<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the Quarterly Period Ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
Commission File No. 0-9976
ARCH PETROLEUM INC.
(Exact name of registrant as specified in its charter)
Delaware 83-0248900
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
777 Taylor Street, Suite II, Fort Worth, Texas 76102
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (817) 332-9209
(Former name, former address and former fiscal year, if changed since
last report.)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at July 31, 1998
Common Stock, $.01 Par Value 17,321,804
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ARCH PETROLEUM INC.
INDEX
Page
Part I. FINANCIAL INFORMATION
Item 1.
CONSOLIDATED BALANCE SHEETS -
June 30, 1998 and December 31, 1997 ................... 3
CONSOLIDATED STATEMENTS OF OPERATIONS -
Three and six months ended June 30, 1998 and 1997 ..... 5
CONSOLIDATED STATEMENTS OF CASH FLOWS -
Six months ended June 30, 1998 and 1997 ............... 6
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.......... 7
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS ................... 8
Part II.OTHER INFORMATION
Item 1.
Legal Proceedings ....................................... N/A
Item 2.
Changes in Securities ................................... N/A
Item 3.
Defaults upon Senior Securities ......................... N/A
Item 4.
Submission of Matters to a Vote of Security Holders ..... N/A
Item 5.
Other Information ....................................... N/A
Item 6.
Exhibits and Reports on Form 8-K
a. Exhibits .......................................... N/A
b. Reports on Form 8-K ............................... 10
SIGNATURES .................................................. 11
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<TABLE>
ARCH PETROLEUM INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
<S> <C> <C>
ASSETS
June 30, December 31,
1998 1997
Current Assets:
Cash and cash equivalents $ 924,000 $ 2,160,000
Accounts receivable - trade 3,295,000 3,585,000
Accounts receivable - related
parties 430,000 729,000
Prepaid expenses and other 643,000 544,000
Total current assets 5,292,000 7,018,000
Property and Equipment, at cost:
Oil and gas properties accounted
for by the successful efforts
method 106,764,000 99,178,000
Natural gas pipelines 5,976,000 5,657,000
Furniture, fixtures and other
equipment 1,053,000 1,033,000
113,793,000 105,868,000
Less accumulated depletion,
depreciation and amortization 28,506,000 25,320,000
Net property and equipment 85,287,000 80,548,000
Accounts receivable - related parties 1,405,000 1,406,000
Notes receivable - related parties 1,950,000 1,874,000
Deferred income taxes 1,808,000 1,511,000
Other 881,000 814,000
$ 96,623,000 $ 93,171,000
The accompanying condensed notes are an integral part of these
consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
ARCH PETROLEUM INC.
CONSOLIDATED BALANCE SHEETS
<S> <C> <C>
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY June 30, December 31,
1998 1997
Current Liabilities:
Accounts payable $ 6,767,000 $ 6,239,000
Current maturities of long-term debt 36,500,000 -
Preferred stock dividends payable 311,000 311,000
Total current liabilities 43,578,000 6,550,000
Long-term debt, less current
maturities - 30,000,000
Non-recourse production payment
obligation 15,824,000 13,317,000
Deferred revenue 310,000 2,123,000
Convertible subordinated notes 5,000,000 5,000,000
Deferred federal income taxes 4,870,000 5,770,000
Other liabilities 312,000 273,000
Exchangeable convertible preferred
stock, $.01 par value, 727,273 shares
authorized, issued and outstanding 20,000,000 20,000,000
Shareholders' Equity:
Preferred stock, $.01 par value,
1,000,000 shares authorized, 727,273
issued as exchangeable convertible
preferred stock - -
Common stock, $.01 par value,
50,000,000 shares authorized,
17,321,804 issued and outstanding 173,000 173,000
Additional paid-in capital 6,137,000 6,137,000
Employee notes for stock purchases (1,091,000) (1,047,000)
Treasury stock, 100,000 shares (206,000) (206,000)
Cumulative translation adjustment (357,000) (219,000)
Retained earnings 2,073,000 5,300,000
6,729,000 10,138,000
$ 96,623,000 $ 93,171,000
The accompanying condensed notes are an integral part of these
consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
ARCH PETROLEUM INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Revenues:
Oil and gas sales $ 4,841,000 $ 5,403,000 $ 9,379,000 $ 11,921,000
Pipeline sales 1,351,000 21,705,000 2,578,000 48,147,000
Interest and other 143,000 199,000 269,000 382,000
6,335,000 27,307,000 12,226,000 60,450,000
Costs and Expenses:
Oil and gas lease
operations 2,786,000 1,887,000 5,116,000 3,989,000
Natural gas
purchases and
pipeline
operations 1,189,000 20,883,000 2,349,000 46,207,000
Exploration 55,000 127,000 144,000 202,000
Depletion,
depreciation and
amortization 1,799,000 1,766,000 3,380,000 3,434,000
General and
administrative 1,663,000 1,430,000 2,677,000 2,667,000
Interest 1,191,000 1,052,000 2,279,000 2,040,000
Foreign currency
transaction (gain)
loss 63,000 (66,000) (49,000) 41,000
Minority interest
in income of
consolidated
subsidiaries - 141,000 - 448,000
8,746,000 27,220,000 15,896,000 59,028,000
Income (loss)
before income
taxes and
dividends (2,411,000) 87,000 (3,670,000) 1,422,000
Income tax expense
(benefit) (788,000) 32,000 (1,243,000) 466,000
Net income (loss)
before dividends (1,623,000) 55,000 (2,427,000) 956,000
Dividends on
preferred stock 400,000 400,000 800,000 800,000
Net income (loss)
available to common
shareholders $(2,023,000) $ (345,000) $(3,227,000) $ 156,000
Net income (loss)
per common share -
basic and diluted $ (0.12) $ (0.02) $ (0.19) $ 0.01
Weighted average
common shares
outstanding -
basic 17,322,000 17,285,000 17,322,000 17,287,000
The accompanying condensed notes are an integral part of these
consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
ARCH PETROLEUM INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
1998 1997
<S> <C> <C>
Cash flows from operating
activities:
Net income (loss) $(2,427,000) $ 956,000
Adjustments to reconcile
to net cash from operations:
Depletion, depreciation and
amortization 3,380,000 3,434,000
Deferred revenue (746,000) (1,196,000)
Deferred income taxes (1,243,000) 357,000
Dry hole costs and other 66,000 -
Interest on production payment
obligation 712,000 457,000
Interest on notes receivable
and other (184,000) (90,000)
Minority interest in net income
of consolidated subsidiaries - 448,000
Foreign currency transaction
(gain) loss (49,000) 41,000
(491,000) 4,407,000
Change in accounts receivable 524,000 4,097,000
Change in other current assets (102,000) 388,000
Change in accounts receivable -
related parties 364,000 (92,000)
Change in accounts payable and
other current liabilities 620,000 (3,135,000)
Production payment remedy adjustment (177,000) (245,000)
Net operating cash flows 738,000 5,420,000
Cash flows from investing activities:
Capital expenditures (7,482,000) (7,865,000)
Notes receivable and other assets (192,000) (216,000)
Net investing cash flows (7,674,000) (8,081,000)
Cash flows from financing activities:
Proceeds from bank borrowing 7,500,000 6,000,000
Payments of bank debt (1,000,000) (3,064,000)
Payment of preferred stock dividends (800,000) (800,000)
Proceeds from note payable - minority
interest holder - 73,000
Net financing cash flows 5,700,000 2,209,000
Change in cash and cash equivalents (1,236,000) (452,000)
Cash and cash equivalents at beginning
of period 2,160,000 3,192,000
Cash and cash equivalents at end of
period $ 924,000 $ 2,740,000
The accompanying condensed notes are an integral part of these
consolidated financial statements.
</TABLE>
<PAGE>
ARCH PETROLEUM INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In the opinion of Arch Petroleum Inc. (the "Company"), the
accompanying consolidated financial statements, which have not been
audited by independent public accountants, contain all adjustments
necessary to present fairly the Company's consolidated financial
position, the results of its operations and its cash flows for the
periods reported. The consolidated financial statements include the
accounts of the Company and its subsidiaries. All significant
intercompany balances and transactions are eliminated. Certain
information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. Certain prior amounts
have been reclassified to conform to 1998 presentation. It is
suggested that these consolidated financial statements be read in
conjunction with the consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K as of
December 31, 1997. The results of operations for the three months and
six months ended June 30, 1998 and 1997 are not necessarily
indicative of the results to be expected for a full year.
