UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
MARK ONE
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2000
[ ] 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
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 [ ]
Number of shares outstanding as of August 4, 2000
Common Stock 9,341,837
Series A Cumulative Preferred Stock 2,263,568
Page 1 of 25
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
HALLWOOD ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
June 30, December 31,
2000 1999
---------------- ------------
CURRENT ASSETS
<S> <C> <C>
Cash and cash equivalents $ 8,424 $ 10,480
Accounts receivable:
Oil and gas revenues 16,047 12,442
Trade 8,079 4,918
Due from affiliates 930 704
Prepaid expenses and other current assets 1,014 1,209
--------- ---------
Total 34,494 29,753
-------- --------
PROPERTY, PLANT AND EQUIPMENT, at cost Oil and gas properties (full cost
method):
Proved mineral interests 748,078 758,473
Unproved mineral interests 4,373 6,543
Furniture, fixtures and other 2,049 1,941
--------- ---------
Total 754,500 766,957
Less accumulated depreciation, depletion,
amortization and property impairment (598,062) (585,336)
------- -------
Total 156,438 181,621
------- -------
OTHER ASSETS
Deferred expenses and other assets 1,272 1,400
--------- ---------
TOTAL ASSETS $192,204 $212,774
======= =======
<FN>
(Continued on the following page)
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HALLWOOD ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands except shares)
June 30, December 31,
2000 1999
-------------- -----------
CURRENT LIABILITIES
<S> <C> <C>
Accounts payable and accrued liabilities $ 23,079 $ 26,382
Current portion of long-term debt 200
----------
23,279 26,382
-------- --------
NONCURRENT LIABILITIES
Long-term debt 89,269 109,357
Deferred revenue and other 1,051 1,066
--------- ---------
Total 90,320 110,423
-------- -------
Total liabilities 113,599 136,805
------- -------
MINORITY INTEREST IN AFFILIATES 582
-------------- ---------
COMMITMENTS AND CONTINGENCIES (NOTE 7)
STOCKHOLDERS' EQUITY
Series A Cumulative Preferred Stock; 5,000,000 shares authorized;
2,263,568 shares issued and outstanding
in 2000 and 2,334,165 shares issued and outstanding in 1999 20,873 21,386
Common Stock par value $.01 per share; 25,000,000
shares authorized; 10,006,287 shares issued and 9,341,837
outstanding in 2000 and 9,999,754 shares
issued and outstanding in 1999 100 100
Additional paid-in capital 66,774 67,883
Accumulated deficit (5,395) (13,982)
Less cost of treasury stock of 664,450 common shares at 2000 (3,747)
---------
Stockholders' equity - net 78,605 75,387
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $192,204 $212,774
======= =======
<FN>
The accompanying notes are an integral part of the
financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HALLWOOD ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands except per share data)
For the Three Months Ended
June 30,
--------------------------
2000 1999
---- ----
REVENUES:
<S> <C> <C>
Gas revenue $14,732 $ 7,546
Oil revenue 3,035 3,031
Pipeline, facilities and other 1,849 1,430
Interest 103 61
-------- --------
19,719 12,068
------ ------
EXPENSES:
Production operating 4,613 3,432
Facilities operating 94 152
General and administrative 2,133 1,152
Depreciation, depletion and amortization 6,192 4,519
Interest 2,155 1,273
------- -------
15,187 10,528
------ ------
OTHER INCOME (EXPENSES):
Equity in income of HCRC 63
Minority interest in net income of affiliates (64)
Litigation 272 100
-------- --------
272 99
-------- --------
INCOME BEFORE INCOME TAXES 4,804 1,639
------- -------
PROVISION (BENEFIT) FOR INCOME TAXES:
Current 622 26
Deferred (100)
----------- --------
622 (74)
-------- - --------
NET INCOME 4,182 1,713
PREFERRED DIVIDENDS 566 584
-------- --------
NET INCOME ATTRIBUTABLE TO
COMMON SHAREHOLDERS $ 3,616 $ 1,129
======= =======
NET INCOME PER SHARE - BASIC $ .37 $ .17
========= =========
NET INCOME PER SHARE - DILUTED $ .37 $ .17
========= =========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 9,724 6,664
======= =======
PRO FORMA INFORMATION ASSUMING PROVISION
FOR INCOME TAXES APPLIED RETROACTIVELY (NOTE 1)
Income before income taxes $ 1,639
Provision for income taxes
Net income $ 1,639
=======
Net income attributable to common shareholders $ 1,055
=======
Net income per share - basic $ .16
=========
Net income per share - diluted $ .16
=========
<FN>
The accompanying notes are an integral part of the
financial statements.
