. vs.
Goldking Production Company, et al., filed in the Thirty-Second Judicial
District Court, Terrebonne Parish, Louisiana on May 30, 1996. The portion of the
lawsuit against Concise was settled in consideration of the payment by Concise
of $600,000. This amount was recorded as litigation settlement expense in the
second quarter of 1998. Concise has been dismissed with prejudice from the
lawsuit.
In addition to the litigation noted above, the Company and its subsidiaries are
from time to time subject to routine litigation and claims incidental to their
business, which the Company believes will be resolved without material effect on
the Company's financial condition, cash flows or operations.
NOTE 14 - COMMITMENTS
The Company currently leases office facilities in Denver, Colorado for
approximately $600,000 per year, under a lease which expires on December 31,
2006. HEC also sub-leases office space in Houston, Texas for approximately
$42,000 per year, under a lease that expires on October 14, 2001. Remaining
commitments under these leases mature as follows:
Year Ending
December 31, Annual Rentals
(In thousands)
2000 $ 643
2001 636
2002 601
2003 601
2004 601
Thereafter 1,379
-----
$4,461
Rent expense for the years ended December 31, 1999, 1998 and 1997 was $421,000,
$287,000 and $288,000, respectively.
NOTE 15 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of SFAS No. 107, "Disclosures about
Fair Value of Financial Instruments." The estimated fair value amounts have been
determined by the Company, using available market information and appropriate
valuation methodologies. However, considerable judgment is required in
interpreting market data to develop the estimates of fair value. Accordingly,
the estimates presented herein are not necessarily indicative of the amounts
that the Company could realize in a current market exchange. The use of
different market assumptions and/or estimation methodologies may have a material
effect on the estimated fair value amounts.
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
----------------- -----------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
(In thousands)
Assets (Liabilities):
<S> <C> <C> <C> <C>
Interest rate hedge contracts $ -- $ 2,156 $ -- $ 4,254
Oil and gas hedge contracts -- (4,558) -- (812)
Long-term debt (109,357) (109,021) (49,700) (49,700)
</TABLE>
The estimated fair value of the interest rate hedge contracts is computed by
multiplying the difference between the quoted contract termination interest rate
and the contract interest rate by the amounts under contract. This amount has
been discounted using an interest rate that could be available to the Company.
The estimated fair value of the oil and gas hedge contracts is determined by
multiplying the difference between the quoted termination prices for oil and gas
and the hedge contract prices by the quantities under contract. This amount has
been discounted using an interest rate that could be available to the Company.
The estimated fair value of long-term debt is computed using interest rates that
could be available to the Company for similar instruments with similar terms.
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 1999. Although management is not
aware of any factors that would significantly affect the estimated fair value
amounts, such amounts have not been comprehensively reevaluated for purposes of
these financial statements since that date, and current estimates of fair value
may differ significantly from the amounts presented herein.
<PAGE>
HALLWOOD ENERGY CORPORATION
SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION
DECEMBER 31, 1999
(Unaudited)
The following reserve quantity and future net cash flow information for HEC
represents proved reserves which are located in the United States. The reserves
have been estimated by the Company's in-house engineers. A majority of these
reserves has been reviewed by independent petroleum engineers. The determination
of oil and gas reserves is based on estimates which are highly complex and
interpretive. The estimates are subject to continuing change as additional
information becomes available.
The standardized measure of discounted future net cash flows provides a
comparison of HEC's proved oil and gas reserves from year to year. No
consideration has been given to future income taxes as of December 31, 1999,
because the tax basis of HEC's properties and net operating loss carryforwards
exceed future net cash flows. No consideration was given to future income taxes
as of December 31, 1998 and 1997 because HEC was not a tax paying entity during
these years. Under the guidelines set forth by the Securities and Exchange
Commission (SEC), the calculation is performed using year-end prices. The oil
and gas prices used at December 31, 1999, 1998 and 1997 were $24.32 per bbl and
$2.00 per mcf, $10.00 per bbl and $1.90 per mcf and $16.90 per bbl and $2.30 per
mcf, respectively, for HEC, including the May Partnerships. Future production
costs are based on year-end costs and include severance taxes. The present value
of future cash inflows is based on a 10% discount rate. The reserve calculations
using these December 31, 1999 prices result in 11.7 million bbls of oil, and
151.7 billion cubic feet of gas and a standardized measure of $208,000,000. The
Mays are included on a consolidated basis, and 8,000 bbls of oil and .1 billion
cubic feet of gas, representing a discounted present value of $352,000 are
attributable to the minority ownership of these entities. This standardized
measure is not necessarily representative of the market value of HEC's
properties.
