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 September 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 November 8, 2000
Common Stock 9,659,239
Series A Cumulative Preferred Stock 2,263,573
Page 1 of 27
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HALLWOOD ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---------------- ------------
CURRENT ASSETS
<S> <C> <C>
Cash and cash equivalents $ 554 $ 10,480
Accounts receivable:
Oil and gas revenues 17,021 12,442
Trade 3,872 4,918
Due from affiliates 1,315 704
Prepaid expenses and other current assets 1,069 1,209
--------- ---------
Total 23,831 29,753
-------- --------
PROPERTY, PLANT AND EQUIPMENT, at cost Oil and gas properties (full cost
method):
Proved mineral interests 758,533 758,473
Unproved mineral interests 7,083 6,543
Furniture, fixtures and other 2,059 1,941
--------- ---------
Total 767,675 766,957
Less accumulated depreciation, depletion,
Total 163,523 181,621
------- -------
OTHER ASSETS
Deferred tax asset 400
Deferred expenses and other assets 1,162 1,400
--------- ---------
Total 1,562 1,400
--------- ---------
TOTAL ASSETS $188,916 $212,774
======= =======
<FN>
(Continued on the following page)
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HALLWOOD ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands except shares)
September 30, December 31,
2000 1999
-------------- -----------
CURRENT LIABILITIES
<S> <C> <C>
Accounts payable and accrued liabilities $ 21,722 $ 26,382
-------- --------
NONCURRENT LIABILITIES
Long-term debt 78,327 109,357
Deferred revenue and other 1,044 1,066
--------- ---------
Total 79,371 110,423
-------- -------
Total liabilities 101,093 136,805
------- -------
MINORITY INTEREST IN AFFILIATES 582
------------- ---------
COMMITMENTS AND CONTINGENCIES (NOTE 8)
STOCKHOLDERS' EQUITY
Series A Cumulative Preferred Stock; 5,000,000 shares Common Stock par value
$.01 per share; 25,000,000
Additional paid-in capital 70,084 67,883
Accumulated earnings (deficit) 1,372 (13,982)
Less cost of treasury stock of 764,454 common shares at 2000 (4,610)
---------
Stockholders' equity - net 87,823 75,387
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $188,916 $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
September 30,
2000 1999
---- ----
REVENUES:
<S> <C> <C>
Gas revenue $ 15,095 $ 10,580
Oil revenue 3,503 5,063
Pipeline, facilities and other 1,982 1,208
Interest 157 92
----------- ------------
20,737 16,943
-------- --------
EXPENSES:
Production operating 5,256 5,238
Facilities operating 86 148
General and administrative 1,536 1,738
Depreciation, depletion and amortization 6,039 6,423
Interest 2,099 2,377
--------- ----------
15,016 15,924
--------- --------
MINORITY INTEREST IN NET INCOME OF AFFILIATES 56
--------------- ------------
INCOME BEFORE INCOME TAXES 5,721 963
---------- -----------
PROVISION (BENEFIT) FOR INCOME TAXES:
Current (1,212) 156
Deferred (400) 100
----------- -----------
(1,612) 256
--------- -----------
NET INCOME 7,333 707
PREFERRED DIVIDENDS 566 552
----------- -----------
NET INCOME ATTRIBUTABLE TO
NET INCOME PER SHARE - BASIC $ .72 $ .02
=========== ===========
NET INCOME PER SHARE - DILUTED $ .70 $ .02
=========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - BASIC 9,397 10,000
========= ========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - DILUTED 9,649 10,000
======== ========
<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 Nine Months Ended
September 30,
2000 1999
---- ----
REVENUES:
<S> <C> <C>
Gas revenue $ 43,672 $ 24,616
Oil revenue 12,683 10,261
Pipeline, facilities and other 5,497 3,847
Interest 413 269
---------- ----------
62,265 38,993
-------- --------
EXPENSES:
Production operating 15,119 11,728
Facilities operating 412 475
General and administrative 5,470 4,232
Depreciation, depletion and amortization 18,665 15,235
Interest 6,649 4,468
---------- ---------
46,315 36,138
-------- --------
OTHER INCOME (EXPENSES):
Equity in loss of HCRC (419)
Minority interest in net income of affiliates (127) (252)
Litigation (345) 100
---------- ----------
(472) (571)
---------- ----------
INCOME BEFORE INCOME TAXES 15,478 2,284
-------- ---------
PROVISION (BENEFIT) FOR INCOME TAXES:
Current (42) 182
Deferred (400)
----------
(442) 182
---------- ----------
NET INCOME 15,920 2,102
PREFERRED DIVIDENDS 1,705 1,752
--------- ---------
NET INCOME ATTRIBUTABLE TO
NET INCOME PER SHARE - BASIC $ 1.46 $ .05
========== ===========
NET INCOME PER SHARE - DILUTED $ 1.46 $ .05
========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - BASIC 9,706 7,437
========= =========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - DILUTED 9,769 7,437