</FN>
</TABLE>
<TABLE>
<CAPTION>
HALLWOOD ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands except per share data)
For the Six Months Ended
June 30,
--------------------------
2000 1999
---- ----
REVENUES:
<S> <C> <C>
Gas revenue $28,577 $14,036
Oil revenue 9,180 5,198
Pipeline, facilities and other 3,515 2,639
Interest 256 177
-------- --------
41,528 22,050
------ ------
EXPENSES:
Production operating 9,863 6,490
Facilities operating 326 327
General and administrative 3,934 2,494
Depreciation, depletion and amortization 12,626 8,812
Interest 4,550 2,091
------- -------
31,299 20,214
------ ------
OTHER INCOME (EXPENSES):
Equity in loss of HCRC (419)
Minority interest in net income of affiliates (127) (196)
Litigation (345) 100
-------- --------
(472) (515)
-------- --------
INCOME BEFORE INCOME TAXES 9,757 1,321
------- -------
PROVISION (BENEFIT) FOR INCOME TAXES:
Current 1,170 26
Deferred (100)
----------- --------
1,170 (74)
------- ---------
NET INCOME 8,587 1,395
PREFERRED DIVIDENDS 1,139 1,200
------- -------
NET INCOME ATTRIBUTABLE TO
COMMON SHAREHOLDERS $ 7,448 $ 195
======= ========
NET INCOME PER SHARE - BASIC $ .76 $ .03
========= =========
NET INCOME PER SHARE - DILUTED $ .75 $ .03
========= =========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 9,862 6,135
======= =======
PRO FORMA INFORMATION ASSUMING PROVISION
FOR INCOME TAXES APPLIED RETROACTIVELY (NOTE 1)
Income before income taxes $ 1,321
Provision for income taxes
Net income $ 1,321
=======
Net income attributable to common shareholders $ 121
========
Net income per share - basic $ .02
=========
Net income per share - diluted $ .02
=========
<FN>
The accompanying notes are an integral part of the
financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HALLWOOD ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
For the Six Months Ended
June 30,
-------------------------
2000 1999
---- ----
OPERATING ACTIVITIES:
<S> <C> <C>
Net income $ 8,587 $ 1,395
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation, depletion and amortization 12,626 8,812
Depreciation charged to affiliates 100 110
Minority interest in net income of affiliates 127 196
Amortization of deferred loan costs and debt discount 222 17
Recoupment of take-or-pay liability (52) (123)
Equity in loss of HCRC 419
Undistributed earnings of affiliates (1,176)
Deferred tax benefit (100)
Changes in operating assets and liabilities provided (used) cash net of
noncash activity:
Oil and gas revenues receivable (4,076) (1,454)
Trade receivables (3,161) 130
Due from affiliates (137) (3,638)
Prepaid expenses and other current assets 213 (2,603)
Deferred expenses and other 2,830
Accounts payable and accrued liabilities (3,240) (5,411)
------- -------
Net cash provided by (used in) operating activities 11,209 (596)
------ --------
INVESTING ACTIVITIES:
Additions to property, plant and equipment (2,951) (1,182)
Exploration and development costs incurred (6,147) (3,568)
Proceeds from sales of property, plant and equipment 21,202 129
Costs incurred in connection with the Consolidation (2,634)
Distributions received from affiliate 1,833
------------ -------
Net cash provided by (used in) investing activities 12,104 (5,422)
------ -------
FINANCING ACTIVITIES:
Payments of long-term debt (21,000)
Proceeds from long-term debt 1,000 6,000
Dividends paid (1,139) (2,893)
Purchase of common shares held in treasury (3,747)
Purchase and cancellation of preferred shares (513)
Exercise of options 30
Distributions paid by consolidated affiliates to minority interest (340)
Syndication costs (47)
------------ ---------
Net cash provided by (used in) financing activities (25,369) 2,720
------ -------
NET DECREASE IN CASH AND CASH EQUIVALENTS (2,056) (3,298)
CASH AND CASH EQUIVALENTS:
BEGINNING OF PERIOD 10,480 11,874
------ ------
END OF PERIOD $ 8,424 $ 8,576
======= =======
<FN>
The accompanying notes are an integral part of the
financial statements.
</FN>
</TABLE>
<PAGE>
HALLWOOD ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - GENERAL
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 is 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, 1999. 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 Three Months Ended June 30, 1999 For the Six Months Ended June 30, 1999
---------------------------------------- --------------------------------------
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 $12,068 $ 5,431 $17,499 $22,050 $11,971 $34,021
Net income (loss) 1,713 (87) 1,626 1,395 (1,065) 330
Net income (loss)
attributable to
common
shareholders 1,129 (87) 1,042 195 (1,065) (870)
Net income (loss)
per share - basic $ .17 $ .10 $ .03 $ (.09)
======= ======= ======= ========
Net income (loss)
per share - diluted $ .17 $ .10 $ .03 $ (.09)
======= ======= ======= ========
Production:
Gas (mcf) 3,960 1,756 5,716 7,540 4,097 11,637
Oil (bbl) 193 100 293 383 252 635
</TABLE>
<PAGE>
The interim financial data are unaudited; however, in the opinion of management,
the interim data include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the results for the interim
periods. These financial statements should be read in conjunction with the
financial statements and accompanying notes included in HEC's 1999 Annual Report
on Form 10-K.
