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, 1998
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, 1998 were $7,144,000.
At July 21, 1998, there were 6,177,432 shares of the registrant's common stock
outstanding. Of this amount, 2,750,740 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-KSB Part
None. Part III
<PAGE>
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 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. Rio Grande Desert Oil Company
("Desert"), a Nevada corporation and wholly-owned subsidiary of Drilling, was
formed in August 1994 and Drilling ultimately conveyed to Desert a 98.75%
limited partnership interest in Offshore. Drilling remained as the general
partner of Offshore with a 1.25% general partnership interest. Substantially all
of the leasehold interests owned by the Company as of January 31, 1998 are held
through Offshore.
The Company restructured Offshore in 1996 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, 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 in
Offshore respectively, 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
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 limited 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.
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, 1998 and 1997. The minority
-2-
<PAGE>
interests of Buschman and the Hightowers in GulfMex are set forth separately in
the balance sheet and the statement of operations of the Company.
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. The
operated oil and gas properties acquired , in which Offshore was 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 acquired for $1,170,000, a 4.1667% leasehold interest in a
non-operated producing federal oil and gas lease and platform located offshore
Louisiana ("Block 76") which 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. In March 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 with total
estimated remaining net proved reserves acquired effective with this acquisition
of 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. 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 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 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 provided that Offshore
commence the drilling of two additional wells within twelve months of closing to
test the Wilcox "B" Sand. Offshore had the option to re-enter one existing well
located on the undeveloped acreage which would count as one of the required
wells. In March 1997, a workover rig was able to recomplete the existing well in
the Wilcox "B" formation. Recompletion procedures were also performed on the
Wilcox "A" formation. When production from the Wilcox "A" and "B" dropped to
uneconomic levels in October 1997, the Company recompleted the well in the
Wilcox "B-1" formation. The well's current production is approximately 16
barrels of oil per day (BOPD).
The Company drilled and completed the second committed well in June
1997 in the Wilcox "B-1" formation. The average production from this well has
been approximately 120 BOPD since August 1997. In connection with Offshore's
requirement to develop the undeveloped leasehold acreage, the sellers were
granted the option to obtain a working interest ranging from 10 to 20 percent in
all new wells completed on the undeveloped leasehold acreage 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
-3-
<PAGE>
to all actual costs of drilling, completing, re-completing, equipping,
maintaining, producing and operating wells on the undeveloped leasehold acreage.
The terms provided that if the sellers exercise their options in their entirety,
the sellers' working interest would 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.
Private Placement
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 were 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 was initially subject to
monthly reductions of $333,000 beginning April 1, 1997 to continue until the
next redetermination of the Borrowing Base.
The determination that Righthand Creek's primary source of energy for
production of the oil reserves was fluid expansion and not water drive caused
the Company's next proved reserves to be reduced by approximately 960,000
barrels. This reduction of proved reserves to probable and possible reserve
classifications significantly reduced the Borrowing Base.
The Company received a Borrowing Base Determination Notice in January
1998 advising the Company that effective February 1, 1998, the Company's
Borrowing Base had been redetermined to be
-4-
<PAGE>
$6,500,000. The balance of the Company's outstanding indebtedness with Comerica
Bank - Texas (the "Bank"), its senior lender, approximately $13,178,000,
exceeded the Borrowing Base by approximately $6,678,000 (the "Deficiency").
Under the terms of the Senior Credit Facility, the Bank gave notice to the
Company to either provide the Bank with additional collateral to increase the
Borrowing Base or reduce the outstanding balance of the Company's indebtedness
to an amount less than or equal to the redetermined Borrowing Base.
The Company entered into a letter agreement with the Bank in March 1998
which extended to the close of business on Friday, April 3, 1998, the time by
which the Company was required to eliminate the Deficiency in the manner set
forth above or reach other accommodations with the Bank. For and in
consideration of the extension to April 3, 1998, the Company agreed to execute
certain supplemental documents pertaining to collateral properties; pay an
extension fee of $25,000 on or before April 3, 1998; terminate its ability to
utilize the Eurodollar Rate Option under the Loan Agreement; increase the
applicable interest rate to prime rate plus three percent; execute a letter
waiving compliance with the working capital covenant for the month of November
1997; pay the Bank specified legal and engineering expenses and furnish the Bank
with copies of any agreements related to any proposed refinancing.
On July 8, 1998, the Bank notified the Company of certain defaults and
events of default ("Default Notice") under terms of the Senior Credit Facility
primarily as a result of not curing the Deficiency. The Default Notice advised
the Company that the Bank declared the entire outstanding indebtedness under the
Senior Credit Facility and all interest accrued thereon to be immediately due
and payable. The Bank also advised the Company that it was the Bank's intention
to pursue all remedies available in law and in equity, including but not limited
to foreclosure proceedings. The Bank has forwarded letters in lieu of transfer
order and division order ("Letters in Lieu") notifying certain purchasers of the
Company's oil and natural gas products to make payments for settlement of
certain product purchases directly to the Bank effective immediately and to
continue until the default under the Senior Credit Facility has been remedied or
other agreements have been negotiated with the Bank.
On August 11, 1998, the Company was notified that the Bank initiated
foreclosure proceedings with regard to the Company's Texas properties by posting
the properties for foreclosure. Under applicable law, such foreclosure is
scheduled to occur on September 1, 1998. The Company is continuing its
discussions with the Bank in an effort to identify and conclude an alternative
transaction which might address and resolve in a mutually satisfactory manner
the Company's default under the Senior Credit Facility. However, while those
discussions are continuing, no agreement has been reached and no assurance can
be given that any agreement will be reached which would cause the Bank to
refrain from pursuing foreclosure on September 1, 1998. The properties posted
for foreclosure and subject to foreclosure on September 1, 1998 include all of
the Company's Texas properties, which represented approximately twenty percent
(20%) of the Company's revenues for the fiscal year ended January 31, 1998 and
approximately sixteen percent (16%) of the Company's revenues for the six months
ended July 31, 1998. The Bank has not advised the Company of its intentions with
regard to other properties owned by the Company and pledged to secure the Bank's
indebtedness. In addition to evaluating and pursuing alternative transactions in
an effort to address the Bank's requirements, the Company continues to consider
other alternatives, including, but not limited to, non-traditional financing
transactions and seeking protection under the federal bankruptcy laws.
-5-
<PAGE>
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
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 and dependent upon the production levels of the Company's oil and gas
properties and the prices received for products produced. The Company is
presently in default of its Senior Credit Facility and has no commitment for
alternative financing. The Letters in Lieu which have been sent by the Bank will
limit working capital available to the Company. If the Company is unable to
obtain additional financing or complete the sale of certain of its leasehold
interests, the Bank will likely effectuate its remedy of foreclosure of its
security interest in the collateral to the Senior Credit Facility.
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.
As a result of the shift in the reserve classification of Righthand
Creek from proved to probable and possible based upon the determination that
field's primary source of energy was fluid expansion and not water
-6-
<PAGE>
drive, the Company's net proved reserves were reduced by approximately 960,000
barrels exclusive of production during the fiscal year. The carrying value of
Righthand Creek was reduced by approximately $7.3 million in order that the
present value of the Company's proved oil and gas reserves of Righthand Creek
will not exceed the net carrying amount for such acquisition the balance sheet.
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
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. The
significant decrease in the prices of oil from approximately $20 per bbl to
approximately $12 per bbl has had an adverse effect on the carrying value of the
Company's proved reserves, borrowing capacity, revenues, profitability, and cash
flow.
Effective February 1, 1997, Offshore 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 provided 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 was 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 was no penalty for under delivery of oil from Righthand Creek unless the
LLS plus Bonus exceeded $23.45 per bbl. The penalty clause was not invoked.
In August 1997, the Company, on behalf of Offshore, entered into a
commodity futures oil swap agreement ("Oil Swap Agreement") with Koch Oil
Company. That Oil Swap Agreement was made pursuant to an existing Master
Commodity Swap Agreement between the Company and Koch, at no current cost to the
Company, and is termed a "Costless Put/Call Collar Option," covering the period
between February 1, 1998 and January 31, 1999. The Oil Swap Agreement is based
upon 400 barrels oil per day and establishes settlement dates on the last day of
each calendar month during the contract period. It sets a floating price equal
to Koch Oil Company's monthly average LLS posting plus $1.50, and strike prices
of $18.20 for put options and $19.97 for call options. On any settlement date,
if the floating price is less than the put option strike price, then Koch must
pay the Company the price difference, multiplied by the determination quantity
for the month. On any settlement date, if the floating price exceeds the call
option strike price, the Company must pay Koch the difference, multiplied by the
determination quantity for the month.
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
-7-
<PAGE>
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, or changes in such laws and by
constantly changing administrative regulations.
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
-8-
<PAGE>
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.
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
-9-
<PAGE>
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
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, 1998 the Company and its affiliates had 18 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. The controller resigned from the Company in
April 1998.
-10-
<PAGE>
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, 1998. All of the properties are located within
the United States.
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, 1998.
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 3,840 349 31,920 1,718
Mississippi 1,470 679 2,539 278
Louisiana 3,047 845 684 681
Oklahoma 10,545 556 -- --
Texas 17,550 6,171 1,220 1,220
Wyoming 520 22 -- --
Michigan 152 4 -- --
------ ------ ------ ------
Total 37,124 8,626 36,360 3,897
====== ===== ====== =====
(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.
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 1998. "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.
-11-
<PAGE>
Oil/Condensates Natural Gas
---------------- -------------------
Gross Net (1) Gross Net (1)
----- ------- ----- -------
Location:
Offshore-Louisiana 6 - 6 -
Mississippi 27 18 - -
Louisiana 21 19 5 -
Oklahoma - - 23 1
Texas 44 30 59 27
Wyoming 7 - - -
Michigan - - 1 -
----- ----- ----- ----
Total 105 67 94 28
====== ===== ===== ====
(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 incident to operating agreements and liens for current taxes which the
Company believes do not materially interfere with the use of or affect the value
of the oil and gas properties.
The Default Notice advised the Company that the Bank declared the
entire outstanding indebtedness under the Senior Credit Facility and all
interest accrued thereon to be immediately due and payable.
On August 11, 1998, the Company was notified that the Bank initiated
foreclosure proceedings with regard to the Company's Texas properties by posting
the properties for foreclosure. Under applicable law, such foreclosure is
scheduled to occur on September 1, 1998. The Company is continuing its
discussions with the Bank in an effort to identify and conclude an alternative
transaction which might address and resolve in a mutually satisfactory manner
the Company's default under the Senior Credit Facility. However, while those
discussions are continuing, no agreement has been reached and no assurance can
be given that any agreement will be reached which would cause the Bank to
refrain from pursuing foreclosure on September 1, 1998. The Bank has not advised
the Company of its intentions with regard to other properties owned by the
Company and pledged to secure the Bank's indebtedness.
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
(fax).
-12-
<PAGE>
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 other
than described above pursuant to the Default and Foreclosure Notice received
from the Bank.
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 July 21, 1998, there were approximately 645 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 1998 and 1997
General Accounting Information
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
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
-13-
<PAGE>
of a sale of the platform with the buyer assuming plugging and abandonment
liabilities. 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 $835,000 of which $492,000 has been accrued.
GulfMex's abandonment escrow account as of January 31, 1997 is approximately
$364,000.
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" which 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 approximately $8,615,000 and $261,000 related to oil and gas
properties for the fiscal years ended January 31, 1998 and 1997 respectively.
