UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-KSB
(Mark One)
[root] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
----------
OF THE SECURITIES EXCHANGE ACT OF
1934 For the Fiscal Year Ended
January 31, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From............. to.......................
Commission File Number 1-8287
RIO GRANDE, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 74-1973357
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
10101 Reunion Place, Suite 210, San Antonio, Texas 78216-4156
(Address of Principal Executive Office) (Zip Code)
Registrant's Telephone Number Including Area Code: 210-308-8000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
None None
Securities Registered Pursuant to Section 12(g) of the Act:
Title of each class: Class A Common Stock, $.01 par value
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 [root] No __
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B not contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [[root]]
Total revenues for the year ended January 31, 1997 were $5,337,593.
At March 31, 1997, there were 5,760,987 shares of the registrant's common stock
outstanding. Of this amount, 1,583,945 shares were held by non-affiliates. There
has been no established market for the Registrant's common stock since the end
of 1985.
DOCUMENTS INCORPORATED BY REFERENCE
Document Form 10-K Part
Portions of the Proxy Statement for the Annual Meeting Part III
of Stockholders to be held July 1, 1997
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PART I
Item 1.
General
Rio Grande, Inc. (the "Company"), which hereinafter in general refers
to Rio Grande, Inc., its subsidiaries and affiliates, is a Delaware corporation
originally formed as a Texas corporation in 1978. The Company is engaged in the
acquisition, production, development, exploration, and sale of oil and gas
properties located in Texas, Oklahoma, onshore and offshore Louisiana, Michigan,
Mississippi, Montana, and Wyoming.
Rio Grande Drilling Company ("Drilling"), a Texas corporation and
wholly-owned subsidiary of the Company, as general partner, formed a Texas
limited partnership, Rio Grande Offshore, Ltd. ("Offshore") in June 1992, in
which Drilling retained an 80% ownership interest. In August 1994, Rio Grande
Desert Oil Company ("Desert"), a Nevada corporation and wholly-owned subsidiary
of Drilling, was formed and Drilling conveyed to Desert a 40% partnership
interest in Offshore. Desert became a limited partner in Offshore, ultimately
owning a 79% limited partnership interest. Drilling remained as the general
partner of Offshore with a 1% general partnership interest. Substantially all of
the leasehold interests owned by the Company as of January 31, 1996 were held
through Offshore with Drilling as the 1% general partner and the limited
partners being as follows: Desert, with a 79% limited partnership interest;
Robert A. Buschman ("Buschman"), Chairman of the Board and stockholder of the
Company, with a 10% limited partnership interest; and H. Wayne Hightower and H.
Wayne Hightower, Jr. (collectively, "Hightowers") with 7% and 3% limited
partnership interests, respectively.
In September 1995, the Company concluded a private offering of 11.50%
subordinated notes ("Notes") in the principal amount of $2 million and issued
warrants to the holders of the Notes ("Holders") which provided for the purchase
of 1,388,160 shares of Class A Common Stock, par value $.01 per share, of the
Company at an initial exercise price of $0.40 per share, subject to adjustment
under certain circumstances. In connection with the modifications and amendments
to the Notes discussed below, the warrant exercise price was reduced to $0.20
per share. The Notes were issued primarily to finance development and production
enhancements to certain oil and gas properties owned and operated by the
Company.
In March 1996, the Company entered into a commitment letter with a new
lender to replace the Company's then existing bank indebtedness of approximately
$1.6 million. The commitment letter required that the Company obtain certain
modifications and amendments from the Holders before the new credit facility
could be concluded. Such consents and amendments, including restructuring the
payment terms of the Notes, were approved by the Holders on March 8, 1996, at
which time the Company executed the loan agreement which provided a new senior
credit facility ("Senior Credit Facility") in an aggregate principal amount of
up to $10 million, subject to limitations on availability as a result of the
borrowing base determination ("Borrowing Base").
The Company also obtained the consent of the Holders to restructure
Offshore in order to permit the Company to realize certain efficiencies through
the proportionate allocation of working interest expenses and overhead to the
then existing minority limited partners of Offshore. As a result of the
restructuring, Buschman and the Hightowers became proportionate individual
working interest owners of the onshore oil and gas properties previously owned
by them through their proportionate limited partnership interests in Offshore.
The offshore oil and gas properties held by Offshore were conveyed into a new
Texas limited partnership, Rio Grande GulfMex, Ltd. ("GulfMex"), which holds the
same beneficial ownership in the pre-existing offshore oil and gas properties as
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Offshore held prior to the restructuring. Offshore is the sole general partner
of GulfMex. The partnership agreement for GulfMex is substantially the same as
the existing Offshore partnership agreement.
As a result of the restructuring, Buschman and the Hightowers directly
own (1) 20% of the onshore leasehold working interests formerly owned by them
through Offshore; and (2) a 20% limited partnership interest in GulfMex.
Buschman and the Hightowers no longer are limited partners in Offshore, however,
the reorganized Offshore remains in existence as a Texas limited partnership
with Drilling as the general partner with a 1.25% partnership interest and
Desert a 98.75% limited partnership interest.
As additional consideration for the restructuring, Buschman and the
Hightowers retained the right to participate in acquisitions of oil and gas
properties in those areas where Offshore had properties as of the effective date
of the restructuring. The effective date of the restructuring was February 1,
1996. Any participation in the subsequent acquisition of oil and gas properties
in those areas of mutual interest will be on a basis proportionate to the
percentage interests of Buschman and the Hightowers in Offshore prior to the
restructuring and would provide for sharing of economic benefits and burdens in
accordance with the relative ownership interests.
As a result of the Company's 80% indirect ownership interest, GulfMex's
financial statements are consolidated with the Company's financial statements
prepared as of January 31, 1997. The minority interests of Buschman and the
Hightowers in GulfMex are set forth separately in the balance sheet and the
statement of operations of the Company. The consolidated statement of operations
for the year ended January 31, 1996 has been reclassified to conform with the
current fiscal year statement of operations to provide for a more meaningful
comparison of the results of operations for the fiscal year ended January 31,
1997.
Acquisition Summary
From June 1992 to January 1996, Offshore has acquired operated and
non-operated oil and gas leasehold interests with total estimated remaining
proved reserves of 2,802 mbbls oil and 14 bcf of natural gas as of the effective
dates of acquisition. In July 1994, Offshore acquired additional operating oil
and gas leasehold interests with net total estimated remaining proved reserves
of 383 mbbls and 2 bcf natural gas as of the effective dates of acquisition.
These operated oil and gas properties, in which Offshore is the principal
working interest owner, are located primarily in Jack and Young Counties in
North Texas and Tom Green County in West Texas.
During the year ended January 31, 1997, Offshore made four significant
acquisitions of producing oil and gas properties. On March 11, 1996, Offshore
acquired for $900,000, a 3.125% leasehold interest in a non- operated producing
federal oil and gas lease and platform located offshore Louisiana ("Block 76").
Subsequently, in July 1996, Offshore acquired an additional 1.041667% leasehold
interest in the same property for $270,000. This acquisition increased
Offshore's net total estimated remaining proved reserves by approximately 1.2
bcf natural gas and 80,000 bbls of condensate as of the effective date of
acquisition. Although this acquisition is an interest in one offshore well and
presents a greater degree of risk than the acquisition of multiple wells,
management believes the cash flow anticipated from the well, if sustained,
provides for a fast payout of the acquisition costs and could provide for
significant cash flows thereafter.
On March 26, 1996, Offshore acquired various leasehold interests in
three gas wells located in Wheeler County, Texas ("Wheeler County") for a net
purchase price of $370,500. The total estimated remaining net proved reserves
acquired effective with this acquisition were approximately 3 mbbls oil and
condensate and 868 mmcf natural gas. Drilling operates these gas wells. Buschman
and the Hightowers exercised their right under the area of mutual interest
agreement by purchasing their proportionate 20% working interests in these
leaseholds.
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In April 1996, Offshore acquired various leasehold interests in 31 oil
wells located in Mississippi and Louisiana ("Belle") for a net purchase price of
approximately $2.8 million, which includes 23 wells operated by Drilling. The
total estimated remaining net proved reserves effective with this acquisition
were approximately 1,110 mbbls oil and condensate.
On January 16, 1997, Offshore completed the acquisition of producing
oil and gas properties in the Righthand Creek Field ("Righthand Creek") located
in Allen Parish, Louisiana. The effective date of the Righthand Creek
acquisition was November 1, 1996. The acquisition price for Righthand Creek was
approximately $15.3 million for total estimated remaining proved producing
reserves as of the effective date of approximately 2 million bbls of oil and 2
bcf natural gas net to Offshore's interest. The acquisition price is subject to
adjustment under certain circumstances as described below. Due to timing of
closing the acquisition, the revenues and related lease operating expenses for
November 1996 through January 1997 have been recorded as an adjustment to the
acquisition price. The acquired properties have recently produced approximately
400 bbls of oil and 500 mcf natural gas per day net to Offshore's interest.
Drilling is the operator for the Righthand Creek wells.
The Righthand Creek acquisition was funded in part by borrowings of
approximately $9 million from the Senior Credit Facility and in part by
approximately $6 million from the proceeds of the $10 million Koch Private
Placement described herein.
The Righthand Creek acquisition agreement provides that Offshore will
conduct certain drilling operations on undeveloped leasehold acreage within
twelve months of the closing date. Offshore must commence the drilling of two
additional wells within twelve months of closing to test the Wilcox "B" Sand;
however, Offshore does have the option to re-enter one existing well located on
the undeveloped acreage which would count as one of the required wells. In the
event that Offshore fails to drill either of the required wells to the Wilcox
"B" formation, the seller has the right to require Offshore to convey to the
seller a working interest in the unearned acreage.
In connection with Offshore's requirement to develop the undeveloped
leasehold acreage, the sellers have the option to obtain a working interest
ranging from 10 to 20 percent in all new wells completed, effective upon
Offshore obtaining project payout ("Project Payout"). Project Payout will occur
when Offshore has received proceeds from production of the wells drilled in the
amount equal to all actual costs of drilling, completing, re-completing,
equipping, maintaining, producing and operating the new wells. If the sellers
exercise their options in their entirety, the sellers' working interest will
remain in effect until the sellers have recovered the sum of $7 million out of
their proportionate shares of proceeds from production sales, net of recoverable
costs and expenses proportionate to their working interests in the wells
drilled. The working interests obtained by the sellers as described above would
then revert back to Offshore.
On March 10, 1997, Offshore entered into a participation agreement
("Mortimer Agreement") with Mortimer Exploration Company ("Mortimer") which
provides for Offshore to assume a 38% participation in all costs associated with
certain exploration prospects that Mortimer identifies and presents to Offshore
effective from January 1, 1997. These costs include overhead incurred by
Mortimer in developing prospects, as well as any seismic and lease acquisitions.
In connection with the Mortimer Agreement, Offshore has committed to participate
in drilling at least two wells, which will be identified within a prospect area
from Beauregard Parish, Louisiana to Montgomery County, Texas. A drillable
prospect, as defined by the Mortimer Agreement, is any single prospect in the
prospect area where the drainage area is sufficient to provide estimated
reserves of at least 200,000 bbls oil equivalent. The Mortimer Agreement has
budgeted approximately $1.1 million for this venture, approximately $420,000
allocable to Offshore's interest. The Mortimer Agreement has an initial term of
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four months from March 10, 1997, but can be extended for additional six month
periods by providing thirty days written notice prior to the expiration of the
original term, or any extension thereof, of the contract.
It is the Company's intention to continue focusing its efforts on
acquiring oil and gas production for the account of Offshore. The Company
expects to make its own geological and geophysical evaluations of potential oil
and gas property acquisitions. The Company's criteria for potential acquisitions
include, but are not limited to, operated properties having what management
believes are attractive exploration and development potentials
Private Placement
In August 1996, the Company engaged Reid Securities Corporation
("Reid") as its exclusive agent to assist the Company in effectuating the sales
of equity in the Company by means of private placement to institutional
investors. On January 15, 1997, the Company filed a Certificate of Designation,
Preferences and Rights of Series A Preferred Stock, Series B Preferred Stock,
and Series C Preferred Stock ("Certificate") with the Secretary of State,
Delaware. The Certificate amended the Company's Certificate of Incorporation to
establish three new series of preferred stock consisting of 700,000 shares of
Series A Preferred Stock, 500,000 shares of Series B Preferred Stock, and
500,000 shares of Series C Preferred Stock, each having a par value of $.01 per
share. The remaining 1,300,000 preferred shares of the Company's 3,000,000 total
shares authorized preferred stock remains undesignated. The Certificate provides
for the rights, preferences, powers, restrictions and limitations of the
respective series of preferred stock.
On January 16, 1997, contemporaneously with the Righthand Creek
acquisition, the Company and Koch Exploration Company ("Koch"), an affiliate of
Koch Industries, Inc., concluded a $10 million private placement ("Koch Private
Placement") in which Koch acquired 500,000 shares of Series A Preferred Stock
for $5 million and 500,000 shares of Series B Preferred Stock for $5 million.
The Koch Private Placement provides Koch the right and option to purchase up to
an additional 200,000 shares of Series A Preferred Stock at the face value of
$10 per share of Series A Preferred Stock at any time after January 16, 1999 but
on or before January 16, 2000. The option may be exercised in whole or part. The
Koch Private Placement also provides for a financing right of first refusal,
which requires the Company to give Koch written notice of any intention of the
Company to issue new securities describing the amount of funds the Company
wishes to raise, the type of new securities to be issued, the price and general
terms. Under the Agreement, Koch has 15 days from the date of receipt of such
notice to agree to purchase all or part of such new securities. For a more
detailed discussion of the Koch Private Placement, see Item 6 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
In connection with the Koch Private Placement and the Righthand Creek
acquisition, the Company and Drilling executed the First Amendment to Loan
Agreement ("First Amendment") with its existing senior lender which provided for
the increase of the Senior Credit Facility to $50 million and the increase of
the Borrowing Base on that date to approximately $17 million. The First
Amendment also provided for extending the maturity date of the Senior Credit
Facility to February 1, 2000. The Borrowing Base is subject to monthly
reductions of $333,000 beginning April 1, 1997 until maturity or the next
determination of the Borrowing Base. The Borrowing Base is approximately $16.5
million at April 30, 1997 and shall continue to be reduced until February 1,
1998; however, the Company may, at its sole expense, request a redetermination
prior to February 1, 1998.
Risks Associated with the Company's Business
The Company is engaged in the acquisition, production, development,
exploration and sale of oil and gas properties and the marketing of oil, natural
gas and related hydrocarbons produced from those properties. There are a variety
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of risks associated with the business of the Company, including, without
limitation, those set forth below.
Exploration, Production and Acquisition Risks. The business of
acquiring producing oil and gas properties is an inherently speculative activity
that involves a high degree of business and financial risk. Property acquisition
decisions generally are based on various assumptions and subjective judgments
relating to achievable production and price levels which are inherently
uncertain and unpredictable. Although available geological and geophysical
information can provide information on the potential for previously overlooked
or untested formations, it is impossible to determine accurately the ultimate
production potential, if any, of a particular well. Actual oil and gas
production may vary considerably from anticipated results. Moreover, the
acquisition of a property or the successful recompletion of an oil or gas well
does not assure a profit on the investment or return of the cost thereof. There
can be no assurance that the Company will succeed in its efforts to acquire
additional older oil and gas wells or in its development efforts aimed at
increasing or restoring production from either currently owned or acquired
wells. If the Company over-estimates the potential oil and gas reserves of a
property to be acquired, or if its subsequent operations on the property are
unsuccessful, the acquisition of the property could result in losses to the
Company. Except to the extent that the Company acquires additional recoverable
reserves or conducts successful exploration and development programs on its
existing properties, the proved reserves of the Company will decline over time
as they are produced. There can be no assurances that the Company will be able
to increase or replace reserves through acquisitions, exploration and
development or that recent production levels can be sustained or increased.
Access to Working Capital. The oil and gas industry is capital
intensive. Depending upon the production levels of the Company's oil and gas
properties and the prices received for products produced, the Company may need
additional financing to continue acquisition and development of producing oil
and gas properties. Such financing may consist of bank or other commercial debt,
forward sales of production, debt securities, equity securities or any
combination thereof. The Company presently has no commitment for additional
financing and there can be no assurance that the Company will be successful in
obtaining financing when required. The Company's ability to meet its financial
requirements under the terms of the Senior Credit Facility and the Koch Private
Placement is dependent upon the deliverability and price received for products
produced. If the Company is unable to obtain additional financing when needed,
it would consider, among other alternatives, sale of certain of its leasehold
interests for additional capital, the curtailment of property acquisitions or
development activities until internally generated funds become available, or
other strategic alternatives in an effort to meet its financial requirements.
Estimates of Oil and Gas Reserves. There are numerous uncertainties
inherent in estimating quantities of proved oil and gas reserves and cash flows
attributable to such reserves, including factors beyond the control of the
Company and its engineers. Reserve engineering is a subjective process of
estimating underground accumulations of oil and gas that cannot be measured in
an exact manner. The accuracy of an estimate of quantities of reserves, or of
cash flows attributable to such reserves, is a function of the available data,
assumptions regarding future oil and gas prices, the amount of expenditures for
future development and exploitation activities, and the quality of engineering
and geological interpretation and judgment. Oil and gas reserves and the related
future cash flows may be subject to material downward or upward revisions, based
upon production history, development and exploration activities and prices of
oil and gas. Actual future production, revenue, taxes, development expenditures,
operating expenses, quantities of recoverable reserves and the value of cash
flows from such reserves may vary significantly.
Price Risks. In addition to production levels, the Company's revenues,
profitability, cash flow, future growth and the carrying value of its oil and
gas properties are affected by changes in oil and gas prices. The Company's
ability to maintain or increase its borrowing capacity and to obtain additional
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capital on acceptable terms is substantially dependent upon such prices. Prices
for oil and gas are subject to large fluctuations in response to changes in
supply, market uncertainty and a variety of additional factors beyond the
control of the Company. These factors include weather conditions in the United
States, the condition of the national economy, the actions of the Organization
of Petroleum Exporting Countries, governmental regulation, political stability
in the Middle East and elsewhere, the supply of foreign oil and gas, the price
of foreign imports and the availability of alternate fuel sources. Decreases in
the prices of oil and gas have had and could continue to have an adverse effect
on the carrying value of the Company's proved reserves, borrowing capacity,
revenues, profitability, and cash flow.
Volatile oil and gas prices also make it difficult to estimate the
value of producing properties for acquisition as well as budget for and project
the return on development projects. Volatile prices often cause disruption in
the market for oil and gas producing properties as buyers and sellers have
difficulty agreeing on the value of properties.
Effective February 1, 1997, Offshore's contract marketing agent entered
into a one year sales contract with an independent oil purchaser to deliver up
to an average of 650 bbl crude oil daily in Righthand Creek. The sales contract
provides for a floor price of $20 per bbl and a ceiling price of $23.45 per bbl
crude oil delivered from Righthand Creek. The price determination for the crude
oil is based on the posted price of Louisiana Sweet Crude at St. James,
Louisiana ("LLS") plus a posting bonus of $1.50 per bbl ("Bonus"). Under the
terms of the sales contract, there is no penalty for under delivery of oil from
Righthand Creek unless the LLS plus Bonus exceeds $23.45 per bbl. If the penalty
clause is invoked, the amount of penalty due would be computed as follows: the
sum of 650 bbl daily crude oil contracted times the number of days in the month
less the actual barrels delivered times the difference between LLS plus Bonus
less $23.45. Although the Righthand Creek wells are currently producing less
than the 650 bbl daily crude oil requirement, the LLS plus Bonus has been less
than $23.45 per bbl.