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 through March
31, 2000 when they were liquidated 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 during 1999. Because of the
Company's net operating loss carryforwards, 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 1999 on a pro forma basis.
Computation of Net Income Per Share
Basic income per share is computed by dividing net income 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 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 2
and the Company's outstanding stock options have been ignored during 1999, and
the stock options issued in June 1999 and the warrants have been ignored during
2000 in the computation of diluted net income per share because their inclusion
would be antidilutive.
<PAGE>
The following table reconciles the number of shares outstanding used in the
calculation of basic and diluted income per share.
<TABLE>
<CAPTION>
Income
to Common
Shareholders Shares Per Share
------------ ------ ---------
(In thousands except per share data)
For the Three Months Ended June 30, 2000
<S> <C> <C> <C>
Net income per share - basic $ 3,616 9,724 $ .37
=====
Effect of options 57
----------- ---------
Net income per share - diluted $ 3,616 9,781 $ .37
====== ====== =====
For the Six Months Ended June 30, 2000
Net income per share- basic $ 7,448 9,862 $ .76
=====
Effect of options 31
----------- ---------
Net income per share- diluted $ 7,448 9,893 $ .75
====== ====== =====
For the Three Months Ended June 30, 1999
Net income per share - basic $ 1,129 6,664 $ .17
------ ------ ======
Net income per share - diluted $ 1,129 6,664 $ .17
====== ====== ======
For the Six Months Ended June 30, 1999
Net income per share- basic $ 195 6,135 $ .03
------- ------ ======
Net income per share- diluted $ 195 6,135 $ .03
======= ====== ======
</TABLE>
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 the prior period amounts to conform
to the classifications used in the current period.
<PAGE>
NOTE 2 - DEBT
HEC's long-term debt at June 30, 2000 and December 31, 1999 consisted of the
following:
June 30, 2000 December 31, 1999
------------- -----------------
(In thousands)
Credit Agreement $ 66,200 $ 86,200
Note Agreement 25,000 25,000
Debt discount (1,731) (1,843)
-------- --------
Total 89,469 109,357
Less current portion (200)
-----------
Total long-term debt $ 89,269 $109,357
======== =======
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 were Morgan Guaranty Trust Company,
First Union National Bank and Bank of America. Effective June 30, 2000, Wells
Fargo Bank replaced Bank of America as one of HEC's lenders under its Credit
Agreement. Effective June 30, 2000, HEC's Credit Agreement was amended to reduce
HEC's borrowing base to $70,000,000, provided that any amounts in excess of
$66,000,000 shall be applied to the purchase price of approved acquisitions. HEC
repaid $200,000 of its borrowings on July 7, 2000, to comply with this
amendment.
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
approximately 8.4% at June 30, 2000. Interest is payable monthly. Quarterly
principal payments of $9,429,000 are scheduled to 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, total expenditures for
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. Total expenditures for 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 Company has requested an amendment from
Prudential to exclude certain hedging transactions of the subsidiaries of HEC
from the calculation of indebtedness. 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
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 July 25, 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
Last six months of 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 3 - STATEMENTS OF CASH FLOWS
Cash paid for interest during the six months ended June 30, 2000 and 1999 was
$3,937,000 and $2,051,000, respectively. Cash paid for income taxes was $594,000
during the six months ended June 30, 2000. There was no cash paid for income
taxes during the six months ended June 30, 1999.
NOTE 4 - STOCK OPTIONS
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. During the quarter ended June 30, 2000, 6,533 of these options were
exercised and 13,067 of these options expired.
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. During the second quarter of 2000, 36,000
of these options were cancelled.
NOTE 5 - STOCK REPURCHASES
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.
On May 5, 2000, the Company repurchased 360,000 shares of common stock at $5.00
per share. These shares are held as treasury shares by the Company.
During March 2000, the Board of Directors of HEC approved the repurchase of up
to $5,000,000 of common and preferred stock of HEC through a combination of an
odd-lot program for certain common and preferred shareholders and the repurchase
of common shares in the open market.
Under the odd-lot program, the Company offered to purchase holdings of 99 or
fewer common shares, or 20 or fewer Series A Preferred shares from its
shareholders of record as of April 10, 2000. The original offer was for the
period from April 21, 2000 through May 22, 2000. The closing date of the offer
was subsequently extended until June 12, 2000.
Under the odd-lot program, the Company repurchased 213,400 shares of common
stock at an average price of $6.19 per share. The Company also repurchased
26,781 shares of preferred shares at an average price of $7.84 per share. The
common shares repurchased under the odd-lot program are being held as treasury
shares, and the preferred shares repurchased have been cancelled.
During the second quarter of 2000, the Company also purchased 91,050 shares of
its common stock on the open market. The purchase prices ranged from $4.10 per
share to $7.75 per share. These shares are being held by the Company as treasury
shares.
NOTE 6 - PROPERTY SALES
During the first six months of 2000, HEC sold its interests in approximately 500
non-strategic oil and gas wells located in the Keystone, Merkle and Weesatche
areas of Texas, as well as various wells in Kansas, Oklahoma, North Dakota and
Montana. The proceeds from all of the Company's property sales during the first
six months of 2000 were $21,202,000 of which $21,000,000 was used to pay down
borrowings under the Credit Agreement.