========= =========
PRO FORMA INFORMATION ASSUMING PROVISION
Income before income taxes $ 2,284
Provision for income taxes
Net income $ 2,284
=========
Net income attributable to common shareholders $ 532
==========
Net income per share - basic $ .07
===========
Net income per share - diluted $ .07
===========
<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 Nine Months Ended
September 30,
2000 1999
---- ----
OPERATING ACTIVITIES:
<S> <C> <C>
Net income $15,920 $ 2,102
Adjustments to reconcile net income to net cash provided
Depreciation, depletion and amortization 18,665 15,235
Depreciation charged to affiliates 151 165
Minority interest in net income of affiliates 127 252
Amortization of deferred loan costs and debt discount 335 202
Recoupment of take-or-pay liability (52) (173)
Equity in loss of HCRC 419
Undistributed earnings of affiliates (1,176)
Deferred tax benefit (400)
Changes in operating assets and liabilities provided (used)
Oil and gas revenues receivable (5,050) (2,673)
Trade receivables 1,046 (2,216)
Due from affiliates (522) (3,863)
Prepaid expenses and other current assets 140 371
Deferred expenses and other 73
Accounts payable and accrued liabilities (4,604) (1,800)
------- -------
Net cash provided by operating activities 25,829 6,845
------ -------
INVESTING ACTIVITIES:
Additions to property, plant and equipment (8,405) (3,498)
Exploration and development costs incurred (10,789) (7,037)
Proceeds from sales of property, plant and equipment 21,437 143
Costs incurred in connection with the Consolidation (2,890)
Distributions received from affiliate 1,635
------------ -------
Net cash provided by (used in) investing activities 2,243 (11,647)
------- --------
FINANCING ACTIVITIES:
Payments of long-term debt (32,200) (2,000)
Proceeds from long-term debt 1,000 6,000
Dividends paid (1,705) (3,477)
Purchase of common shares held in treasury (4,610)
Purchase and cancellation of preferred shares (513)
Exercise of options 30
Distributions paid by consolidated affiliates to minority interest (429)
Syndication costs (47)
------------ ---------
Net cash provided by (used in) financing activities (37,998) 47
------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS (9,926) (4,755)
CASH AND CASH EQUIVALENTS:
BEGINNING OF PERIOD 10,480 11,874
------ ------
END OF PERIOD $ 554 $ 7,119
========= =======
<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 ("Hallwood" or the "Company") is a Delaware
corporation engaged in the development, exploration, acquisition and production
of oil and gas properties. Hallwood 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 Hallwood, and all
share and per share information assumes that the shares of Hallwood 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.
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 Nine Months Ended September 30,
1999
As Acquired
Reported Interests Pro Forma
-------- --------- ---------
(In thousands except per share
data)
<S> <C> <C> <C>
Revenues $38,993 $11,971 $50,964
Net income (loss) 2,102 (1,065) 1,037
Net income (loss) attributable to common
Net income (loss) per share - basic $ .05 $ (.07)
========= =========
Net income (loss) per share - diluted $ .05 $ (.07)
========= =========
Production:
Gas (mcf) 13,016 4,097 17,113
Oil (bbl) 661 252 913
</TABLE>
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 Hallwood's 1999 Annual
Report on Form 10-K.
<PAGE>
Accounting Policies
Consolidation
Hallwood 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
the nine months ended September 30, 2000 in the computation of diluted net
income per share because their inclusion would be antidilutive.
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 September 30, 2000
<S> <C> <C> <C>
Net income per share - basic $ 6,767 9,397 $ .72
========
Effect of options and warrants 252
----------- --------
Net income per share - diluted $ 6,767 9,649 $ .70
======= ======= ========
For the Nine Months Ended September 30, 2000
Net income per share- basic $14,215 9,706 $ 1.46
=======
Effect of options 63
----------- ---------
Net income per share- diluted $14,215 9,769 $ 1.46
====== ======= =======
For the Three Months Ended September 30, 1999
Net income per share - basic $ 155 10,000 $ .02
------- ------ ========
Net income per share - diluted $ 155 10,000 $ .02
======= ====== ========
For the Nine Months Ended September 30, 1999
Net income per share- basic $ 350 7,437 $ .05
------- ------- ========
Net income per share- diluted $ 350 7,437 $ .05
======= ======= ========
</TABLE>
<PAGE>
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.