Competition. The oil and gas industry is highly competitive. The
Company's competitors include major integrated oil companies, substantial
independent energy companies, affiliates of major interstate pipelines and
national and local gas gatherers. Many such competitors are larger and have
substantially greater financial resources than the Company. The market for
acquisition of existing oil and gas properties is particularly competitive, and
no assurance can be provided that acquisitions of additional properties, if
successfully identified, can be concluded on favorable economic terms.
Markets. The Company's ability to market oil and gas from its wells
depends upon numerous factors beyond its control, including the extent of
domestic production and imports of oil and gas, the proximity of the Company's
gas production to gas pipelines, the availability of capacity in pipelines, the
demand for oil and gas by utilities and other end users, the effects of
inclement weather, state and federal regulation of oil and gas production, and
federal regulation of gas sold or transported in interstate commerce. There is
no assurance that the Company will be able to market all of the oil or gas
produced by it or that favorable prices can be obtained for the oil and gas
produced.
Regulations of Oil and Gas Producing Activity. The Company's operations
are affected from time to time in varying degrees by political developments and
federal, state, provincial and local laws and regulations. In particular, oil
and gas production operations and economics are, or in the past have been,
affected by price controls, taxes, conservation, safety, environmental and other
laws relating to the petroleum industry, by changes in such laws and by
constantly changing administrative regulations.
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Price Regulations. In the recent past, maximum selling prices for
certain categories of crude oil, natural gas, condensate and NGLs were subject
to federal regulation. In 1981, all federal price controls over sales of crude
oil, condensate and NGLs were lifted. Effective January 1, 1993, the Natural Gas
Wellhead Decontrol Act (the "Decontrol Act") deregulated natural gas prices for
all "first sales" of natural gas, which includes all sales by the Company of its
own production. As a result, all sales of the Company's domestically produced
crude oil, natural gas, condensate and NGLs may be sold at market prices, unless
otherwise committed by contract.
Natural Gas Regulation. Historically, interstate pipeline companies
generally acted as wholesale merchants by purchasing natural gas from producers
and reselling the gas to local distribution companies and large end users.
Commencing in late 1985, the Federal Energy Regulatory Commission ("FERC")
issued a series of orders that have had a major impact on interstate natural gas
pipeline operations, services, and rates, and thus have significantly altered
the marketing and price of natural gas. The FERC's key rule making action, order
No. 636 ("Order 636"), issued in April 1992, required each interstate pipeline
to, among other things, "unbundle" its traditional bundled sales services and
create and make available on an open and nondiscriminatory basis numerous
constituent services (such as gathering services, storage services, firm and
interruptible transportation services, and standby sales and gas balancing
services), and to adopt a new ratemaking methodology to determine appropriate
rates for those services. To the extent the pipeline company or its sales
affiliate makes natural gas sales as a merchant, it does so pursuant to private
contracts in direct competition with all of the sellers, such as the Company;
however, pipeline companies and their affiliates were not required to remain
"merchants" of natural gas, and most of the interstate pipeline companies have
become "transporters only." In subsequent orders, the FERC largely affirmed the
major features of Order 636 and denied a stay of the implementation of the new
rules pending judicial review. By the end of 1994, the FERC had concluded the
Order 636 restructuring proceedings, and, in general accepted rate filings
implementing Order 636 on every major interstate pipeline. However, even though
the implementation of Order 636 on individual interstate pipelines is
essentially complete, many of the individual pipeline restructuring proceedings,
as well as Order 636 itself and the regulations promulgated thereunder, are
subject to pending appellate review and could possibly be changed as a result of
future court orders. The Company cannot predict whether the FERC's orders will
be affirmed on appeal or what the effects will be on its business.
In recent years the FERC has pursued a number of other important policy
initiatives which could significantly affect the marketing of natural gas. Some
of the more notable of these regulatory initiatives include (i) a series of
orders in individual pipeline proceedings articulating a policy of generally
approving the voluntary divestiture of interstate pipeline owned gathering
facilities by interstate pipelines to their affiliates (the so-called "spin
down" of previously regulated gathering facilities to the pipeline's
nonregulated affiliates), (ii) the completion of rule-making involving the
regulation of pipelines with marketing affiliates under Order No. 497, (iii) the
FERC's ongoing efforts to promulgate standards for pipeline electronic bulletin
boards and electronic data exchange, (iv) a generic inquiry into the pricing of
interstate pipeline capacity, (v) efforts to refine the FERC's regulations
controlling operation of the secondary market for released pipeline capacity,
and (vi) a policy statement regarding market based rates and other
non-cost-based rates for interstate pipeline transmission and storage capacity.
Several of these initiatives are intended to enhance competition in natural gas
markets, although some, such as, "spin downs," may have the adverse effect of
increasing the cost of doing business on some in the industry as a result of the
monopolization of those facilities by their new, unregulated owners. The FERC
has attempted to address some of these concerns in its orders authorizing such
"spin downs," but it remains to be seen what effect these activities will have
on access to markets and the cost to do business. As to all of these recent FERC
initiatives, the ongoing, or, in some instances, preliminary evolving nature of
these regulatory initiatives makes it impossible at this time to predict their
ultimate impact on the Company's business.
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Recent orders of the FERC have been more liberal in their reliance upon
traditional tests for determining what facilities are "gathering" and therefore
exempt from federal regulatory control. In many instances, what was once
classified as "transmission" may now be classified as "gathering." The Company
transports certain of its natural gas through gathering facilities owned by
others, including interstate pipelines, under existing long term contractual
arrangements. With respect to item (i) in the preceding paragraph, on May 27,
1994, the FERC issued orders in the context of the "spin off" or "spin down" of
interstate pipeline owned gathering facilities. A "spin off" is a FERC-approved
sale of such facilities to a non-affiliate. A "spin down" is the transfer by the
interstate pipeline of its gathering facilities to an affiliate. A number of
spin offs and spin downs have been approved by the FERC and implemented. The
FERC held that it retains jurisdiction over gathering provided by interstate
pipelines, but that is generally does not have jurisdiction over pipeline
gathering affiliates, except in the event of affiliate abuse (such as actions by
the affiliate undermining open and nondiscriminatory access to the interstate
pipeline). These orders require nondiscriminatory access for all sources of
supply and prohibit the trying of pipeline transportation service to any service
provided by the pipeline's gathering affiliate. On November 30, 1994, the FERC
issued a series of rehearing orders largely affirming the May 27, 1994 orders.
The FERC now requires interstate pipelines to not only seek authority under
Section 7(b) of the Natural Gas Act of 1938 (the "NGA") to abandon certificated
facilities, but also to seek authority under Section 4 of the NGA to terminate
service from both certificated and uncertificated Facilities. On December 31,
1994, an appeal was filed with the U.S. Court of Appeals for the D.C. Circuit to
overturn three of the FERC's November 30, 1994, orders. The Company cannot
predict what the ultimate effect of the FERC's orders pertaining to gathering
will have on its production and marketing, or whether the Appellate Court will
affirm the FERCs orders on these matters.
State and Other Regulations. All of the jurisdictions in which the
Company owns producing crude oil and natural gas properties have statutory
provisions regulating the exploration for and production of crude oil and
natural gas, including provisions requiring permits for the drilling of wells
and maintaining bonding requirements in order to drill or operate wells and
provisions relating to the location of wells, the method of drilling and casing
wells, the surface use and restoration of properties upon which wells are
drilled and the plugging and abandoning of wells. The Company's operations are
also subject to various conservation laws and regulations. These include the
regulation of the size of drilling and spacing units or proration units and the
density of wells which may be drilled and the unitization or pooling of crude
oil and natural gas properties. In this regard, some states allow the forced
pooling or integration of tracts to facilitate exploration while other states
rely on voluntary pooling of lands and leases. In addition, state conservation
laws establish maximum rates of production from crude oil and natural gas wells,
generally prohibit the venting or flaring of natural gas and impose certain
requirements regarding the ratability of production. Some states, such as Texas
and Oklahoma, have, in recent years, reviewed and substantially revised methods
previously used to make monthly determinations of allowable rates of production
from fields and individual wells. The effect of these regulations is to limit
the amounts of crude oil and natural gas the Company can produce from its well,
and to limit the number of wells or the location at which the Company can drill.
State regulation of gathering facilities generally includes various
safety, environmental, and in some circumstances, non-discriminatory take
requirements, but does not generally entail rate regulation. Natural gas
gathering has received greater regulatory scrutiny at both the state and federal
levels in the wake of the interstate pipeline restructuring under Order 636. For
example, Oklahoma recently enacted a prohibition against discriminatory
gathering rates and certain Texas regulatory officials have expressed interest
in evaluating similar rules.
Environmental Regulations. The Company's oil and gas properties are
subject to numerous federal, state and local laws and regulations related to
protection of the environment. The Company believes its oil and gas properties
and the related operations are in substantial compliance with applicable
material environmental laws and regulations. The Company is not a party to any
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litigation involving environmental matters and has not been notified by any
federal, state, or local governmental agency that it is responsible for any
environmental cleanup. The trend in environmental legislation is towards
stricter standards; however, the Company is not aware of any future
environmental standards that are reasonably likely to be adopted that will
materially affect the Company.
Operating Hazards and Insurance. The oil and gas business involves a
variety of operating risks, including the risk of fire, explosions, blowouts,
pipe failure, casing collapse, abnormally pressured formations and environmental
hazards such as oil spills, gas leaks, ruptures, and discharges of toxic gases.
The occurrence of any of the above could result in substantial losses to the
Company as a result of injuries, loss of life, severe damage to or destruction
of property, natural resources and equipment, pollution or other environmental
damage, cleanup responsibilities, regulatory investigations, penalties, and
suspension of operations. In addition to the foregoing, all of the Company's
operations that are currently offshore are subject to the additional hazards of
marine operations, such as capsizing, collision, and adverse weather and sea
conditions.
The Company maintains customary insurance in accordance with industry
practice against some, but not all, of the risks described above. The Company's
insurance does not cover business interruption or protect against loss of
revenues. There can be no assurance that any of the insurance obtained by the
Company will be adequate to cover all losses or liabilities. The Company cannot
predict the continued availability of insurance or the availability of insurance
at premium levels that justify the premium cost. The occurrence of a significant
event not fully insured or indemnified against could materially and adversely
affect the Company's financial condition and operations.
Employees
At January 31, 1997, the Company and its affiliates had 19 employees,
three of whom are in executive positions. Included in the Company's staff are a
production engineer who is certified as a Professional Engineer in the State of
Texas, a geologist who is certified as a Petroleum Geologist through the
American Association of Petroleum Geologist and a controller who is a CPA
certified in the State of Texas.
Item 2. Properties
Oil and Gas Properties
The following table details the Company's working interest in oil and
gas properties as of January 31, 1997. All of the properties are located within
the United States.
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Acreage
The following table sets forth the developed and undeveloped oil and
gas acreage in which the Company has an interest as of January 31, 1997.
Undeveloped acreage is considered to be those lease acres on which wells have
not been drilled or completed to a point that would permit the production of
commercial quantities of oil and natural gas, regardless of whether or not such
acreage contains proved reserves.
Developed Acreage Undeveloped Acreage
------------------- -------------------
Gross Net (1) Gross Net (1)
Acres Acres Acres Acres
----- ------- ------- -------
Location:
Offshore-Louisiana 8,000 484 42,000 2,034
Mississippi 868 581 -- --
Louisiana 3,317 990 956 956
Oklahoma 14,265 1,290 -- --
Texas 24,787 13,523 -- --
Wyoming 960 60 -- --
Michigan 152 4 -- --
------- ------- ------- -------
Total 52,349 16,932 42,956 2,990
======= ======= ======= =======
- ----------
(1) For further information regarding the Company's oil and gas activities, see
Note 10 of Notes to Consolidated Financial Statements which is incorporated
herein by reference.
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Gross and Net Productive Wells
The following table sets forth the gross and net number of productive,
dry, and development or exploratory wells in which the Company had ownership
interests in fiscal 1997. "Gross wells" refers to the total wells in which the
Company has an interest. "Net wells" refers to the percentage of interest owned
by the Company in the gross wells.
Oil/Condensates Natural Gas
------------------ --------------
Gross Net (1) Gross Net (1)
----- ------- ----- ------
Location:
Offshore - Louisiana 14 1 12 1
Mississippi 33 24 -- --
Louisiana 17 11 6 --
Oklahoma 10 6 25 2
Texas 187 142 77 41
Wyoming 8 -- -- --
Michigan -- -- 1 --
--- --- --- ---
Total 269 184 121 44
=== === === ===
- ----------
(1) For further information regarding the Company's oil and gas activities, see
Note 10 of Notes to Consolidated Financial Statements which is incorporated
herein by reference.
Title to Properties
The Company believes it has satisfactory title to all of its producing
properties in accordance with standards generally accepted in the oil and gas
industry. The Company's properties are subject to customary royalty interests,
liens for existing indebtedness, liens incident to operating agreements, liens
for current taxes and other burdens which the Company believes do not materially
interfere with the use of or affect the value of the oil and gas properties.
Executive Office
The Company's executive offices occupy approximately 8,900 square feet
of leased space in San Antonio, Texas. The mailing address, telephone and
telefax, respectively, for the executive offices is: 10101 Reunion Place, Union
Square, Suite 210, San Antonio, Texas 78216-4156, (210) 308-8000, (210)
308-8111.
Item 3. Legal Proceedings
The Company is not a party to any material legal proceedings now
pending and has no knowledge that any such proceedings are contemplated.
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Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters
There are presently no listed market quotes for the Company's common
stock. The Company has no immediate plans for seeking a listing on a nationally
recognized exchange.
As of March 31, 1997, there were approximately 634 stockholders of
record.
The Company has never paid cash dividends, and does not presently
anticipate payment of any dividends, to its common stockholders in the future.
The Senior Credit Facility and Koch Private Placement restrict the payment of
such dividends. Refer to Item 6 below for explanation of the preferred stock
dividends payable in accordance with the Koch Private Placement.
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Results of Operations for 1996 and 1997
Effective February 1, 1996, Buschman and the Hightowers agreed to
restructure Offshore whereby the aggregate 20% minority limited partnership
interests of Buschman and the Hightowers would be redeemed, and as a result of
in-kind distributions, Buschman and the Hightowers became proportionate working
interest owners of the onshore oil and gas properties previously held by
Offshore. All existing interest in the offshore oil and gas properties held by
Offshore at January 31, 1996 were conveyed to GulfMex, a newly formed Texas
limited partnership, which has the same proportionate ownership structure as
that of Offshore prior to the restructuring. Buschman and the Hightowers no
longer are limited partners of Offshore but remain 20% limited partners in
GulfMex. Subsequent to January 31, 1996, Offshore is 100% indirectly owned by
the Company, and GulfMex is 80% indirectly owned by the Company. The minority
interests of Buschman and the Hightowers in GulfMex are set forth separately in
the consolidated balance sheet and the consolidated statement of operations for
the Company. The consolidated statement of operations for the period ended
January 31, 1996 has been reclassified to be consistent with the current year's
statement of operations to provide for a more meaningful comparison of the
results of operations for the fiscal year ended January 31, 1997.
The Company has adopted the successful efforts method of accounting for
the oil and gas properties purchased. Under this method of accounting, the
acquisition costs of the oil and gas properties applicable to proved reserves
are amortized as produced on the unit-of-production method. Future development
costs or exploratory costs applicable to purchased properties are capitalized
and amortized on the unit-of-production method if proved reserves are
discovered, or expensed if the well is a dry hole.
The existing oil and gas properties which are located in federal waters
offshore Louisiana consist of a series of platforms for each "OCS" lease, each
of which accommodate one or more producing oil and gas wells. Federal
regulations mandate strict rules for the plugging and abandonment of the
offshore wells and platforms. Due to the offshore locations, the costs related
with such plugging and abandonment can be substantial; therefore, the operator
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of the offshore oil and gas properties has scheduled monthly deductions from
production proceeds of the working interest owners of certain properties to fund
the total estimated liability at the completion of the productive life of the
wells and platform. GulfMex's estimated ultimate plugging and abandonment
requirements may increase due to inflation or other circumstances, or may
decrease as a result of a sale of the platform with the buyer assuming plugging
and abandonment liabilities. The operator commenced the plugging and abandonment
of the platform and wells for Eugene Island Block 343 and anticipates that the
plugging and abandonment should be completed by June 1997. GulfMex will need to
fund approximately $34,000 in excess of its abandonment escrow for its portion
of the abandonment liability for that platform. The operator estimates the total
plugging and abandonment liability for the remaining platforms and wells in
which GulfMex or Offshore own an interest to be approximately $1.4 million, of
which $1 million has been accrued. GulfMex's abandonment escrow account as of
January 31, 1997 is approximately $1 million.
The Company has adopted, Statement of Financial Accounting Standards
("SFAS") No. 121 "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of" establishes accounting standards for the
impairment of long-lived assets, certain identifiable intangibles, and goodwill
related to those assets to be held and used and for long-lived assets and
certain identifiable intangibles to be disposed of. As a result of the adoption
of SFAS No. 121, the Company recognized a non-cash pre-tax charge against
earnings of $260,800 related to oil and gas properties.
Revenues and Lease Operating Expenses
Oil and gas sales increased $2.2 million from $3.1 million in 1996 to
$5.3 million in 1997, a 70% increase. Likewise, lease operating expenses
increased $829,000 from $1.6 million in 1996 to $2.4 million in 1997, a 52%
increase. The growth in oil and gas sales and related lease operating expenses
is due mainly to the acquisition of 35 producing oil and gas properties in March
and April 1996. These new properties accounted for $1.7 million of additional
revenues and $771,000 of additional lease operating expenses. Due to the timing
of closing the revenues and related lease operating expenses for the Righthand
Creek acquisition for November 1996 through January 1997 have been recorded as
an adjustment to the acquisition price. The following table summarizes the
operating activity for the oil and gas properties of the Company during fiscal
year 1997 and 1996. The existing properties are those oil and gas properties
acquired by the Company prior to February 1, 1996.