NOTE 7 - 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 and dismissed. During
February 2000, HEC paid approximately $673,000 in connection with these
lawsuits. During May 2000, the Company received a settlement offer from its
insurance company to reimburse approximately $419,000 of the costs paid in
connection with these lawsuits. This amount was accrued as litigation income
during the quarter ended June 30, 2000.
In connection with the 1995 closing of the Jakarta, Indonesia office of HEP and
HCRC, three former employees filed a lawsuit against those entities, primarily
based on allegations that their employment contracts had been breached. The case
was tried in 1997, and after appeals, a final judgment of $487,820 plus interest
was awarded to the plaintiffs. The amount due was accrued as of March 31, 2000,
and was paid to the plaintiffs in the second quarter of 2000.
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.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 the reporting of results
on a basis that makes it difficult to compare to prior periods. Therefore, this
Overview provides certain information on a pro forma basis to facilitate the
comparison with prior periods.
<PAGE>
Pro Forma Results
The following pro forma information is prepared as if the Consolidation had been
completed on January 1, 1999.
<TABLE>
<CAPTION>
For the Three Months Ended For the Six Months Ended
-------------------------- ------------------------
June 30, 2000 June 30, 1999 June 30, 2000 June 30, 1999
------------- ------------- ------------- -------------
(In thousands except prices)
Prices
<S> <C> <C> <C> <C>
Gas (per mcf) $ 2.70 $ 1.89 $ 2.42 $ 1.84
Oil (per bbl) $23.35 $15.90 $23.91 $13.47
Production
Gas (mcf) 5,464 5,716 11,787 11,637
Oil (bbl) 130 293 384 635
Gas revenue $14,732 $10,785 $28,577 $21,408
Oil revenue 3,035 4,660 9,180 8,556
Production operating expense 4,613 5,054 9,863 10,577
</TABLE>
Liquidity and Capital Resources
Cash Flow
HEC had $11,209,000 of cash flow from operating activities during the first six
months of 2000.
Primary cash inflows were:
o Proceeds from the sale of properties of $21,202,000; and
o Proceeds from long-term debt of $1,000,000.
Cash was used primarily for:
o Additions to property and development costs incurred of $9,098,000;
o Payments of long-term debt of $21,000,000;
o Purchase of preferred and common stock of $4,260,000; and
o Dividends to preferred shareholders of $1,139,000.
When combined with miscellaneous other cash activity during the period, the
result was a decrease of $2,056,000 in HEC's cash from $10,480,000 at December
31, 1999 to $8,424,000 at June 30, 2000.
Exploration and Development Projects and Acquisitions
Through June 30, 2000, HEC incurred $9,098,000 in direct property additions,
development, exploitation, and exploration costs. The costs were comprised of
$2,951,000 for property additions and approximately $6,147,000 for domestic
exploration and development. HEC's 2000 capital budget is set at $24,000,000.
The significant capital expenditures through June 30, 2000 are as follows.
Gulf Coast Region
During the first half of 2000, HEC expended approximately $6,774,000 of its
capital budget in the Gulf Coast Region in Louisiana and South and East Texas.
The following are major projects within the region. Louisiana. In May of 2000,
HEC successfully completed a 13,600-foot Bol Mex 3 well located in the Scott
Field. The well has sustained production rates of approximately 25,000 mcf per
day and 500 barrels of oil per day. In 2000, HEC's drilling and completion costs
for the well are approximately $1,497,000. HEC owns an approximate 35% working
interest in the well. The originally targeted upper zone will remain as behind
pipe proved nonproducing reserves while the lower zone is produced. HEC's plans
in the area include a Bol Mex 16 exploration well testing sands which are
productive in nearby fields. Drilling is expected to commence in the fourth
quarter of 2000, subject to drilling rig availability. Land and leasehold costs
incurred during the second quarter for this well were approximately $150,000.
HEC incurred $135,000 acquiring 377 small working interests totaling less than
1% in the Scott Field and in the Bol Mex 16 exploration acreage.
Yoakum Gorge Project. From January 1 through June 30, 2000, HEC continued its
participation with non-operated and operated Wilcox projects located in the
Yoakum Gorge area of Lavaca County, Texas. HEC participated with three different
operators in the drilling of six non-operated wells. Two wells, with working
interests of 12.5% and 3.1%, are in the process of being completed, two other
wells with working interests of 15.9% and 12.5% have recently been placed on
production at approximately 4,000 and 1,300 mcf per day respectively, and
another well, having a 28.9% working interest, is awaiting a decision on whether
to sidetrack the well to a more optimum position relative to area faulting. One
non-operated recompletion in which HEC has a 28.8% working interest has been
placed on production at 4,500 mcf per day. An operated recompletion is presently
underway and HEC owns a 90% working interest in the well. HEC's participation in
the Yoakum Gorge area has cost approximately $1,791,000 during the first six
months of 2000. HEC anticipates continued activity in the area resulting from
additional exploitation of the 1999 Seisgen Acquisition and from a third quarter
acquisition of 945 acres of land and 196 square miles of additional 3-D seismic
data. With the recent seismic acquisition, HEC now owns approximately 381 square
miles of 3-D seismic data in the area. The third quarter seismic and land
expenditures are anticipated to cost HEC approximately $2,069,000.