NOTE 2 - DEBT
Hallwood's long-term debt at September 30, 2000 and December 31, 1999 consisted
of the following:
September 30, 2000 December 31, 1999
------------------ -----------------
(In thousands)
Credit Agreement $55,000 $ 86,200
Note Agreement 25,000 25,000
Debt discount (1,673) (1,843)
------- --------
Total long-term debt $78,327 $109,357
====== =======
On June 8, 1999, Hallwood 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 Hallwood's lenders under its
Credit Agreement. Effective June 30, 2000, Hallwood's Credit Agreement was
amended to reduce Hallwood's borrowing base to $70,000,000. Subsequent to
September 30, 2000, Hallwood borrowed an additional $6,000,000 under its Credit
Agreement, therefore Hallwood's unused borrowing base was $9,000,000 as of
November 8, 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 .5% or the
Euro-Dollar rate plus from 1.25% to 2.0%. The applicable interest rate was
approximately 8.6% at September 30, 2000. Interest is payable monthly. Quarterly
principal payments of $8,714,000 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 Hallwood's oil and gas properties. Additionally, total expenditures for
dividends paid and stock repurchased by Hallwood 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
Hallwood is 50% or more of the borrowing base. Total expenditures for dividends
paid and stock repurchased by Hallwood 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.
<PAGE>
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 Hallwood'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
Hallwood 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.
Hallwood 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, Hallwood enters into financial
contracts to hedge the interest rate payments under its Credit Agreement.
Hallwood 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 October 23, 2000,
Hallwood was a party to eight contracts with three different counterparties.
The following table provides a summary of Hallwood's financial contracts.
Average
Amount of Contract
Period Debt Hedged Floor Rate
Last three 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
During the nine months ended September 30, 2000, Hallwood's noncash investing
activity included the issuance of 417,406 shares of common stock for the
acquisition of oil and gas property as described in Note 6.
Cash paid for interest during the nine months ended September 30, 2000 and 1999
was $6,124,000 and $4,251,000, respectively. Cash paid for income taxes was
$594,000 during the nine months ended September 30, 2000. There was no cash paid
for income taxes during the nine months ended September 30, 1999.
NOTE 4 - STOCK OPTIONS
On January 28, 2000, the Compensation Committee of Hallwood 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 nine months ended September 30, 2000, 6,533 of these
options were exercised and 13,067 of these options expired.
<PAGE>
On June 9, 1999, the Compensation Committee of Hallwood 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, Hallwood 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 nine months
ended September 30, 2000, 36,000 of these options were cancelled.
NOTE 5 - STOCK REPURCHASES
On February 18, 2000, Hallwood 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 Hallwood approved the repurchase of
up to $5,000,000 of common and preferred stock of Hallwood 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 213,404 shares of common
stock at an average price of $6.19 per share. The Company also repurchased
26,776 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 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.
During the third quarter of 2000, the Company purchased 100,000 shares of its
common stock at $8.625 per share. These shares are held as treasury shares by
the Company.
NOTE 6 - PROPERTY ACQUISITION
On August 30, 2000, Hallwood completed the acquisition of interests in 34
producing wells, five service wells and 69 inactive wells in five fields located
in Chambers, San Patricio and Frio Counties in Texas and St. James and
Assumption Parishes in Louisiana, as well as approximately 7,000 acres of
undeveloped leasehold and 3-D seismic data. The total purchase price was
comprised of $4,000,000 in cash and 417,406 shares of Hallwood's common stock
valued at $3,314,000.
NOTE 7 - PROPERTY SALES
During the first nine months of 2000, Hallwood 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 nine months of 2000 were $21,437,000 of which
$21,000,000 was used to pay down borrowings under the Credit Agreement.
<PAGE>
NOTE 8 - LEGAL SETTLEMENTS
In connection with the Consolidation, Hallwood 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, Hallwood 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, and was received by the Company during
the third quarter of 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
Hallwood 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.
Pro Forma Results
The following pro forma information is prepared as if the Consolidation had been
completed on January 1, 1999.
For the Nine Months Ended
September 30,
2000 1999
---- ----
(In thousands except price)
Prices
Gas (per mcf) $2.55 $1.87
Oil (per bbl) $23.80 $14.92
Production
Gas (mcf) 17,095 17,113
Oil (bbl) 533 913
Gas revenues $43,672 $31,988
Oil revenues 12,683 13,619
Production operating expenses 15,119 15,815
<PAGE>
Liquidity and Capital Resources
Cash Flow
Hallwood had $25,829,000 of cash flow from operating activities during the first
nine months of 2000.
Primary cash inflows were:
o Proceeds from the sale of properties of $21,437,000; 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 $19,194,000;
o Payments of long-term debt of $32,200,000;
o Purchase of preferred and common stock of $5,123,000; and
o Dividends to preferred shareholders of $1,705,000.
When combined with miscellaneous other cash activity during the period, the
result was a decrease of $9,926,000 in Hallwood's cash from $10,480,000 at
December 31, 1999 to $554,000 at September 30, 2000.