Acquisition Year Ended January 31,
Date 1997 1996
---- ---- ----
Oil and gas sales:
Existing properties -- $3,673,030 3,148,311
Wheeler County properties March 1996 264,905 0
Block 76 March 1996 468,555 0
Belle properties April 1996 931,103 0
---------- ----------
Total oil and gas sales $5,337,593 3,148,311
========== ==========
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Acquisition Year Ended January 31,
Date 1997 1996
----------- ---------- ---------
Lease operating expenses:
Existing properties -- $1,623,273 1,565,682
Wheeler County properties March 1996 81,409 0
Block 76 March 1996 40,777 0
Belle properties April 1996 648,859 0
---------- --------- ----------
Total lease operating expenses $2,394,318 1,565,682
========== ==========
Depletion of oil and gas producing properties:
Existing properties -- $ 659,702 933,231
Wheeler County properties March 1996 13,895 0
Block 76 March 1996 337,015 0
Belle properties April 1996 466,221 0
---------- --------- ---------
Total depletion of oil and gas
producing properties $1,476,833 933,231
========== =========
Operating profit (loss) %:
Existing properties -- 38% 21%
Wheeler County properties March 1996 64% 0%
Block 76 March 1996 19% 0%
Belle properties (1) April 1996 -20% 0%
-------- ------
Total operating profit % 27% 21%
====== =====
Oil production volumes (bbl):
Existing properties -- 67,898 97,082
Wheeler County properties March 1996 171 0
Block 76 March 1996 6,814 0
Belle properties April 1996 43,296 0
------- -------
Total production volumes (bbl) 118,179 97,082
======== =======
Gas production volume (mcf):
Existing properties -- 881,833 1,208,292
Wheeler County properties March 1996 115,548 0
Block 76 March 1996 119,281 0
Belle properties April 1996 301 0
-------- -------
Total gas production volume (mcf) 1,116,963 1,208,292
========== =========
Average oil price per bbl $ 20.73 $ 17.90
========== ==========
Average gas price per mcf $ 2.54 $ 1.68
========== ==========
(1) The operating loss reflected by the Belle properties resulted primarily
from additional workover expenses incurred by the Company subsequent to
taking over operations and a depletion charge of $135,000 and additional
impairment loss of $100,000 incurred on a significant property as further
described below.
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<PAGE>
Dry Hole Costs and Lease Abandonments
Dry hole costs and lease abandonments increased from $236,000 for
fiscal year ended January 31, 1996 to $822,000 for the fiscal year ended January
31, 1997. A significant portion of the increase is due to two dry holes drilled
in Sutton County, Texas, which cost approximately $326,000, and one dry hole
drilled in Wheeler County, Texas, which cost approximately $132,000, for total
dry hole costs of $458,000. The Company does not anticipate further exploratory
efforts with regard to these leaseholds. A portion of the dry hole costs
incurred during fiscal year 1996 were as a result of exploration efforts in
Lipscomb and Duval County. Although the leasehold period has not expired for
these properties, the Company has expensed the leasehold costs associated with
those properties for the year ended January 31, 1997. The Sutton County
leasehold abandonment was $110,000 and the Lipscomb and Duval County leasehold
abandonments were $177,000.
Depletion of Oil and Gas Producing Properties
The Company amortizes as depletion expense the capitalized acquisition
costs and the capitalized cost of exploratory wells that find proved reserves or
the development costs that increase proved reserves by the unit-of-production
method. The unit-of-production method assigns a pro rata portion of the
capitalized cost to each unit of reserves. The amortization of the capitalized
costs of proved producing reserves may be computed either on a
property-by-property basis or with reference to some reasonable aggregation of
properties in the same field area.
The Company revises the unit-of-production rate annually based on the
estimates of remaining proved reserves prepared by independent petroleum reserve
engineers. Reserve estimates for producing oil and gas properties are inherently
imprecise and may, therefore, change dramatically from year to year.
SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of" requires that long-lived assets and
certain identifiable intangibles to be held and used by an entity be reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. This new pronouncement was
adopted effective February 1, 1996.
Depletion expense increased from $1 million for the fiscal year ended
January 31, 1996 to $1.6 million for the fiscal year ended January 31, 1997.
Depletion expense for oil and gas properties acquired during the fiscal year
1997 was $717,000. Although the depletion expense for Block 76 and Rosenblatt
#4, a property acquired from Belle, were estimated at $117,000 and $4,000,
respectively, during the fiscal year ended 1997, these amounts were determined
to be insufficient as a result of a significant reduction in the estimated net
remaining reserves at year end for these properties.
Block 76's net total remaining reserves as of the date of acquisition
were estimated to be approximately 1.2 bcf natural gas and 80 mbbl condensate.
Although Block 76 produced approximately 119,000 mcf natural gas and 7 mbbl
condensate net to the Company's interest since its acquisition, a decline in
production from the well during the later half of the fiscal year ended January
31, 1997 caused the estimate for remaining net proved natural gas and condensate
reserves to be reduced by approximately 770 mmcf and 47 mbbl condensate. This
reduction in reserves resulted in an unanticipated additional depletion
adjustment of approximately $219,000 for the fiscal year ended January 31, 1997.
Rosenblatt #4's net total remaining reserves as of the date of
acquisition were estimated to be approximately 37 mbbl crude oil. This well
produced approximately 1,900 bbl during the fiscal year ended January 31, 1997;
however, a significant decrease in the crude oil production resulted in the
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<PAGE>
estimated remaining net crude oil reserves being reduced by 32 mbbl. This
reduction in reserves resulted in an unanticipated additional depletion
adjustment of approximately $135,000 and an impairment loss of $100,000 for the
fiscal year ended January 31, 1997.
Based upon the evaluation of the net carrying values of the Company's
other oil and gas properties relative to future net cash flows, approximately
$161,000 charge to depletion expense was recorded for the fiscal year ended
January 31, 1997 due to impairment loss.
Depreciation and Other Amortization
Depreciation costs for the fiscal year ended January 31, 1996 was
$32,500 as compared to $45,000 for the fiscal year ended January 31, 1997. Other
amortization costs include the amortization of deferred loan costs and deferred
costs related to the Notes and the Koch Private Placement. On January 31, 1997,
the Company paid off the 11.50% Notes which were not due until September 30,
2002. As a result of this early extinguishment of debt, the unamortized balance
of deferred costs of $118,000 associated with this debt was written off and is
included in depreciation and other amortization. Amortization expense, exclusive
of the $118,000 described above, was $40,000 for the fiscal year ended January
31, 1996 and $142,000 for the fiscal year ended January 31, 1997.
General and Administrative
General and administrative expenses decreased 2% in 1997 compared to
1996 due to better management of overall operating expenses. As a percentage of
revenue, general and administrative expenses decreased from 42% in 1996 to 24%
in 1997 as a result of the increased oil and gas revenues.
Interest Expense
Interest expense increased from $318,000 in 1996 to $696,000 in 1997 as
a result of additional debt obtained during the year for the three property
acquisitions in March and April 1996 and the fourth property acquisition in
January 1997. The fiscal year ended January 31, 1997 also reflects a full year
of interest expense related to the $2 million Notes which were issued in
September 1995 at 11.75% interest and prepaid effective January 31, 1997.
Gain on Sale
During the fiscal year ended January 31, 1997, the number of asset
sales were fewer than during the fiscal year ended January 31, 1996 and on lower
valued properties than in fiscal 1997 and, therefore, the gain on sale of assets
recognized by the Company decreased from $1.2 million to $316,000.
Minority Interests of Limited Partners
Minority interest in earnings of limited partnerships decreased from
$281,000 in 1996 to $94,000 in 1997 due to a decrease in the gain on sale of
assets from the limited partnership. The cumulative minority interest of the
limited partners of GulfMex, $129,613 is set out in the consolidated balance
sheet for the year ended January 31, 1997.
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<PAGE>
Koch Private Placement
In August 1996, the Company engaged Reid as its exclusive agent to
assist the Company in effectuating the sales of equity in the Company by means
of private placement to institutional investors. On January 16, 1997, the
Company and Koch concluded a $10 million private placement. Koch acquired
500,000 shares of Series A Preferred Stock for $5 million and 500,000 shares of
Series B Preferred Stock for $5 million. The Koch Private Placement provides
Koch the right and option to purchase up to an additional 200,000 shares of
Series A Preferred Stock at the face value of $10 per share of Series A
Preferred Stock at any time after January 16, 1999 but on or before January 16,
2000. The option may be exercised in whole or part. The Koch Private Placement
also provides for a financing right of first refusal, which requires the Company
to give Koch written notice of any intention of the Company to issue new
securities, further describing the amount of funds the Company wishes to raise,
the type of new securities to be issued, the price and general terms. Under the
terms of the Koch Private Placement, Koch has 15 days from the date of its
receipt of such notice to agree to purchase all or part of such new securities.
The summary of the terms of the private placement and the rights, designation
and preferences of the three series of preferred stock as set forth herein is
qualified in its entirety by reference to the Certificate of Designation,
Preferences and Rights of Series A Preferred Stock, Series B Preferred Stock,
and Series C Preferred Stock of Rio Grande, Inc., Stock Purchase Agreement
between Koch Exploration Company and Rio Grande, Inc. and Registration Rights
Agreement between Rio Grande, Inc. and Koch Exploration Company, all of which
were filed as Exhibits to Form 8-K filed on January 31, 1997.
Series A Preferred Stock. Pursuant to the Koch Private Placement,
500,000 shares of Series A Preferred Stock were initially issued by the Company
at $10 per share. Holders of the Series A Preferred Stock, which has a face
value of $10, are entitled to receive, out of funds legally available,
cumulative dividends at the rate of 15% of the face value payable on the first
day of February, May, August and November of each year. The first dividend
payment date was May 1, 1997, and included pro-rata dividends from the date of
issuance on January 16, 1997 to May 1, 1997.
In the event of any voluntary or involuntary liquidation, dissolution
or winding up of the Company, holders of Series A Preferred Stock shall have
preference, second only to the Senior Credit Facility, to the distribution of
the assets of the Company up to an amount equal to the aggregate face value of
the then outstanding Series A Preferred Stock plus accrued but unpaid dividends.
The Company's merger, consolidation or any other combination into another
corporation, partnership or other entity which results in the exchange of more
than 50% of the voting securities of the Company requires the consent of the
majority of the holders of the Series A Preferred Stock, however, the holders of
the Series A Preferred Stock are not entitled to any other voting rights.
If the Company completes a registered public offering for aggregate
consideration in excess of $20 million before January 16, 2002, all of the
outstanding shares of Series A Preferred Stock must be redeemed at face value
plus any accrued and unpaid dividends. If the Company does not successfully
complete such a registered public offering by January 16, 2002, the holders of a
majority of the outstanding Series A Preferred Stock after that date may at
anytime during the first 10 days after each dividend payment date require the
Company to redeem shares of the Series A Preferred Stock equal to 10% of the
aggregate number of shares of Series A Preferred Stock the Company issued. The
Company may redeem after January 16, 2003 all of the issued outstanding shares
of Series A Preferred Stock if all accrued dividends have been declared and paid
prior to the notice of redemption by the Company. The Company must pay a premium
of 10% of the face value of the Series A Preferred Stock to effectuate such
redemption.
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<PAGE>
Series B Preferred Stock. Pursuant to the Koch Private Placement,
500,000 shares of Series B Preferred Stock were issued by the Company for
consideration of $10 per share. Holders of the Series B Preferred Stock, which
has a face value of $10 per share, are entitled to receive, out of funds legally
available, cumulative dividends at the rate of .035 shares of Series C Preferred
Stock, which also has a face value of $10 per share. The dividend payment date
for the Series B Preferred Stock is the first day of February, May, August and
November of each year, with the first dividend having been paid May 1, 1997 and
including dividends beginning February 1, 1997. Dividends on the Series C
Preferred Stock are payable in preference and priority to payment of dividends
on the Series B Preferred Stock.
In the event of any voluntary or involuntary liquidation, dissolution
or winding up of the Company, holders of Series B Preferred Stock shall have
preference in the distribution of the assets of the Company after and subject to
the payment of the Senior Credit Facility and payment in full of all amounts,
including accrued but unpaid dividends, required to be distributed to the
holders of Series A Preferred Stock. The Series B Preferred Stock liquidation
preference shall be in an amount equal to the aggregate face value of the then
outstanding Series B Preferred Stock plus accrued but unpaid dividends.
If the Company successfully completes a registered public offering on
or before January 16, 2002 which results in gross proceeds greater than $15
million but less than $20 million, each holder of Series B Preferred Stock may
elect to require the Company to redeem not more than one-half of the then issued
and outstanding shares of Series B Preferred Stock at an amount per share of
Series B Preferred Stock equal to the offering price per share of common stock
in the registered public offering. Any holders of Series B Preferred Stock
electing to redeem shares will have an equal percentage of Series B Preferred
Stock converted into common stock of the Company.
Upon the successful completion of a registered public offering
resulting in gross proceeds to the Company of more than $20 million and at a
price per share of common stock which is equal to or greater than the per share
value of the aggregate face value of the issued and outstanding Series B and
Series C Preferred Stock divided by the total number of shares of common stock
issuable upon conversion of the Series B Preferred Stock at the time of the
offering, all outstanding Series B Preferred Stock shall be automatically
converted into common stock of the Company. Thereafter, outstanding shares of
the Series B Preferred Stock shall be deemed canceled.
If the Company does not successfully complete a registered public
offering on or before January 16, 2002, then at any time after that date, but
only during the first 10 days after each dividend payment date, the holders of a
majority of the issued and outstanding Series B Preferred Stock may elect to
require the Company to redeem up to 10% of the aggregate number of shares of
Series B Preferred Stock issued by the Company. The Company may redeem after
January 16, 2003, all of the issued and outstanding shares of Series B Preferred
Stock if all accrued dividends have been declared and paid prior to the notice
of redemption by the Company. The redemption price will be face value of all
outstanding shares of Series B Preferred Stock plus a premium of 10% of the face
value of Series B Preferred Stock.
Holders of Series B Preferred Stock have the option and right at any
time upon the surrender of certificates representing Series B Preferred Stock to
convert each share of Series B Preferred Stock into 5.26795 fully paid and
nonassessable shares of common stock of the Company, subject to adjustment as
set forth in the Certificate. The holders of Series B Preferred Stock have
certain anti-dilutive rights such that if any additional shares of common stock
are issued by the Company at any time after January 16, 1997 but before
conversion of any Series B Preferred Stock is converted and if the issue price
per share of common stock is less than the then applicable conversion price, as
defined in the Certificate, holders of the Series B Preferred Stock will be
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<PAGE>
granted an adjustment to the number of shares of common stock issuable upon
conversion. The initial conversion price per share is $1.898. The initial number
of fully diluted shares at January 16, 1997 is 10,974,895, which is the sum of
common shares then currently issued and outstanding, shares of common stock then
reserved for current and future option plans, plus shares then reserved for the
exercise of warrants granted to certain subordinated debt holders on September
27, 1995 and those shares which are reserved pursuant to conversion rights of
the Series B Preferred Stock. The aggregate number of shares of common stock
into which the Series B Preferred Stock can initially be converted is 2,633,975
shares, subject to adjustment from time to time as set forth in the Certificate.
Voting Rights - Series B Preferred Stock. Holders of all the issued and
outstanding 500,000 shares of Series B Preferred Stock collectively are eligible
to cast votes equivalent to 24% of the then issued and outstanding shares of
common stock on all matters submitted to the stockholders for vote at any annual
or special stockholders meeting. If at any time the Company is in arrears in
whole or in part with regard to quarterly dividends and such nonpayment remains
in effect for three consecutive dividend payment dates, the holders of the
Series B Preferred Stock may notify the Company of their election to exercise
rights to cast votes equivalent to 51% of the then issued and outstanding shares
of common stock. At any time that the holders hold less than 500,000 shares of
Series B Preferred Stock, the voting percentage of either 24% or 51% is reduced
on a pro-rata basis.
Board of Directors. The holders of Series B Preferred Stock shall have
the right to nominate and elect to the Company's Board of Directors nominees
representing not less than one-third of the number of members constituting the
Board of Directors so long as there are more than 200,000 shares of Series B
Preferred Stock issued and outstanding. Dale G. Schlinsog, Vice President of
Koch Capital Services, and Todd E. Banks, Chief Financial Officer of Koch
Capital Services, are serving on the Board of Directors during the interim
period and until the next election of directors at the annual meeting of
stockholders. Mr. Schlinsog and Mr. R. Allan Allford, Managing Director of Koch
Producer Services, will be placed on the ballot for election at the annual
meeting of stockholders to be held July 1, 1997.
If at any time there are less than 200,000 issued and outstanding
shares of Series B Preferred Stock, the holders shall have the right to elect
only one director to the Company's Board. If at any time the Company is in
arrears in whole or in part with regard to quarterly dividends and such
nonpayment remains in effect for three consecutive quarters or, if a significant
event (as defined in the Certificate) occurs, the holders have the right at any
annual or special meeting of the stockholders to nominate and elect such number
of individuals as shall after the election represent a majority of the number of
directors constituting the Company's Board. A significant event shall mean and
be deemed to exist if (i) the Company files a voluntary petition, or there is
filed against the Company an involuntary petition, seeking relief under any
applicable bankruptcy or insolvency law, (ii) a receiver is appointed for any of
the Company's properties or assets, (iii) the Company makes or consents to the
making of a general assignment for the benefit of creditors or (iv) the Company
becomes insolvent or generally fails to pay, or admits in writing its inability
or unwillingness to pay, its debts as they become due. At such time that there
is a cure or waiver received in writing from the holders of a majority of the
Series B Preferred Stock, the additional board members elected by the holders
shall be removed from the Company's Board.
Series C Preferred Stock. The holders of Series C Preferred Stock,
which has a face value of $10, are entitled to receive cumulative dividends, out
of funds legally available, at the rate of 14% of the face value payable on the
first day of February, May, August and November of each year. Pursuant to the
Koch Private Placement, 17,500 shares of Series C Preferred Stock will be issued
as dividends on the Series B Preferred Stock on May 1, 1997. No shares of Series
C Preferred Stock were initially issued in connection with consummation of the
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sale of the Series A and Series B Preferred Stock pursuant to the Koch Private
Placement. The first dividend payment date for the Series C Preferred Stock will
be August 1, 1997.
In the event of any voluntary or involuntary liquidation, dissolution
or winding up of the Company, the holders of the then outstanding Series C
Preferred Stock shall have preference in the distribution of the assets of the
Company, after and subject to the payment in full of all amounts required to be
distributed to the holders of Series A and Series B Preferred Stock. The Series
C Preferred Stock liquidation preference shall be in an amount equal to the
aggregate face value of the then outstanding Series C Preferred Stock plus
accrued but unpaid dividends. Series C Preferred Stock shall not be entitled to
any voting rights other than provided by law.
If the Company successfully completes a registered public offering on
or before January 16, 2002 resulting in gross proceeds to the Company of more
than $20 million and at a price per share of common stock which is equal to or
greater than the per share value of the aggregate face value of the issued and
outstanding Series B and Series C Preferred Stock divided by the total number of
shares of common stock issuable upon conversion of the Series B Preferred Stock
at the time of the offering, all issued and outstanding Series B Preferred Stock
shall be automatically converted into common stock of the Company and the
Company then shall have the right to redeem all of the Series C Preferred Stock
for a redemption price of $0.01 per share. The redemption shall occur on the
same day on which the registered public offering is completed. If there is a
partial conversion of Series B Preferred Stock, the Company has the right to
redeem the number of shares of Series C Preferred Stock which were issued as
dividends to such Series B Preferred Stock being redeemed. If the Company does
not successfully complete a registered public offering on or before January 16,
2002, then at any time after January 16, 2002, but only during the first ten
days after each dividend payment date, the majority of holders of Series C
Preferred Stock may require the Company to redeem up to 10% of the aggregate
number of shares of Series C Preferred Stock issued by the Company. The Company,
at any time after January 16, 2003, may redeem all of the then issued and
outstanding shares of Series C Preferred Stock at face value plus a premium of
10% of the face value if all accrued dividends have been paid before the notice
of redemption.