Goliad County Expanded Wilcox Project. A 16,500-foot non-operated, discovery
well was completed in the Upper Wilcox, and is producing approximately 8,000 mcf
per day. HEC owns a 20.8% working interest in the well. Additional exploitation
and exploration wells are possible, but the performance of the discovery well
will be assessed prior to proceeding. HEC's drilling and leasehold acquisition
costs during 2000 totaled approximately $1,119,000.
Bell Prospect. During the first six months of 2000, HEC incurred approximately
$723,000 for costs associated with completing two wells, and for various gas
gathering, gas treating, and produced water handling facility costs associated
with the Bell prospect area. One well tested the Georgetown formation and was
completed in the Buda formation and the other well is a dual lateral Buda
formation development well. Both wells are currently producing at a combined
rate of approximately 300 gross barrels of oil per day. HEC owns 36% working
interests in the two wells. The Company may drill one additional well in this
area during the current year.
Rocky Mountain Region
Through the second quarter of 2000, HEC expended approximately $848,000 of its
capital budget in the Rocky Mountain Region located in Colorado and Northwest
New Mexico. Of this amount, HEC incurred approximately $177,000 to frac two
wells located on the Colorado Western Slope. These two workovers have improved
production and should increase the wells' ultimate recovery. In addition, during
the first quarter of 2000, HEC participated in a Hudson Ranch exploration play
that tested the Red River and Nisku formations of North Dakota. The well found
insufficient pay to justify completion. HEC's costs incurred through the second
quarter of 2000 were approximately $251,000.
San Juan Basin Project - Colorado and New Mexico. HEC, along with many other
industry partners, made application to the Colorado Oil and Gas Commission for
fieldwide infill drilling in the Fruitland Coal formation. The application was
to reduce the present 320-acre spacing units to 160 acres, because the existing
spacing units cannot be adequately drained by a single well. Approval was
granted in July 2000, and could result in as many as 18 locations on the acreage
in which the Company has an indirect interest through its special purpose tax
credit vehicle. It is not yet known what the economic effect will be of any
contractual requirements related to drilling on the tax credit vehicle acreage.
If a mutually acceptable agreement can be reached with the owner of the tax
credit vehicle, HEC anticipates that infill drilling in Colorado could begin as
soon as 2001, subject to the resolution of drilling and lease rights issues
which currently exist. In addition to the Colorado locations, HEC has the
potential for 14 similar locations in New Mexico if infill drilling is permitted
there. HEC has not added any volumes to its reserve projections in connection
with the Colorado or New Mexico infill drilling opportunities.
During the second quarter of 2000, HEC recompleted one well in the Colorado San
Juan area which is presently dewatering. HEC's costs totaled approximately
$129,000 and HEC has an 85% working interest in the well. Prior to the
recompletion, the well had not produced since April 1999. Also in the area, HEC
is currently sidetracking a Colorado San Juan well. Total costs for this project
are anticipated to be $110,000 and HEC has a 40% working interest.
Other
The remaining $1,476,000 of HEC's capital expenditures incurred during the first
half of 2000 relate to all other areas. One successful non-operated well was
drilled in Gaines County, Texas and an offset well is underway. The well was
completed in the Leonard sand at approximately 8,000 feet. HEC owns a 17.50%
working interest in the well and has incurred costs of approximately $116,000
through the second quarter of 2000. One 7,850-foot operated Spraberry well was
successfully drilled and completed during the second quarter of 2000. HEC's
costs for the well were approximately $344,000. The well has produced
approximately 5,000 barrels to date and is currently producing approximately 65
barrels of oil per day. HEC owns an approximate 87% working interest. The
remaining costs are associated principally with technical general and
administrative expenditures totaling approximately $915,000, and for numerous
other projects which are completed or underway and which are individually less
significant.
Property Acquisitions
HEC signed a Letter of Intent on July 27, 2000 to purchase properties located in
South Texas and Louisiana. The acquisition includes oil and gas properties,
including interests in approximately 30 wells located in five fields, numerous
proven and unproven drilling locations, 7,000 acres of exploration lease
holdings, and 3-D seismic data. HEC anticipates the acquisition will add proven
reserves of approximately 443,000 barrels of oil and 10.2 billion cubic feet of
natural gas. The closing of this acquisition is subject to the resolution of
certain contingencies. The purchase price is estimated at $4,000,000 cash and
430,000 shares of HEC common stock.