HEC's standardized measure of future net cash flows has been decreased by
$3,357,000 at December 31, 1999 for the effects of its hedge contracts. This
amount represents the difference between year-end oil and gas prices and the
hedge contract prices multiplied by the quantities subject to contract,
discounted at 10%.
<PAGE>
<TABLE>
<CAPTION>
HALLWOOD ENERGY CORPORATION
RESERVE QUANTITIES
(In thousands)
(Unaudited)
Gas Oil
--- ---
Mcf Bbls
Proved Reserves:
<S> <C> <C>
Balance, December 31, 1996 88,542 7,531
Extensions and discoveries 4,228 817
Revisions of previous estimates 11,578 (1,930)
Sales of reserves in place (140) (9)
Purchases of reserves in place 619 128
Production (11,774) (770)
------- --------
Balance, December 31, 1997 93,053 5,767
Extensions and discoveries 1,542 415
Revisions of previous estimates (9,369) (1,385)
Sales of reserves in place (244) (35)
Purchases of reserves in place 23,994 512
Production (14,037) (787)
-------- --------
Balance, December 31, 1998 94,939 4,487
Extensions and discoveries 10,929 180
Revisions of previous estimates (10,730) 2,245
Sales of reserves in place (1,067) (185)
Purchases of reserves in place 75,860 5,879
Production (18,263) (925)
-------- --------
Balance, December 31, 1999 151,668 11,681
======= ======
Proved Developed Reserves:
Balance, December 31, 1997 89,816 5,181
======== =======
Balance, December 31, 1998 90,915 3,577
======== =======
Balance, December 31, 1999 139,839 10,301
======= ======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HALLWOOD ENERGY CORPORATION
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
(In thousands)
(Unaudited)
December 31,
-----------------------------------------------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Future cash flows $ 597,000 $ 245,000 $ 293,000
Future production and development costs (263,000) (102,000) (115,000)
-------- ------- --------
Future net cash flows before discount 334,000 143,000 178,000
10% discount to present value (126,000) (42,000) (49,000)
-------- --------- ---------
Standardized measure of discounted
future net cash flows $ 208,000 $ 101,000 $ 129,000
========= ========= =========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HALLWOOD ENERGY CORPORATION
CHANGES IN THE STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
(In thousands)
(Unaudited)
For the Year Ended December 31,
-------------------------------
1999 1998 1997
---- ---- ----
Standardized measure of discounted future net
<S> <C> <C> <C>
cash flows at beginning of year $101,000 $129,000 $206,000
Sales of oil and gas produced, net of production costs (32,919) (26,932) (30,209)
Net changes in prices and production costs 12,454 (21,211) (78,965)
Extensions and discoveries, net of future production
and development costs 11,719 3,546 9,592
Changes in estimated future development costs (12,959) (9,738) (10,012)
Development costs incurred 7,302 8,087 7,607
Revisions of previous quantity estimates 2,674 (15,547) (8)
Purchases of reserves in place 108,449 23,802 1,457
Sales of reserves in place (2,124) (399) (204)
Accretion of discount 10,136 12,936 20,600
Changes in production rates and other 2,268 (2,544) 3,142
-------- -------- --------
Standardized measure of discounted future net
cash flows at end of year $208,000 $101,000 $129,000
======= ======= =======
</TABLE>
<PAGE>
ITEM 9 - DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURES
None.
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item will be included in the definitive proxy
statement of HEC relating to HEC's 2000 Annual Meeting of Shareholders to be
filed with the SEC pursuant to Regulation 14A, which information is incorporated
herein by reference.
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this item will be included in the definitive proxy
statement of HEC relating to HEC's 2000 Annual Meeting of Shareholders to be
filed with the SEC pursuant to Regulation 14A, which information is incorporated
herein by reference.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required by this item will be included in the definitive proxy
statement of HEC relating to HEC's 2000 Annual Meeting of Shareholders to be
filed with the SEC pursuant to Regulation 14A, which information is incorporated
herein by reference.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will be included in the definitive proxy
statement of HEC relating to HEC's 2000 Annual Meeting of Shareholders to be
filed with the SEC pursuant to Regulation 14A, which information is incorporated
herein by reference.
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements and Financial Statement Schedules.
(See Index at Item 8).
(b) Reports on Form 8-K.
HEC filed no current reports on Form 8-K during the last quarter of the
period covered by this report.