Results of Operations for 1998 and 1997
Revenues and Lease Operating Expenses
Oil and gas sales increased from $5.3 million in 1997 to $7.1 million
in 1998. Likewise, lease operating expenses increased from $2.4 million in 1997
to $3.5 million in 1998. The increase in revenues and operating expense is
primarily due to the acquisition of Righthand Creek on January 16, 1997. The
following table summarizes the operating activity for the oil and gas properties
of the Company during fiscal year 1998 and 1997. The existing properties are
those oil and gas properties acquired by the Company prior to February 1, 1996.
Acquisition Year Ended January 31,
Date 1998 1997
----------- ---- ----
Oil and gas sales:
Existing properties -- $2,300,884 3,673,030
Wheeler County properties March 1996 273,059 264,905
Block 76 March 1996 401,497 468,555
Belle properties April 1996 967,010 931,103
Righthand Creek January 1997 3,201,791 -
--------- ----------
Total oil and gas sales $7,144,241 5,337,593
========== ==========
Lease operating expenses:
Existing properties -- $1,248,902 1,623,273
Wheeler County properties March 1996 64,976 81,409
Block 76 March 1996 38,720 40,777
Belle properties April 1996 746,409 648,859
Righthand Creek January 1997 1,350,422 -
--------- ----------
Total lease operating expenses $3,449,429 2,394,318
========== ==========
-14-
<PAGE>
Acquisition Year Ended January 31,
Date 1998 1997
----------- ---- ----
Depletion of oil and gas producing properties:
Existing properties -- $1,149,439 659,702
Wheeler County properties March 1996 43,052 13,895
Block 76 March 1996 337,015 337,015
Belle properties April 1996 852,815 366,221
Righthand Creek January 1997 4,341,568 -
---------- ---------
Total depletion of oil and gas
producing properties $ 6,723,889 1,376,833
=========== =========
Impairment of oil and gas properties:
Existing properties -- $ 257,115 160,801
Wheeler County properties March 1996 - -
Block 76 March 1996 - -
Belle properties April 1996 1,109,739 100,000
Righthand Creek January 1997 7,248,552 -
--------- ---------
Total impairment of oil and gas
properties $ 8,615,406 260,801
=========== ========
Oil production volumes (bbl):
Existing properties -- 40,444 67,898
Wheeler County properties March 1996 143 171
Block 76 March 1996 6,985 6,814
Belle properties April 1996 52,230 43,296
Righthand Creek January 1997 130,642 -
------- --------
Total production volumes (bbl) 230,444 118,179
======= ========
Gas production volume (mcf):
Existing properties -- 679,413 881,833
Wheeler County properties March 1996 130,776 115,548
Block 76 March 1996 103,437 119,281
Belle properties April 1996 68 301
Righthand Creek January 1997 125,240 -
-------- --------
Total gas production volume (mcf) 1,038,934 1,116,963
========= ==========
Average oil price per bbl $ 20.22 $ 20.73
========= ==========
Average gas price per mcf $ 2.36 $ 2.54
========== ==========
-15-
<PAGE>
Dry Hole Costs and Lease Abandonments
Dry hole costs and lease abandonments for the fiscal year ended January
31, 1997 were approximately $822,000 as compared to approximately $294,000 for
the fiscal year ended January 31, 1998. During the fiscal year ended January 31,
1997, two dry holes were drilled in Sutton County, Texas which cost
approximately $326,000 and one dry hole was drilled in Wheeler County, Texas
which cost approximately $132,000 for total dry hole costs of $458,000. The
Sutton County leasehold abandonment was $110,000 and the Lipscomb and Duval
County leasehold abandonments were $177,000. The remainder of the dry hole costs
and leasehold abandonments during the fiscal year ended 1997 were for
miscellaneous properties.
In March 1997, Offshore entered into a participation agreement
("Mortimer Agreement") with Mortimer Exploration Company ("Mortimer") which
provided for Offshore to assume a 38% participation in all costs associated with
certain exploration prospects that Mortimer identified and presented to Offshore
effective from and after January 1, 1997. The costs included overhead incurred
by Mortimer in developing prospects, as well as any seismic and lease
acquisitions. In connection with the Mortimer Agreement, Offshore committed to
participate in drilling at least two wells, to be identified within a prospect
area from Beauregard Parish, Louisiana to Montgomery County, Texas. A drillable
prospect, as defined by the Mortimer Agreement, was any single prospect in the
prospect area where the drainage area was sufficient to provide estimated
reserves of at least 200,000 bbls oil equivalent. The Company invested
approximately $274,000 in leasehold, geologic and seismic costs during the
fiscal year ended January 31, 1998 in accordance with the Mortimer Agreement
("Mortimer Project"). A drilling requirement for one of the leaseholds obtained
through a farmout required a March 1, 1998 commencement date by the working
interest group or a $50,000 penalty would be assessed if the commencement date
was missed. Since the Company's working capital was not adequate to fund its
proportionate share of the drilling costs, the Company's Board of Directors
accepted an offer from Buschman to acquire the Company's interest in the
Mortimer Project in exchange for the Company being released and held harmless
from any and all liability related to the Mortimer Agreement. The Company's
investment in the Mortimer Project was expensed as leasehold abandonment. The
initial well drilled as required by the farmout detailed above resulted in a dry
hole.
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.
Depletion expense for the fiscal year ended January 31, 1998 was
approximately $6.7 million as compared to approximately $1.5 for the fiscal year
ended January 31, 1997.
The significant increase in depletion is the result of reduction in the
estimated net remaining reserves of oil and natural gas at year end for the
Company's oil and gas properties.
-16-
<PAGE>
Impairment of Long-Lived Assets
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.
The Company recognized a $261,000 non-cash writedown of oil and gas
properties for the year ended January 31, 1997 which increased to $8.6 million
for the year ended January 31, 1998. The increase in the impairment loss is due
primarily as a result of the shift in the reserve classification of Righthand
Creek from proved to probable and possible based upon the determination that the
field's primary source of energy is fluid expansion and not water drive as was
considered when the field was acquired. The decline in oil prices has also
contributed to the present value of future cash flows of proved oil reserves
declining as of January 1, 1998.
In accordance with SFAS No. 121, the carrying value of oil and gas
properties have been reduced such that the present value of the Company's proved
oil and gas reserves does not exceed the net carrying value on the balance
sheet.
Depreciation and Other Amortization
Depreciation costs for the fiscal year ended January 31, 1997 was
$45,000 as compared to $53,000 for the fiscal year ended January 31, 1998. Other
amortization costs include the amortization of deferred loan costs and deferred
costs related to the Senior Credit Facility 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 for the
fiscal year ended January 31, 1997. Amortization expense, exclusive of the
$118,000 described above, was $142,000 for the fiscal year ended January 31,
1997 and $177,000 for the fiscal year ended January 31, 1998.
General and Administrative
General and administrative expenses increased from approximately $1.3
million in 1997 to $1.6 million for the fiscal year 1998 due primarily to
additional salary expense for personnel added in January 1997 as a result of the
Righthand Creek acquisition and the increase in salary for Guy Bob Buschman and
Gary Scheele that resulted from employment agreements required as a condition of
the Koch Private Placement. Professional and legal fees also increased
significantly during the current year due primarily to continuing negotiations
with the Bank and evaluation of various alternative transactions.
Interest Expense
Interest expense increased from $696,000 in 1997 to $1.14 million in
1998 as a result of increase in debt for the acquisition of Righthand Creek in
January 1997. The interest expense related to the $2 million Notes which were
issued in September 1995 at 11.75% interest and prepaid effective January 31,
1997 was approximately $231,000 during the fiscal year ended January 31, 1997.
-17-
<PAGE>
Gain on Sale
The gain on sale of assets recognized by the Company for the fiscal
year ended January 31, 1997 was approximately $316,000 as compared to
approximately $708,000 for the fiscal year ended January 31, 1998. The principal
amount of gain of approximately $373,000 for the fiscal year ended January 31,
1998 was from the sale of the KWB Field in Tom Green County, Texas.
Minority Interests of Limited Partners
Minority interest in earnings of limited partnerships decreased from
approximately $94,000 in 1997 to approximately $13,000 in 1998 due to operating
losses from the limited partnership. The cumulative minority interest of the
limited partners of GulfMex, approximately $145,000, is set out in the
consolidated balance sheet for the year ended January 31, 1998.
Koch Private Placement
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.
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 of $220,377 was paid May 1, 1997, and included pro-rata dividends from
the date of issuance on January 16, 1997 to May 1, 1997. The Company's Board of
Director's declared dividends be paid for the August 1, 1997 dividend payment
date; however, due to the Company's inadequate working capital, the dividend has
not been paid. Dividends on the Series A Preferred Stock have not been declared
for the November 1997 through May 1998 dividend payment dates. As of January 31,
1998, accrued dividends for holders of Series A Preferred Stock are
approximately $562,500, which has been added to the redeemable preferred stock
capital account.
In the event of any voluntary or involuntary liquidation, dissolution
or winding up of the Company, holders of Series A Preferred Stock shall be
entitled to be paid out of the assets of the Company available for distribution
to its stockholders up to an amount equal to the aggregate face value of the
then outstanding Series
-18-
<PAGE>
A Preferred Stock plus accrued but unpaid dividends before any payment shall be
made to the holders of Series B and Series C Preferred Stock and the common
stockholders. 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.
Series B Preferred Stock. Pursuant to the Koch Private Placement,
500,000 shares of Series B Preferred Stock were issued by the Company at $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. Dividends on the Series C Preferred Stock are payable in preference and
priority to payment of dividends on the Series B Preferred Stock.
On the first dividend payment date of May 1, 1997, 17,500 shares of
Series C Preferred Stock were issued to Koch as dividend on the Series B
Preferred Stock. The Company's Board of Directors declared a dividend on the
Series B Preferred Stock for the August 1, 1997 dividend payment date; however,
the 17,500 shares of Series C Preferred Stock have not been issued to Koch.
Dividends due on the Series B Preferred Stock have not been declared for the
dividend payment dates of November 1997 through May 1998. The Series B Preferred
Stock dividends are payable in shares of Series C Preferred Stock which have a
liquidation value of $10 per share at maturity January 16, 2002. The liquidation
value of each share of Series C Preferred Stock is accreted, as accrued
dividends, from the date of issue to maturity. The accrued dividends
attributable to such accretion value are approximately $68,900 as of January 31,
1998, which have been added to the redeemable preferred stock capital account.
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
-19-
<PAGE>
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
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 was 10,974,895, which was 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 debtholders 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.
-20-
<PAGE>
The Company is currently in arrears on four consecutive dividend
payments on the Series A, Series B and Series C Preferred Stock. As of August 7,
1998, Koch has not given notice to the Company of their election to exercise
rights to cast votes equivalent to 51% of the current outstanding shares of
common stock of the Company. As more fully described below, Koch also has the
right to convene a special meeting of the stockholders at which Koch would have
the right to elect a majority of the number of directors constituting the
Company's Board. Koch to date has not invoked such rights.
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 R. Allan Allford, Managing Director of Koch Producer
Services, are serving on the Board of Directors until the next election of
directors at the annual meeting of stockholders.
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 of Directors. 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 of Directors. 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 of
Directors.