Property Divestments
During the first six months of 2000, HEC sold its interests in approximately 500
non-strategic oil and gas wells located in the Keystone, Merkle, and Weesatche
areas of Texas, and various oil and gas wells in Oklahoma, North Dakota,
Montana, and Kansas. Total proceeds received through the second quarter of 2000
were approximately $21,202,000. The wells sold represent approximately 35% 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. The completion of HEC's 2000 sales effort has enabled HEC to reduce its
level of debt and will allow the Company to reduce its administrative overhead,
and to focus on its core areas of Colorado, Utah, New Mexico, Texas, and
Louisiana.
Dividends
On June 20, 2000, HEC declared a quarterly dividend of $.25 per Series A
Cumulative Preferred share, payable on August 15, 2000 to shareholders of record
on June 30, 2000. This amount was accrued as of June 30, 2000.
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 Repurchases
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.
On May 5, 2000, the Company repurchased 360,000 shares of common stock at $5.00
per share. These shares are held as treasury shares by the Company.
During March 2000, the Board of Directors of HEC approved the repurchase of up
to $5,000,000 of common and preferred stock of HEC through a combination of an
odd-lot program for certain common and preferred shareholders and the repurchase
of common shares in the open market.
Under the odd-lot program, the Company offered to purchase holdings of 99 or
fewer common shares, or 20 or fewer Series A Preferred shares from its
shareholders of record as of April 10, 2000. The original offer was for the
period from April 21, 2000 through May 22, 2000. The closing date of the offer
was subsequently extended until June 12, 2000.
Under the odd-lot program, the Company repurchased 213,400 shares of common
stock at an average price of $6.19 per share. The Company also repurchased
26,781 shares of preferred shares at an average price of $7.84 per share. The
common shares repurchased under the odd-lot program are being held as treasury
shares, and the preferred shares repurchased have been cancelled.
During the second quarter of 2000, the Company also purchased 91,050 shares of
its common stock on the open market. The purchase prices ranged from $4.10 per
share to $7.75 per share. These shares are being held, by the Company, as
treasury shares.
Financing
HEC's long-term debt at June 30, 2000 and December 31, 1999 consisted of the
following:
June 30, 2000 December 31, 1999
------------- -----------------
(In thousands)
Credit Agreement $ 66,200 $ 86,200
Note Agreement 25,000 25,000
Debt discount (1,731) (1,843)
-------- --------
Total 89,469 109,357
Less current portion (200)
-----------
Total long-term debt $ 89,269 $109,357
======== =======
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 were Morgan Guaranty Trust Company,
First Union National Bank and Bank of America. Effective June 30, 2000, Wells
Fargo Bank replaced Bank of America as one of HEC's lenders under its Credit
Agreement. Effective June 30, 2000, HEC's Credit Agreement was amended to reduce
HEC's borrowing base to $70,000,000 provided that any amounts in excess of
$66,000,000 shall be applied to the purchase price of approved acquisitions. HEC
repaid $200,000 of its borrowings on July 7, 2000, to comply with this
amendment.
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
approximately 8.4% at June 30, 2000. Interest is payable monthly. Quarterly
principal payments of $9,429,000 are scheduled to commence May 31, 2002.
<PAGE>
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, total expenditures for
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. Total expenditures for 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 Company has requested an amendment from
Prudential to exclude certain hedging transactions of the subsidiaries of HEC
from the calculation of indebtedness.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
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 July 25, 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
Last six months of 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
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-Q 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-Q or otherwise expressed by or on behalf of the Company are, to the
knowledge and in the judgment of the officers and directors of the Company,
expected to prove true and come to pass, management is not able to predict the
future with absolute certainty. Forward-looking statements involve known and
unknown risks and uncertainties which may cause the Company's actual performance
and financial results in future periods to differ materially from any
projection, estimate or forecasted result. Please refer to the Company's
Registration Statement dated May 4, 1999, SEC file #333-77409 for additional
statements concerning important factors that could cause actual results to
differ materially from the Company's expectations. These risks and uncertainties
include, among other things, volatility of oil and gas prices, competition,
risks inherent in the Company's oil and gas operations, risk of mechanical
failure, the inexact nature of interpretation of seismic and other geological
and geophysical data, imprecision of reserve estimates, the availability of
capital, the Company's ability to replace and expand oil and gas reserves, and
such other risks and uncertainties described from time to time in the Company's
periodic reports and filings with the Securities and Exchange Commission.
Accordingly, shareholders and potential investors are cautioned that certain
events or circumstances could cause actual results to differ materially from
those projected, estimated or predicted.
Inflation and Changing Prices
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, and government regulations and tax laws.
Prices for both oil and gas fluctuated significantly during 1999 and through the
second quarter of 2000. The following table presents the weighted average prices
received each quarter by HEC and the effects of the hedging transactions
discussed below.