Production and Capital Spending
Hallwood expects total year 2000 production to approximate 27.0 bcfe which will
represent an increase of 13% over the 23.8 bcfe produced in 1999. September's
daily production totaled 67 mmcfe per day which is approximately 5 mmcfe/day
lower than June 2000 production rates. The reduction in rate is due primarily to
reduced rates from the Bol Mex 3 well described below (4 mmcfe/day net), high
line pressure in its South Canyon production area (1 mmcfe/day net) and
continuing line pressure problems with San Juan Basin production. Hallwood
expects to address the problems causing the rate reductions through remedial
downhole procedures which may reinstate higher or initial production rates on
the Bol Mex 3 well (if the procedures are deemed to be economically viable) as
well as the addition of, new gas sales delivery points in the San Juan Basin,
scheduled for connection this year, which may yield 4-5 mmcfde of increased
production net to Hallwood. Hallwood is also pursuing line looping with the
gatherer for South Canyon; however, no definite plans exist at this time.
Hallwood is experiencing what it believes to be an industry wide shortage of oil
field goods and services. This shortage has resulted in the delay of drilling
certain wells and other work procedures and may continue to cause delays in
future periods. Hallwood is unable to quantify the potential impact of the
foregoing on estimated production, sales or any other economic barometer.
Capital spending is expected to reach $32,000,000 for the year 2000. Hallwood
has not set budget for the year 2001 and expects to do so in early 2001.
Exploration and Development Projects and Acquisitions
Through September 30, 2000, Hallwood incurred $19,194,000 in cash for property
additions, development, exploitation, and exploration costs. The costs were
comprised of $8,405,000 for property additions and approximately $10,789,000 for
domestic exploration and development. Hallwood also issued shares of its stock
valued at $3,314,000 as part of a property acquisition completed in the third
quarter. Hallwood's original 2000 capital budget of $24,000,000 has been
increased to $32,000,000 to reflect property acquisitions, expanded exploration
and development activity and share repurchases as discussed in Note 5 of the
accompanying financial statements. The significant capital expenditures through
September 30, 2000 are as follows.
Gulf Coast Region
During the first nine months of 2000, Hallwood expended approximately
$15,190,000 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, Hallwood successfully completed a 13,600-foot Bol Mex
3 well located in the Scott Field. The well had stabilized production rates of
approximately 25,000 mcf per day and 500 barrels of oil per day through
mid-August, but as a result of sand production has since been choked back to its
current level of approximately 10,000 mcf per day and 225 barrels of oil per
day. In 2000, Hallwood's drilling and completion costs for the well are
approximately $1,627,000. Hallwood owns an approximate 35% working interest in
the well. The originally targeted upper zone remains as behind pipe proved
nonproducing reserves while the lower zone is produced. Hallwood's plans in the
area include a Bol Mex 16 exploration well testing sands which are productive in
nearby fields and a Flambeau prospect exploration well testing Marg Tex sands
productive in the adjacent fault block. Klump drilling is expected to commence
in the first quarter of 2001, subject to drilling rig availability. Land and
leasehold costs incurred this year for this Klump drilling were approximately
$161,000. Hallwood will have an approximate 33% working interest in the well
that has a gross 200 bcfe potential and an estimated $3.8 million completed well
cost. Marg Tex drilling is also expected to commence in the first quarter of
2001. Hallwood will have a 35% working interest in this well that has a 22 bcfe
potential and is estimated to have a $1.2 million dry hole cost. Hallwood also
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 September 30, 2000, Hallwood
continued its participation with non-operated and operated Wilcox projects
located in the Yoakum Gorge area of Lavaca County, Texas. Hallwood participated
with three different operators in the drilling of six non-operated wells. Four
of the wells, with working interests of 12.5%, 3.1%, 15.9% and 12.5% are
producing at a combined rate of 8,000 gross mcf per day, 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 Hallwood has a 28.8% working interest has been placed on
production at 4,500 mcf per day. Another operated, unsuccessful recompletion was
attempted in an uphole sand. Hallwood owns a 90% working interest in this well.
Hallwood's exploration and development expenditures in the Yoakum Gorge area
have totaled approximately $2,827,000 during the first nine months of 2000.
Hallwood anticipates continued activity in the area resulting from additional
exploitation of the 1999 Seisgen Acquisition and from third quarter expenditures
of $2,143,000 to acquire land and additional 3-D seismic data. With the recent
seismic acquisition, Hallwood now owns approximately 381 square miles of 3-D
seismic data in the area. Hallwood is currently evaluating opportunities for
three additional Lower Wilcox locations in the fourth quarter of this year.
In the first nine months of 2000, Hallwood participated in the drilling or
recompletion of six wells in neighboring Victoria County, Texas, where the
objective was the shallower Frio sands. Three of the wells are producing and two
are waiting on completion. Hallwood averages a 5% working interest in the wells.
In addition, Hallwood anticipates that its drilling activity in the shallower
Frio and Yegua formations in Lavaca County will increase over the next several
quarters. While the potential reserves in these shallower wells are not as great
as in the Wilcox, averaging between .5 bcfe and 1.5 bcfe gross per well, the
risk and expense to drill the wells are lower.