(c) Exhibits.
<PAGE>
(1) 3.1 - Certificate of Incorporation of Hallwood Energy Corporation
(1) 3.2 - Bylaws of Hallwood Energy Corporation
(1) 4.1 - Certificate of Designations of the Series A Cumulative
Preferred Stock of Hallwood
Energy Corporation
(2) 4.1.1 - Executed Rights Agreement dated as of June 8, 1999,
between the Company and Registrar and Transfer Company
(1) 4.2 - Form of Certificate of Designation of Series A Junior
Participating Preferred Stock of Hallwood Energy
Corporation
(1) 10.1 - Form of Rights Agreement
(1) 10.2* - 1999 Long-Term Incentive Plan of Hallwood Energy Corporation
(1) 10.3* - 1999 Long-Term Incentive Plan Loan Program of Hallwood
Energy Corporation
(2) 10.5 - Registration Rights Agreement dated as of June 8, 1999,
between the Company and The Prudential Insurance Company
of America
(2) 10.6* - Change of Control Agreement between the Company and
Certain Executives, dated as of June 9, 1999
10.61* - Amended Schedule for Change of Control Contracts, dated as
of December 13, 1999
(2) 10.7 - Amended and Restated Credit Agreement dated as of
June 8, 1999, among the Company and certain of its
subsidiaries and the Banks listed therein
(2) 10.8 - Agreement Regarding Initial Exercise Price dated
June 9, 1999, between the Company and The Prudential
Insurance Company of America
(2) 10.9* - Phantom Working Interest Incentive Plan of Hallwood Energy
Corporation dated as of June 8, 1999
(2) 10.10 - Amended and Restated Subordinated Note and Warrant Purchase
Agreement dated as of June 8, 1999, between Hallwood
Consolidated Resources Corporation and The Prudential
Insurance Company of America
(2) 10.11 - Common Stock Purchase Warrant dated June 8, 1999 between
the Company and The Prudential Insurance Company of America
(3) 10.12 - Amendment No. 1 to Credit Agreement, dated as of
October 15, 1999
(3) 10.13 - Letter Amendment No. 1 to Note Agreement, dated as of
October 15, 1999
10.14 - Amendment No. 2 and Waiver to Credit Agreement, dated as of
January 27, 2000
(1) 21 - Subsidiaries of the Registrant
27 - Financial Data Schedule
---------------
(1) Incorporated by reference to the same Exhibit number filed with
Registrant's Registration Statement No. 33-77409.
(2) Incorporated by reference to the same exhibit number filed with the
Registrant's Quarterly Report on Form 10-Q for the quarter ended June
30, 1999.
(3) Incorporated by reference to the same exhibit number filed with the
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1999.
*Designates management contracts or compensatory plans or arrangements.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
HALLWOOD ENERGY CORPORATION
Date: March 6, 2000 By: /s/William L.Guzzetti
- ----------------------- ---------------------
William L. Guzzetti
President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Capacity Date
/s/Anthony J. Gumbiner Chairman of the Board and March 6, 2000
- ----------------------
Anthony J. Gumbiner Director (Chief Executive Officer)
/s/William L. Guzzetti President and Director March 6, 2000
- ----------------------
William L. Guzzetti
/s/Hans-Peter Holinger Director March 6, 2000
- ----------------------
Hans-Peter Holinger
/s/Rex A. Sebastian Director March 6, 2000
- ---------------------
Rex A. Sebastian
/s/Nathan C. Collins Director March 6, 2000
- ---------------------
Nathan C. Collins
/s/John R. Isaac, Jr. Director March 6, 2000
- ---------------------
John R. Isaac, Jr.
Director March 6, 2000
- ---------------------
Jerry A. Lubliner
/s/Hamilton P. Schrauff Director March 6, 2000
- ------------------------
Hamilton P. Schrauff
Director March 6, 2000
- ------------------------
Bill M. Van Meter
/s/William J. Baumgartner Vice President March 6, 2000
- -------------------------
William J. Baumgartner Chief Financial Officer
(Principal Financial and
Accounting Officer)
Amended Schedule for Change of Control Contracts
Signing Executives Effective Date Severance Amount
Anthony J. Gumbiner June 9, 1999 three times compensation
William L. Guzzetti June 9, 1999 three times compensation
Russell P. Meduna June 9, 1999 two and one-half times compensation
Cathleen M. Osborn June 9, 1999 two and one-half times compensation
George L. Brinkworth June 9, 1999 two times compensation
Betty J. Dieter June 9, 1999 two times compensation
William H. Marble June 9, 1999 two times compensation
Thomas J. Jung June 9, 1999 two times compensation
William J. Baumgartner December 13, 1999 two and one-half times compensation
[CONFORMED COPY]
AMENDMENT NO. 2 AND WAIVER TO CREDIT AGREEMENT
AMENDMENT AND WAIVER dated as of January 27, 2000 to the Amended and
Restated Credit Agreement dated as of June 8, 1999, as amended by Amendment No.