Effective January 1, 1998, the Company adopted Statement of
Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income". Comprehensive income as defined by SFAS No.
130 is net income plus direct adjustments to shareholders' equity.
The cumulative translation adjustment of the Company's Canadian
subsidiary, Arch Petroleum Ltd. ("APL"), is the only such direct
adjustment recorded by the Company.
<TABLE>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Comprehensive income:
Net income (loss) $(1,623,000) $ 55,000 $(2,427,000) $ 956,000
Cumulative translation
adjustment, net of
tax (186,000) 17,000 (138,000) (55,000)
Total comprehensive
income (loss) $(1,809,000) $ 72,000 $(2,565,000) $ 901,000
</TABLE>
<PAGE>
On May 28, 1998, the Company and Pogo Producing Company ("Pogo")
entered into a definitive Agreement and Plan of Merger (the "Merger
Agreement") that will provide for a tax-free, stock for stock
transaction through which the Company will become a wholly owned
subsidiary of Pogo. The Merger Agreement provides for a fixed
exchange ratio of one share of Pogo common stock for 10.4 shares of
the Company's common stock. In addition, holders of the Company's
preferred stock will receive one share of Pogo common stock for each
1.04 shares of preferred stock they hold. Former holders of the
Company's stock will hold approximately six percent of Pogo common
stock after the merger. The total number of outstanding Pogo shares
after the merger will be approximately 40,100,000 shares. Based on
the Company's closing price of $2.47 on May 28, 1998, and the
assumption of approximately $48.5 million of the Company's debt and
production payment obligations, the transaction has a total value of
approximately $115 million.
The Boards of Directors of both Pogo and the Company unanimously
approved the merger; however, the merger is also subject to approval
by the Company's shareholders and to customary regulatory approvals.
Executive officers and directors of the Company, Threshold
Development Corporation and all of the holders of the Company's
preferred stock, representing approximately 47% of Arch's outstanding
stock entitled to vote on the merger at the shareholders meeting,
have entered into agreements with Pogo agreeing to vote in favor of
the merger. A special meeting of shareholders of the Company will
take place on August 14, 1998, wherein the shareholders will be asked
to approve and adopt the Merger Agreement. If approved, the Merger
Agreement will be closed on or about August 17, 1998. The merger is
expected to be accounted for as a pooling of interests and qualify as
a tax-free reorganization.
ARCH PETROLEUM INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
With the exception of historical information, the matters
discussed herein are forward-looking statements that involve risks
and uncertainties including, but not limited to, oil and gas price
fluctuations, economic conditions, reserve estimates, interest rate
fluctuations, the regulatory and political environments, estimated
volumes of gas to be delivered pursuant to the volumetric production
payment and other risks indicated in filings with the Securities and
Exchange Commission.
The Company operates in an industry that is subject to volatile
prices for its products. Cash flows from operations may be affected
to a significant degree by fluctuations in prices that are brought on
by factors beyond the Company's control.
<PAGE>
Liquidity and Capital Resources
In 1998 the Company's chief sources of funds were $6.5 million
(net) from its bank credit facilities and $0.7 million from
operations. Cash flows from operations were decreased by
approximately $4.7 million in 1998 as compared to 1997 as a result of
lower than normal oil and gas prices. These funds were primarily
used to fund $3.5 million of domestic drilling, primarily in New
Mexico and West Texas, $4.0 million for the drilling of new wells in
Canada, including construction of supporting facilities and
pipelines, and $0.8 million for preferred stock dividends.
The Company participates in two bank credit facilities: the
Third Restated Revolving Credit Loan Agreement among the Company and
Bank One, Texas, NA, the Agent bank and other banks (the "Domestic
Revolver"), and the Credit Agreement among APL and Bank of Montreal,
the Canadian Agent bank (the "Canadian Revolver"). The Agent bank
and the Canadian Agent bank together are (the "Lenders"). The two
credit facilities are separate bank revolvers.