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. 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. On May 1, 1997, 17,500 shares of Series C Preferred Stock
were issued as dividends on the Series B Preferred Stock. The Company's Board
declared a dividend payment of $6,125 on the Series C Preferred Stock effective
August 1, 1997; however, due to the Company's inadequate working capital, the
cash dividend payment due on August 1, 1997 was not made. No subsequent
dividends have been declared or paid for the Series C Preferred Stock. As of
January 31, 1998, accrued dividends of $36,750 on Series C Preferred Stock have
been added to the redeemable preferred stock capital account.
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
-21-
<PAGE>
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. The First Amendment to the Senior
Credit Facility permits the payment of dividends on the 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 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. 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 agreed to a
price risk protection program in the form of one or more swap, hedge, floor or
collar agreements 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.
-22-
<PAGE>
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 produced less than the 650 bbl daily crude oil requirement, the LLS plus
Bonus was less than $23.45 per bbl during the contract period.
In August 1997, the Company, on behalf of Offshore, entered into a
commodity futures oil swap agreement ("Oil Swap Agreement") with Koch Oil
Company. That Oil Swap Agreement was made pursuant to an existing Master
Commodity Swap Agreement between the Company and Koch, at no current cost to the
Company, and is termed a "Costless Put/Call Collar Option," covering the period
between February 1, 1998 and January 31, 1999. The Oil Swap Agreement is based
upon 400 barrels oil per day and establishes settlement dates on the last day of
each calendar month during the contract period. It sets a floating price equal
to Koch Oil Company's monthly average LLS posting plus $1.50, and strike prices
of $18.20 for put options and $19.97 for call options. On any settlement date,
if the floating price is less than the put option strike price, then Koch must
pay the Company the price difference, multiplied by the determination quantity
for the month. On any settlement date, if the floating price exceeds the call
option strike price, the Company must pay Koch the difference, multiplied by the
determination quantity for the month.
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 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
-23-
<PAGE>
(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.
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.
-24-
<PAGE>
Recent Developments, Capital Resources and Liquidity
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.
The Company received a Borrowing Base Determination Notice in January
1998 advising the Company that effective February 1, 1998, the Company's
Borrowing Base had been redetermined to be $6,500,000. The balance of the
Company's outstanding indebtedness with Comerica Bank - Texas (the "Bank"), its
senior lender, approximately $13,178,000, exceeded the Borrowing Base by
approximately $6,678,000 (the "Deficiency"). Under the terms of the Senior
Credit Facility, the Bank gave notice to the Company to either provide the Bank
with additional collateral to increase the Borrowing Base, or reduce the
outstanding balance of the Company's indebtedness to an amount less than or
equal to the redetermined Borrowing Base.
The Company entered into a subsequent letter agreement with the Bank in
March 1998 which extended to the close of business on April 3, 1998 to eliminate
the Deficiency or reach other accommodations with the Bank. For and in
consideration of the extension to April 3, 1998, the Company agreed to execute
certain supplemental documents pertaining to collateral properties; pay an
extension fee of $25,000 on or before April 3, 1998; terminate its ability to
utilize the Eurodollar Rate Option under the Loan Agreement; increase the
applicable interest rate to prime rate plus three percent; execute a letter
waiving compliance with the working capital covenant for the month of November
1997; pay the Bank specified legal and engineering expenses and furnish the Bank
with copies of any agreements related to any proposed refinancing.
The Company has received from the Bank, a "Notice of Defaults and
Events of Default" whereby the Bank has declared the entire outstanding
principal balance of the Senior Credit Facility and all interest accrued thereon
to be immediately due and payable. In addition, the Bank has advised that it
intends to pursue all remedies that are available in law and in equity,
including but not limited to, foreclosure proceedings in order to collect all
amounts due. The aggregate amount of principal and interest currently
outstanding is approximately $13,400,000.
-25-
<PAGE>
The Bank has also submitted "Letters in Lieu of Transfer Order and
Division Order" to certain purchasers and marketing entities of the Company's
oil and gas products. The Letters in Lieu direct such purchasers to make
payments for the settlement of purchased products directly to the Bank. As a
result of such action, the Company will likely receive no further payments from
such purchasers until the default under the Senior Credit Facility has been
remedied or other agreements have been negotiated with the Bank. Such action
will impact the Company's ability to pay direct operating expenses of its oil
and gas leases, including applicable royalties, and general and administrative
expenses.
The Company is currently negotiating the sales of certain or all of its
oil and gas properties; however, any significant sale of oil and gas properties
outside of a bankruptcy proceeding requires stockholder approval, which in turn
requires the preparation and circulation of a Proxy Statement or Information
Statement (the "Statement") and the passage of approximately twenty days between
the mailing of the Statement and the ability to effectuate any such sale.
On August 11, 1998, the Company was notified that the Bank initiated
foreclosure proceedings with regard to the Company's Texas properties by posting
the properties for foreclosure. Under applicable law, such foreclosure is
scheduled to occur on September 1, 1998. The Company is continuing its
discussions with the Bank in an effort to identify and conclude an alternative
transaction which might address and resolve in a mutually satisfactory manner
the Company's default under the Senior Credit Facility. However, while those
discussions are continuing, no agreement has been reached and no assurance can
be given that any agreement will be reached which would cause the Bank to
refrain from pursuing foreclosure on September 1, 1998. The properties posted
for foreclosure and subject to foreclosure on September 1, 1998 include all of
the Company's Texas properties, which represented approximately twenty percent
(20%) of the Company's revenues for the fiscal year ended January 31, 1998 and
approximately sixteen percent (16%) of the Company's revenues for the six months
ended July 31, 1998. The Bank has not advised the Company of its intentions with
regard to other properties owned by the Company and pledged to secure the Bank's
indebtedness. In addition to evaluating and pursuing alternative transactions in
an effort to address the Bank's requirements, the Company continues to consider
other alternatives, including, but not limited to, non-traditional financing
transactions and seeking protection under the federal bankruptcy laws. No
assurances can be given that the Company can identify a transaction acceptable
to the Bank or that if any such transaction can be identified, that it can be
documented and concluded successfully or in a timely manner. Any of the
transactions or occurrences described above would likely result in nominal or no
value being afforded to the interests of existing holders of the Company's
common stock.
Year 2000
The Company has not addressed the impact of the Year 2000 on its
computer systems and applications. The Company does not expect the cost of
becoming Year 2000 compliant to be significant; however, due to its current
financial condition, no Year 2000 plan has been developed.
Recently Issued Accounting Pronouncement
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information" which establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas, and major
-26-
<PAGE>
customers. The Company believes that SFAS No. 131 will not have a material
impact on its financial statements and disclosures.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which established standards of accounting
and reporting for derivative instruments and for hedging activities. It requires
that all derivatives be recognized as either assets and liabilities in the
statement of financial position and measures these instruments at fair value.
This statement is effective for financial statements for periods beginning June
15, 1999. The Company believes that SFAS No. 133 will not have a material impact
on its financial statements and disclosures.
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.
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
The Company has not changed accountants nor reported any disagreements
on matters of accounting principles.
PART III
Item 9. Directors and Executive Officers of the Registrant
Each person serving on the Board of Directors has held such position
since July 1, 1997 and shall hold such position until the next Annual Meeting or
until his successor is duly elected and qualified.
The following table lists the persons now serving as Directors of the
Company:
Director
Name Position Age Since
- ---------------------- ------------------- --------- ---------
Robert A. Buschman Chairman of the Board 71 1979
of Directors
Guy Bob Buschman President and Director 47 1978
H. M. Shearin, Jr. Director 75 1992
Hobby A. Abshier Director 66 1995
Ralph F. Cox Director 65 1995
Dale G. Schlinsog Director 40 1997
R. Allan Allford Director 41 1997
-27-
<PAGE>
Robert A. Buschman is Chairman of the Board of Directors of the
Company. Prior to joining the Company in February 1979, Mr. Buschman was
President, Chief Executive Officer and a Director of Dixilyn- Field Drilling
Company, a subsidiary of Panhandle Eastern Pipeline Company, from April 1978 to
February 1979. Mr. Buschman has served as President and a member of the Board of
Directors of the Texas Mid- Continent Oil and Gas Association, member of
Executive and Steering Committee of Texas Mid-Continent Oil and Gas Association,
member of the International Association of Drilling Contractors, member of the
Independent Petroleum Association and member of the All American Wildcatters.
Guy Bob Buschman, President, Chief Executive Officer and a Director, is
the founder of the Company which was organized in April 1978. Mr. Buschman was
employed by Field International Drilling Company from August 1973 through March
1978 while working for Field International Drilling Company. Mr. Buschman held
multiple positions domestically and internationally including Supervisor of
Shipyard Construction of Offshore Drilling Rigs, Material Manager, Safety and
Insurance Manager, Area Manager and Contracts and Sales Representative. During
his Field International Drilling Company career, he was based in Alice, Texas;
Vicksburg, Mississippi; Beaumont, Texas; Trinidad-Tobago; the Republic of
Singapore; Egypt and San Antonio, Texas. He is a past director of the
Independent Association of Drilling Contracts and the Chairman of the Board of
IADC Publications Inc. Presently, he is a Director of the Texas Mid-Continent
Oil and Gas Association and a member of IPAA and San Antonio's local Society of
Petroleum Engineers- American Petroleum Institute Chapter. Mr. Buschman has
served as Chairman and Director of the San Antonio Children's Shelter. He also
is a member and former Chairman of the Austin-San Antonio Chapter of the Young
President's Organization. Mr. Buschman received his B.A. degree from Texas
Christian University in 1973.
H. M. ("Johnny") Shearin, Jr., a Director, was President of SPG
Exploration Corporation from 1971 to 1988. Prior to 1971, Mr. Shearin was Vice
President and Manager of Engineering for Core Laboratories, Inc. In 1988, he
retired from Quantum Chemical (formerly National Distillers who acquired SPG).
From 1988 to present, Mr. Shearin has performed consulting services for various
independent operators and oil field service and engineering companies.
H. A. ("Hobby") Abshier, Jr. is a Managing Director of Crossroads
Group. For the past 12 years he has been a General Partner and co-founder of the
Triad Group of Venture Capital Funds. Prior to starting the Triad Group, he
spent 21 years at Rotan Mosle, Inc., Texas largest investment banking firm, as a
Partner, Officer and a member of its Board of Directors. Mr. Abshier has been on
the Board of Directors of Technology Works, DTM Corp., B'trieve Technologies,
all in Austin, Texas, and South Texas Drilling and Exploration Co., and Dawson
Well Servicing, Inc. in San Antonio, Texas. Mr. Abshier is a graduate of Culver,
Rice and Harvard, and served both as an enlisted man and officer in the United
States Air Force.
Ralph F. Cox is currently self-employed as an energy management
consultant. For four years prior thereto, Mr. Cox was President of Greenhill
Petroleum Corporation, a subsidiary of Western Mining Corporation. From 1985
through 1990, he served as President and Chief Operating Officer of Union
Pacific Resources Company, a petroleum exploration and production company.
Before 1985, Mr. Cox spent 31 years with Atlantic Richfield Company ("ARCO"),
joining the ARCO board in 1978, assuming responsibility for ARCO's worldwide
petroleum exploration and production activities and minerals exploration and
production activities in 1984, and culminating with his election as Vice
Chairman of ARCO in 1985. Mr. Cox serves as a Director of Bonneville Pacific
Corporation, an independent power company, as a Director of CHZM Hill,
engineering consulting firm, as a Director of USA Waste Inc., non-hazardous
waste management, as a Director of Daniel Industries, Inc., oil and gas
measurement equipment, and as Independent Trustee for The Fidelity
-28-
<PAGE>
Group of Funds. Mr. Cox holds a Bachelor of Science in Petroleum Engineering and
a Bachelor of Science in Mechanical Engineering from Texas A & M University.