The holders of Series C Preferred Stock may not transfer shares
independently and apart from the underlying shares of Series B Preferred Stock
for which holders received such preferred stock. All shares of Series B and
Series C Preferred Stock shall bear a legend which shall advise of the
restrictions on transfer including that the shares have not been registered
under the Securities Act of 1933 and that the shares are subject to the terms
and conditions of the Certificate.
Other Information and Agreements. Reid, as the investment banker, was
paid $250,000 plus expenses from the proceeds for representing the Company in
the Koch Private Placement. Approximately $6 million of the proceeds of the Koch
Private Placement was used to acquire Righthand Creek. Approximately $2 million
has been used by the Company to retire the Company's 11.5% Subordinated Notes
dated September 27, 1995. The Company incurred approximately $741,700 in closing
costs and other fees for the placement of the equity and the purchase of
Righthand Creek. The remaining proceeds will be used to develop and workover
various behind pipe or undeveloped reserves of Company-owned oil and gas
properties.
The First Amendment to the Senior Credit Facility permits the payment
of dividends on the various preferred stock acquired by Koch unless an event of
default under the Senior Credit Facility has occurred and is continuing. The
Koch Private Placement provides for certain restrictions on the Company's total
indebtedness. Under the Koch Private Placement, the Company can only increase
indebtedness through the Senior Credit Facility; however, if the incurrence of
additional debt results in the Company's total indebtedness exceeding 65% of the
present value of the Company's proved reserves discounted at 12%, the Company
cannot incur such additional debt. The Koch Private Placement does provide Koch
the right and option to purchase up to an additional 200,000 shares of Series A
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Preferred Stock at the face value of $10 per share of Series A Preferred Stock
at any time after January 16, 1999 but on or before January 16, 2000. This
option may be exercised in whole or in part. The Koch Private Placement also
provides for a financing right of first refusal. If the Company intends to issue
new securities, it shall give Koch written notice of such intention, describing
the amount of funds the Company wishes to raise, the type of new securities to
be issued, the price and general terms. Koch has 15 days from the date of
receipt of notice to agree to purchase all or part of such new securities.
Under the Koch Private Placement and pursuant to a Master Commodity
Swap Agreement between the Company and Koch Oil Company, the Company has agreed
to put in place a price risk protection program in the form of one or more swap,
hedge, floor or collar agreements to be in place for the Company's net oil and
gas production, using a 6:1 gas/oil ratio, so long as Koch owns any preferred
stock in the Company. Subject to the conditions of the First Amendment with the
senior lender, the Company is restricted to placing the following volume and
pricing parameters for any commodity swap transactions of aggregate crude oil
barrels equivalent, net to the Company's interest as follows:
(a) For the period of November 1, 1996 through October 31, 1997,
700 Bbls oil equivalent at a base price of $20.09/Bbl
(b) For the period of November 1, 1997 through October 31, 1998,
600 Bbls oil equivalent at a base price of $20.06/Bbl
(c) For the period of November 1, 1998 through October 31, 1999,
500 Bbls oil equivalent at a base price of $20.23/Bbl
Effective February 1, 1997, Offshore's contract marketing agent entered
into a one year sales contract with an independent oil purchaser to deliver up
to an average of 650 bbl crude oil daily in Righthand Creek. The sales contract
provides for a floor price of $20 per bbl and a ceiling price of $23.45 per bbl
delivered from Righthand Creek. The price determination on the posted price of
Louisiana Sweet Crude at St. James, Louisiana ("LLS") plus a posting bonus of
$1.50 per bbl ("Bonus"). Under the terms of the sales contract, there is no
penalty for under delivery of oil from Righthand Creek unless the LLS plus Bonus
exceeds $23.45 per bbl. If the penalty clause is invoked, the amount of penalty
due would be computed as follows: the sum of 650 bbl daily crude oil contracted
times the number of days in the month less the actual barrels delivered times
the difference between LLS plus Bonus less $23.45. Although the Righthand Creek
wells are currently producing less than the 650 bbl daily crude oil requirement,
the LLS plus Bonus has been less than $23.45 per bbl.
The Company has also agreed to enter into negotiations with Koch to
enter into one or more marketing agreements for the purchase, sale and
transportation of all oil and gas products produced by the Company so long as
Koch owns a majority of the Series B Preferred Stock. The Company currently has
a marketing agreement in place with another party, therefore the marketing
agreement to be negotiated with Koch will become effective at such time when the
existing contract expires. The marketing agreement to be negotiated with Koch
shall be at arms-length, for a term of not less than five years, and shall
incorporate terms and conditions satisfactory to the Company and the senior
lender.
As a condition to consummating the Koch Private Placement, Robert A.
Buschman, Guy Bob Buschman, Koch and the Company executed a Stockholders
Agreement ("Stockholders Agreement"). Under the terms of the Stockholders
Agreement, if prior to January 18, 2002, either Buschman proposes to accept an
offer to sell their shares of the Company's common stock, then either Buschman
shall notify Koch regarding such offer and Koch may elect to participate in the
sale of common stock on the same terms and conditions. Excluded from the
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limitations in the Stockholders Agreement are certain permitted transfers.
Likewise, Koch may not sell any Series B Preferred Stock to an outsider, as
defined in the agreement, without first offering the Series B Preferred Stock to
the Buschmans. Pursuant to the Stockholders Agreement, the Buschmans also agreed
to vote shares owned by them for any Koch nominees to the Board of Directors
from and after conversion of the Series B Preferred Stock to Common Stock.
The Stockholders Agreement will terminate upon the earlier of:
(a) consummation of a public offering which results in aggregate
net proceeds of not less than $20 million;
(b) death of either party thereto;
(c) Koch ceases to own at least 50,000 shares of Series A
Preferred Stock, 50,000 shares of Series B Preferred Stock, or
more than 10% of common stock shares;
(d) either Buschman ceases to own more than 10% of outstanding
common stock; or
(e) five years.
An additional condition of closing required that Guy Bob Buschman,
President and Chief Executive Officer, and Gary Scheele, Vice President and
Chief Financial Officer, enter into employment agreements with the Company and
Drilling for initial terms of five years which may be renewed annually
thereafter at base salaries of $125,000 and $100,000 per annum, respectively.
Any subsequent increase in base salaries, payment of bonuses or grants of stock
options will be at the sole discretion of the Board of Directors. Under terms of
the employment agreement, Buschman and Scheele are provided company vehicles for
business and personal use at the sole expense of the Company. The Company may
terminate the employment agreements at any time for cause by providing 15 days
notice to the individuals, or at its sole discretion pay the individual for 15
days in lieu of notice. If the individual is terminated without cause, the
Company is obligated to pay the individual three years of the annual base salary
in effect, an amount sufficient, after taking into effect individual's federal
and state income taxes, to pay the exercise price of any options granted, and
the individual's COBRA cost for eighteen months following the termination date.
The Registration Rights Agreement grants Koch up to three demand
registration rights upon notice to the Company from holders of at least 40% of
the Registrable Securities, which is defined in the Registration Rights
Agreement to mean the Common Stock issued and issuable upon conversion of the
Series B Preferred Stock, including any dividends or distributions thereon.
Whenever a demand registration is made, the Company shall be entitled to include
in any registration statement shares of Common Stock to be sold by other holders
of Common Stock with registration rights that allow such holders to participate
in the registration and shares of Common Stock to be sold by the Company for its
own account, subject to underwriter's cutbacks.
The Company may not cause any other registration of securities for sale
of its own account or for persons other than a holder of Registrable Securities
(other than a registration effected solely to implement an employee benefit plan
or a transaction to which Rule 145 of the Commission is applicable, or as may be
required pursuant to the terms of those certain Warrant Agreements, as amended
through the date hereof, issued by the Company in connection with the Company's
1995 11.50% Subordinated Notes) to become effective less than 180 days after the
effective date of any demand registration required pursuant to the terms of the
Registration Rights Agreement.
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The Company has limited rights to postpone or avoid the demand
registration obligations contained in the Registration Rights Agreement under
certain circumstances, such as when the Company is already preparing a
registration statement when a demand is received, when the Board of Directors
shall determine in good faith that an offering would interfere materially with a
pending or contemplated financing, merger, sale of assets, recapitalization or
other similar corporate action of the Company, or when the Board of Directors
shall determine in good faith that the disclosures required in connection with
such a registration could reasonably be expected to materially and adversely
affect the business or prospects of the Company.
The Registration Rights Agreements also provides for "piggyback"
registration rights for holders of Registrable Securities. If the Company at any
time proposes a Registered Public Offering, it must give written notice to all
holders of Registrable Securities of its intention to do so. Upon the written
request of any holders of Registrable Securities given within 20 days after
transmittal by the Company to the holders of such notice, the Company will,
subject to the limits contained in the Registration Rights Agreement, including
underwriter cutbacks, use its best efforts to cause those Registrable Securities
of said requesting holders to be included in such registration statement.
Recent Operating Developments
The Company's future results of operations and the other forward
looking statements contained in this section involve a number of risks and
uncertainties. In particular, no assurances can be given that any current or
future development or exploration plans and operations will be successful or
that, if successful, production from the wells and the associated revenues over
the production life of the properties will equal or exceed the costs associated
with properties and their development.
The Company operates a number of wells in the KWB Field in West Texas,
in which Offshore owns approximately 80% of the working interest. With a portion
of the proceeds of the Notes, the Company initiated a pilot secondary recovery
waterflood project in that field. The pilot development well and conversion of
the surrounding production wells to water injection wells required capital
expenditures of approximately $122,000 as of January 31, 1997. The water
injection procedures have been proceeding since January 1996. While the water
injection wells are causing a build-up in reservoir pressure, no material
additional incremental oil production has been experienced in the pilot
development well. The Company expected it would take several months before any
noticeable increase in secondary recovery production, if any, would be realized.
If the waterflood pilot proves successful, the projected number of additional
development wells drilled would be 29 with projected development costs to the
Company of approximately $5,800,000 and a projected increase in reserves of
1,100 mbbls of oil equivalent. Should the waterflood pilot prove to be
uneconomical, the Company would likely abandon the field. The Company
anticipates that the sale of salvageable equipment would exceed plugging and
abandonment expense for the existing production and water injection wells.
Offshore commenced the workover and additional development work at
Righthand Creek in March 1997. A workover drilling rig was placed on a
previously abandoned well in the field and was able to recomplete the well in
the Wilcox "B" formation with production currently at approximately 70 bbls per
day. The total workover and completion costs incurred for this well was
approximately $275,000 through April 15, 1997. It will be necessary to produce
the well for several months before any determination can be made on the total
estimated reserves of this well.
On March 26, 1997, a drilling rig commenced an 11,300 foot Wilcox "B"
formation development well in Righthand Creek as well. This development well,
budgeted at approximately $800,000, is expected to be completed in May 1997.
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On April 1, 1997, production from Block 76 was suspended to repair
mechanical problems with the downhole equipment. The total workover cost is
expected to approximate $2.08 million. Offshore's portion of the workover
expense will be approximately $115,000. As of April 30, 1997 the level of
production net to Offshore's interest has been restored to approximately 550 mcf
per day as compared to approximately 700 mcf per day prior to the suspension of
production.
Capital Resources and Liquidity
In May 1995, Offshore sold its interest in Ewing Bank Block 947 located
offshore Louisiana. Proceeds from the sale of this property were approximately
$1.3 million, which resulted in a gain on sale to the partnership of
approximately $1.1 million. Drilling, as an 80% partner, received a cash
distribution of approximately $1 million from the sale, of which $800,000 was
applied as principal reduction to the Company's then outstanding bank
indebtedness, which was secured by substantially all of the Company's and
Offshore's assets. Effective July 1995, the Company sold its interest in certain
additional properties for approximately $184,000 and applied $170,000 of the
proceeds as a further reduction of bank indebtedness.
On September 27, 1995, the Company consummated a private offering of
11.50% Notes in the aggregate principal amount of $2 million with warrants
providing for the purchase of an aggregate of 1,388,160 shares of Class A Common
Stock, par value $.01 per share, of the Company at an initial exercise price of
$0.40 per share, subject to adjustment under certain circumstances. In
connection with the modifications and amendments to the Notes discussed below,
the warrant exercise price was reduced to $0.20 per share. The Notes were issued
primarily to finance further development and production enhancements to certain
oil and gas properties acquired by the Company in 1994. Net proceeds of
approximately $1.9 million were provided to the Company by the private offering.
In March 1996, the Company entered into a commitment letter with a new
lender to replace the Company's then existing bank indebtedness of approximately
$1.6 million. The commitment letter required that the Company obtain certain
modifications and amendments from the Holders before the new credit facility
could be concluded. Such consents and amendments were approved by the Holders on
March 8, 1996. As amended, the Notes provided for a final maturity on September
30, 2002 (instead of September 30, 2000) and the quarterly amortization of
principal over four years, commencing in December 1998, at annual rates of
12.5%, 12.5%, 37.5% and 37.5% of the original principal amount (instead of
amortization of principal over three years, commencing in December 1997, at
annual rates of 12.5%, 37.5% and 50% of the original principal amount). In
addition to other provisions amended, the exercise price of the warrants granted
was reduced from $.40 per share to $.20 per share.
The Company's Senior Credit Facility initially provided for up to $10
million in borrowings, subject to limitations of availability as a result of the
Borrowing Base determination. The initial Borrowing Base under the Senior Credit
Facility was $5 million. Initial proceeds from the Borrowing Base were used to
refinance the Company's existing senior indebtedness of $1.6 million on March
11, 1996 and provided $900,000 to purchase a 3.125% working interest in an
existing producing oil and gas lease located offshore Louisiana.
On March 26, 1996, Offshore acquired leasehold interests in three gas
wells located in Wheeler County, Texas ("Wheeler County") for a net purchase
price of approximately $370,500. Funds of $320,500 from the Borrowing Base and
working capital of $50,000 were used by the Company to make the acquisition of
these wells. Drilling operates these gas wells.
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In April 1996, Offshore acquired various leasehold interests in
approximately 31 onshore oil and gas wells located in Mississippi and Louisiana
("Belle") for an acquisition price of approximately $2.8 million, which includes
23 wells to be operated by Drilling. At closing, the Company paid half of the
acquisition price with funds of approximately $1.1 million from the Borrowing
Base and approximately $300,000 of working capital. By agreement with the
seller, the remaining balance of approximately $1.4 million was financed by a
note issued to the seller ("Seller's Note") payable with interest at prime on
August 30, 1996. In August 1996, the Company requested the senior lender to
increase the Borrowing Base to facilitate funding the Seller's Note. On August
30, 1996, the senior lender and the Company agreed to increase the Borrowing
Base to $5.4 million. The Borrowing Base is determined by the senior lender, in
its sole discretion, using procedures and standards customary for its petroleum
industry customers, and represents the amount of borrowings which in the senior
lender's opinion the Company's oil and gas properties will support. On August
30, 1996, the Seller's Note of approximately $1.45 million was paid with $1.2
million of additional financing through the Senior Credit Facility and
approximately $251,000 of the Company's working capital.
Effective January 16, 1997, in connection with the Righthand Creek
acquisition and the Koch Private Placement, the Company and Drilling executed
the First Amendment to the Senior Credit Facility which provided for the
increase of the Senior Credit Facility to $50 million and the increase of the
Borrowing Base on January 16, 1997 to approximately $17 million. The First
Amendment also provided for extending the maturity date of the Senior Credit
Facility to February 1, 2000. The Borrowing Base was subject to monthly
reductions of $75,000 for February and March 1997, and is thereafter subject to
monthly reductions of $333,000 until maturity or the next determination of the
Borrowing Base. The Borrowing Base of approximately $16.5 million as of April
30, 1997 shall continue to reduce until February 1, 1998. The Company may, at
its sole expense, request a redetermination prior to February 1, 1998.
The interest rate options available to the Company are based on either
a prime rate determination or a Eurodollar rate determination. The outstanding
principal balance under the Borrowing Base will be subject to the senior
lender's prime rate plus 0.5% calculated on actual days of a year consisting of
365 days, unless written notice is provided to the bank to elect an amount to be
converted to a Eurodollar rate determination. The Company can elect that any
amount of the outstanding principal under the Borrowing Base be converted into
Eurodollar interest rate financing for recurring 30, 60, 90 or 180 day periods.
The Eurodollar interest rate is based on the time period selected plus an
incremental margin payable to the senior lender equivalent to 2.25%. Interest
calculated under the Eurodollar rate is determined on actual days in a year
consisting of 360 days. For any unused portion of the Borrowing Base, a
commitment fee of 3/8ths of one percent per annum will be charged to the
Company. The senior lender was paid a loan origination fee of $75,000 to
facilitate the First Amendment. The outstanding principal balance of the Senior
Credit Facility was $13.3 million at April 30, 1997.
On January 16, 1997, Offshore completed the acquisition of producing
oil and gas properties in Righthand Creek Field ("Righthand Creek") located in
Allen Parish, Louisiana. The acquisition price of approximately $15.3 million
was funded by approximately $9 million borrowed under the Senior Credit Facility
and approximately $6 million from the proceeds of the $10 million Koch Private
Placement.
Lower oil and gas prices during calendar year 1995 adversely affected
the Company's financial performance and cash flow. Approximately 54% of the
Company's sales production volume during fiscal year ended January 31, 1996 was
from gas. The average gas price for fiscal year 1996 was approximately $1.68 per
mcf. Although posted natural gas and crude oil prices increased significantly
during the fourth quarter of the fiscal year ended January 31, 1996, regional
prices for those products did not increase at the same rate. During the fiscal
year ended January 31, 1997, the increase in crude oil and natural gas sales,
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other than by the addition of oil and gas properties acquired, was attributable
to the increase in the average unit prices of crude oil and natural gas received
by the Company to $20.73 per bbl and $2.54 per mcf, respectively.
The Company's ability to meet its current financial commitments,
including those imposed by the Senior Credit Facility and the terms of the
Preferred Stock, and to have access to additional working capital to operate and
develop its existing oil and gas properties is principally dependent on the
market prices for oil and natural gas, the production levels of the Company's
properties, and the success of the development program commenced by the Company.
The Company presently has no commitment for additional financing and there can
be no assurance that the Company will be successful in obtaining additional
financing when and if required. If the Company is unable to obtain additional
financing when needed, it would consider, among other alternatives, sale of
certain of its leasehold interests for additional capital, the curtailment of
property acquisitions or development activities until internally generated funds
become available, or other strategic alternatives in an effort to meet its
financial requirements.
Oil and gas exploration and production operations involve substantial
economic risks. No assurances can be given that any current or future
development plans and operations will be successful or that, if successful,
production from the wells and the associated revenues over the productive life
of the properties will equal or exceed the costs associated with properties and
their development.
The Company is not obligated to provide a fixed or determinable
quantity of oil or gas in the future under any existing contracts, agreements,
hedge or swap arrangements, except as described for the Righthand Creek oil
contract above.