Goliad County Expanded Wilcox Project. During the first nine months of 2000, a
16,500-foot non-operated, discovery well was completed in the Upper Wilcox, and
is producing approximately 8,000 mcf per day. Hallwood owns a 20.8% working
interest in the well. Additional exploitation and exploration wells are
possible, but the performance of the discovery well continues to be assessed
prior to proceeding. Hallwood's drilling and leasehold acquisition costs during
2000 totaled approximately $1,311,000.
Bell Prospect. During the first nine months of 2000, Hallwood incurred
approximately $912,000 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. The wells are currently producing at a combined
rate of approximately 500 gross barrels of oil per day. Hallwood owns 36%
working interests in the two wells. Hallwood plans to propose another location
to be drilled in the fourth quarter of 2000 or during 2001, subject to rig
availability. Hallwood will have an approximate 35% working interest in this
well.
<PAGE>
Boca Chica Prospect. Hallwood plans to participate in the reentry of a
directionally drilled 10,000 foot exploration well in the Big Hum formation from
the shore to the bottom hole location under the waters of the Gulf of Mexico. A
twenty-three square mile proprietary seismic shoot has been completed in the
area. Hallwood will have an approximate 25% working interest in the well which
has unrisked reserve potential of 2.0 bcfe. The reserve potential for the field
in which this exploratory well is located is 70 bcfe and would require the
drilling of multiple wells.
Property Acquisition. On August 30, 2000, Hallwood completed the acquisition of
interests in 34 producing wells, five service wells and 69 inactive wells in
five fields located in Chambers, San Patricio and Frio Counties in Texas and St.
James and Assumption Parishes in Louisiana, as well as approximately 7,000 acres
of undeveloped leasehold and 3-D seismic data. Total consideration included
approximately $4.0 million in cash and Hallwood stock valued at approximately
$3.3 million. The properties include 13 bcfe of proved reserves, 21% of which
are proved developed producing. Hallwood plans to spend more than $4,000,000
over the next two years developing the proved undeveloped reserves and
anticipates spending $2,000,000 over the next two years to acquire or shoot 3-D
seismic. Hallwood feels that significant additional recoveries may be gained
with the application of 3-D seismic imaging. This acquisition yields an
estimated purchase cost per mcfe of $0.60, and replaces approximately 50% of
estimated 2000 production. Hallwood believes this acquisition fits strategically
with its ongoing activities in the Gulf Coast and South Texas and Hallwood will
operate virtually all of the properties acquired.
Rocky Mountain Region
Through the third quarter of 2000, Hallwood expended approximately $1,657,000 of
its capital budget in the Rocky Mountain Region located in Colorado and
Northwest New Mexico. Of this amount, Hallwood incurred approximately $800,000
in the Colorado Western Slope area to drill two wells, workover two wells and
perform maintenance work on several others. The post-workover production rates
have increased on the wells undergoing the workovers. One of the two drilled
wells came on at 2,500 mcf per day, declined rapidly, and is waiting for further
stimulation of all the pay zones pending rig availability. In addition, during
the first quarter of 2000, Hallwood 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. Hallwood's costs incurred on this
well through the third quarter of 2000 were approximately $289,000.
San Juan Basin Project - Colorado and New Mexico. Hallwood, 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. Hallwood anticipates that infill drilling in
Colorado could begin as soon as 2001, and is actively making preparations to do
so. Hallwood historically has not included these locations in its proven reserve
base, but plans to classify most of these as proved undeveloped reserves by year
end. Using prices at September 30, 2000, Hallwood's share of these locations
would increase proven reserves by approximately 35 bcf. Hallwood has the right
to acquire the remaining reserves attributable to the Colorado Fruitland Coal
locations, approximately 18 net bcfe, in January 2003. In addition to the
Colorado locations, Hallwood has the potential for 12 similar locations in New
Mexico if infill drilling is permitted there. It is estimated that at current
pricing these additional locations would add approximately 25 net bcfe in
reserve volumes. Hallwood has not made application for infill drilling locations
in New Mexico.
During the second quarter of 2000, Hallwood recompleted one well in the Colorado
San Juan area which is presently dewatering. Hallwood's costs totaled
approximately $129,000 and Hallwood has an 85% working interest in the well.
Prior to the recompletion, the well had not produced since April 1999. Also in
the area, Hallwood participated in sidetracking a nonoperated Colorado San Juan
well. Hallwood incurred approximately $90,000 and the current production is
2,800 mcf per day compared to 1,800 mcf per day prior to the sidetrack. Hallwood
has a 40% working interest in the well. In the third quarter of 2000, Hallwood
completed a workover on another well in which Hallwood has a 60% working
interest. Post workover production rates increased by 700 mcf per day gross.
Hallwood has another recompletion planned in the fourth quarter of 2000.
<PAGE>
Hallwood currently has two pipeline projects underway in this basin. The first
project came on line during October 2000 and is expected to increase production
through backpressure reduction by 1,000 mcf per day gross. The second project is
currently under construction and is expected to be complete in the first quarter
of 2001. Hallwood anticipates production to increase by 3,000 mcf per day gross
when this project is completed.