Dale G. Schlinsog is Vice President of Koch Capital Services and Vice
President of Koch Exploration Company and is serving as an interim Director on
the Board of the Company. Mr. Schlinsog is a graduate of the University of
Wisconsin - Parkside and the University of Kansas and holds a Bachelor in
Science in Earth Science/Geology and Master of Science in Geology with Honors,
respectively. He has been employed with various Koch Industries entities since
1982. Mr. Schlinsog is a member of American Association of Petroleum Geologists
and Kansas Geological Survey.
R. Allan Allford is Managing Director, Koch Producer Services - Capital
Group. Mr. Allford has been at Koch Industries since 1993, where he has held
positions as CFO and Vice President for Koch Capital Services. Prior to joining
Koch Industries, Mr. Allford held various senior financial management positions
working for high net worth individuals in a variety of industries. Mr. Allford
is a graduate of the University of Kansas and is a Certified Public Accountant.
Guy Bob Buschman is the son of Robert A. Buschman. Ralph Cox is the
brother-in-law to Robert A. Buschman and uncle to Guy Bob Buschman. There are no
other family relationships in the Company.
Koch, as the holder of Series B Preferred Stock, has 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
R. Allan Allford, Managing Director of Koch Producer Services, are Koch's
representatives on the Company's Board of Directors.
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 of Directors.
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. The Company is currently in arrears on four consecutive
dividend payments on the Series A, Series B and Series C Preferred Stock. Koch
to date has not called for special meeting to elect directors.
Koch, as the holder 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
-29-
<PAGE>
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. Koch has not given notice to the Company
of their election to exercise rights to cast votes equivalent to 51%.
The 95 Non-Qualified Plan provides that newly elected directors who
have not previously been granted options will be granted options to purchase
50,000 shares of the Company's Common Stock. Each year thereafter, if the
director is reelected the director is entitled to be granted options to purchase
an additional 5,000 shares of Common Stock. The maximum options any director may
be granted is 75,000. The 95 NonQualified Plan is proposed to be amended by the
Board of Directors to allow directors to disclaim their rights to options under
the 95 Non-Qualified Plan, and the Koch representatives have indicated their
desire to so disclaim such options. Pursuant to the Koch Agreement, the Company
will issue to Koch the number of options which the Koch representatives would
have been entitled pursuant to the 95 Non-Qualified Plan.
Committees of the Board of Directors
The Company's Board of Directors has an Audit Committee and a
Compensation and Stock Option Committee. Both Committees are composed of Messrs.
Abshier, Cox and Schlinsog. The principal functions of the Audit Committee are
to give additional assurance that financial information is accurate and timely,
recommend to the Board of Directors the engagement of independent auditors,
ascertain the existence of an effective accounting and internal control system,
oversee the entire audit function, and review and pass on the fairness of
existing arrangements between the Company and affiliated parties on an annual
basis. The Compensation and Stock Option Committee administers the Company's
stock option plans and recommends compensation for executive officers to the
Board of Directors.
During the fiscal year ended January 31, 1997, the Board held seven
meetings which were attended by a quorum of all the Directors. There was one
meeting of the Audit Committee attended by all committee members, and one
meeting of the Compensation and Stock Option Committee attended by all committee
members. The non-employee Directors serving on the Board's Audit and
Compensation and Stock Option Committees receive $100 per committee meeting.
Item 10. Executive Compensation
Executive Officers
The following individuals serve as Executive Officers of the Company
and have been elected by the Board to serve in the positions indicated for the
terms indicated in the Bylaws of the Company.
Robert A. Buschman Chairman
Guy Bob Buschman President and Chief Executive Officer
Gary Scheele (1) Vice President, Chief Financial Officer
and Secretary/Treasurer
- ------------
(1) Gary Scheele, a Certified Public Accountant, has been with the Company
since its organization in April, 1978.
-30-
<PAGE>
As condition of the Koch Agreement, Guy Bob Buschman, President and
Chief Executive Officer, and Gary Scheele, Vice President and Chief Financial
Officer, entered 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 shall 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.
Summary Compensation Table
The following table summarizes the compensation paid by the Company to
its Chairman, President Chief Executive Officer and Vice President and Chief
Financial Officer for services rendered to the Company during the fiscal year
ended January 31, 1998.
Annual Compensation Long-term Compensation
----------------------------- ------------------------------------
(2) Restricted
Name and Fiscal Salary Bonus Other Stock Options All
Principal Year $ $ $ Awards # Other
Position
- ---------- ------ ------ ----- ----- ----------- ------- -----
Robert A.
Buschman 1998 86,288 - 3,704 - - -
Chairman
1997 84,788 - 3,603 - - -
1996 84,788 - 9,349 - - -
Guy Bob
Buschman 1998 126,500 - 9,255 - - -
President
and Chief
Executive
Officer 1997 84,788 - 8,769 - - -
1996 84,788 - 12,583 - - -
Gary Scheele 1998 101,500 - 9,440 - - -
Vice
President
and Chief
Financial 1997 81,118 - 9,795 - - -
Officer
1996 82,878 - 6,282 - - -
(2) Includes the cost to the Company of the personal use of a Company
vehicle, group life insurance premiums and other miscellaneous personal
benefits paid by the Company.
-31-
<PAGE>
Options/Grants in Last Fiscal Year
There were no grants of stock options to the executive officers during
the fiscal year ended January 31, 1998.
Aggregate Option Exercises and Fiscal Year-End Option Value Table
The following table presents certain information regarding the exercise
of options during fiscal 1998, and options held at January 31, 1998 by Robert A.
Buschman, Chairman of the Board of the Company, Guy Bob Buschman, President and
Chief Executive Officer and Gary Scheele, Vice President and Chief Financial
Officer.
Number of Value of
Unexercised Unexercised
Options at Options at
Shares January 31, 1998 January 31, 1998
Acquired ------------------------- -------------------------
on Value (3)
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
---- -------- -------- ----------- ------------- ----------- -------------
Robert A.
Buschman - - 100,000 - $ - -
Guy Bob
Buschman - - 100,000 - - -
Gary Scheele - - 265,000 - - -
- -------------
(3) There are no listed market quotes for the Company's common stock. The
exercise price of the unexercised options is greater than the Company's
deficit book value per share at January 31, 1998.
Director Compensation
Each Director of the Company who is not an officer of the Company is
paid $1,000 per month for serving as a Director. The monthly compensation to
Koch's representatives on the Board was paid directly to Koch Exploration
Company. H. J. Shearin, Jr. and H. A. Abshier, Jr. served as a consultants to
the Company during the year ended January 31, 1998 and were paid total director
and consultant fees of $30,000 and $30,200, respectively.
Other Compensation
The Company's 1986 Incentive Stock Option Plan ("86 Incentive Plan")
and the 1986 Non-Qualified Stock Option Plan ("86 Non-Qualified Plan")
(collectively, the "86 Plans") terminated December 31, 1995. Any options
outstanding under the 86 Plans shall remain in effect until they have been
exercised or have expired. All options outstanding under the 86 Plans expire in
1999. The Company received approval from stockholders for the 1995 Incentive
Stock Option Plan ("95 Incentive Plan") and the 1995 Non-Qualified Stock Option
Plan ("95 Non-Qualified Plan")(collectively, the "95 Plans") at the 1995 Annual
Stockholder's Meeting. The 95 Plans are anticipated to assist the Company in
attracting, motivating and retaining key employees and non-employee directors.
The 95 Plans are administered by the Compensation and Stock Option Committee of
the Board of Directors.
-32-
<PAGE>
The following discussion summarizes the material differences between
the 95 Plans.
The 95 Incentive Plan. The Company has reserved 500,000 shares
of its $.01 par value Common Stock for issuance under the 1995
Incentive Plan. Only key employees, as determined by the Compensation
and Stock Option Committee, are eligible for participation in the 95
Incentive Plan. The options are exercisable beginning one (1) year from
the date of grant. The unexercised portion of any option granted under
the 95 Incentive Plan terminates or becomes null and void ten (10)
years from the date of the grant, except for holders of more than 10%
of the Company Stock. Such grants expire after five (5) years. Grants
also expire ninety (90) days after the termination of Optionee's
employment with the Company, one (1) year after the termination of
Optionee's employment with the Company on account of disability or one
(1) year after Optionee's death.
The Committee determines the exercise price of an option,
which may never be less than the fair market value of the Common Stock
on the date of grant. The Common Stock is currently not listed on a
national exchange, therefore, the Committee will determine the fair
market value based on the information available at the time options are
granted.
The 95 Non-Qualified Plan. The Company has reserved 525,000
shares of its $.01 par value Common Stock for issuance under the 1995
Non-Qualified Plan. Non-employee directors are eligible for
participation in this plan. Options granted to non-employee directors
are exercisable beginning one (1) year from the date of grant, and
expire on the tenth anniversary of such date. Non-employee directors
who, at the date of their election to the Board, have not previously
been granted options in the 95 Non-Qualified Plan, are to be
automatically granted options to purchase 50,000 shares of the
Company's Common Stock under terms described in the 95 Non-Qualified
Plan. Thereafter, each year, upon re-election to the Board,
non-employee directors will be granted options to purchase an
additional 5,000 shares of the Company's Common Stock, up to a maximum
of 75,000. The unexercised portion of any option granted under the 95
Non-Qualified Plan terminates or becomes null and void ten (10) years
from the date of the grant. Grants also expire ninety (90) days after
Optionee ceases to serve as a member of the Board of Directors with the
Company or one (1) year after Optionee's death.
The exercise price of an option will be computed by formula.
If the Common Stock is actively traded on a national exchange, the
option price will be the average of the highest and lowest trades for
the date the option is granted. If the Common Stock is not actively
traded on a national exchange, the exercise price will be determined by
dividing the stockholders' equity at the end of the immediately
preceding fiscal quarter by the total outstanding Common Stock on such
date and multiplying by 1.2. The re-election of the non-employee
nominees as directors of the Company at the Annual Meeting will entitle
each such nominee options to purchase 5,000 shares of the Company Stock
at an approximate price of $0.20, however the exact option price will
not be determined until after the Annual Meeting and the selection of
the new Compensation and Stock Option Committee.
Federal Income Tax Consequences
The 95 Incentive Plan. A participant who receives an incentive stock
option under the 95 Incentive Plan will ordinarily not recognize any income for
federal income tax purposes as a result of the receipt or exercise of such
option. However, the exercise of an incentive stock option will give rise to an
increase in the participant's alternative minimum taxable income for purposes of
the alternative minimum tax in an amount
-33-
<PAGE>
equal to the excess of the fair market value of the Common Stock at such time as
the participant's rights to the stock are freely transferable and are not
subject to a substantial risk of forfeiture. The Company will not be entitled to
a compensation deduction for federal income tax purposes with respect to either
the grant of an incentive stock option under the 95 Incentive Plan or the
exercise of such an option by the participant. If the participant does not
dispose of the shares of Common Stock acquired through the exercise of the
incentive stock option within two (2) years of the date of the grant of such
option, or within one (1) year after the exercise date, and if the participant
is employed by the Company from the time the option is granted until three (3)
months before its exercise, any gain or loss recognized upon the disposition
will constitute a long-term capital gain or loss and the Company will not be
entitled to a deduction. If a participant disposes of the shares prior to the
expiration of such holding periods, the participant will recognize, at the time
of such disqualified disposition, ordinary income equal to the difference
between the exercise price and the lower of (i) the fair market value of the
shares subject to the option on the date of exercise or (ii) the amount realized
by the participant on the sale of such shares. Any remaining gain will be taxed
as a capital gain. In the event of a disqualified disposition, the Company will
be entitled to a deduction in an amount equal to the income recognized by the
participant.