Statements in this Annual Report including those contained in the
foregoing discussion and other items herein, concerning the Company which are
(a) statements of plans and objectives for future operations, (b) statements of
future economic performance, or (c) statements of assumptions or estimates
underlying or supporting the foregoing are forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. The ultimate accuracy of forward-looking
statements is subject to a wide range of business risks and changes in
circumstances, and actual results and outcomes often differ from expectations.
Any number of important factors could cause actual results to differ materially
from those in the forward-looking statements herein, including the following:
the timing and extent of changes in crude oil and natural gas prices; actions of
the Company's purchasers and competitors; changes in the cost or availability of
pipelines and other means of transporting products; state and federal
environmental, economic, safety and other policies and regulations, any changes
therein, and any legal or regulatory delays or other factors beyond the
Company's control; weather conditions affecting the Company's operations or the
areas in which the Company's products are marketed; future well performance; the
extent of the Company's success in acquiring oil and gas properties and in
discovering, developing and producing reserves; political developments in
foreign countries, the conditions of the capital markets and equity markets
during the periods covered by the forward-looking statements. The Company
undertakes no obligation to publicly release the result of any revisions to any
such forward-looking statements that may be made to reflect the events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
Item 7. Financial Statements
1) The financial statements of the Company beginning on page F-1
are filed as part of this Form 10-KSB.
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Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
The Company has never changed accountants nor reported a disagreement
on any matter of accounting principles.
PART III
Item 9. Directors and Executive Officers of the Registrant
See "Election of Directors" incorporated herein by reference from the
Proxy Statement to the Company's Stockholders.
Item 10. Executive Compensation
See "Executive Compensation" incorporated herein by reference from the
Proxy Statement to the Company's Stockholders.
Item 11. Security Ownership of Certain Beneficial Owners and Management
See "Voting Securities and Principal Stockholders" incorporated herein
by reference from the Proxy Statement to the Company's Stockholders.
Item 12. Certain Relationships and Related Transactions
See "Related Transactions" incorporated herein by reference from the
Proxy Statement to the Company's Stockholders.
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits
The exhibits listed on the accompanying Index to Exhibits on
page E-1 are filed as part of this Form 10-KSB. The Company
will furnish a copy of any exhibit to a requesting stockholder
upon payment of a fee of $.25 per page.
10(o) Participation Agreement between Mortimer Exploration
Company and Rio Grande Offshore, Ltd. for the
Texas/Louisiana Yegua Project dated March 10, 1997.
(b) Reports on Form 8-K
The Company filed a Form 8-K on January 31, 1997 which
describes the Righthand Creek acquisition, the First Amendment
to the Loan Agreement, and the Koch Private Placement.
The Company filed a Form 8-K/A on March 31 1997 to supplement
the information filed by Form 8-K on January 31, 1997.
Included in the Form 8-K/A are the pro forma statements of
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revenues and direct operating expenses for the Righthand Creek
acquisition and the accompanying audit report by the Company's
independent accountants.
(c) No annual report or proxy material has been sent to the
stockholders as of the date of this Form 10-KSB; however, the
Company anticipates sending the Form 10-KSB and Proxy
Statement on or about May 31, 1997.
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SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
RIO GRANDE, INC.
By: /s/ ROBERT A. BUSCHMAN
--------------------------------------------
ROBERT A. BUSCHMAN, Chairman of the Board
Date: May 16, 1997
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
/s/ ROBERT A. BUSCHMAN Chairman of the Board May 16, 1997
ROBERT A. BUSCHMAN (Principal Executive)
Officer and Director)
/s/ GUY R. BUSCHMAN President and Director May 16, 1997
- ---------------------------
GUY R. BUSCHMAN
/s/ GARY SCHEELE Vice President and May 16, 1997
- --------------------------- Secretary/Treasurer
GARY SCHEELE (Principal Financial and
Accounting Officer)
/s/ JOHN G. HURD Director May 16, 1997
JOHN G. HURD
/s/ H. M. SHEARIN, JR. Director May 16, 1997
--------------------------
H. M. SHEARIN, JR.
/s/ RALPH F. COX Director May 16, 1997
- ---------------------------
RALPH F. COX
/s/ HOBBY A. ABSHIER, JR. Director May 16, 1997
- ---------------------------
HOBBY A. ABSHIER, JR.
/s/ TODD E. BANKS Director May 16, 1997
- ---------------------------
TODD E. BANKS
/s/ DALE G. SCHLINSOG Director May 16, 1997
- ---------------------------
DALE G. SCHLINSOG
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INDEX TO EXHIBITS
The following exhibits are numbered in accordance with Item 601 of Regulation
S-B:
3(a) Certificate of Incorporation of the Company (incorporated by reference
to Exhibit 3(a) to Form 8-K dated December 29, 1986 [File No. 1-8287]).
3(b) Bylaws of the Company (incorporated by reference to Exhibit 3(b) to
Form 8-K dated December 29, 1986 [File No. 1-8287]).
3(c) Certificate of Amendment of Certificate of Incorporation of the Company
(E-3).
4(a) Specimen stock certificate (incorporated by reference to Exhibit 4(a)
to Form 8-K dated December 29, 1986 [File No. 1-8287]).
4(b) Specimen Stock Purchase Warrant (incorporated by reference to Exhibit
4(b) to form 8-K dated December 29, 1986 [File No. 1- 8287]).
4(c) Note Purchase Agreement, dated September 27, 1995, by and among the
Company, Rio Grande Drilling Company, and the various purchasers of
11.50% Subordinated Notes due September 30, 2000 (incorporated herein
by reference from October 31, 1995 Form 10-QSB).
4(d) Form of Common Stock Purchase Warrant issued in connection with the
Offering described in this report (incorporated herein by reference
from October 31, 1995 Form 10-QSB).
4(e) Amendments to Note Purchase Agreement, by and among the Company,
Drilling and the Holders (incorporated herein by reference from March
26, 1996 Form 8-K).
4(f) Amendments to Notes, by and among the Company and the Holders
(incorporated herein by reference from March 26, 1996 Form 8-K).
4(g) Consents to Proposed Transactions by the Holders to the Company
(incorporated herein by reference from March 26, 1996 Form 8-K).
4(h) Amendment to Warrant Agreement among the Company and the Holders
(incorporated herein by reference from March 26, 1996 Form 8-K).
4(i) Certificate of Designation, Preferences and Rights of Series A
Preferred Stock, Series B Preferred Stock, and Series C Preferred Stock
of Rio Grande, Inc. dated January 15, 1997 (incorporated herein by
reference from January 31, 1997 Form 8-K).
4(j) Preferred Stock Purchase Agreement between Koch Exploration Company and
Rio Grande, Inc. dated January 16, 1997 (incorporated herein by
reference from January 31, 1997 Form 8-K).
4(k) Registration Rights Agreement between Rio Grande, Inc. and Koch
Exploration Company dated January 16, 1997 (incorporated herein by
reference from January 31, 1997 Form 8-K).
E-1
<PAGE>
4(l) Stockholders Agreement between Robert A. Buschman, Guy Bob Buschman,
Rio Grande, Inc., and Koch Exploration Company dated January 16, 1997
(incorporated herein by reference from January 31, 1997 Form 8-K).
10(a) Asset Purchase Agreement dated June 26, 1992 by and between SHV Oil and
Gas Company and Rio Grande Drilling Company (incorporated herein by
reference from July 31, 1992 Form 10-Q).
10(b) Agreement of Limited Partnership dated June 25, 1992 for Rio Grande
Offshore, Ltd. between Rio Grande Drilling Company, Robert A. Buschman,
H. Wayne Hightower and H. W. Hightower, Jr. (incorporated herein by
reference from July 31, 1992 Form 10-Q).
10(c) Loan Agreement by and between International Bank of Commerce and Rio
Grande Drilling Company dated June 26, 1992 (incorporated herein by
reference from July 31, 1992 Form 10-Q).
10(d) Purchase and Sale Agreement dated May 24, 1995, between Newfield
Exploration Company and Rio Grande Offshore, Ltd. for the sale of Ewing
Bank Blocks 947/903 and Ship Shoal Block 356 at a sales price of
$1,200,000 (incorporated by reference from July 31, 1995 Form 10-QSB).
10(e) Consulting Agreement dated August 10, 1995, between Hobby A. Abshier
and Rio Grande, Inc. (incorporated by reference from July 31, 1995 Form
10-QSB).
10(f) Closing Agreement between Fortune Petroleum Corporation, Pendragon
Resources, L.L.C. and Rio Grande Offshore, Ltd. dated March 6, 1996 for
the acquisition of South Timbalier Block 76 (incorporated by reference
from March 26, 1996 Form 8-K).
10(g) Loan Agreement between Comerica Bank-Texas, Rio Grande, Inc. and Rio
Grande Drilling Company dated March 8, 1996 for a senior credit
facility of $10,000,000 (incorporated herein by reference from March
26, 1996 Form 8-K).
10(h) Purchase and Sale Agreement between Belle Oil, Inc., Belle Exploration,
Inc., Louisiana Well Service Co., Alton J. Ogden, Jr., Alton J. Ogden,
Sr., Jeff L. Burkhalter and Rio Grande Offshore, Ltd. (incorporated
herein by reference from April 29, 1996 Form 8-K).
10(i) Engagement letter between Reid Investment Corporation and Rio Grande,
Inc. dated August 28, 1996, as exclusive agent to sell equity in Rio
Grande, Inc. (incorporated herein by reference from October 31, 1996
Form 10-QSB).
10(j) Purchase and Sale Agreement between Brechtel Energy Corporation, et al
and Rio Grande Offshore, Ltd. dated November 20, 1996 for the
acquisition of oil and gas properties located in the Righthand Creek
Field, Allen Parish, Louisiana (incorporated herein by reference from
October 31, 1996 Form 10-QSB).
10(k) First Amendment to Loan Agreement between Rio Grande, Inc., Rio Grande
Drilling Company and Comerica Bank - Texas dated January 15, 1997
(incorporated herein by reference from January 31, 1997 Form 8-K).
10(l) Employment Agreement between Rio Grande, Inc., Rio Grande Drilling
Company and Guy Bob Buschman dated January 16, 1997 (incorporated
herein by reference from January 31, 1997 Form 8-K).
E-2
<PAGE>
10(m) Employment Agreement between Rio Grande, Inc., Rio Grande Drilling
Company and Gary Scheele dated January 16, 1997 (incorporated herein by
reference from January 31, 1997 Form 8-K).
10(n) Master Commodity Swap Agreement between Rio Grande, Inc. and Koch Oil
Company dated January 16, 1997 (incorporated herein by reference from
January 31, 1997 Form 8-K).
10(o) Participation Agreement between Mortimer Exploration Company and Rio
Grande Offshore, Ltd. for the Texas/Louisiana Yegua Project dated March
10, 1997 with attached amended letter agreement (E-4).
22 The following list sets forth the name of each subsidiary or affiliate
of the Company, with the State of incorporation as noted which are
wholly-owned by the Company (except as noted):
Rio Grande Drilling Company, Texas corporation Rio Grande
Desert Oil Company, Nevada corporation Rio Grande Offshore,
Ltd., a Texas limited partnership Rio Grande GulfMex, Ltd., a
Texas limited partnership (80% interest)
27 Financial Data Schedule (F-29).
99(a) Private Offering Memorandum of the Company dated August 27, 1995
(incorporated herein by reference from October 31, 1995 Form 10-QSB).
E-3
<PAGE>
MORTIMER EXPLORATION COMPANY
PARTICIPATION AGREEMENT
TEXAS/LOUISIANA YEGUA PROJECT
THIS AGREEMENT is made and entered into this _____ day of March, 1997
[to be effective as of the 1st day of January, 1997] by and between MORTIMER
EXPLORATION COMPANY ("MEC"), whose address is 8700 Crownhill Boulevard, Suite
800, San Antonio, Texas 78209-1197 [telephone: 210) 821-6168; facsimile: (210)
821-6203] and RIO GRANDE OFFSHORE, LTD. ("RG"), whose address is 10101 Reunion
Place, Union Square, Suite 210, San Antonio, Texas 78216-4156 [telephone: (210)
308-8000; facsimile (210) 308-8111]. In consideration of the mutual covenants
herein made, the parties agree as follows:
I.
EXHIBITS
The following Exhibits are attached hereto and shall be considered part
of this Agreement:
Exhibit "A": Identification of Project Area.
Exhibit "B": Schedule of Working Interest Ownership
Exhibit "C": JERRML/Signature Agreement.
Exhibit "D": Joint Operating Agreement [JOA].
Exhibit "E": Form of Assignment.
Exhibit "F": JERRML/Mortimer Agreement.
Exhibit "G": Estimated Budget.
II.
DEFINITIONS
For purposes of this Agreement, the following definitions shall apply:
1. "Drillable Prospect" is any single Prospect within the Prospect Area
proposed and identified by MEC containing acreage of sufficient size to
drill at least two wells and with estimated reserves of at least
200,000 barrels of oil or gas equivalent. Under no circumstance will a
E-4
<PAGE>
one well step out be defined as a Drillable Prospect. A proposed
Drillable Prospect not meeting these parameters will be excluded from
this Agreement unless specifically accepted in writing by both RG and
MEC.
2. "Working Interest" is defined as that portion of the oil and gas
leasehold estate which is owned or assigned by MEC to RG and which is
subject to its proportionate share of all geological and geophysical
evaluation, drilling and completing of wells within a Drillable
Prospect; including but not limited to seismic permits, options,
leases, evaluations, interpretations, analysis, land, legal, drilling,
reworking, and completion of wells, including any and all costs,
expenses, and overhead identified in the JOA or which are associated or
allocated to a Drillable Prospect.
3. "Carried Working Interest" is defined as that portion of the oil and
gas leasehold estate which does not bear its proportionate share of any
cost or expense associated with drilling a well within a Drillable
Prospect until such well either reaches casing point (as to Signature's
interest) or through the tanks (as to MEC's interest).
III.
INTEREST ACQUIRED
For the consideration herein expressed, RG will acquire an undivided
fifty percent (50%) of the right, title and interest owned by MEC within the
Prospect Area (or "Project"), subject to the JERRML/Signature Agreement,
JERRML/Mortimer Agreement and Joint Operating Agreement. The Interest of RG is
subject to the following:
CONSIDERATION
1. A payment by RG to MEC of the sum of fifty percent (50%) of Sixty-Seven
Thousand Three Hundred Sixty-Six Dollars ($67,366.00) being
Thirty-Three Thousand Eight Hundred Sixty-Three Dollars ($33,863.00)
upon execution of this Agreement representing costs incurred as to the
Project prior to January 1, 1997.
E-5
<PAGE>
2. A payment by RG to JERRML of the sum of fifty percent (50%) of Ten
Thousand Dollars ($10,000.00) being Five Thousand Dollars ($5,000.00)
upon execution of this Agreement representing the "JERRML Payment"
shown on Exhibit "G" attached hereto.
3. Beginning January 1, 1997, payment to MEC on or before fifteen (15)
days from receipt of invoice of an undivided fifty percent (50%) of all
costs associated with the Project, including but not limited to: (i)
overhead, (ii) seismic, and (iii) lease acquisition.
4. Payment by RG to MEC of its portion of all costs associated with
drilling of the first two (2) wells ("Commitment Wells") within the
Prospect Area.
IV.
PARTICIPATION AND CONDUCT OF OPERATIONS
By execution of this Agreement, RG does hereby commit to participate in
all costs associated with drilling of the first two (2) wells on two separate
Drillable Prospects within the Project Area. In the event seismic operations
turn up more than two Drillable Prospects, RG and MEC will mutually agree on the
first two prospects to be drilled which will be considered the two Commitment
Wells. RG has the option to forego participation in any subsequent well proposed
on a "new" Drillable Prospect after the drilling of the two Commitment Wells. In
the event RG elects not to participate in the drilling of a well on a "new"
Drillable Prospect, it shall automatically forfeit all right, title, and
interest in and to the entire Project and in any additional wells drilled or to
be drilled on any other "new" Drillable Prospect. However, RG shall retain its
interest in all previously drilled Prospects. Wells drilled pursuant to this
Agreement shall be subject to the terms and provisions of the Joint Operating
Agreement.
V.
CARRIED WORKING INTEREST
ASSIGNMENT
1. MEC will retain a Nine and One-Half Percent (9.5%) Carried Working
Interest through the tanks on the initial wells drilled on the first
six (6) Drillable Prospects.
E-6
<PAGE>
2. Beginning with the seventh Drillable Prospect, MEC shall retain a
Twelve Percent (12%) Undivided Working Interest.
3. RG and MEC shall bear proportionately the Signature Five Percent (5%)
Carried Working Interest as to the initial wells drilled on the first
six (6) Drillable Prospects.
4. Beginning with the seventh Drillable Prospect, Signature's Carried
Working Interest shall be borne solely by MEC.
5. RG shall receive its Assignment on a Drillable Prospect by Drillable
Prospect Basis.
VI.
OPERATIONS
RG shall be Operator of Record as to all Drillable Prospects in which
it owns an interest. In the event RG does not elect to participate in a new
Drillable Prospect, MEC shall be the Operator.
VII.
TERM
The term of this Agreement shall commence upon the Effective Date
hereof and shall continue for a period of four (4) months. RG may extend the
original four (4) month term for additional six (6) month periods by providing
written notice to MEC on or before thirty (30) days prior to the expiration of
the original term or any subsequent six (6) month extension period. This
Agreement may not be cancelled by either Party within the original four (4)
month term, or in any optional six (6) month period without three (3) months
advance written notification.
VIII.
MISCELLANEOUS
1. The interest of RG is subject to the terms and conditions of the
Agreements attached hereto.
2. Venue for any legal proceedings shall be in San Antonio, Bexar County,
Texas.
3. Budget meeting will be held monthly and estimated expenses will be
mutually agreed upon.
E-7
<PAGE>
4. The interest set out to RG in this Agreement will be assigned to other
parties that RG designates. RG will inform MEC of said Assignees and
MEC will bill each Assignee individually for all costs under this
Agreement.
WITNESS the execution hereof by the parties as of the dates of the
acknowledgment of their execution, but effective for all purposes as of the
Effective Date.
MORTIMER EXPLORATION COMPANY
By: __________________________
RIO GRANDE OFFSHORE, LTD.
By: Rio Grande Drilling Company,
General Partner
By: __________________________
Name:_________________________
Title:________________________
E-8
<PAGE>
ACKNOWLEDGMENT
STATE OF TEXAS ss.
ss.
COUNTY OF BEXAR ss.
This instrument was acknowledged before me on the ______ day of
_________________, 1997, by ______________________________, the
_______________________ of Mortimer Exploration Company, a Texas corporation, on
behalf of said corporation.
----------------------------------
Notary Public, State of Texas
STATE OF TEXAS ss.
ss.
COUNTY OF BEXAR ss.
This instrument was acknowledged before me on the ______ day of
_________________, 1997, by _______________________________, the
______________________ of Rio Grande Drilling Company, General Partner of Rio
Grande Offshore, Ltd., on behalf Rio Grande Offshore, Ltd.
----------------------------------
Notary Public, State of Texas
E-9
<PAGE>
April 28, 1997
Mr. Guy Bob Buschman
Rio Grande Offshore, Ltd.