<PAGE>
<TABLE>
<CAPTION>
Oil Oil Gas Gas
(excluding the (including the (excluding the (including the
effects of effects of effects of effects of
hedging hedging hedging hedging
transactions) transactions) transactions) transactions)
------------- ------------- ------------- -------------
(per bbl) (per bbl) (per mcf) (per mcf)
<S> <C> <C> <C> <C>
Second quarter - 1999 $15.99 $15.70 $1.93 $1.91
Third quarter - 1999 20.22 18.21 2.25 1.95
Fourth quarter - 1999 22.50 19.01 2.26 1.93
First quarter - 2000 27.26 24.19 2.29 2.19
Second quarter - 2000 29.42 23.35 3.22 2.70
</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 and collars. 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 July 25, 2000, HEC was a party to 30
financial contracts with four different counterparties.
<PAGE>
The following tables provide a summary of HEC's outstanding financial contracts:
Oil Contract
Percent of Production Delivered
Period Hedged Price
(per bbl)
Last six months of 2000 68% $18.55
2001 32 20.59
<PAGE>
Gas Contract
Percent of Production Delivered
Period Hedged Price
(per mcf)
Last six months of 2000 55% $2.16
2001 61 2.14
2002 34 1.95
Between 8% and 12% of the gas volumes hedged in each year are subject to a
collar agreement under which 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 third quarter through July 25, 2000, the weighted average oil price
(for barrels not hedged) was approximately $29.45 per barrel. The weighted
average price of natural gas (for mcf not hedged) during that period was
approximately $3.65 per mcf.
Inflation
Inflation did not have a material impact on HEC in 1999 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 is considered to be the
acquiring entity for accounting purposes.
<PAGE>
Second Quarter of 2000 Compared to the Second Quarter of 1999
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.
2000 1999
---- ----
(In thousands except price)
Gas
Production (mcf) 5,464 3,960
Price (per mcf) $ 2.70 $ 1.91
Oil
Production (bbl) 130 193
Price (per bbl) $23.35 $15.70
Gas Revenue
Gas revenue increased $7,186,000 during the second quarter of 2000 compared with
the second quarter of 1999. The increase is the result of an increase in
production from 3,960,000 mcf in 1999 to 5,464,000 mcf in 2000. The average gas
price increased from $1.91 per mcf in 1999 to $2.70 per mcf in 2000. The
increase in production is primarily due to the Consolidation which caused an
increase in gas production of 1,583,000 mcf and property acquisitions during
1999. The increase is partially offset by a decrease in production primarily due
to a production decline on two significant wells in Louisiana caused by
increased rates of water production on the wells and property sales during the
first and second quarters of 2000.
The effect of HEC's hedging transactions as described under "Inflation and
Changing Prices," during the second quarter of 2000, was to decrease HEC's
average gas price from $3.22 per mcf to $2.70 per mcf, representing a $2,841,000
decrease in revenue from hedging transactions.
Oil Revenue
Oil revenue increased $4,000 during the second quarter of 2000 compared with the
second quarter of 1999. The increase is the result of an increase in the average
oil price from $15.70 per barrel in 1999 to $23.35 per barrel in 2000, almost
entirely offset by a decrease in production from 193,000 barrels in 1999 to
130,000 barrels in 2000. The production decrease is primarily due to property
sales during the first and second quarters of 2000 and a production decline on
two wells in Louisiana caused by increased rates of water production during the
first quarter of 2000.
The effect of HEC's hedging transactions during the second quarter of 2000 was
to decrease HEC's average oil price from $29.42 per barrel to $23.35 per barrel,
resulting in a $789,000 decrease in revenue from hedging transactions.
Pipeline, Facilities and Other
Pipeline, facilities 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 $419,000 during the second quarter of 2000 compared with the
second quarter of 1999. The increase is primarily due to additional revenue from
the Consolidation.
Interest Income
Interest income increased $42,000 during the second quarter of 2000 compared
with the second quarter of 1999 due primarily to a higher average cash balance
during 2000.
<PAGE>
Production Operating
Production operating expense increased $1,181,000 during the second quarter of
2000 compared with the second quarter of 1999. The majority of the increase is
the result of the Consolidation, partially offset by decreased operating costs
due to property sales during the first and second quarters of 2000.
General and Administrative
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 $981,000 during the second quarter of 2000. During
April 2000, HEC reduced its work force to reflect the operational efficiencies
caused by the property sales during the first and second quarters of 2000. In
connection with this work force reduction HEC incurred approximately $500,000 of
one-time severance related costs. The remaining increase in general and
administrative expenses is primarily due to the Consolidation.
Depreciation, Depletion and Amortization Expense
Depreciation, depletion and amortization expense increased $1,673,000 during the
second quarter of 2000 compared with the second quarter of 1999. The increase is
primarily the result of higher capitalized costs and a higher depletion rate in
2000 due to the increase in gas production discussed above.
Interest
Interest expense increased $882,000 during the second quarter of 2000 compared
with the second quarter of 1999 due to a higher average outstanding debt balance
during 2000 resulting from the Consolidation.
Equity in Income of HCRC
Equity in income of HCRC represents HEC's share of its equity investment in HCRC
prior to the Consolidation. This income decreased to zero during the second
quarter of 2000, compared with the second quarter of 1999, as a result of the
Consolidation.
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 zero balance during the
second quarter of 2000 reflects the liquidation of the last three May
Partnerships in April 2000.