If a participant pays the exercise price of an incentive stock option
solely with Common Stock, and if the shares surrendered are (i) shares not
received pursuant to the exercise of an incentive stock option and not subject
to a substantial risk or forfeiture or (ii) the result of the participant's
exercise of another incentive stock option, the exercise of which satisfied the
above stated holding period requirements, the participant will not recognize
income. Additionally the basis and holding period of the surrendered Common
Stock will be transferred to that number of new shares equal to the number of
old shares surrendered. If more shares are received than were surrendered, the
additional shares' basis will be zero. If these conditions are not met, the
payment of the exercise price with shares of Common Stock may be treated as a
disqualified disposition or otherwise taxable disposition.
The 95 Non-Qualified Plan. The grant of a non-qualified option under
the 95 Non-Qualified Plan should not ordinarily be a taxable event for federal
income tax purposes. Upon exercise of a non-qualified option, the participant
will recognize ordinary income in an amount equal to the difference between the
amount paid by the participant for the shares of Common Stock and the fair
market value of such shares determined on the later of (i) the date of exercise
or (ii) the date on which the shares of Common Stock become transferable by the
participant and are not subject to a substantial risk of forfeiture. If the
Company withholds all amounts required to be withheld under applicable law or
other authority, the Company ordinarily will be entitled to a deduction
equivalent to the amount of compensation income recognized by the participant.
If a participant pays the exercise price of non-qualified options
solely with Common Stock, the shares received will generally have the same basis
and holding period as the Common Stock surrendered. If more shares are received
than were surrendered, the additional shares will cause the participant to
recognize compensation income either at the time of transfer or when
restrictions with respect to those shares lapse.
Item 11. Security Ownership of Certain Beneficial Owners and Management
Principal Stockholders
The following table provides information known to the Company as to the
Common Stock ownership, as of August 1, 1998, of (i) each beneficial owner of 5%
or more of the Common Stock, (ii) each named
-34-
<PAGE>
executive officer, (iii) each Director who owns any Common Stock and (iv) all
officers and Directors as a group:
Name and Address of Amount of Beneficial
Beneficial Owner Ownership of Common
- ------------------------------ ----------------------
Shares % of Class
------ -----------
Robert A. Buschman (1) 1,190,920 (2) 12.26%
10101 Reunion Place, Suite 210
San Antonio, Texas
Guy Bob Buschman (1) 1,487,960 (2) 15.31%
10101 Reunion Place, Suite 210
San Antonio, Texas
John G. Hurd (1) 800,400 (2) 8.24%
4040 Broadway, Suite 525
San Antonio, Texas
Edward Randall, III (1) 868,800 (4) 8.94%
5851 San Felipe, Suite 850
Houston, Texas
H. M. Shearin, Jr. (1) 155,000 (2) 1.60%
10 Ashley Greens
San Antonio, Texas
Ralph F. Cox (1) 184,000 (2) 1.89%
200 Rivercrest Drive
Fort Worth, Texas
H. A. Abshier, Jr. (1) 72,352 (2) 0.74%
3716 Millswood (3)
Irving, Texas
Koch Exploration Company (5) 2,733,975 28.14%
4111 East 37th Street
Wichita, Kansas
Dale G. Schlinsog (6) N/A N/A
20 Greenway Plaza, 6th Floor
Houston, Texas
R. Allan Allford (6) N/A N/A
20 Greenway Plaza, 6th Floor
Houston, Texas
Officers, directors and nominees for
directors as a group (8 owners) 7,493,407 (2) 77.12%
(3)
-35-
<PAGE>
- ------------
(1) Information as to beneficial ownership has been furnished by the
respective stockholders. Each owner has the sole voting and investment
power with respect to their shares, except as noted below. The shares
above include options which are exercisable within 60 days of the date
of this proxy.
(2) Includes, respectively, options to purchase the equivalent number of
shares of Common Stock, which are exercisable at any time at exercise
prices of $0.34 to $0.45 per share: Robert A. Buschman, 100,000
options; Guy R. Buschman, 100,000 options; H. A. Abshier, Jr., 55,000
options; Ralph F. Cox, 55,000 options; H.M. Shearin, Jr., 155,000
options; Koch Exploration Company, 100,000 options; Gary Scheele,
265,000 options.
(3) Includes 17,352 shares of Common Stock held by trustee for H. A.
Abshier, Jr.'s IRA account.
(4) Includes 600,000 shares held in trusts, of which Mr. Randall is
Co-Trustee. Mr. Randall is neither an employee nor a director of the
Company.
(5) On January 16, 1997, the Company and Koch Exploration Company ("Koch"),
an affiliate of Koch Industries, Inc. concluded a $10 million private
placement ("Koch Agreement") for designated preferred stock consisting
of 500,000 shares of Series A Preferred Stock for $5 million and
500,000 shares of Series B Preferred Stock for $5 million.
Koch, as the holder of Series B Preferred Stock, has 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.
Koch, as the holder 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.
Included in Koch's total shares are 100,000 of Non-Qualified Options
entitled to Koch's representatives which were granted upon election to
the Company's Board of Directors.
(6) R. Allan Allford and Dale G. Schlinsog, are employees of Koch
subsidiaries.
-36-
<PAGE>
Warrants
On September 27, 1995 the Company consummated a private offering of
11.50% Subordinated Notes for a total principal amount of $2,000,000 combined
with issuance of Warrants to the note purchasers ("Holders") which provided for
the purchase of up to 1,388,160 shares of the Company's Class A Common Stock,
par value $.01 per share, at an exercise price of $0.40 per share. In connection
with obtaining the consent of the Holders to certain amendments to the
Subordinated Notes (and certain other consents) as part of the refinancing of
the Company's senior indebtedness, the exercise price of the Warrants was
reduced to $0.20 per share. The Warrants remain outstanding for seven years from
the date of the Closing, unless they are detached from the Notes and transferred
to persons who are not affiliates of the initial holder of the Warrants, in
which case they expire on the 31st date following such transfer. The Common
Stock reserved for issuance upon exercise of the Common Stock the Warrants
represents twenty percent (20%) of the Company's common stock, exclusive of
certain shares issuable upon the exercise of executive stock options.
The number of shares of Common Stock of the Company subject to purchase
pursuant to the Warrant also adjusts under certain circumstances. The number of
shares subject to the Warrants shall be adjusted proportionately and the
exercise price shall be adjusted proportionately, for any stock splits or stock
dividends. If the Company declares and pays any dividends other than in common
stock or cash, or makes any other distributions, to common stockholders, then
the Holders of the Warrants, upon exercise of the Warrants, are entitled to
receive their respective pro-rata share of the dividend, distribution, or right
which they would have received if they had exercised the Warrant before the
declaration of the dividend, distribution, or right, or, at the Company's
option, the number of shares subject to the Warrant shall be adjusted
appropriately.
If at any time while the Warrant is outstanding the Company grants to
all of its common stockholders any rights, options or warrants entitling them to
purchase shares of common stock at a price per share lower at the record date
for such issuance than the fair market value on such date, then the number of
shares of common stock subject to the Warrants shall be adjusted
proportionately. Alternatively, the Company may grant and convey to the Holders
of the Warrants the rights that such Holders would have received had it
exercised the Warrant before issuance of the rights. An appropriate readjustment
would be made to the number of shares of common stock subject to the Warrants
upon expiration or termination of any of the rights.
In case of any capital reorganization or reclassification of the
capital stock of the Company, the Holders of the Warrants shall thereafter be
entitled to purchase pursuant to the Warrant the kind and number of shares of
any stock or class or classes or other securities or property for or into which
such shares of common stock would have been exchanged, converted, or
reclassified if the Warrant stock had been purchased immediately before such
reorganization or reclassification.
The number of shares subject to the Warrant and/or the exercise price
of the Warrants shall also be adjusted in the event certain options to purchase
shares of Common Stock pursuant to stock option plans of the Company are
exercised.
Under the Warrants, the Company is required to give 30 days prior
written notice to Holders of record of the Warrants of significant events,
including payment of dividends, reorganization or reclassification, merger,
liquidation, dissolution, or other fundamental changes.
The Warrants carry piggyback registration rights requiring the Company
to deliver notice of its intent to file registration statement for the public
sale of its common stock to the Holders of the Warrants not later
-37-
<PAGE>
than 30 days prior to the initial filing of the registration statement, setting
forth the minimum and maximum proposed offering price, commissions, discounts in
connection with the offering, and other relevant information. Within twenty days
after receipt of the notice, holders of Warrants are entitled to request that
the Warrant stock be included in such registration statement and the Company
will use its best efforts to cause such Warrant stock to be included in the
offering covered by such registration statement. In the event the underwriter of
the offering determines that the inclusion of all of the stock requested to be
registered (including the Warrant Stock) would adversely affect the offering,
then the inclusion of shares other than those of the Company are subject to pro
rata reductions in accordance with the number of shares requested to be included
by the Holders.
During the fiscal year ended January 31, 1998, 624,670 Warrants to
acquire the Company's Common Stock have been exercised by certain Holders. Total
Warrants outstanding on January 31, 1998 are 763,490.
Item 12. Certain Relationships and Related Transactions
Related Party Transactions
In June 1992, Rio Grande Drilling Company ("Drilling") a Texas
corporation and wholly owned subsidiary of the Company, formed a Texas limited
partnership, Rio Grande Offshore, Ltd. ("Offshore") to acquire certain
non-operated offshore and onshore oil and gas properties. Substantially all of
the oil and gas properties leasehold interests of the Company as of January 31,
1996 were held through Offshore with the limited partners being Rio Grande
Desert Oil Company ("Desert"), a Nevada corporation and wholly owned subsidiary
of Drilling with a 79% limited partnership interest, Robert A. Buschman,
Chairman of the Board 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. Drilling was the sole general
partner with a 1% ownership interest. Prior to January 31, 1996, Buschman made
capital contributions equivalent to his ten percent (10%) ownership interest in
Offshore. Under the partnership agreement, however, Drilling was not entitled to
reimbursement for general and administrative expenses associated with the
properties such as costs and expenses associated with the maintenance of the
books and records of Offshore or the preparation of any type of financial
statement or report with respect to Offshore operations unless such documents
were prepared by a third party.
The limited partners agreed to restructure Offshore effective February
1, 1996, whereby the 20% limited partnership interest of Buschman and Hightowers
would be redeemed and, as a result of a distribution to them in consideration
for the redemption, Buschman and Hightowers would become proportionate
individual working interest owners of the onshore oil and gas properties
previously owned through their proportionate limited partnership interests in
Offshore. The restructure also provided that the existing offshore oil and gas
properties located offshore Louisiana ("OCS Properties") held by Offshore be
conveyed into a new Texas limited partnership, Rio Grande GulfMex, Ltd.