10101 Reunion Place
Union Square, Suite 210
San Antonio, Texas 78216-4156
RE: Clarification of Effective Date
of Rio Grande/Mortimer Agreement
Executed March 10, 1997 covering
Texas/Louisiana Yegua Project
Dear Guy Bob:
You have brought to our attention that the Agreement we signed covering
the Texas/Louisiana Yegua Project referenced above is unclear as to the
Effective Date of said Agreement. Please use this letter as a clarification of
said Agreement whereby we jointly agree that the Effective Date of the Agreement
is the date of execution, March 10, 1997. All other terms and conditions of said
Agreement will remain as they are stated in the Agreement.
Please signify below your acceptance to this clarification and return
one copy of this letter to me at the address below.
Thank you very much.
Yours truly,
Leon N. Walthall, III
Vice President - Land
ACCEPTED AND AGREED TO this ____ day of __________________, 1997.
RIO GRANDE OFFSHORE, LTD.
By: Rio Grande Drilling Company,
General Partner
By:_____________________________
Guy Bob Buschman
President
LNW/nls
Enclosure
E-10
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Rio Grande, Inc.:
We have audited the consolidated balance sheet of Rio Grande, Inc. and
Subsidiaries as of January 31, 1997, and the related consolidated statements of
operations, stockholders' equity, and cash flows for the years ended January 31,
1997 and 1996. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Rio Grande, Inc. and
Subsidiaries as of January 31, 1997, and the results of their operations and
their cash flows for the years ended January 31, 1997 and 1996, in conformity
with generally accepted accounting principles.
As discussed in Note 1, in 1997 the Company changed its method of accounting for
the impairment of long-lived assets and for long-lived assets to be disposed of
to adopt the provisions of the Financial Accounting Standards Board's Statement
of Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of."
KPMG PEAT MARWICK LLP
San Antonio, Texas
April 30, 1997
F-1
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Consolidated Balance Sheet
January 31, 1997
----------------
Assets
Current assets:
Cash and cash equivalents $ 1,045,331
Trade receivables 1,808,663
Prepaid expenses 36,819
------------
Total current assets 2,890,813
------------
Property and equipment, at cost:
Oil and gas properties, successful efforts method 24,976,467
Transportation equipment 133,555
Other depreciable assets 399,933
------------
25,509,955
Less accumulated depreciation, depletion and
amortization (4,111,900)
------------
Net property and equipment 21,398,055
------------
Other assets:
Platform abandonment fund 1,001,963
Other assets, net 654,183
-----------
1,656,146
-----------
Total Assets $ 25,945,014
============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable 1,031,137
Accrued expenses 203,837
Current installments of long-term debt 3,350,868
------------
Total current liabilities 4,585,842
------------
Accrued platform abandonment expense 1,050,706
Long-term debt, excluding current installments 10,010,442
Minority interest in limited partnership 129,613
Redeemable preferred stock, $0.01 par value;
$10 redemption value. Authorized 1,700,000
shares; issued and outstanding 1,000,000 shares 10,000,000
Common stock of $0.01 par value. Authorized
10,000,000 shares; issued and outstanding
5,552,760 shares 55,528
Additional paid-in capital 1,029,338
Deficit (916,455)
------------
Total Stockholders' Equity 168,411
Contingent liabilities
Total Liabilities and Stockholders' Equity $ 25,945,014
============
See accompanying notes to consolidated financial statements.
F-2
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Year ended January 31,
--------------------------------
1997 1996
---- -----
Revenues:
Oil and gas sales $ 5,337,593 3,148,311
--------- ----------
Costs and expenses:
Lease operating 2,394,318 1,565,682
Dry hole costs and lease abandonments 821,982 236,116
Depletion of oil and gas producing properties 1,637,634 933,231
Depreciation and other amortization 305,414 72,502
Provision for abandonment expense 140,800 182,481
General and administrative 1,297,010 1,322,736
--------- ----------
Total costs and expenses 6,597,158 4,312,748
--------- ---------
Loss from operations (1,259,565) (1,164,437)
---------- ---------
Other income (expense):
Interest expense (695,580) (318,222)
Interest income 78,415 64,281
Gain on sale of assets, net 315,884 1,237,411
Minority interest in earnings of limited partnership (94,034) (281,188)
--------- ----------
Total other income (expense) (395,315) 702,282
--------- ----------
Loss before income taxes (1,654,880) (462,155)
Income taxes 260 2,924
--------- ----------
Net loss (1,655,140) (465,079)
Cash dividends on preferred stock 32,877 -
--------- ----------
Net loss applicable to common stock (1,688,017) (465,079)
=========== =========
Net loss per common share $ (0.30) (0.08)
=========== =========
Weighted average common shares outstanding 5,552,760 5,552,760
========= =========
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Additional Retained Total
Common paid-in earnings stockholders'
stock capital (deficit) equity
------- ---------- ---------- -----------
Balances at January 31, 1995 55,528 1,029,338 1,236,641 2,321,507
Net loss -- -- (465,079) (465,079)
------- ---------- ---------- ----------
Balances at January 31, 1996 55,528 1,029,338 771,562 1,856,428
Net loss -- -- (1,655,140) (1,655,140)
Cash dividends on preferred stock -- -- (32,877) (32,877)
-------- -------- ----------- ----------
Balances at January 31, 1997 $ 55,528 1,029,338 (916,455) 168,411
====== ========== ========== ==========
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Year ended January 31,
------------------------------
1997 1996
----------- ------------
Cash flows from operating activities:
Net loss $ (1,655,140) (465,079)
Adjustments to reconcile net loss
to net cash provided by (used in)
operating activities:
Depreciation and amortization 305,414 72,502
Depletion of oil and gas producing
properties 1,637,634 933,231
Provision for abandonment expense 140,800 182,481
Gain on sale of assets, net (315,884) (1,237,411)
Minority interest in earnings of
limited partnership 94,034 281,188
Decrease (increase) in accounts receivable (1,171,371) 111,700
Decrease (increase) in prepaid expenses (23,264) 16,524
Increase in accounts payable and accrued
expenses 498,686 315,616
Decrease in accrued platform abandonment expense (129,452) (122,196)
---------- ---------
Net cash provided by (used in) operating
activities (618,543) 88,556
----------- ---------
Cash flows from investing activities:
Purchase and development of oil and gas
producing properties (19,259,658) (828,061)
Additions to other property and equipment (49,859) (33,119)
Net reductions in platform abandonment fund 33,607 23,955
Additions to other assets (12,870) -
Proceeds from the sale of property and equipment 861,731 1,646,834
----------- ----------
Net cash provided by (used in) investing
activities (18,427,049) 809,609
----------- ----------
Cash flows from financing activities:
Additions to other assets (696,359) (147,650)
Proceeds from long-term debt 19,436,045 2,000,000
Repayment of long-term debt (9,758,950) (1,333,589)
Proceeds from issuance of redeemable
preferred stock 10,000,000 -
Contribution from limited partners of
limited partnership - 97,833
Distribution to limited partners (134,081) (465,183)
----------- ----------
Net cash provided by financing activities 18,846,655 151,411
---------- ----------
Net increase (decrease) in cash and cash
equivalents (198,937) 1,049,576
Cash and cash equivalents at beginning of year 1,244,268 194,692
---------- ----------
Cash and cash equivalents at end of year $ 1,045,331 1,244,268
========= ==========
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
(1) Description of Business and Summary of Significant Accounting Policies
Business
The Company had been engaged in the contract drilling of oil
and gas wells since its incorporation in Texas in 1978 until May 1992.
In June 1992, Drilling formed a Texas limited partnership,
Offshore, to acquire certain non- operated oil and gas properties
located offshore Louisiana in the Gulf of Mexico and onshore properties
located in Louisiana, Texas, and Michigan. Offshore subsequently has
acquired additional non-operated oil and gas properties in Texas,
Oklahoma, and Wyoming.
In July 1994, Offshore acquired certain operated oil and gas
properties which are located primarily in Jack, Young, and Tom Green
Counties, Texas. Drilling assumed the operating responsibilities of the
seller. As the operator of the oil and gas wells, Drilling charges the
other participating working interest owners, including Offshore, for
overhead based on the Council of Petroleum Accountants Societies
("COPAS") monthly rates. COPAS overhead rates are charged on an
individual well basis to reimburse the operator for general costs of
executive and administrative functions incurred at the home office. The
COPAS overhead is normally adjusted on an annual basis based on
inflationary increases.
The business of acquiring producing oil and gas properties is
an inherently speculative activity that involves a high degree of
business and financial risk. Property acquisition decisions generally
are based on various assumptions and subjective judgments relating to
achievable production and price levels which are inherently uncertain
and unpredictable. Although available geological and geophysical
information can provide information on the potential for previously
overlooked or untested formations, it is impossible to determine
accurately the ultimate production potential, if any, of a particular
well. Actual oil and gas production may vary considerably from
anticipated results. Moreover, the acquisition of a property or the
successful recompletion of an oil or gas well does not assure a profit
on the investment or return of the cost thereof. There can be no
assurance that the Company will succeed in its efforts to acquire
additional older oil and gas wells or in its development efforts aimed
at increasing or restoring production from either currently owned or
acquired wells. If the Company over-estimates the potential oil and gas
reserves of a property to be acquired, or if its subsequent operations
on the property are unsuccessful, the acquisition of the property could
result in losses to the Company. Except to the extent that the Company
acquires additional recoverable reserves or conducts successful
exploration and development programs on its existing properties, the
proved reserves of the Company will decline over time as they are
produced. There can be no assurances that the Company will be able to
increase or replace reserves through acquisitions, exploration and
development.
F-6
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
Organization and Principles of Consolidation
The consolidated financial statements include the accounts of
Rio Grande, Inc. (the "Company") and its subsidiaries and
majority-owned limited partnerships as follows:
Form of Ownership
Name Organization Status Interest
Rio Grande Drilling Company Corporation Active 100%
("Drilling")
Rio Grande Desert Oil Company Corporation Active 100%
("RG-Desert")
Rio Grande Offshore, Ltd. Partnership Active 100%
("Offshore")
Rio Grande GulfMex, Ltd. Partnership Active 80%
("GulfMex")
Prior to February 1, 1996, Drilling's ownership interest in
the oil and gas properties acquired by Offshore was 80%. Robert A.
Buschman ("Buschman"), H. Wayne Hightower and H. Wayne Hightower, Jr.
(the "Hightowers") owned the remaining 20% interest. As a result of the
Company's 80% ownership interest, GulfMex's financial statements are
combined with the Company's financial statements prepared as of January
31, 1997. The minority interests of Buschman and the Hightowers are
separately set forth in the balance sheet and the statements of
operations of the Company. The statement of operations for the period
ended January 31, 1996 has been reclassified to provide for a more
meaningful comparison with the results of operations for the period
ended January 31, 1997.
Effective February 1, 1996, Buschman and the Hightowers agreed
to restructure Offshore whereby the aggregate 20% minority limited
partnership interests of Buschman and the Hightowers would be redeemed,
and as a result of in kind distributions, became proportionate working
interest owners of the onshore oil and gas properties previously held
by Offshore. All existing interests in the offshore oil and gas
properties held by Offshore at January 31, 1996 were conveyed to
GulfMex, a newly formed Texas limited partnership, which has the same
proportionate ownership structure as that of Offshore prior to the
restructuring. Buschman and the Hightowers no longer are limited
partners of Offshore and are now 20% limited partners in GulfMex.
Subsequent to January 31, 1996, Offshore is 100% indirectly owned by
the Company and GulfMex is 80% indirectly owned by the Company which is
reflected in the consolidated financial statements prepared as of
January 31, 1997.
All intercompany balances and transactions have been
eliminated in consolidation.
F-7
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
Cash and Cash Equivalents
For purposes of the statement of cash flows, cash and cash
equivalents are characterized as having high liquidity with little
market risk and include checking accounts and money market accounts.
Oil and Gas Properties
The Company utilizes the successful efforts method of
accounting for its oil and gas properties. Under this method, the
acquisition costs of oil and gas properties acquired with proven
reserves are capitalized and amortized on the unit-of-production method
as produced. Development costs or exploratory costs are capitalized and
amortized on the unit-of-production method if proved reserves are
discovered, or expensed if the well is a dry hole.
Capitalized costs of proved properties are periodically
reviewed for impairment on a property-by-property basis, and, if
necessary, an impairment provision is recognized to reduce the net
carrying amount of such properties to their estimated fair values. Fair
values for the properties are based on future net cash flows as
reflected on the year end reserve report. As a result of the adoption
of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of," the Company recognized a
non-cash pre-tax charge against earnings of approximately $261,000
related to oil and gas properties.
Other Property and Equipment
Depreciation on other property and equipment is provided using
the straight-line method over their estimated useful lives. Maintenance
and repairs are expensed as incurred.
Federal Income Taxes
The Company utilizes the asset and liability method to account
for income taxes as prescribed by Statement of Financial Accounting
Standards No. 109. Under this method, deferred income tax assets and
liabilities are recognized for the tax consequences of temporary
differences by applying enacted statutory tax rates expected to apply
in future years to differences between the financial statement carrying
amounts and the tax bases of existing assets and liabilities. Under
statement 109, the effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes
the enactment date.
The Company files a consolidated Federal income tax return
with its subsidiaries, including the operations from certain
partnerships.
Use of Estimates
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that effect the reported amounts of assets
F-8
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
differ from those estimates.
Earnings Per Share
Earnings per share computations are based on the weighted
average number of shares and dilutive common stock equivalents
outstanding during the respective periods. Fully diluted earnings per
share is the same as earnings per common and common equivalent share.
Fair Value of Financial Instruments
Because of their maturities and/or interest rates, the
Company's financial instruments have a fair value approximating their
carrying value. These instruments include trade receivables and
long-term debt. The fair value of the redeemable preferred stock
approximates its carrying value due to the timing of the issue of the
redeemable preferred stock.
Stock-Based Compensation
Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation," allows a Company to adopt a
fair value based method of accounting for stock-based employee
compensation plans or to continue to use the intrinsic-value based
method of accounting prescribed by Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees." The Company has
elected to account for stock-based compensation under the intrinsic-
value method under the provisions of APB Opinion 25 and related
Interpretations. Under this method, compensation expense is recognized
for stock options when the exercise price of the options is less than
the value attributed to the stock on the date of grant. The impact of
SFAS No. 123 had no material effect on the Company's consolidated
results of operations or financial condition.
Recently Issued Accounting Pronouncement
In February 1997, the Financial Accounting Standards Board
issued SFAS No. 128, "Earnings Per Share," which establishes standards
for computing and presenting earnings per share. This Standard,
effective for financial statements issued for periods ending after
December 15, 1997, replaces the presentation of primary earnings per
share with a presentation of basic earnings per share. In addition,
this standard requires dual presentation of basic and diluted earnings
per share on the face of the statement of operations. The Company does
not anticipate the adoption of SFAS No. 128 will have an impact on
earnings per share for 1997 and 1996.
Hedging Transactions
The Company may enter into commodity derivative contracts for
non-trading purposes as a hedging strategy to manage commodity prices
associated with certain oil and gas sales and to reduce the impact of
F-9
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
price fluctuations. The Company primarily uses collar arrangements for
production on properties. While derivative financial instruments are
intended to reduce the Company's exposure to declines in the market
price of oil and natural gas, the derivative financial instruments may
limit the Company's gain from increases in the market price of oil and
natural gas. Income and costs related to these hedging activities are
recognized in oil and gas revenues when the commodities are produced.
Sales Contract
Effective February 1, 1997, Offshore's contract marketing
agent entered into a one year sales contract with an independent oil
purchaser to deliver up to an average of 650 bbl crude oil daily in
Righthand Creek. The sales contract provides for a floor price of $20
per bbl and a ceiling price of $23.45 per bbl crude oil delivered from
Righthand Creek. The price determination for the crude oil is based on
the posted price of Louisiana Sweet Crude at St. James, Louisiana
("LLS") plus a posting bonus of $1.50 per bbl ("Bonus"). Under the
terms of the sales contract, there is no penalty for under delivery of
oil from Righthand Creek unless the LLS plus Bonus exceeds $23.45 per
bbl. If the penalty clause is invoked, the amount of penalty due would
be computed as follows: the sum of 650 bbl daily crude oil contracted
times the number of days in the month less the actual barrels delivered
times the difference between LLS plus Bonus less $23.45. Although the
Righthand Creek wells are currently producing less than the 650 bbl
daily crude oil requirement, the LLS plus Bonus has been less than
$23.45 per bbl.
Except as described above, the Company is not obligated to
provide a fixed or determinable quantity of oil and gas in the future
under any existing contracts, agreements, hedge or swap arrangements.
(2) Acquisition of Oil and Gas Properties
During the year ended January 31, 1997, Offshore made four
significant acquisitions of producing oil and gas properties. On March
11, 1996, Offshore acquired for $900,000 a 3.125% leasehold interest in
a non-operated producing federal oil and gas lease and platform located
offshore Louisiana ("Block 76"). Subsequently, in July 1996, Offshore
acquired an additional 1.041667% leasehold interest in the same
property for $270,000. This acquisition increased Offshore's net total
estimated remaining proved reserves by approximately 1.2 bcf natural
gas and 80,000 bbls of condensate as of the effective date of
acquisition.
On March 26, 1996, Offshore acquired various leasehold
interests in three gas wells located in Wheeler County, Texas ("Wheeler
County") for a net purchase price of $370,500. The total estimated
remaining net proved reserves acquired effective with this acquisition
were approximately 3 mbbls oil and condensate and 868 mmcf natural gas.
In April 1996, Offshore acquired various leasehold interests
in 31 oil wells located in Mississippi and Louisiana ("Belle") for a
net purchase price of approximately $2.8 million, which includes 23
F-10
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
wells operated by Drilling. The total estimated remaining net proved
reserves effective with this acquisition were approximately 1,110 mbbls
oil and condensate.
On January 16, 1997, Offshore completed the acquisition of
producing oil and gas properties in the Righthand Creek Field
("Righthand Creek") located in Allen Parish, Louisiana. The effective
date of the Righthand Creek acquisition was November 1, 1996. The
acquisition price for Righthand Creek was approximately $15.3 million
for total estimated remaining proved producing reserves as of the
effective date of approximately 2 million bbls of oil and 2 bcf natural
gas net to Offshore's interest. The acquisition price is subject to
adjustment under certain circumstances as described below. Due to
timing of closing the acquisition, the revenues and related lease
operating expenses for November 1996 through January 1997 have been
recorded as an adjustment to the acquisition price. Drilling is the
operator for the Righthand Creek wells. The reserve information
discussed above is unaudited.
The following pro forma financial information for the year
ended January 31, 1997 and 1996 gives effect to the above acquisitions
as though they were effective at the beginning of those respective
periods. The pro forma information may not be indicative of the results
that would have occurred had the acquisitions been effective on the
dates indicated or of the results that may be obtained in the future.
The pro forma information should be read in conjunction with the
consolidated financial statements and notes thereto of the Company.