1 dated as of October 15, 1999 (as so amended, the "Credit Agreement"), among
HALLWOOD ENERGY CORPORATION, HALLWOOD ENERGY PARTNERS, L.P. and HALLWOOD
CONSOLIDATED RESOURCES CORPORATION (collectively, the "Borrowers"), the BANKS
party thereto (the "Banks"), FIRST UNION NATIONAL BANK, as Collateral Agent and
MORGAN GUARANTY TRUST COMPANY OF NEW YORK, as Agent (the "Agent").
W I T N E S S E T H :
WHEREAS, the parties hereto desire to amend the Credit Agreement as set
forth herein and the Banks have agreed to grant a waiver of certain provisions
thereof as set forth herein;
NOW, THEREFORE, the parties hereto agree as follows:
SECTION 1. Defined Terms; References. Unless otherwise specifically
defined herein, each term used herein which is defined in the Credit Agreement
has the meaning assigned to such term in the Credit Agreement. Each reference to
"hereof", "hereunder", "herein" and "hereby" and each other similar reference
and each reference to "this Agreement" and each other similar reference
contained in the Credit Agreement shall, after this Amendment and Waiver becomes
effective, refer to the Credit Agreement as amended hereby.
SECTION 2. Resetting of the Availability Limit and the Debt Limit.
(a) The definition of "Availability Limit" set forth in Section 1.01 of the
Credit Agreement is amended by to read in its entirety as follows:
"Availability Limit" means, on any date, an amount equal to the lesser
of (i) the aggregate amount of the Commitments at such date and (ii)
$85,000,000. The Availability Limit may be increased only by an amendment in
accordance with Section 8.05, which the Banks may agree to or not agree to in
their sole discretion.
(NY) 27008/757/AMEND/amend00.2.conf
<PAGE>
(b) Effective on and as of the date hereof, the "Debt Limit", as
determined in accordance with subsection (b) of Section 4.17 of the Credit
Agreement, shall be $85,000,000.
SECTION 3. Amendment to Section 4.17(c)(ii). Section 4.17(c)(ii) of the
Credit Agreement is hereby amended in its entirety as set forth below:
"(ii) Upon any sale by the Borrowers or the Property Base
Subsidiaries of Petroleum Property having, together with all previous
such sales not taken into account in previous adjustments or
redeterminations of the Debt Limit pursuant to this Section 4.17(c), an
aggregate fair market value of $1,000,000 or more, under circumstances
when subparagraph (iv) is not applicable, or, if subparagraph (iv) is
applicable, until the Debt Limit is redetermined pursuant to
subparagraph (iv), the Debt Limit shall be reduced, effective on the
date of consummation of such sale, by an amount equal to 50% of the
aggregate net proceeds to the Borrowers and the Property Base
Subsidiaries of (x) such sale and (y) all previous such sales not taken
into account in previous adjustments or rederminations of the Debt
Limit pursuant to this Section 4.17(c)."
SECTION 4. Waiver of the Asset Sale Covenant. The Banks hereby waive
compliance by the Borrowers with the requirement in subsection (b) of Section
4.27 of the Credit Agreement that the net proceeds of all sales of Property by
HEC and its Subsidiaries not exceed $5,000,000 during any period of six
consecutive calendar months, such waiver being granted for the limited purpose
of permitting HEC and its Subsidiaries to sell the Properties described in
Schedules A-1 and A- 2 hereto for an aggregate purchase price of approximately
$3,950,000 and $2,000,000, respectively, in each case substantially on the terms
described by HEC to the Banks prior to the date hereof.
SECTION 5. No Other Waivers. Other than as specifically provided
herein, this Amendment and Waiver shall not operate as a waiver of any right,
remedy, power or privilege of the Agent, the Collateral Agent or the Banks under
the Credit Agreement or any other Financing Document or of any other term or
condition thereof.
SECTION 6. Representations of Borrowers. The Borrowers represent and
warrant that (i) the representations and warranties of the Borrowers set forth
in Article 3 of the Credit Agreement are true on and as of the date hereof and
(ii) no Default has occurred and is continuing.