("GulfMex"), with the same beneficial ownership in the OCS Properties as
Offshore prior to the restructuring. Offshore is the sole general partner. The
limited partnership agreement for GulfMex is substantially the same as the
existing Offshore limited partnership agreement.
As a result of the restructuring, Buschman and Hightowers individually
own 20% of the onshore oil and gas properties leasehold working interests and a
20% limited partnership interest in GulfMex. Buschman and Hightowers no longer
are limited partners in Offshore, however, 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 partner. Drilling has been
operating many of the onshore leases where Buschman and the Hightowers
-38-
<PAGE>
will be the non-operating working interest owners. Buschman and the Hightowers,
as working interest owners, will be subject to existing standard joint oil and
gas operating agreements for each of the individual onshore leasehold interests.
Offshore, Buschman and the Hightowers will each be subject to individual
operating agreements with third party operators for non-operated oil and gas
leasehold interests. With regard to the OCS Properties held by GulfMex, Offshore
will receive a management fee of $500 per month for serving as the general
partner of GulfMex. Since the OCS Properties are operated by a third party, the
Company believes the expenses associated with administering the OCS Properties
for GulfMex are nominal.
As an additional consideration for the restructure, Buschman and
Hightowers retained the right to participate in the acquisitions of oil and gas
properties in those areas where Offshore had properties as of the effective date
of the restructuring. Any participation in subsequent acquisition of oil and gas
properties in those areas of mutual interest will be on a basis proportionate to
the interests of Buschman and Hightowers in Offshore prior to the restructure.
On March 26, 1996, Buschman and Hightowers exercised this right by purchasing
their proportionate 20% interests in the $500,000 acquisition Offshore made of
three gas wells located in Wheeler County, Texas.
Under the Koch Agreement 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
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 entity
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 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.
In August 1997, the Company, on behalf of Offshore, entered into a
commodity futures oil swap agreement ("Oil Swap Agreement") with Koch Oil
Company. That Oil Swap Agreement was made pursuant
-39-
<PAGE>
to an existing Master Commodity Swap Agreement between the Company and Koch, at
no current cost to the Company, and is termed a "Costless Put/Call Collar
Option," covering the period between February 1, 1998 and January 31, 1999. The
Oil Swap Agreement is based upon 400 barrels oil per day and establishes
settlement dates on the last day of each calendar month during the contract
period. It sets a floating price equal to Koch Oil Company's monthly average LLS
posting plus $1.50, and strike prices of $18.20 for put options and $19.97 for
call options. On any settlement date, if the floating price is less than the put
option strike price, then Koch must pay the Company the price difference,
multiplied by the determination quantity for the month. On any settlement date,
if the floating price exceeds the call option strike price, the Company must pay
Koch the difference, multiplied by the determination quantity for the month.
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 lender.
As a condition to consummating the Koch Agreement, 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.
In March 1997, Offshore entered into a participation agreement
("Mortimer Agreement") with Mortimer Exploration Company ("Mortimer") which
provided that Offshore assume a 38% participation in all costs associated with
certain exploration prospects that Mortimer identified and presented to Offshore
effective from January 1, 1997. The costs included overhead incurred by Mortimer
in developing prospects,
-40-
<PAGE>
as well as any seismic and lease acquisitions. In connection with the Mortimer
Agreement, Offshore committed to participate in drilling at least two wells, to
be identified within a prospect area from Beauregard Parish, Louisiana to
Montgomery County, Texas. A drillable prospect, as defined by the Mortimer
Agreement, was any single prospect in the prospect area where the drainage area
was sufficient to provide estimated reserves of at least 200,000 bbls oil
equivalent. The Company invested approximately $274,000 in leasehold, geologic
and seismic costs during the fiscal year ended January 31, 1998 in accordance
with the Mortimer Agreement ("Mortimer Project"). A drilling requirement for one
of the leaseholds obtained through a farmout required a March 1, 1998
commencement date by the working interest group or a $50,000 penalty would be
assessed if the commencement date was missed. Since the Company's working
capital was not adequate to fund its proportionate share of the drilling costs,
the Company's Board of Directors accepted an offer from Buschman to acquire the
Company's interest in the Mortimer Project in lieu of the Company being released
and held harmless from any and all liability related to the Mortimer Agreement.
The Company's investment in the Mortimer Project was expensed as leasehold
abandonment.
H. M. Shearin, Jr. and H. A. Abshier, Jr., non-employee Directors of
the Company, served as consultants to the Company for the year ended January 31,
1997 and were paid total Directors compensation and Consultant fees of $30,000
and $30,200, respectively.
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.
(b) Reports on Form 8-K
The Company filed a Form 8-K on February 19, 1998 which
described the Borrowing Base Notification letter received from
the Bank.
The Company filed a Form 8-K on March 25,1998 which described
a Letter Agreement between the Company and the Bank whereby
the Company agreed to reduce the Borrowing Base Deficiency by
April 3, 1998 or provide the Bank with additional collateral.
The Company filed a Form 8-K on June 9, 1998 which provided
the unaudited financial statements for the year ended January
31, 1998 and provided an update on the financial condition of
the Company.
The Company filed a Form 8-K on July 23, 1998 which provided a
Notice of Default and Acceleration from the Company's Senior
Credit Facility.
(c) No annual report or proxy material has been sent to the
stockholders as of the date of this Form 10-KSB.
-41-
<PAGE>
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: August 24, 1998
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 August 24, 1998
- ------------------------------ (Principal Executive)
ROBERT A. BUSCHMAN Officer and Director)
/s/ GUY R. BUSCHMAN President and Director August 24, 1998
- ------------------------------
GUY R. BUSCHMAN
/s/ GARY SCHEELE Vice President and August 24, 1998
- ------------------------------ Secretary/Treasurer
GARY SCHEELE (Principal Financial and
Accounting Officer)
/s/ H. M. SHEARIN, JR. Director August 24, 1998
- ------------------------------
H. M. SHEARIN, JR.
/s/ RALPH F. COX Director August 24, 1998
- ------------------------------
RALPH F. COX
/s/ HOBBY A. ABSHIER, JR. Director August 24, 1998
- ------------------------------
HOBBY A. ABSHIER, JR.
/s/ R. ALLAN ALLFORD Director August 24, 1998
- ------------------------------
R. ALLAN ALLFORD
/s/ DALE G. SCHLINSOG Director August 24, 1998
- ------------------------------
DALE G. SCHLINSOG
-42-
<PAGE>
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
(incorporated herein by reference from January 31, 1997 Form 10-KSB).
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).
E-2
<PAGE>
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).
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 (incorporated herein by
reference from Form 10-KSB from January 31, 1997).
10(p) Confirmation of Costless Collar Put/Call Option subject to Master
Commodity Swap Agreement between Koch Oil Company and Rio Grande, Inc.,
dated August 15, 1997 (incorporated herein by reference from July 31,
1997 Form 10-QSB).
10(q) Letter Agreement between Comerica Bank - Texas and Rio Grande, Inc. and
Rio Grande Drilling Company dated December 22, 1997 (incorporated
herein by reference from October 31, 1997 Form 10-QSB).
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-30).
99(a) Private Offering Memorandum of the Company dated August 27, 1995
(incorporated herein by reference from October 31, 1995 Form 10-QSB).
99(b) Comerica Bank - Texas letter dated February 18, 1998, regarding waiver
letter concerning non-compliance with working capital covenant for
month of November (incorporated herein by reference from March 25, 1998
Form 8-K).
99(c) Comerica Bank - Texas letter dated March 5, 1998, regarding Borrowing
Base Deficiency Deferral/Waiver Letter concerning non-compliance with
working capital covenant for month of December (incorporated herein by
reference from March 25, 1998 Form 8-K).
99(d) Thompson & Knight, attorneys for Comerica Bank - Texas, letter dated
July 8, 1998 regarding notice of default of Company to terms of the
Senior Credit Facility and notice that all outstanding indebtedness is
immediately due and payable (incorporated herein by reference from July
23, 1998 Form 8-K).
E-3
<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, 1998, and the related consolidated statements of
operations, stockholders' equity (deficit), and cash flows for the years ended
January 31, 1998 and 1997. 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, 1998, and the results of their operations and
their cash flows for the years ended January 31, 1998 and 1997, in conformity
with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 5 to the
financial statements, the Company has suffered recurring losses from operations
and has net capital deficiencies. During 1998, the Company's primary lender
indicated it will undertake proceedings to obtain collection for bank loans. At
January 31, 1998, these circumstances raise substantial doubt about the entity's
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 5. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
KPMG PEAT MARWICK LLP
August 11, 1998
San Antonio, Texas
F-1
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Consolidated Balance Sheet
January 31, 1998
Assets
Current assets:
Cash and cash equivalents $ 340,133
Trade receivables 836,843
Prepaid expenses 16,854
------------
Total current assets 1,193,830
------------
Property and equipment, at cost:
Oil and gas properties, successful efforts method 26,760,906
Transportation equipment 183,011
Other depreciable assets 411,055
------------
27,354,972
Less accumulated depreciation, depletion and amortization (18,307,996)
------------
Net property and equipment 9,046,976
------------
Other assets:
Platform abandonment fund 363,618
Other assets, net 500,118
------------
863,736
------------
$ 11,104,542
============
Liabilities and Stockholders' Equity Current liabilities:
Accounts payable 1,012,444
Accrued expenses 226,119
Long-term debt, reclassified as current 13,251,871
------------
Total current liabilities 14,490,434
------------
Other accrued expenses 491,982
Minority interest in limited partnership 144,981
Redeemable preferred stock, $0.01 par value; $10
redemption value. Authorized 1,700,000 shares; issued
and outstanding 1,017,500 shares 10,668,199
Common stock of $0.01 par value. Authorized
10,000,000 shares; issued and outstanding
6,177,471 shares 61,774
Additional paid-in capital 292,327
Deficit (15,045,155)
-----------
Total stockholders' equity (deficit) (14,691,054)
-----------
$ 11,104,542
============
See accompanying notes to consolidated financial statements.