Pro Forma
Year Ended January 31,
----------------------
(unaudited)
1997 1996
---- ----
Net revenues $ 10,481,000 7,500,000
Net loss applicable to common stock $ (1,146,000) (1,901,000)
Net loss per common and common
equivalent share $ (0.21) (0.34)
Weighted average common and common
equivalent shares outstanding 5,552,760 5,552,760
(3) Platform Abandonment Fund
The existing oil and gas properties which are located in
federal waters offshore Louisiana consist of a series of platforms for
each "OCS" lease, each of which accommodate one or more producing oil
and gas wells. Federal regulations mandate strict rules for the
plugging and abandonment of the offshore wells and platforms. Due to
the offshore locations, the costs related with such plugging and
abandonment can be substantial; therefore, the operator of the offshore
oil and gas properties has scheduled monthly deductions from production
F-11
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
proceeds of the working interest owners of certain properties to fund
the total estimated liability at the completion of the productive life
of the wells and platform. The amount deducted each month is based upon
a ratio of that month's production to the estimated remaining proved
producing reserves of each property. GulfMex's estimated ultimate
plugging and abandonment requirements may increase due to inflation or
other circumstances, or may decrease as a result of a sale of the
platform with the buyer assuming plugging and abandonment liabilities.
The operator commenced the plugging and abandonment of the platform and
wells for Eugene Island Block 343 and anticipates that the plugging and
abandonment should be completed by June 1997. GulfMex will need to fund
approximately $34,000 in excess of its abandonment escrow for its
portion of the abandonment liability for that platform. The operator
estimates the total plugging and abandonment liability for the
remaining platforms in which GulfMex or Offshore own interests and
wells to be approximately $1.4 million, of which $1 million has been
accrued. GulfMex's abandonment escrow account as of January 31, 1997 is
approximately $1 million.
(4) Long-Term Debt
Long-term debt consists of the following:
Senior indebtedness $13,300,000
Vehicle loans 61,310
----------
13,361,310
Less current installments of long-term debt 3,350,868
----------
$10,010,442
===========
On September 27, 1995, the Company consummated a private
offering of 11.5% subordinated notes ("Notes") for a total principal
amount of $2,000,000. The Notes were issued primarily to finance
further development and production enhancements to certain West Texas
oil and gas properties acquired by the Company in 1994.
On March 8, 1996, the Company executed a loan agreement with a
senior lender which provided a new senior credit facility ("Senior
Credit Facility") in an aggregate principal amount of up to
$10,000,000. The initial available credit under this credit facility
was $4,967,000 (the "Borrowing Base"). The Senior Credit Facility was
used to refinance the Company's existing senior indebtedness of
$1,575,000 on March 11, 1996 and provide $900,000 to purchase a 3.125%
working interest in an existing producing oil and gas lease located
offshore Louisiana for an acquisition price of $900,000.
On March 26, 1996, the Company acquired various leasehold
interests in three gas wells located in Wheeler County, Texas for a net
purchase price of approximately $370,500 of which approximately
$320,500 was financed by the Senior Credit Facility.
On April 12, 1996, the Company acquired various leasehold
interests in 31 onshore oil wells located in Mississippi and Louisiana
for a net acquisition price of approximately $2.8 million of which
approximately $1.1 million was financed by the senior lender for a
total outstanding bank indebtedness of approximately $3.8 million on
that date. Approximately, $300,000 was funded from working capital.
F-12
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
By an agreement with the seller, the remaining balance of approximately
$1.4 was financed by a seller's note (" Seller's Note") payable with
interest at prime on August 30, 1996. In August 1996, the Company
requested the senior lender to increase the Borrowing Base to
facilitate funding the Seller's Note. On August 30, 1996, the senior
lender and the Company agreed to increase the Borrowing Base to
approximately $5.4 million. The Borrowing Base is determined by the
senior lender, in its sole discretion, using procedures and standards
customary for its petroleum industry customers, and represents the
amount of borrowings which, in the senior lender's opinion, the
Company's oil and gas properties will support. On August 30, 1996, the
Seller's Note of approximately $1.45 million was paid with $1.2 million
of additional financing through the Senior Credit Facility and
approximately $251,000 of the Company's working capital.
Effective January 16, 1997, the Company and Drilling executed
the First Amendment to the Senior Credit Facility with the senior
lender which provided for the increase of the Senior Credit Facility to
$50 million and the increase of the Borrowing Base to approximately $17
million on that date. The Borrowing Base is subject to monthly
reductions of $333,000 beginning April 1, 1997 until maturity or the
next determination of the Borrowing Base on February 1, 1998. The
Company may, at its sole expense, request a redetermination prior to
February 1, 1998. The First Amendment also provided for extending the
maturity date of the Senior Credit Facility to February 1, 2000.
All of the Company's interests (direct or indirect) in
existing oil and gas properties, miscellaneous assets, and future oil
and gas property acquisitions will serve as collateral for the Senior
Credit Facility. The Senior Credit Facility contains various
restrictions including, but not limited to, restrictions on payments of
dividends or distributions other than those capital distributions to
Buschman and the Hightowers in GulfMex, maintenance of positive working
capital, and no change in the ownership control or the President of the
Company. At January 31, 1997, the Company was in compliance with the
restrictions in the Senior Credit Facility.
The senior lender's initial commitment to provide the Company
a Senior Credit Facility required that the Company obtain certain
modifications and amendments from the holders ("Holders") of the 11.50%
Notes before the Senior Credit Facility could be concluded. Such
consents and amendments were approved by the Holders on March 8, 1996.
The Notes were paid in full by the Company on January 31, 1997.
The First Amendment to the Senior Credit Facility provides for
the payment of dividends on the various preferred stock acquired by
Koch unless an event of default under the Senior Credit Facility has
occurred and is continuing. The Koch Private Placement provides for
certain restrictions on the Company's total indebtedness. The Company
can only increase indebtedness through the Senior Credit Facility;
however, if the incurrence of additional debt results in the Company's
total indebtedness exceeding 65% of the present value of the Company's
proved reserves discounted at 12%, the Company cannot incur any
additional debt.
The interest rate options available to the Company are based
either on a prime rate determination or a Eurodollar rate
determination. The outstanding principal balance under the Borrowing
F-13
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
Base will be subject to the senior lender's prime rate plus 0.5%
calculated on actual days of a year consisting of 365 days unless
written notice is provided to the bank to elect an amount to be
converted to a Eurodollar rate determination. The Company can select
any amount of the outstanding principal under the Borrowing Base to be
converted into recurring terms of 30, 60, 90 or 180 day periods. The
interest rate is based on the time period selected plus an incremental
margin payable to the senior lender equivalent to 2.25%. Interest under
the Eurodollar rate is determined on actual days of a year consisting
of 360 days. For any unused portion of the Borrowing Base, a commitment
fee of 3/8ths of one percent per annum will be charged to the Company.
The senior lender was paid a loan origination fee of $75,000 to
facilitate the First Amendment. The outstanding principal balance of
the Senior Credit Facility was $13.3 million at January 31, 1997.
Interest expense paid during the years ended January 31, 1997
and 1996, was approximately $695,000 and $318,000, respectively. The
average interest rate for the years ended January 31, 1997 and 1996 was
9.78% and 10.69%, respectively.
The scheduled reductions to principal outstanding at January
31, 1997 for each of the fiscal years ending January 31 are as follows:
1998 $ 3,350,106
1999 4,017,217
2000 4,012,456
2001 1,981,531
-----------
$ 13,361,310
===========
(5) Income Taxes
The Company utilizes the asset and liability method to account
for income taxes as prescribed by Statement of Financial Accounting
Standards No. 109. Under this method, deferred income tax assets or
liabilities are recognized for the tax consequences of temporary
differences by applying enacted statutory tax rates applicable to
future years to differences between the financial statement carrying
amounts and the tax basis of existing assets and liabilities.
There was no federal income tax expense for the years ended
January 31, 1997 and 1996. State income tax for the years ended January
31, 1997 and 1996 was $260 and $2,924, respectively.
Actual tax expense in 1997 and 1996 differs from the
"expected" tax benefit (at 34%) primarily due to the change in the
valuation allowance resulting from net operating loss carryforwards.
F-14
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
The Company has significant tax carryforwards available to
reduce its future tax liability. The following table summarizes the
Company's tax carryforwards at January 31, 1997:
Description Amount Expiration Date
Federal and state net operating losses $19,992,000 1999 through 2012
General business credits 54,000 1998 through 2001
Alternative minimum tax credits 15,000 None
The tax effects of temporary differences that give rise to
significant portions of the deferred tax assets and deferred tax
liabilities at January 31, 1997 and 1996 are as follows:
1997 1996
-------------- ---------------
Deferred tax liabilities:
Property, plant and equipment,
principally due to differences in
depreciation, depletion and
amortization $ 474,000 31,000
---------- ----------
Deferred tax assets:
Net operating loss carryforwards 6,597,000 6,704,000
General business credit
carryforwards 54,000 54,000
Alternative minimum tax credit
carryforwards 15,000 15,000
Deferred abandonment costs and
other 140,000 253,000
---------- ----------
Total gross deferred tax assets $6,806,000 7,026,000
---------- ----------
Total net deferred tax assets 6,332,000 6,995,000
Less valuation allowance 6,332,000 6,995,000
----------- ----------
Net deferred tax asset -- --
=========== ==========
A valuation allowance has been established to decrease total
gross deferred tax assets to the amount of the total gross deferred tax
liabilities due to the uncertainties involved in the ultimate
realization of the deferred tax assets. The valuation allowance
decreased by approximately $663,000 in 1997 and increased by
approximately $986,000 in 1996 due to the change in the corresponding
gross deferred tax assets and liabilities.
No federal income taxes were paid during the years ended
January 31, 1997 and 1996.
F-15
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
(6) Redeemable Preferred Stock
On January 15, 1997, the Company filed a Certificate of
Designation, Preferences and Rights of Series A Preferred Stock, Series
B Preferred Stock, and Series C Preferred Stock ("Certificate") with
the Secretary of State, Delaware. The Certificate amended the Company's
Certificate of Incorporation to establish three new series of preferred
stock consisting of 700,000 shares of Series A Preferred Stock, 500,000
shares of Series B Preferred Stock, and 500,000 shares of Series C
Preferred Stock, each having a par value of $.01 per share. The
remaining 1,300,000 preferred shares of the Company's 3,000,000 total
shares authorized preferred stock remain undesignated. The Certificate
provides for the rights, preferences, powers, restrictions and
limitations of the respective series of preferred stock, and the
summary of the rights, preferences and other terms of the respective
series of preferred stock.
On January 16, 1997, the Company and Koch Exploration Company
("Koch"), an affiliate of Koch Industries, Inc., concluded a $10
million private placement for the designated preferred stock as
described above. Koch acquired 500,000 shares of Series A Preferred
Stock for $5 million and 500,000 shares of Series B Preferred Stock for
$5 million. The Koch Private Placement provides Koch the right and
option to purchase up to an additional 200,000 shares of Series A
Preferred Stock at the face value of $10 per share of Series A
Preferred Stock at any time after January 16, 1999 but on or before
January 16, 2000. The option may be exercised in whole or part. The
Koch Private Placement also provides for a financing right of first
refusal. If the Company intends to issue new securities, it shall give
Koch written notice of such intention, describing the amount of funds
the Company wishes to raise, the type of new securities to be issued,
the price and general terms. Koch has 15 days from the date of the date
of receipt of notice to agree to purchase all or part of such new
securities.
Series A Preferred Stock. Pursuant to the Koch Agreement,
500,000 shares of Series A Preferred Stock were initially issued by the
Company for consideration of $10 per share. Holders of the Series A
Preferred Stock, which has a face value of $10, shall be entitled to
receive, out of funds legally available, cumulative dividends at the
rate of 15% of the face value payable on the first day of February,
May, August and November of each year. The first dividend payment date
will be May 1, 1997 and will include pro-rata dividends from the date
of issuance on January 16, 1997 to May 1, 1997.
In the event of any voluntary or involuntary liquidation,
dissolution or winding up of the Company, holders of Series A Preferred
Stock shall have preference, second only to the Senior Credit Facility,
to the distribution of the assets of the Company up to an amount equal
to the aggregate face value of the then outstanding Series A Preferred
Stock plus accrued but unpaid dividends. The Company's merger,
consolidation or any other combination into another corporation,
partnership or other entity which results in the exchange of more than
50% of the voting securities of the Company requires the consent of the
majority of the holders of the Series A Preferred Stock, however, the
holders of the Series A Preferred Stock are not entitled to any other
voting rights.
If the Company completes a registered public offering before
January 16, 2002, all of the outstanding shares of Series A Preferred
Stock must be redeemed at face value plus any accrued and unpaid
dividends. If the Company does not successfully complete a registered
public offering by January 16, 2002, the holders of a majority of the
F-16
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
outstanding Series A Preferred Stock after that date may at anytime
during the first 10 days after each dividend payment date require the
Company to redeem shares of the Series A Preferred Stock equal to 10%
of the aggregate number of shares of Series A Preferred Stock the
Company issued. The Company may redeem after January 16, 2003 all of
the issued outstanding shares of Series A Preferred Stock if all
accrued dividends have been declared and paid prior to the notice of
redemption by the Company. The Company must pay a premium of 10% of the
face value of the Series A Preferred Stock to effectuate such
redemption.
Series B Preferred Stock. Pursuant to the Koch Agreement,
500,000 shares of Series B Preferred Stock were issued by the Company
for consideration of $10 per share. Holders of the Series B Preferred
Stock, which has a face value of $10 per share, shall be entitled to
receive, out of funds legally available, cumulative dividends at the
rate of .035 shares of Series C Preferred Stock, which also has a face
value of $10 per share. The dividend payment date for the Series B
Preferred Stock is the first day of February, May, August and November
of each year with the first dividend to be paid May 1, 1997 and shall
include dividends beginning February 1, 1997. Dividends on the Series C
Preferred Stock are payable in preference and priority to payment of
dividends on the Series B Preferred Stock.
In the event of any voluntary or involuntary liquidation,
dissolution or winding up of the Company, holders of Series B Preferred
Stock shall have preference in the distribution of the assets of the
Company after and subject to the payment of the Senior Credit Facility
and payment in full of all amounts, including accrued but unpaid
dividends, required to be distributed to the holders of Series A
Preferred Stock. The Series B Preferred Stock liquidation preference
shall be in an amount equal to the aggregate face value of the then
outstanding Series B Preferred Stock plus accrued but unpaid dividends.
If the Company successfully completes a registered public
offering on or before January 16, 2002 which results in gross proceeds
greater than $15 million but less than $20 million each holder of
Series B Preferred Stock may elect to require the Company to redeem not
more than one-half of the then issued and outstanding shares of Series
B Preferred Stock at an amount per share of Series B Preferred Stock
equal to the offering price per share of common stock in the registered
public offering. Any holders of Series B Preferred Stock electing to
redeem shares will have an equal percentage of Series B Preferred Stock
converted into common stock of the Company.
Upon the successful completion of a registered public offering
resulting in gross proceeds to the Company of more than $20 million and
at a price per share of common stock which is equal to or greater than
the per share value of the aggregate face value of the issued and
outstanding Series B and Series C Preferred Stock divided by the total
number of shares of common stock issuable upon conversion of the Series
B Preferred Stock at the time of the offering, all outstanding Series B
Preferred Stock shall be automatically converted into common stock of
the Company. Thereafter, outstanding shares of the Series B Preferred
Stock shall be deemed canceled.
If the Company does not successfully complete a registered
public offering on or before January 16, 2002, then at any time after
that date, but only during the first 10 days after each dividend
payment date, the holders of a majority of the issued and outstanding
Series B Preferred Stock may elect to require the Company to redeem up
F-17
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
to 10% of the aggregate number of shares of Series B Preferred Stock
issued by the Company. The Company may redeem after January 16, 2003,
all of the issued and outstanding shares of Series B Preferred Stock if
all accrued dividends have been declared and paid prior to the notice
of redemption by the Company. The redemption price will be face value
of all outstanding shares of Series B Preferred Stock plus a premium of
10% of the face value of Series B Preferred Stock.
Holders of Series B Preferred Stock have the option and right
at any time upon the surrender of certificates representing Series B
Preferred Stock to convert each share of Series B Preferred Stock into
5.26795 fully paid and nonassessable shares of common stock of the
Company, subject to adjustment as set forth in the Certificate. The
holders of Series B Preferred Stock have certain anti-dilutive rights
such that if any additional shares of common stock are issued by the
Company at any time after January 16, 1997 but before conversion of any
Series B Preferred Stock is converted and if the issue price per share
of common stock is less than the then applicable conversion price, as
defined in the Certificate, holders of the Series B Preferred Stock
will be granted an adjustment to the number of shares of common stock
issuable upon conversion. The initial conversion price per share is
$1.898. The initial number of fully diluted shares at January 16, 1997
is 10,974,895, which is the sum of common shares currently issued and
outstanding, shares of common stock reserved for current and future
option plans, plus shares reserved for the exercise of warrants granted
to certain subordinated debt holders on September 27, 1995 and those
shares which are reserved pursuant to conversion rights of the Series B
Preferred Stock. The aggregate number of shares of common stock into
which the Series B Preferred Stock can initially be converted is
2,633,975 shares, subject to adjustment from time to time as set forth
in the Certificate.
Voting Rights - Series B Preferred Stock. Holders of all the
issued and outstanding 500,000 shares of Series B Preferred Stock will
collectively be eligible to cast votes equivalent to 24% of the then
issued and outstanding shares of common stock on all matters submitted
to the stockholders for vote at any annual or special stockholders
meeting. If at any time the Company is in arrears in whole or in part
with regard to quarterly dividends and such nonpayment remains in
effect for three consecutive dividend payment dates, the holders of the
Series B Preferred Stock may notify the Company of their election to
exercise rights to cast votes equivalent to 51% of the then issued and
outstanding shares of common stock. At any time that the holders hold
less than 500,000 shares of Series B Preferred Stock, the voting
percentage of either 24% or 51% is reduced on a pro-rata basis.
Board of Directors. The holders of Series B Preferred Stock
shall have the right to nominate and elect to the Company's Board of
Directors nominees representing not less than one-third of the number
of members constituting the Board of Directors so long as there are
more than 200,000 shares of Series B Preferred Stock issued and
outstanding. If at any time the issued and outstanding shares of Series
B Preferred Stock are less than 200,000, the holders shall have the
right to elect only one director to the Company's Board. Two Koch
employees are currently serving as Directors on the Board during the
interim until duly elected at the Annual Meeting of Stockholders on
July 1, 1997.
If at any time the Company is in arrears in whole or in part
with regard to quarterly dividends and such nonpayment remains in
effect for three consecutive quarters or, if a significant event (as
defined in the Certificate) occurs, the holders have the right at any
annual or special meeting of the stockholders to nominate and elect
F-18
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
such number of individuals as shall after the election represent a
majority of the number of directors constituting the Company's Board. A
significant event shall mean and be deemed to exist if (i) the Company
files a voluntary petition, or there is filed against the Company an
involuntary petition, seeking relief under any applicable bankruptcy or
insolvency law, (ii) a receiver is appointed for any of the Company's
properties or assets, (iii) the Company makes or consents to the making
of a general assignment for the benefit of creditors or (iv) the
Company becomes insolvent or generally fails to pay, or admits in
writing its inability or unwillingness to pay, its debts as they become
due. At such time that there is a cure or waiver received in writing
from the holders of a majority of the Series B Preferred Stock, the
additional board members elected by the holders shall be removed from
the Company's Board.