Litigation
Litigation income during the second quarter of 2000 represents insurance
proceeds which reimbursed a portion of the costs paid to settle the lawsuits
assumed by HEC in connection with the Consolidation as described in Note 7 of
the accompanying financial statements. The income was partially offset by
expenses accrued on the employee related lawsuit also described in Note 7 of the
accompanying financial statements.
Provision for Income Taxes
On June 8, 1999, in connection with the Consolidation, HEC began operations as a
taxable entity. Prior to the Consolidation, HEP was a partnership and was not
subject to federal income tax. The provision for income taxes during the second
quarter of 2000 is comprised of a provision for current federal taxes resulting
from alternative minimum taxes, and current state taxes. The effective tax rate
is lower than the statutory tax rate primarily because of the use of net
operating loss carryforwards. The net benefit for income taxes during the second
quarter of 1999 was comprised of a current provision for state taxes and a
deferred tax benefit.
<PAGE>
First Six Months of 2000 Compared to First Six Months of 1999
The comparisons for the first six months 2000 and the first six months 1999 are
consistent with those discussed in the second quarter of 2000 compared to the
second quarter of 1999 except as discussed below. 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.
2000 1999
------ -----
(In thousands except price)
Gas
Production (mcf) 11,787 7,540
Price (per mcf) $2.42 $1.86
Oil
Production (bbl) 384 383
Price (per bbl) $23.91 $13.57
Gas Revenue
Gas revenue increased $14,541,000 during the first six months of 2000 as
compared to the first six months of 1999. The increase is the result of an
increase in production from 7,540,000 mcf in 1999 to 11,787,000 mcf in 2000 and
an increase in price from $1.86 per mcf in 1999 to $2.42 per mcf in 2000. The
increase in production is due to the property activity discussed above.
The effect of HEC's hedging transactions during the first six months of 2000 was
to decrease HEC's average gas price from $2.72 to $2.42 per mcf representing a
$3,536,000 decrease in revenue from hedging transactions.
Oil Revenue
Oil revenue increased $3,982,000 during the first six months of 2000 compared
with the first six months of 1999. The increase is the result of an increase in
price from $13.57 per barrel in 1999 to $23.91 per barrel in 2000. Production
remained fairly consistent during the first six months of 1999 and 2000 because
the increased production from the Consolidation was offset by the property sales
discussed above.
The effect of HEC's hedging transactions during the first six months of 2000 was
to decrease HEC's average oil price from $27.99 per barrel to $23.91 per barrel
resulting in a $1,567,000 reduction in revenue from hedging transactions.
Litigation
Litigation expense during the first six months of 2000 is comprised of the costs
related to the settlement of the employment litigation described in Note 7 of
the accompanying financial statements, partially offset by the litigation income
described above.
ITEM 3 - 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 and collars. 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 the
Company's estimated debt levels and 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.
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 readers are cautioned to avoid simplistic
use of these disclosures. Readers 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.
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 July 25, 2000, HEC has entered into
derivative commodity hedges covering an aggregate of 391,000 barrels of oil and
21,300,000 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 June 30, 2000 would cause a
loss in income and cash flows of $5,277,000 during the remaining six months of
2000, assuming that oil and gas production remain at projected levels. This loss
in income and cash flows would be offset by a $3,032,000 increase in income and
cash flows associated with the oil and natural gas derivative contracts that are
in effect for the remaining six months of 2000.
Interest Rate Risks (non-trading) - HEC uses both fixed and variable rate debt
to partially finance operations and capital expenditures. As of June 30, 2000,
HEC's debt consisted of $66,200,000 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 $662,000 during the remaining six months of 2000, assuming
that outstanding borrowings under the Credit Agreement remain at June 30, 2000
levels. This loss in income and cash flows would be offset by a $450,000
increase in income and cash flows associated with the interest rate swap and
collar agreements that are in effect for the remaining six months of 2000.
<PAGE>
PART II -OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
Reference is made to Item 8 - Notes 12 and 13 of Form 10-K for the
year ended December 31, 1999 and Note 7 of this Form 10-Q.
ITEM 2 - CHANGES IN SECURITIES
None.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 17, 2000, HEC held its Annual Meeting of Shareholders at
which William L. Guzzetti, Nathan, C. Collins and Jerry A.
Lubliner were elected directors. Following is the number of votes
cast for and votes withheld for each of the directors:
Name Votes For Votes Withheld
William L. Guzzetti 7,867,171 1,827,856
Nathan C. Collins 7,867,005 1,828,022
Jerry A. Lubliner 7,866,354 1,828,673
There were no abstentions.
ITEM 5 - OTHER INFORMATION
None.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
10.17 Amendment No. 5 to Credit Agreement, dated as of June 30, 2000
27 Financial Data Schedule
b) Reports on Form 8-K
None.
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
HALLWOOD ENERGY CORPORATION
Date: August 4, 2000 By: /s/William J. Baumgartner
William J. Baumgartner, Vice President
(Chief Financial Officer)