F-2
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Year Ended January 31,
1998 1997
---- ----
Revenues:
Oil and gas sales $ 7,144,241 5,337,593
------------ --------------
Costs and expenses:
Lease operating and other production expense 3,449,429 2,394,318
Dry hole costs and lease abandonments 294,265 821,982
Depletion of oil and gas producing properties,
including provision for impairments 15,339,295 1,637,634
Depreciation and other amortization 229,872 305,414
Provisions for abandonment expense -- 140,800
General and administrative 1,614,783 1,297,010
------------ --------------
Total costs and expenses 20,927,644 6,597,158
------------ --------------
Loss from operations (13,783,403) (1,259,565)
------------- --------------
Other income (expense):
Interest expense (1,139,232) (695,580)
Interest income 84,769 78,415
Gain on sale of assets, net 708,257 315,884
Other, net 18,058 --
Minority interest in earnings of limited
partnership (12,798) (94,034)
------------ -------------
Total other income (expense) (340,946) (395,315)
------------ -------------
Loss before income taxes (14,124,349) (1,654,880)
Income taxes 4,351 260
------------ -------------
Net loss (14,128,700) (1,655,140)
Dividends on preferred stock 855,700 32,877
------------ -------------
Net loss applicable to common stock $(14,984,400) (1,688,017)
============= =============
Loss per share,
Basic and diluted $ (2.54) (0.30)
============= =============
Common shares outstanding,
Basic and diluted 5,890,767 5,552,760
============= =============
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Total
Additional Retained stockholders'
Common paid-in earnings equity
stock capital (deficit) (deficit)
------ ---------- --------- -----------
Balance 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
Net loss -- -- (14,128,700) (14,128,700)
Cash dividends on preferred
stock -- (187,500) -- (187,500)
Dividends on Series B Preferred
Stock - accretion of Series C
Preferred Stock -- (68,949) -- (68,949)
Accrued dividends on Preferred
Stock - Series A -- (562,500) -- (562,500)
- Series C -- (36,750) -- (36,750)
Proceeds from exercise of
common stock warrants 6,246 118,688 -- 124,934
------ ---------- --------- ----------
Balances at January 31, 1998 $ 61,774 292,327 (15,045,155) (14,691,054)
======= ========== =========== ===========
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Year Ended January 31,
---------------------
1998 1997
---- ----
(unaudited) (audited)
Cash flows from operating activities:
Loss from continuing operations $ (14,128,700) (1,655,140)
Adjustments to reconcile loss from continuing
operations to net cash provided by (used in)
operating activities:
Depreciation and other amortization 229,872 305,414
Depletion of oil and gas producing properties,
including provisions for impairments 15,339,295 1,637,634
Provision for abandonment expense - 140,800
Gain on sale of assets (708,257) (315,884)
Minority interest in earnings of
limited partnership 12,798 94,034
Decrease (increase) in trade receivables 971,820 (1,171,371)
Decrease (increase) in prepaid expenses 19,965 (23,264)
Increase (decrease) in accounts payable and
accrued expenses 36,464 498,686
Increase (decrease) in other accrued expenses (558,724) (129,452)
---------- -----------
Net cash used in continuing operating activities 1,214,533 (618,543)
---------- -----------
Cash flows from investing activities:
Purchase of oil and gas producing properties (4,408,131) (19,259,658)
Additions to other property and equipment (75,595) (49,859)
Net reductions in platform abandonment fund 638,345 33,607
Additions to (deletion from) other assets (22,863) (12,870)
Proceeds from sale of property and equipment 2,150,824 861,731
---------- -----------
Net cash used in investing activities (1,717,420) (18,427,049)
---------- -----------
Cash flows from financing activities:
Additions to other assets - (696,359)
Proceeds from long-term debt 1,152,619 19,436,045
Repayment of long-term debt (1,262,057) (9,758,950)
Proceeds from issuance of common stock 124,934 -
Proceeds from issuance of redeemable preferred
stock - 10,000,000
Preferred stock dividends (220,377) -
Contributions from limited partners 95,570 -
Distributions to limited partners (93,000) (134,081)
---------- -----------
Net cash provided by (used in) financing activities (202,311) 18,846,655
---------- -----------
Net decrease in cash and cash equivalents (705,198) (198,937)
Cash and cash equivalents at beginning of period 1,045,331 1,244,268
---------- -----------
Cash and cash equivalents at end of period $ 340,133 1,045,331
========== ===========
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
(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, 1998 and 1997
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.
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, 1998 and 1997
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. In accordance with 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," the Company recognized a non-cash pre-tax charges against
earnings of approximately $8,615,000 and $261,000 for the fiscal years
ended January 31, 1998 and 1997, respectively, related to its 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 SFAS 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 SFAS No. 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.
F-8
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
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
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
In February 1997, the Financial Accounting Standards Board
("FASB") 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
December 15, 1997, replaces the presentation of primary earnings per
share with a presentation of basic earnings per share. This standard
requires dual presentation of basic and diluted earnings per share on
the face of the statement of operations.
Basic net earnings (loss) per common share is computed by
dividing net loss by the weighted average number of common shares
outstanding. Diluted earnings (loss) per share is computed by assuming
the issuance of common shares for all dilutive potential common shares
outstanding.
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, reclassified as current. 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
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 ("APB") 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.
F-9
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
Recently Issued Accounting Pronouncement
In June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information" which establishes
standards for the way that public business enterprises report
information about operating segments in annual financial statements and
requires that those enterprises report selected information about
operating segments in interim financial reports issued to shareholders.
It also establishes standards for related disclosures about products
and services, geographic areas, and major customers. The Company
believes that SFAS No. 131 will not have a material impact on its
financial statements and disclosures.
In June 1998, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities", which established
standards of accounting and reporting for derivative instruments and
for hedging activities. It requires that all derivatives be recognized
as either assets and liabilities in the statement of financial position
and measures these instruments at fair value. This statement is
effective for financial statements for periods beginning June 15, 1999.
The Company believes that SFAS No. 133 will not have a material impact
on its financial statements and disclosures.
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
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.
Financial Statement Presentation
The accompanying consolidated financial statements have been
prepared assuming the Company will continue as a going concern.
(2) 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
F-10
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
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.
In August 1997, the Company, on behalf of Offshore, entered
into a commodity futures oil swap agreement ("Oil Swap Agreement") with
Koch Oil Company. That Oil Swap Agreement was made pursuant to an
existing Master Commodity Swap Agreement between the Company and Koch,
at no current cost to the Company, and is termed a "Costless Put/Call
Collar Option," covering the period between February 1, 1998 and
January 31, 1999. The Oil Swap Agreement is based upon 400 barrels oil
per day and establishes settlement dates on the last day of each
calendar month during the contract period. It sets a floating price
equal to Koch Oil Company's monthly average LLS posting plus $1.50, and
strike prices of $18.20 for put options and $19.97 for call options. On
any settlement date, if the floating price is less than the put option
strike price, then Koch must pay the Company the price difference,
multiplied by the determination quantity for the month. On any
settlement date, if the floating price exceeds the call option strike
price, the Company must pay Koch the difference, multiplied by the
determination quantity for the month.
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.
(3) Acquisition of Oil and Gas Properties
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 was 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 were recorded
as an adjustment to the acquisition price.
Drilling is the operator for the Righthand Creek wells.
(4) 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
proceeds of the working interest owners of certain properties to fund
the total estimated liability at the completion of the productive life
of the
F-11
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
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.
During the fiscal year ended January 31, 1998, Eugene Island Block
343's wells and platform were plugged and abandoned. GulfMex funded
approximately $64,000 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 $835,000 of which $492,000 has been accrued.
GulfMex's abandonment escrow account as of January 31, 1998 is
approximately $364,000.
(5) Long-Term Debt and Going Concern
Long-term debt consists of the following:
Senior indebtedness ("Senior Credit Facility") $13,178,002
Vehicle loans 73,869
------------
$13,251,871
============
Effective January 16, 1997, the Company and Drilling executed
the First Amendment to the Senior Credit Facility ("First Amendment")
with Comerica Bank - Texas (the "Bank") 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 was initially subject to monthly reductions of $333,000 beginning
April 1, 1997 to continue until the next determination of the Borrowing
Base on 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.
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
F-12
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
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 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 outstanding principal balance of the Senior Credit Facility was
approximately $13,178,000 at January 31, 1998.
The Company received a Borrowing Base Determination Notice in
January 1998 advising the Company that effective February 1, 1998, the
Company's Borrowing Base had been redetermined to be $6,500,000. The
balance of the Company's outstanding indebtedness with Comerica Bank -
Texas (the "Bank"), its senior lender, approximately $13,178,000,
exceeded the Borrowing Base by approximately $6,678,000 (the
"Deficiency"). Under the terms of the Senior Credit Facility, the Bank
gave notice to the Company to either provide the Bank with additional
collateral to increase the Borrowing Base, or reduce the outstanding
balance of the Company's indebtedness to an amount less than or equal
to the redetermined Borrowing Base.
The Company entered into a subsequent letter agreement with
the Bank in March 1998 which extended to the close of business on
Friday, April 3, 1998, the time by which the Company must eliminate the
Deficiency in the manner set forth above or reach other accommodation
with the Bank. For and in consideration of the extension to April 3,
1998, the Company agreed to execute certain supplemental documents
pertaining to collateral properties; pay an extension fee of $25,000 on
or before April 3, 1998; terminate its ability to utilize the
Eurodollar Rate Option under the Loan Agreement; increase the
applicable interest rate to prime rate plus three percent; execute a
letter waiving compliance with the working capital covenant for the
month of November 1997; pay the Bank specified legal and engineering
expenses and furnish the Bank with copies of any agreements related to
any proposed refinancing.
The Company has received from the Bank, a "Notice of Defaults
and Events of Default" whereby the Bank has declared the entire
outstanding principal balance of the Senior Credit Facility and all
interest accrued thereon to be immediately due and payable. In
addition, the Bank has advised that it intends to pursue all remedies
that are available in law and in equity, including but not limited to,
foreclosure proceedings in order to collect all amounts due.
The Bank has also submitted "Letters in Lieu of Transfer Order
and Division Order" to certain purchasers and marketing entities of the
Company's oil and gas products. The Letters in Lieu direct such
purchasers to make payments for the settlement of purchased products
directly to the Bank.
The Company is currently negotiating the sales of certain or
all of its oil and gas properties; however, any significant sale of oil
and gas properties outside of a bankruptcy proceeding requires
stockholder approval, which in turn requires the preparation of
circulation of a Proxy Statement or
F-13
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
Information Statement (the "Statement") and the passage of
approximately twenty days between the mailing of the Statement and the
ability to effectuate any such sale.
On August 11, 1998, the Company was notified that the Bank
initiated foreclosure proceedings with regard to the Company's Texas
properties by posting the properties for foreclosure. Under applicable
law, such foreclosure is scheduled to occur on September 1, 1998. The
Company is continuing its discussions with the Bank in an effort to
identify and conclude an alternative transaction which might address
and resolve in a mutually satisfactory manner the Company's default
under the Senior Credit Facility. However, while those discussions are
continuing, no agreement has been reached and no assurance can be given
that any agreement will be reached which would cause the Bank to
refrain from pursuing foreclosure on September 1, 1998. The Bank has
not advised the Company of its intentions with regard to other
properties owned by the Company and pledged to secure the Bank's
indebtedness. In addition to evaluating and pursuing alternative
transactions in an effort to address the Bank's requirements, the
Company continues to consider other alternatives, including, but not
limited to, non-traditional financing transactions and seeking
protection under the federal bankruptcy laws. No assurances can be
given that the Company can identify a transaction acceptable to the
Bank or that if any such transaction can be identified, that it can be
documented and concluded successfully or in a timely manner. Any of the
transactions or occurrences described above would likely result in
nominal or no value being afforded to the interests of existing holders
of the Company's common stock.
Interest expense paid during the years ended January 31, 1998
and 1997, was approximately $1,139,000 and $695,000, respectively. The
average interest rate for the years ended January 31, 1998 and 1997 was
approximately 8.2% and 9.8%, respectively.
(6) 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, 1998 and 1997 as a result of the operating losses incurred.
State income tax for the years ended January 31, 1998 and 1997 was
approximately $4,350 and $260, respectively.
F-14
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
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, 1998:
Description Amount Expiration Date
Federal net operating losses $26,356,000 1999 through 2013
State net operating losses 7,835,000 Various
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, 1998 and 1997 are as follows:
1998 1997
---- ----
Deferred tax liabilities:
Property, plant and equipment,
principally due to differences in
depreciation, depletion and
amortization $ - 474,000
------------ ----------
Deferred tax assets:
Property, plant and equipment,
principally due to difference in
depreciation, depletion and
amortization 2,478,000 -
Net operating loss carryforwards 10,368,000 6,597,000
General business credit
carryforwards - 54,000
Alternative minimum tax credit
carryforwards 15,000 15,000
Deferred abandonment costs and
other 140,000 140,000
------------- -----------
Total gross deferred tax assets 13,001,000 6,806,000
------------- -----------
Total net deferred tax assets 13,001,000 6,332,000
Less valuation allowance 13,001,000 (6,332,000)
------------- -----------
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
increased by approximately $6,669,000
F-15
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
in 1998 and decreased approximately $663,000 in 1997 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, 1998 and 1997.