Greater Permian Region and Other
The remaining $2,347,000 of Hallwood's capital expenditures incurred during the
first nine months of 2000 primarily relate to projects in the Greater Permian
Region and for technical general and administrative expenditures. Two successful
non-operated wells were drilled in Gaines County, Texas. The wells were
completed in the Leonard sand at approximately 8,000 feet. Hallwood owns a
17.50% working interests in the wells and has incurred costs of approximately
$231,000 through the third quarter of 2000. Two 7,850-foot operated Spraberry
wells were successfully drilled in the first nine months of 2000. The first well
was completed and is currently producing approximately 60 gross barrels of oil
per day. The second well is awaiting completion. Hallwood's costs for the two
wells to date are approximately $618,000. Hallwood owns an approximate 87%
working interest in the completed well and approximately 78% in the second well.
Hallwood is contemplating an infill drilling program in the Spraberry area.
Hallwood estimates that over one hundred 80-acre infill drilling locations exist
in this area and that the top 40 prospects could yield a rate of return in
excess of 40% at commodity pricing lower than current pricing. West Texas
Permian production is very predictable, and a drilling program coupled with an
appropriate crude oil hedging program can be expected to yield relatively safe
and adequate returns. The remainder of Hallwood's costs are associated
principally with technical general and administrative expenditures totaling
approximately $1,364,000, and for numerous other projects which are completed or
underway and which are individually less significant.
Property Divestments
During the first nine months of 2000, Hallwood 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 third
quarter of 2000 were approximately $21,437,000. The wells sold represent
approximately 35% of Hallwood's total well count as of the beginning of the
year, approximately 16% of Hallwood's reserve value, and approximately 11% of
its operating cash flow based on five year average reserve pricing. The
completion of Hallwood's 2000 sales effort has enabled Hallwood to reduce its
level of debt, reduce its administrative overhead, and to focus on its core
areas of Colorado, New Mexico, Texas, and Louisiana.
Dividends
On September 14, 2000, Hallwood declared a quarterly dividend of $.25 per Series
A Cumulative Preferred share, payable on November 15, 2000 to shareholders of
record on September 30, 2000. This amount was accrued as of September 30, 2000.
The Series A Cumulative Preferred Stock has a dividend preference of $1.00 per
share per year. Hallwood may not declare or pay dividends to common shareholders
unless full cumulative dividends have been paid on the preferred stock.
Stock Repurchases
On February 18, 2000, Hallwood 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 Hallwood approved the repurchase of
up to $5,000,000 of common and preferred stock of Hallwood 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 213,404 shares of common
stock at an average price of $6.19 per share. The Company also repurchased
26,776 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 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.
During the third quarter of 2000, the Company purchased 100,000 shares of its
common stock at $8.625 per share. These shares are held by the Company as
treasury shares.
Financing
Hallwood's long-term debt at September 30, 2000 and December 31, 1999 consisted
of the following:
September 30, 2000 December 31, 1999
------------------ -----------------
(In thousands)
Credit Agreement $55,000 $ 86,200
Note Agreement 25,000 25,000
Debt discount (1,673) (1,843)
------- ---------
Total long-term debt $78,327 $109,357
====== =======
On June 8, 1999, Hallwood 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 Hallwood's lenders under its
Credit Agreement. Effective June 30, 2000, Hallwood's Credit Agreement was
amended to reduce Hallwood's borrowing base to $70,000,000. Subsequent to
September 30, 2000, Hallwood borrowed an additional $6,000,000 under its Credit
Agreement, therefore, Hallwood's unused borrowing base was $9,000,000 as of
November 8, 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 .5% or the
Euro-Dollar rate plus from 1.25% to 2.0%. The applicable interest rate was
approximately 8.6% at September 30, 2000. Interest is payable monthly. Quarterly
principal payments of $8,714,000 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 Hallwood's oil and gas properties. Additionally, total expenditures for
dividends paid and stock repurchased by Hallwood 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
Hallwood is 50% or more of the borrowing base. Total expenditures for dividends
paid and stock repurchased by Hallwood 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.
<PAGE>
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 Hallwood'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
Hallwood 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.
Hallwood 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, Hallwood enters into financial
contracts to hedge the interest rate payments under its Credit Agreement.
Hallwood 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 October 23, 2000,
Hallwood was a party to eight contracts with three different counterparties.
The following table provides a summary of Hallwood's financial contracts.
Average
Amount of Contract
Period Debt Hedged Floor Rate
Last three 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, objectives and expectations. 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.
<PAGE>
Inflation and Changing Prices
Prices
Prices obtained for oil and gas production depend upon numerous factors that are
beyond the control of Hallwood, 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
third quarter of 2000. The following table presents the weighted average prices
received each quarter by Hallwood 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>
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
Third quarter - 2000 30.69 23.51 3.77 2.84
</TABLE>
As part of its risk management strategy, Hallwood 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.