Series C Preferred Stock. The holders of Series C Preferred
Stock, which has a face value of $10, shall be entitled to receive
cumulative dividends, out of funds legally available, at the rate of
14% of the face value payable on the first day of February, May, August
and November of each year. Pursuant to the Koch Private Placement,
17,500 shares of Series C Preferred Stock will be issued as dividends
on the Series B Preferred Stock on May 1, 1997. No shares of Series C
Preferred Stock were initially issued in connection with consummation
of the sale of the Series A and Series B Preferred Stock pursuant to
the Koch Private Placement. The first dividend payment date for the
Series C Preferred Stock will be August 1, 1997.
In the event of any voluntary or involuntary liquidation,
dissolution or winding up of the Company, the holders of the then
outstanding Series C Preferred Stock shall have preference in the
distribution of the assets of the Company, after and subject to the
payment in full of all amounts required to be distributed to the
holders of Series A and Series B Preferred Stock. The Series C
Preferred Stock liquidation preference shall be in an amount equal to
the aggregate face value of the then outstanding Series C Preferred
Stock plus accrued but unpaid dividends. Series C Preferred Stock shall
not be entitled to any voting rights other than provided by law.
If the Company successfully completes a registered public
offering on or before January 16, 2002 resulting in gross proceeds to
the Company of more than $20 million and at a price per share of common
stock which is equal to or greater than the per share value of the
aggregate face value of the issued and outstanding Series B and Series
C Preferred Stock divided by the total number of shares of common stock
issuable upon conversion of the Series B Preferred Stock at the time of
the offering, all issued and outstanding Series B Preferred Stock shall
be automatically converted into common stock of the Company and the
Company then has the right to redeem all of the Series C Preferred
Stock for a redemption price of $0.01 per share. The redemption shall
occur on the same day on which the registered public offering is
completed. If there is a partial conversion of Series B Preferred
Stock, the Company has the right to redeem the number of shares of
Series C Preferred Stock which were issued as dividends to such Series
B Preferred Stock being redeemed. If the Company does not successfully
complete a registered public offering on or before January 16, 2002,
then at any time after January 16, 2002, but only during the first ten
days after each dividend payment date, the majority of holders of
Series C Preferred Stock may require the Company to redeem up to 10% of
the aggregate number of shares of Series C Preferred Stock issued by
the Company. The Company, at any time after January 16, 2003, may
F-19
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
redeem all of the then issued and outstanding shares of Series C
Preferred Stock at face value plus a premium of 10% of the face value
if all accrued dividends have been paid before the notice of
redemption.
The holders of Series C Preferred Stock may not transfer
shares independently and apart from the underlying shares of Series B
Preferred Stock for which holders received such preferred stock. All
shares of Series B and Series C Preferred Stock shall bear a legend
which shall advise of the restrictions on transfer including that the
shares have not been registered under the Securities Act of 1933 and
that the shares are subject to the terms and conditions of the
Certificate.
The First Amendment to the Senior Credit Facility provides for
the payment of dividends on the various preferred stock acquired by
Koch unless an event of default under the Senior Credit Facility has
occurred and is continuing. The Koch Private Placement provides for
certain restrictions on the Company's total indebtedness. The Company
can only increase indebtedness through the Senior Credit Facility,
however, if the incurrence of additional debt results in the Company's
total indebtedness exceeding 65% of the present value of the Company's
proved reserves discounted at 12%, the Company cannot incur such
additional debt. The Koch Private Placement does provide Koch the right
and option to purchase up to an additional 200,000 shares of Series A
Preferred Stock at the face value of $10 per share of Series A
Preferred Stock at any time after January 16, 1999 but on or before
January 16, 2000. This option may be exercised in whole or in part. The
Koch Private Placement also provides for a financing right of first
refusal. If the Company intends to issue new securities, it shall give
Koch written notice of such intention, describing the amount of funds
the Company wishes to raise, the type of new securities to be issued,
the price and general terms. Koch has 15 days from the date of receipt
of notice to agree to purchase all or part of such new securities.
The Registration Rights Agreement grants Koch up to three
demand registration rights upon notice to the Company from holders of
at least 40% of the Registrable Securities, which is defined in the
Registration Rights Agreement to mean the Common Stock issued and
issuable upon conversion of the Series B Preferred Stock, including any
dividends or distributions thereon. Whenever a demand registration is
made, the Company shall be entitled to include in any registration
statement shares of Common Stock to be sold by other holders of Common
Stock with registration rights that allow such holders to participate
in the registration and shares of Common Stock to be sold by the
Company for its own account, subject to underwriter's cutbacks.
The Company may not cause any other registration of securities
for sale of its own account or for persons other than a holder of
Registrable Securities (other than a registration effected solely to
implement an employee benefit plan or a transaction to which Rule 145
of the Commission is applicable, or as may be required pursuant to the
terms of those certain Warrant Agreements, as amended through the date
hereof, issued by the Company in connection with the Company's 1995
11.50% Subordinated Notes) to become effective less than 180 days after
the effective date of any demand registration required pursuant to the
terms of the Registration Rights Agreement.
F-20
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
The Company has limited rights to postpone or avoid the demand
registration obligations contained in the Registration Rights Agreement
under certain circumstances, such as when the Company is already
preparing a registration statement when a demand is received, when the
Board of Directors shall determine in good faith that an offering would
interfere materially with a pending or contemplated financing, merger,
sale of assets, recapitalization or other similar corporate action of
the Company, or when the Board of Directors shall determine in good
faith that the disclosures required in connection with such a
registration could reasonably be expected to materially adversely
affect the business or prospects of the Company.
The Registration Rights Agreements also provides for
"piggyback" registration rights for holders of Registrable Securities.
If the Company at any time proposes a Registered Public Offering, it
must give written notice to all holders of Registrable Securities of
its intention to do so. Upon the written request of any holders of
Registrable Securities given within 20 days after transmittal by the
Company to the holders of such notice, the Company will, subject to the
limits contained in the Registration Rights Agreement, including
underwriter cutbacks, use its best efforts to cause those Registrable
Securities of said requesting holders to be included in such
registration statement.
(7) Common Stock
As discussed in Note 1, the Company has elected to account for
stock-based compensation under the intrinsic-value method under the
provisions of APB Opinion 25. The impact of SFAS No. 123 had no
material effect on the Company's consolidated results of operations or
financial condition.
Common Stock Options
As of January 31, 1996, options for a total of 375,000 shares
of common stock at exercise prices (not less than fair market value at
the time the options were issued) of $0.385 to $0.44 per share granted,
pursuant to the 1986 Non-Qualified Stock Option Plan and 1986 Incentive
Stock Option Plan ("collectively the "86 Plans") remained outstanding.
All outstanding options under the 86 Plans shall remain in effect until
they have been exercised or have expired.
On June 1, 1995, the Company adopted the 1995 Non-Qualified
Stock Option Plan and 1995 Incentive Stock Option Plan to replace the
86 Plans, under which a total of 1,025,000 shares of common stock has
been reserved. As of January 31, 1997, options for a total of 624,250
shares of common stock at an exercise price (not less than fair market
value at the time the options were issued) of $0.34 to $0.45 per share
have been granted, of which none have been exercised. All outstanding
options were exercisable at January 31, 1997.
Common Stock Warrants
On September 27, 1995, the Holders of the Notes were issued
warrants which provide for the purchase of up to 1,388,160 shares of
Class A Common Stock, par value $0.01 per share at an exercise price of
$0.40 per share, subject to adjustment under certain circumstances. The
F-21
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
exercise price of the warrants was reduced from the initial $0.40 per
share to $0.20 per share in connection with the amendments and
modifications necessary to finalize the Senior Credit Facility. The
warrants expire September 30, 2002. Management has estimated these
warrants to have nominal value.
(8) Related Party Transactions
One of the limited partners in Offshore is Robert A. Buschman,
Chairman of the Board of the Company. Buschman has made capital
contributions equivalent to his ten percent (10%) ownership interest in
GulfMex.
The Company obtained the consent of the Holders to restructure
Offshore in order to permit the Company to realize certain efficiencies
through the proportionate allocation of working interest expenses and
overhead to the minority limited partners of GulfMex. As a result of
the restructuring, Buschman and the Hightowers became proportionate
individual working interest owners of the onshore oil and gas
properties previously owned by them through their proportionate limited
partnership interests in Offshore. The offshore oil and gas properties
held by Offshore were conveyed to GulfMex, a newly formed Texas limited
partnership, which holds the same beneficial ownership in the offshore
oil and gas properties as Offshore held prior to the restructure.
Offshore is the sole general partner of GulfMex. The partnership
agreement for GulfMex is substantially the same as the existing
Offshore partnership agreement.
As a result of the restructuring, Buschman and the Hightowers
directly own (1) 20% of the onshore leasehold working interests
formerly owned by them through Offshore; and (2) a 20% limited
partnership interest in GulfMex. Buschman and the Hightowers no longer
are limited partners in Offshore; however, the reorganized Offshore
remains in existence as a Texas limited partnership with Drilling as
the general partner with a 1.25% partnership interest and Desert a
98.75% limited partnership interest.
As additional consideration for the restructuring, Buschman
and the Hightowers retained the right to participate in acquisitions of
oil and gas properties in those areas where Offshore had properties as
of the effective date of the restructuring. The effective date of the
restructuring was February 1, 1996. Any participation in the subsequent
acquisition of oil and gas properties in those areas of mutual interest
will be on a basis proportionate to the percentage interests of
Buschman and the Hightowers in Offshore prior to the restructuring and
would provide for sharing of economic benefits and burdens in
accordance with the relative ownership interests.
The Company has also agreed to enter into negotiations with
Koch to enter into one or more marketing agreements for the purchase,
sale and transportation of all oil and gas products produced by the
Company so long as Koch owns a majority of the Series B Preferred
Stock. The Company currently has a marketing agreement in place with
another party; therefore, the marketing agreement to be negotiated with
Koch will become effective at such time when the existing contract
expires. The marketing agreement to be negotiated with Koch shall be at
arms-length, for a term of not less than five years and shall
incorporate terms and conditions satisfactory to the Company and the
senior lender.
F-22
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
As a condition to consummating the Koch Private Placement,
Robert A. Buschman, Guy Bob Buschman, Koch and the Company executed a
Stockholders Agreement ("Stockholders Agreement"). Under the terms of
the Stockholders Agreement, if prior to January 18, 2002, either
Buschman proposes to accept an offer to sell their shares of the
Company's common stock, then either Buschman shall notify Koch
regarding such offer and Koch may elect to participate in the sale of
common stock on the same terms and conditions. Excluded from the
limitations in the Stockholders Agreement are certain permitted
transfers. Likewise, Koch may not sell any Series B Preferred Stock to
an outsider, as defined in the agreement, without first offering the
Series B Preferred Stock to the Buschmans. Pursuant to the Stockholders
Agreement, the Buschmans also agreed to vote shares owned by them for
any Koch nominees to the Board of Directors from and after conversion
of the Series B Preferred Stock to Common Stock.
The Stockholders Agreement will terminate upon the earlier of:
(a) consummation of a public offering which results in
aggregate net proceeds of not less than $20 million;
(b) death of either party thereto;
(c) Koch ceases to own 50,000 shares of Series A
Preferred Stock, 50,000 shares of Series B Preferred
Stock, or more than 10% of common stock shares;
(d) either Buschman ceases to own more than 10% of
outstanding common stock; or
(e) five years.
An additional condition of closing required that Guy Bob
Buschman, President and Chief Executive Officer, and Gary Scheele, Vice
President and Chief Financial Officer, enter into employment agreements
with the Company and Drilling for initial terms of five years which may
be renewed annually thereafter.
(9) Major Customers and Other Information
The Company had two purchasers that accounted for $1,019,000
and $963,000 of production revenue for the year ended January 31, 1997
and accounted for 52% of the trade receivables balance at January 31,
1997.
The Company had two purchasers that accounted for $1,182,400
and $421,500 of production revenue for the year ended January 31, 1996
and accounted for 45% of the trade receivables balance at January 31,
1996.
F-23
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
Rental expense under an operating lease for office space,
which terminates July 31, 1998, was approximately $115,000 and
$109,000, for the years ended January 31, 1997 and 1996, respectively.
Future minimum rental payments are approximately $118,000 for
1998 and $59,000 for 1999.
(10) Oil and Gas Activities (unaudited)
Capitalized Costs Incurred Relating to Oil and Gas Producing Activities
The following tables set forth the aggregate capitalized costs
and accumulated depreciation, depletion, and amortization for oil and
gas properties, all of which are proved, at January 31, 1997 and 1996.
1997 1996
------------ ------------
Capitalized costs of proved
properties $ 24,976,467 7,979,389
Accumulated depreciation, depletion
and amortization (3,768,705) 3,033,474
------------ ------------
Net capitalized costs 21,207,762 4,945,915
Less minority interest of
limited partner 63,366 923,014
------------ ------------
Net to Company $ 21,144,396 4,022,901
============ ============
For the year ended January 31, 1997 and 1996, the following
costs were incurred:
1997 1996
------------ ---------
Producing properties $ 19,259,658 828,061
Exploratory properties 552,300 277,471
------------- ---------
Total $ 19,811,958 1,105,532
============= ===========
F-24
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
Results of Operations from Oil and Gas Producing Activities
The following tables set forth the results of operations for
oil and gas producing activities in the aggregate for the years ended
January 31, 1997 and 1996. All of the Company's oil and gas producing
properties are located in the United States.
1997 1996
---- ----
Oil and gas sales $ 5,337,593 3,148,311
Lease operating expenses (2,394,318) (1,565,682)
Dry hole costs and lease
abandonments (821,982) (236,116)
Provision for abandonment (140,800) (182,481)
Depletion (1,637,634) (933,231)
----------- -----------
Pretax results of operations 342,859 230,801
Income tax expense (260) (2,924)
----------- -----------
Results of operations from oil and gas
producing activities
(excluding corporate overhead
and interest costs) 342,599 227,877
Less minority interest of
limited partners 77,787 47,496
----------- -----------
Net to Company $ 264,812 180,381
=========== ===========
F-25
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
Estimated Quantities of Proved Oil and Gas Reserves
The following table represents the Company's estimate of its
proved oil and gas reserves, developed and undeveloped, as of January
31, 1997 and 1996. Proved undeveloped reserves include approximately
1,727 mbbls of oil and 1,507 mmcf of gas. The reserve estimates have
been prepared by Paul Clevenger and Ryder-Scott Company, independent
petroleum reserve engineers. Reserve estimates for producing oil and
gas properties are inherently imprecise. Even more imprecise are
reserve estimates for new discoveries.
Consolidated
---------------------------
Oil/Condensates Gas
---------- ----------
(Bbls) (Mmcf)
Proved Reserves:
Balance at January 31, 1995 1,939,568 10,958
Production (97,082) (1,208)
Revisions of previous
estimates (101,532) (4,807)
---------- ----------
Balance at January 31, 1996 1,740,954 4,943
Acquisitions 3,125,070 4,080
Production (118,179) (1,117)
Revisions of previous
estimates (562,668) 2,310
---------- ----------
Balance at January 31, 1997 4,185,177 10,216
=========== ==========
Standardized Measure of Discounted Future Net Cash Flows Relating to
Proved Reserves
The following table sets forth the computation of the
standardized measure of discounted future net cash flows relating to
proved reserves for 1997. The standardized measure is the estimated
excess future cash inflows from proved reserves less estimated future
production and development costs, estimated future income taxes and a
discount factor. Future cash inflows represent expected revenues from
production of year-end quantities of proved reserves based on year-end
prices and fixed and determinable future escalation provided by
contractual arrangements in existence at year-end. Escalation based on
inflation, federal regulatory changes, and supply and demand are not
considered. Estimated future production costs related to year-end
reserves are based on year-end costs. Such costs include, but are not
limited to, production taxes and direct operating costs. Inflation and
other anticipatory costs are not considered until the actual cost
change takes effect. Estimated future income tax expenses are computed
using the appropriate year-end statutory tax rates. Consideration is
given for the effects of operating loss carryforwards, permanent
differences, tax credits and allowances. A discount rate of 10% is
applied to the annual future net cash flows after income taxes.
The methodology and assumptions used in calculating the
standardized measure are those required by Statement of Financial
Accounting Standards No. 69. It is not intended to be representative
F-26
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
of the fair market value of the Company's proved reserves. The
valuations of revenues and costs do not necessarily reflect the amounts
to be received or expended by the Company. In addition to the
valuations used, numerous other factors are considered in evaluating
known and prospective oil and gas reserves.
January 31, January 31,
1997 1996
Consolidated Consolidated
----------------- ------------
Future cash inflows $ 127,237,500 38,929,500
Future production costs (22,575,900) (13,616,900)
Future development costs (8,286,100) (7,338,300)
Future provision for abandonment in
excess of revenue deductions (394,700) (527,500)
------------- -------------
Future net cash flows before income tax
expense 95,980,800 17,446,800
Future income tax expense, after
consideration of the effect of net
operating loss carryforwards (2,984,600) (453,100)
------------- -------------
Future net cash flows 92,996,200 16,993,700
Future net cash flows 10% annual
discount to reflect timing of net cash
flows (30,440,600) (7,767,600)
------------- -------------
Standardized measure of discounted
future net cash flows relating to proved
reserves $ 62,555,600 9,226,100
============= =============
F-27
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1997 and 1996
January 31, January 31,
1997 1996
Consolidated Consolidated
----------------- ----------------
Changes in discounted net cash flows:
Beginning of Year $ 9,226,100 12,528,100
----------------- ----------------
Increase (decrease):
Purchase of minerals in place 35,455,900 -
Accretion of discount 2,700,700 370,900
Sales of oil and gas net of production
costs (2,943,300) (1,630,000)
Revisions of previous estimates
Changes in prices 23,048,500 3,952,900
Changes in quantities (7,463,800) (6,120,300)
Changes in estimated income
taxes 2,531,500 124,500
----------------- ----------------
Net increase (decrease) 53,329,500 (3,302,000)
----------------- ----------------
End of year $ 62,555,600 9,226,100
================= ================
F-28
<PAGE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
(This schedule contains summary financial information extracted from this
January 31, 1997 Form 10-KSB and is qualified in its entirety by reference
to such financial statements)
</LEGEND>
<CIK> 0000352964
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> Jan-31-1997
<CASH> 1045331
<SECURITIES> 0
<RECEIVABLES> 1808663
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<INVENTORY> 0
<CURRENT-ASSETS> 2890813
<PP&E> 25509955
<DEPRECIATION> (4111900)
<TOTAL-ASSETS> 25945014
<CURRENT-LIABILITIES> 4585842
<BONDS> 10010442
10000000
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<COMMON> 55528
<OTHER-SE> 112883
<TOTAL-LIABILITY-AND-EQUITY> 25945014
<SALES> 5337593
<TOTAL-REVENUES> 5337593
<CGS> 5300148
<TOTAL-COSTS> 6597158
<OTHER-EXPENSES> 1297010
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 695580
<INCOME-PRETAX> (1654880)
<INCOME-TAX> 260
<INCOME-CONTINUING> (1655140)
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<EXTRAORDINARY> 0
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<NET-INCOME> (1655140)
<EPS-PRIMARY> (.30)
<EPS-DILUTED> (.30)
</TABLE>