SECTION 7. Governing Law. This Amendment and Waiver shall be
governed by and construed in accordance with the laws of the State of New York.
(NY) 27008/757/AMEND/amend00.2.conf
<PAGE>
SECTION 8. Counterparts. This Amendment and Waiver may be signed in any
number of counterparts, each of which shall be an original, with the same effect
as if the signatures thereto and hereto were upon the same instrument.
SECTION 9. Effectiveness. This Amendment and Waiver shall become
effective as of the date hereof on the date on which the Agent shall have
received from the Borrowers and the Banks a counterpart hereof signed by such
party or facsimile or other written confirmation (in form satisfactory to the
Agent) that such party has signed a counterpart hereof.
(NY) 27008/757/AMEND/amend00.2.conf
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Amendment and
Waiver to be duly executed as of the date first above written.
HALLWOOD ENERGY CORPORATION
By: /s/ William J. Baumgartner
Title: Vice President
HALLWOOD CONSOLIDATED
RESOURCES CORPORATION
By: /s/ William J. Baumgartner
Title: Vice President
HALLWOOD ENERGY PARTNERS, L.P.
By: HEC Acquisition Corp., its
General Partner
By/s/ William J. Baumgartner
Title: Vice President
(NY) 27008/757/AMEND/amend00.2.conf
<PAGE>
MORGAN GUARANTY TRUST
COMPANY OF NEW YORK
By: /s/ John Kowalczuk
Title: Vice President
FIRST UNION NATIONAL BANK
By: /s/ Robert Wetteroff
Title: Senior Vice President
BANK OF AMERICA, N.A., formerly
NATIONSBANK, N.A.
By: /s/ Tracey S. Barclay
Title: Principal
(NY) 27008/757/AMEND/amend00.2.conf
<PAGE>
Acknowledged by:
HALLWOOD LA PLATA, LLC
LA PLATA ASSOCIATES, LLC
By: HALLWOOD PETROLEUM, INC.
By:/s/ Cathleen M. Osborn
Title: Vice President
The Manager of Hallwood La Plata LLC and La
Plata Associates LLC
CONCISE OIL AND GAS PARTNERSHIP
EM NOMINEE PARTNERSHIP COMPANY
MAY ENERGY PARTNERS OPERATING
PARTNERSHIP LTD.
By: HEC ACQUISITION CORP.
By:/s/ Cathleen M. Osborn
Title: Vice President
The General Partner of Concise Oil and Gas
Partnership, EM Nominee Partnership Company,
May Energy Partners Operating Partnership
LTD.
HALLWOOD CONSOLIDATED PARTNERS,
L.P.
By: HALLWOOD CONSOLIDATED
RESOURCES CORPORATION
By:/s/ Cathleen M. Osborn
Title: Vice President
The General Partner of Hallwood Consolidated
Partners, L.P.
(NY) 27008/757/AMEND/amend00.2.conf
<PAGE>
SCHEDULE A-1
The Properties marked by an asterisk in this Schedule A-1 are the
Properties referred to in Section 4 of the Amendment and Waiver to which this
Schedule A-1 is attached.
(NY) 27008/757/AMEND/amend00.2.conf
<PAGE>
SCHEDULE A-2
The Properties marked by an asterisk in this Schedule A-2 are the
Properties referred to in Section 4 of the Amendment and Waiver to which this
Schedule A-2 is attached.
(NY) 27008/757/AMEND/amend00.2.conf
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Form 10-K
for the year ended December 31, 1999 for Hallwood Energy Corporation and is
qualified in its entirety by reference to such Form 10-K.
</LEGEND>
<CIK> 0000319019
<NAME> Hallwood Energy Corporation
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 10,480
<SECURITIES> 0
<RECEIVABLES> 18,064
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 29,753
<PP&E> 766,957
<DEPRECIATION> 585,336
<TOTAL-ASSETS> 212,774
<CURRENT-LIABILITIES> 26,382
<BONDS> 0
0
21,386
<COMMON> 100
<OTHER-SE> 53,091
<TOTAL-LIABILITY-AND-EQUITY> 212,774
<SALES> 56,523
<TOTAL-REVENUES> 56,881
<CGS> 0
<TOTAL-COSTS> 17,726
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,815
<INCOME-PRETAX> 3,218
<INCOME-TAX> 338
<INCOME-CONTINUING> 2,880
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,880
<EPS-BASIC> .06
<EPS-DILUTED> .06
</TABLE>