Hallwood'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, Hallwood 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 Hallwood to hedge the price of its oil and
natural gas production are swaps and collars. Under the swap contracts, Hallwood
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 October 23, 2000, Hallwood
was a party to 30 financial contracts with four different counterparties.
The following tables provide a summary of Hallwood's outstanding financial
contracts:
Oil Contract
-----------------------
Percent of Production Delivered
Period Hedged Price
(per bbl)
Last three months of 2000 58% $18.55
2001 32 20.59
<PAGE>
Gas Contract
--------------------
Percent of Production Delivered
Period Hedged Price
(per mcf)
Last three months of 2000 56% $ 2.16
2001 60 2.14
2002 33 1.95
Between 8% and 12% of the gas volumes hedged in each year are subject to a
collar agreement under which Hallwood 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 fourth quarter through October 23, 2000, the weighted average oil
price (for barrels not hedged) was approximately $31.90 per barrel. The weighted
average price of natural gas (for mcf not hedged) during that period was
approximately $4.85 per mcf.
Inflation
Inflation did not have a material impact on Hallwood 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.
Third Quarter of 2000 Compared to the Third Quarter of 1999
The following table is presented to contrast Hallwood'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) 5,308 5,476
Price (per mcf) $ 2.84 $ 1.95
Oil
Production (bbl) 149 278
Price (per bbl) $23.51 $18.21
Gas Revenue
Gas revenue increased $4,515,000 during the third quarter of 2000 compared with
the third quarter of 1999. The increase is the result of an increase in the
average gas price from $1.95 per mcf in 1999 to $2.84 per mcf in 2000, partially
offset by a decrease in production from 5,476,000 mcf in 1999 to 5,308,000 in
2000. The decrease in production is primarily due to the property sales during
the first and second quarters of 2000, partially offset by increased production
from successful drilling projects during 2000 as well as a property acquisition
made by Hallwood during the fourth quarter of 1999.
The effect of Hallwood's hedging transactions as described under "Inflation and
Changing Prices," during the third quarter of 2000, was to decrease Hallwood's
average gas price from $3.77 per mcf to $2.84 per mcf, representing a $4,936,000
decrease in revenue from hedging transactions.
Oil Revenue
Oil revenue decreased $1,560,000 during the third quarter of 2000 compared with
the third quarter of 1999. The decrease is the result of a decrease in
production from 278,000 barrels in 1999 to 149,000 barrels in 2000, partially
offset by an increase in the average oil price from $18.21 per barrel in 1999 to
$23.51 per barrel in 2000. The production decrease is primarily due to property
sales during the first and second quarters of 2000.
The effect of Hallwood's hedging transactions during the third quarter of 2000
was to decrease Hallwood's average oil price from $30.69 per barrel to $23.51
per barrel, resulting in a $1,070,000 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 $774,000 during the third quarter of 2000 compared with the
third quarter of 1999. The increase is primarily due to a one-time downward
adjustment to incentive payment income during 1999, which related to gas
measurements made in prior periods.
Interest Income
Interest income increased $65,000 during the third quarter of 2000 compared with
the third quarter of 1999 primarily due to a higher average cash balance during
2000.
Production Operating
Production operating expense increased $18,000 during the third quarter of 2000
compared with the third quarter of 1999. The increase is the result of increased
operating expenses from the drilling projects and the property acquisition
discussed above, 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
Hallwood. These expenses decreased $202,000 during the third quarter of 2000.
The decrease is primarily due to Hallwood's reduction in its work force during
April 2000. The work force reduction was made to reflect the operational
efficiencies caused by the property sales during the first and second quarters
of 2000.
Depreciation, Depletion and Amortization Expense
Depreciation, depletion and amortization expense decreased $384,000 during the
third quarter of 2000 compared with the third quarter of 1999. The decrease is
primarily the result of lower capitalized costs in 2000 due to the property
sales discussed above.
Interest
Interest expense decreased $278,000 during the third quarter of 2000 compared
with the third quarter of 1999 due to a lower average outstanding debt balance
during 2000.
<PAGE>
Provision (Benefit) for Income Taxes
The current benefit for income taxes during the third quarter of 2000 is
comprised of a benefit for both federal and state income taxes. The benefit
resulted from a production decline during late 1999 on two significant wells in
Louisiana. The deferred tax benefit during 2000 represents the effect of
partially removing the valuation allowance for the Company's total tax assets
which are primarily comprised of the Company's net operating loss carryforwards.
The effective tax rate during 1999 is lower than the statutory rate primarily
because of the use of net operating loss carryforwards.
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
third quarter of 2000 reflects the liquidation of the last three May
Partnerships in April 2000.