The Company's Revolvers are in place for use by the Company at
its discretion for certain activities including drilling, development
and acquisition of oil and gas properties. The Company has borrowed
$22.5 million and $14.0 million against the Domestic and Canadian
Revolvers at June 30, 1998, respectively. The Revolvers' borrowing
base is the amount that the Lenders commit to loan to the Company
based on the designated loan value established by the Lenders at
their sole discretion and assigned to certain of the Company's oil
and gas properties which serve as collateral for any loan which may
be outstanding under the Revolvers. The Revolver facility is $50.0
million and the borrowing base is currently allocated $23.0 million
Domestic and $14.0 million Canadian. The Revolvers' borrowing base is
reviewed semiannually by the Lenders at their discretion. A
commitment fee of one half of one percent of the unused borrowing
base accrues and is payable quarterly. The Revolvers mature on May
1, 1999. Borrowings under the Revolvers will, at the Company's
option, bear interest either at the Lenders' Base Rate or a rate
based on the London Interbank Offered Rate (LIBOR). The effective
interest rate realized was 8.19% at June 30, 1998.
The Revolvers contain normal and standard covenants generally
found in lending agreements. Among other things, these covenants
prohibit the declaration and payment of cash dividends on the
Company's common stock. In addition, the covenants stipulate the
maintenance of financial criteria including: a minimum level of net
worth, a certain current ratio, a certain debt to net worth ratio and
a defined net income in excess of scheduled interest and principal
payments.
The entire $36.5 million due under the Revolvers has been
classified as current on the June 30, 1998 Consolidated Balance
Sheets because the Revolvers mature within one year. As a result,
the Company is in technical default with certain covenants in the
loan agreements. If the Merger Agreement is not consummated, the
Company will begin discussions with its Lenders to extend its bank
credit facilities. The Company has no other unused lines of credit.
<PAGE>
Results of Operations
Six months ended June 30, 1998 compared to
six months ended June 30, 1997
The Company recorded a net loss before dividends of $2,427,000
in 1998 as compared to net income of $956,000 before dividends in
1997. Total revenues and expenses decreased as a result of
diminished natural gas pipeline segment operations after the sale of
a pipeline subsidiary effective June 30, 1997. Net income was
decreased primarily as a result of lower oil and gas prices during
1998.
Revenues from oil and gas sales decreased $2,542,000 in 1998 as
compared to 1997. Oil production increased to 336,000 barrels in
1998 as compared to 307,000 barrels in 1997, resulting in a $590,000
sales increase. The Company has begun realizing production from the
new wells drilled during late 1997 and early 1998. The average price
received for oil was $14.12 in 1998 as compared to $20.58 in 1997,
resulting in a $2,168,000 sales decrease. Gas production in 1998
increased to 2,813,000 Mcf as compared to 2,684,000 Mcf in 1997,
resulting in a $270,000 sales increase. The increase in gas
production is attributable primarily to new wells drilled in Canada
in late 1997. The average price received for gas decreased to $1.65
in 1998 as compared to $2.09 in 1997, resulting in a $1,233,000 sales
decrease. The average price received for gas excluding certain
production payment volumes was $1.83 in 1998 as compared to $2.94 in
1997.
Lease operating expenses ("LOE") related to oil and gas
properties increased $1,127,000 as a result of the new wells drilled
during 1998 and general increases in the cost of field services.
Lifting costs per equivalent barrel increased in 1998 to $6.36 from
$5.29 in 1997 primarily as a result of increases in the cost of
services.
Interest expense increased $239,000 in 1998 due entirely to
interest associated with the accounting treatment of volume
deficiencies related to the production payment obligation. Interest
related to the production payment obligation of $712,000 and $457,000
in 1998 and 1997, respectively, is a non-cash item that is added back
to cash flows in the Consolidated Statements of Cash Flows.
<PAGE>
Three months ended June 30, 1998 compared to
three months ended June 30, 1997
The Company recorded a net loss before dividends of $1,623,000
in 1998 as compared to net income of $55,000 before dividends in
1997. Total revenues and expenses decreased as a result of diminished
natural gas pipeline segment operations after the sale of a pipeline
subsidiary effective June 30, 1997. Net income was decreased
primarily as a result of lower oil and gas prices during 1998.