First Nine Months of 2000 Compared to First Nine Months of 1999
The comparisons for the first nine months 2000 and the first nine months 1999
are consistent with those discussed in the third quarter of 2000 compared to the
third quarter of 1999 except as discussed below. The following table is
presented to contrast Hallwood'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) 17,095 13,016
Price (per mcf) $2.55 $1.89
Oil
Production (bbl) 533 661
Price (per bbl) $23.80 $15.52
Gas Revenue
Gas revenue increased $19,056,000 during the first nine months of 2000 as
compared to the first nine months of 1999. The increase is the result of an
increase in production from 13,016,000 mcf in 1999 to 17,095,000 mcf in 2000 and
an increase in price from $1.89 per mcf in 1999 to $2.55 per mcf in 2000. The
increase in production is primarily due to the Consolidation partially offset by
the production decline discussed above.
The effect of Hallwood's hedging transactions during the first nine months of
2000 was to decrease Hallwood's average gas price from $3.05 to $2.55 per mcf
representing a $8,548,000 decrease in revenue from hedging transactions.
Oil Revenue
Oil revenue increased $2,422,000 during the first nine months of 2000 compared
with the first nine months of 1999. The increase is the result of an increase in
price from $15.52 per barrel in 1999 to $23.80 per barrel in 2000, partially
offset by a decrease in production from 661,000 mcf in 1999 to 533,000 mcf in
2000. The decreased production is primarily due to the property sales discussed
above, partially offset by the increased production from the Consolidation.
The effect of Hallwood's hedging transactions during the first nine months of
2000 was to decrease Hallwood's average oil price from $28.74 per barrel to
$23.80 per barrel resulting in a $2,633,000 reduction in revenue from hedging
transactions.
<PAGE>
Pipeline, Facilities and Other
Pipeline, facilities and other revenue increased $1,650,000 during the first
nine months of 2000 compared with the first nine months of 1999. The increase is
primarily due to additional revenue from the Consolidation as well as the
increase during the third quarter of 2000 discussed above.
Production Operating
Production operating expense increased $3,391,000 during the first nine months
of 2000 compared with the first nine months of 2000. The majority of the
increase is the result of the Consolidation and increased operating expenses
described above, partially offset by property sales during the first and second
quarters of 2000.
General and Administrative
General and administrative expenses increased $1,238,000 during the first nine
months of 2000 compared with the first nine months of 1999. The increase is
primarily due to the Consolidation, the one-time severance related costs paid in
connection with the previously described work force reduction partially offset
by the reduced salary costs resulting from the work force reduction.
Depreciation, Depletion and Amortization
Depreciation, depletion and amortization expense increased $3,430,000 during the
first nine months of 2000 compared with the first nine months of 1999. The
increase is primarily the result of a higher depletion rate due to the increased
production described above.
Equity in Loss of HCRC
Equity in loss of HCRC represents Hallwood's share of its equity investment in
HCRC prior to the Consolidation. This loss decreased to zero during the first
nine months of 2000, compared with the first nine months of 1999, as a result of
the Consolidation.
Litigation
Litigation expense during the first nine months of 2000 is comprised of the
costs related to the settlement of the employment litigation described in Note 8
of the accompanying financial statements. This expense was partially offset by
insurance proceeds which reimbursed a portion of the costs paid to settle the
lawsuits assumed by Hallwood in connection with the Consolidation as described
in Note 8 of the accompanying financial statements. Litigation income during the
nine months ended September 30, 1999 represents the proceeds from a property
related claim.
<PAGE>
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Hallwood's primary market risks relate to changes in interest rates and in the
prices received from sales of oil and natural gas. Hallwood'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, Hallwood 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, Hallwood 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. Hallwood 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.
Hallwood does not use or hold derivative instruments for trading purposes nor
does it use derivative instruments with leveraged features. Hallwood's
derivative instruments are designated and effective as hedges against its
identified risks, and do not of themselves expose Hallwood 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. Hallwood 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 Hallwood'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) - Hallwood 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 Hallwood'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 October 23, 2000, Hallwood has
entered into derivative commodity hedges covering an aggregate of 296,000
barrels of oil and 18,300,000 mcf of gas that extend through 2002. Under these
contracts, Hallwood 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
September 30, 2000 would cause a loss in income and cash flows of $2,551,000
during the remaining three 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 $1,494,000 increase in income and cash flows associated with the oil and
natural gas derivative contracts that are in effect for the remaining three
months of 2000.
<PAGE>
Interest Rate Risks (non-trading) - Hallwood uses both fixed and variable rate
debt to partially finance operations and capital expenditures. As of September
30, 2000, Hallwood's debt consisted of $55,000,000 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. Hallwood 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, Hallwood 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 Hallwood'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 $275,000
during the remaining three months of 2000, assuming that outstanding borrowings
under the Credit Agreement remain at September 30, 2000 levels. This loss in
income and cash flows would be offset by a $225,000 increase in income and cash
flows associated with the interest rate swap and collar agreements that are in
effect for the remaining three 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 8 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
None.
ITEM 5 - OTHER INFORMATION
None.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
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: November 8, 2000 By: /s/William J.Baumgartner
---------------------------- --------------------------------
William J. Baumgartner, Vice President
(Chief Financial Officer)