Revenues from oil and gas sales decreased $562,000 in 1998 as
compared to 1997. Oil production increased to 175,000 barrels in
1998 as compared to 165,000 barrels in 1997, resulting in a $192,000
sales increase. The Company has begun realizing production from the
new wells drilled during late 1997 and early 1998. The average price
received for oil was $13.77 in 1998 as compared to $19.34 in 1997,
resulting in a $975,000 sales decrease. Gas production in 1998
increased to 1,437,000 Mcf as compared to 1,171,000 Mcf in 1997,
resulting in a $502,000 sales increase. The increase in gas
production is attributable primarily to new wells drilled in Canada
in late 1997. The average price received for gas decreased to $1.69
in 1998 as compared to $1.89 in 1997, resulting in a $281,000 sales
decrease. The average price received for gas excluding certain
production payment volumes was $1.88 in 1998 as compared to $2.46 in
1997.
Lease operating expenses ("LOE") related to oil and gas
properties increased $899,000 as a result of the new wells drilled
during 1998 and general increases in the cost of field services.
Lifting costs per equivalent barrel increased in 1998 to $6.72 from
$5.24 in 1997 as a result of increases in the cost of services as
well as decreased gas production from Keystone.
Interest expense increased $139,000 in 1998 due entirely to
interest associated with the accounting treatment of volume
deficiencies related to the production payment obligation. Interest
related to the production payment obligation of $373,000 and $233,000
in 1998 and 1997, respectively, is a non-cash item that is added back
to cash flows in the Consolidated Statements of Cash Flows.
<PAGE>
Part II.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
Form 8-K current report dated May 28, 1998, was filed on June 4,
1998. This report was filed pursuant to the Company and Pogo
entering into the Merger Agreement that will provide for a tax-free,
stock for stock transaction through which the Company will become a
wholly owned subsidiary of Pogo. The Merger Agreement provides for a
fixed exchange ratio of one share of Pogo common stock for 10.4
shares of the Company's common stock. In addition, holders of the
Company's preferred stock will receive one share of Pogo common stock
for each 1.04 shares of preferred stock they hold. Former holders of
the Company's stock will hold approximately six percent of Pogo
common stock after the merger. The total number of outstanding Pogo
shares after the merger will be approximately 40,100,000 shares.
Based on the Company's closing price of $2.47 on May 28, 1998, and
the assumption of approximately $48.5 million of the Company's debt
and production payment obligations, the transaction has a total value
of approximately $115 million.
The Boards of Directors of both Pogo and the Company unanimously
approved the merger; however, the merger is also subject to approval
by the Company's shareholders and to customary regulatory approvals.
Executive officers and directors of the Company, Threshold
Development Corporation and all of the holders of the Company's
preferred stock, representing approximately 47% of the Company's
outstanding stock entitled to vote on the merger at the shareholders
meeting, have entered into agreements with Pogo agreeing to vote in
favor of the merger. A special meeting of shareholders of the
Company will take place on August 14, 1998, wherein the shareholders
will be asked to approve and adopt the Merger Agreement. If
approved, the Merger Agreement will be closed on or about August 17,
1998. The merger is expected to be accounted for as a pooling of
interests and qualify as a tax-free reorganization.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act
of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
ARCH PETROLEUM INC.
(Registrant)
Date: August 12, 1998 /s/ Fred Cantu
Fred Cantu
Treasurer and
Chief Financial Officer
11
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 924
<SECURITIES> 0
<RECEIVABLES> 3,725
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 5,292
<PP&E> 113,793
<DEPRECIATION> 28,506
<TOTAL-ASSETS> 96,623
<CURRENT-LIABILITIES> 43,578
<BONDS> 0
20,000
0
<COMMON> 173
<OTHER-SE> 6,556
<TOTAL-LIABILITY-AND-EQUITY> 96,623
<SALES> 11,957
<TOTAL-REVENUES> 12,226
<CGS> 7,465
<TOTAL-COSTS> 7,465
<OTHER-EXPENSES> 3,524
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,279
<INCOME-PRETAX> (3,670)
<INCOME-TAX> (1,243)
<INCOME-CONTINUING> (2,427)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,427)
<EPS-PRIMARY> (0.19)
<EPS-DILUTED> 0
</TABLE>