(7) 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 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 of
$220,377 was paid May 1, 1997, and included pro-rata dividends from the
date of issuance on January 16, 1997 to May 1, 1997. The Company's
Board of Directors declared dividends be paid for the August 1, 1997
dividend payment date; however, due to the Company's inadequate working
capital, the dividend was not paid. Dividends on the Series A Preferred
Stock have not been declared for the November 1997 through May 1998
dividend payment dates. As of January 31, 1998, accrued dividends for
holders of Series A Preferred Stock is approximately $562,500 which has
been added to the redeemable preferred stock capital account.
F-16
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
In the event of any voluntary or involuntary liquidation,
dissolution or winding up of the Company, holders of Series A Preferred
Stock shall be entitled to be paid out of the assets of the Company
available for distribution to its stockholders up to an amount equal to
the aggregate face value of the then outstanding Series A Preferred
Stock plus accrued but unpaid dividends before any payment shall be
made to the holders of Series B and Series C Preferred Stock and the
common stockholders. 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.
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 per quarter, 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. Dividends on the Series C Preferred Stock are
payable in preference and priority to payment of dividends on the
Series B Preferred Stock.
On the first dividend payment date of May 1, 1997, 17,500
shares of Series C Preferred Stock were issued to Koch as dividend on
the Series B Preferred Stock. The Company's Board of Directors declared
a dividend on the Series B Preferred Stock for the August 1, 1997
dividend payment date; however, the 17,500 shares of Series C Preferred
Stock have not been issued to Koch. Dividends due on the Series B
Preferred Stock have not been declared for the dividend payment dates
of November 1997 through May 1998. The Series B Preferred Stock
dividends are payable in shares of Series C Preferred Stock which have
a liquidation value of $10 per share at maturity January 16,2002. The
liquidation value of each share of Series C Preferred Stock is
accreted, as accrued dividends, from the date of issue to maturity. The
accrued dividends attributable to such accretion value are
approximately $68,900 as of January 31, 1998, which have been added to
the redeemable preferred stock capital account.
F-17
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
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 granted an adjustment to the number of shares of common stock
issuable upon conversion. The initial conversion price per share
F-18
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
is $1.898. The initial number of fully diluted shares at January 16,
1997 was 10,974,895, which was 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.
The Company is currently in arrears on four consecutive
dividend payments on the Series A, Series B and Series C Preferred
Stock. As of August 7, 1998, Koch has not given notice to the Company
of their election to exercise rights to cast votes equivalent to 51% of
the current outstanding shares of common stock of the Company. As more
fully described below, Koch also has the right to convene a special
meeting of the stockholders at which Koch would have the right to elect
a majority of the number of directors constituting the Company's Board
of Directors. Koch to date has not invoked such rights.
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 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 of
Directors. 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 of
Directors. 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,
F-19
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
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 of Directors.
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. 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. On May 1, 1997, 17,500 shares of Series C Preferred Stock
were issued as dividends on the Series B Preferred Stock. The Company's
Board declared a dividend payment of $6,125 on the Series C Preferred
Stock effective August 1, 1997; however, due to the Company's
inadequate working capital, the cash dividend payment due on August 1,
1997 was not made. No subsequent dividends have been declared or paid
for the Series C Preferred Stock. As of January 31, 1998, accrued
dividends of $36,750 has been added to the redeemable preferred stock
capital account.
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.
F-20
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
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.
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
F-21
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
Company, or when the Company's 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.
(8) 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. SFAS No. 123 had no impact on the
Company's consolidated results of operations or financial condition.
Common Stock Options
As of January 31, 1998, options for a total of 270,000 shares
of common stock at exercise prices (not less than fair market value at
the time the options were issued) of $0.385 to $0.40 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, 1998, options for a total of 170,000
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, 1998. The re-election of the
non-employee nominees as directors of the Company at the Annual Meeting
will entitle each such nominee options to purchase 5,000 shares of the
Company Stock at an approximate price of $0.20, however the exact
option price will not be determined until after the Annual Meeting and
the selection of the new Compensation and Stock Option Committee.
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
exercise
F-22
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
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. During the fiscal year ended January 31, 1998,
624,672 warrants to purchase common stock were exercised at $0.20 per
share for total consideration of $124,934. A total of 763,488 warrants
remains outstanding at January 31, 1998.
(9) Related Party Transactions
One of the limited partners in GulfMex 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 limited
partnership agreement for GulfMex is substantially the same as the
existing Offshore limited 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 with 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
F-23
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
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
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.
In March 1997, Offshore entered into a participation agreement
("Mortimer Agreement") with Mortimer Exploration Company ("Mortimer")
which provided that Offshore assume a 38% participation in all costs
associated with certain exploration prospects that Mortimer identified
and presented to Offshore effective from January 1, 1997. The costs
included overhead incurred by Mortimer in developing prospects, as well
as any seismic and lease acquisitions. In connection with the Mortimer
Agreement, Offshore committed to participate in drilling at least two
wells, to be identified within a prospect area from Beauregard Parish,
Louisiana to Montgomery County, Texas. A drillable prospect, as defined
by the Mortimer Agreement, was any single prospect in the prospect
F-24
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
area where the drainage area was sufficient to provide estimated
reserves of at least 200,000 bbls oil equivalent. The Company invested
approximately $274,000 in leasehold, geologic and seismic costs during
the fiscal year ended January 31, 1998 in accordance with the Mortimer
Agreement ("Mortimer Project"). A drilling requirement for one of the
leaseholds obtained through a farmout required a March 1, 1998
commencement date by the working interest group or a $50,000 penalty
would be assessed if the commencement date was missed. Since the
Company's working capital was not adequate to fund its proportionate
share of the drilling costs, the Company's Board of Directors accepted
an offer from Buschman to acquire the Company's interest in the
Mortimer Project in lieu of the Company being released and held
harmless from any and all liability related to the Mortimer Agreement.
The Company's investment in the Mortimer Project was expensed as
leasehold abandonment.
(10) Major Customers and Other Information
The Company had two purchasers that accounted for $6,523,072
and $372,249 of production revenue for the year ended January 31, 1998
and accounted for 79% of the trade receivables balance at January 31,
1998.
Rental expense under an operating lease for office space,
which terminates July 31, 1998, was approximately $122,000 and
$115,000, for the years ended January 31, 1998 and 1997, respectively.
Future minimum rental payments are approximately $59,000 for
1999.
(11) 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, 1998 and 1997.
1998 1997
------------------- ------------------
Capitalized costs of proved
properties $ 26,760,906 24,976,467
Accumulated depreciation,
depletion and amortization (17,914,860) (3,768,705)
------------------- ----------------
Net capitalized costs 8,846,046 21,207,762
Less minority interest of
limited partner 128,837 63,366
------------------- ----------------
Net to Company $ 8,717,209 21,144,396
=================== ================
F-25
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
For the year ended January 31, 1998 and 1997, the following
costs were incurred:
1998 1997
------------------- ----------------
Producing properties $ 4,089,276 19,259,658
Exploratory properties 318,855 552,300
------------------- ----------------
Total $ 4,408,131 19,811,958
=================== ================
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, 1998 and 1997. All of the Company's oil and gas producing
properties are located in the United States.
1998 1997
---- ----
Oil and gas sales $ 7,144,241 5,337,593
Lease operating expenses (3,449,429) (2,394,318)
Dry hole costs and lease abandonments (294,265) (821,982)
Provision for abandonment - (140,800)
Depletion and impairment (15,339,295) (1,637,634)
----------------- ----------------
Pretax results of operations (11,938,748) 342,859
Income tax expense (benefit) 4,351 (260)
----------------- ----------------
Results of operations from oil and gas
producing activities (excluding corporate
overhead and interest costs) (11,943,099) 342,599
Less minority interest of limited partners 12,798 94,034
----------------- ----------------
Net to Company $ (11,955,897) 248,565
================= ================
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, 1998 and 1997. The reserve estimates have been prepared by
independent petroleum reserve engineers . Reserve estimates for
producing oil and gas properties are inherently imprecise. Even more
imprecise are reserve estimates for new discoveries.
F-26
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
Consolidated
------------------------------------------
Oil/Condensates Gas
--------------------- ----------------
(Bbls) (Mmcf)
Proved Reserves:
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
Acquisition 38,662 291
Production (230,444) (1,039)
Revisions of previous estimates (2,449,277) (4,486)
------------ -------------
Balance at January 31, 1998 1,544,118 4,982
============ =============
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 1998. 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 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.
F-27
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
January 31, January 31,
1998 1997
Consolidated Consolidated
-------------- ----------------
Future cash inflows $ 37,065,200 127,237,500
Future production costs (12,496,800) (22,575,900)
Future development costs (3,260,700) (8,286,100)
Future provision for abandonment in
excess of revenue deductions (146,500) (394,700)
--------------- ----------------
Future net cash flows before income tax
expense 21,161,200 95,980,800
Future income tax expense, after
consideration of the effect of net
operating loss carryforwards - (2,984,600)
--------------- ---------------
Future net cash flows 21,161,200 92,996,200
Future net cash flows 10% annual
discount to reflect timing of net cash
flows (6,565,800) (30,440,600)
--------------- ---------------
Standardized measure of discounted
future net cash flows relating to proved
reserves $ 14,595,400 62,555,600
=============== ===============
F-28
<PAGE>
RIO GRANDE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 31, 1998 and 1997
January 31, January 31,
1998 1997
Consolidated Consolidated
----------------- ----------------
Changes in discounted net cash flows:
Beginning of Year $ 62,555,600 9,226,100
--------------- ----------------
Increase (decrease):
Purchase of minerals in place - 35,455,900
Additions to proved reserves 2,523,200 -
Accretion of discount and other 14,367,200 2,700,700
Sales of oil and gas net of production
costs (3,694,800) (2,943,300)
Revisions of previous estimates
Changes in prices (27,800,400) 23,048,500
Changes in quantities (30,370,800) (7,463,800)
Changes in estimated income taxes (2,984,600) 2,531,500
--------------- ----------------
Net increase (decrease) (47,960,200) 53,329,500
--------------- ----------------
End of year $ 14,595,400 62,555,600
=============== ================
F-29
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
(This schedule contains summary financial information extracted from this
January 31, 1998 Form 10-KSB and is qualified in its entirety by reference
to such financial statements)
</LEGEND>
<CIK> 0000352964
<NAME> Gary Scheele
210-308-8000
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> Jan-31-1998
<PERIOD-END> Jan-31-1998
<CASH> 340133
<SECURITIES> 0
<RECEIVABLES> 836843
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1193830
<PP&E> 27354972
<DEPRECIATION> (18307996)
<TOTAL-ASSETS> 11104542
<CURRENT-LIABILITIES> 14490434
<BONDS> 0
10668199
0
<COMMON> 61774
<OTHER-SE> 292327
<TOTAL-LIABILITY-AND-EQUITY> 11104542
<SALES> 7144241
<TOTAL-REVENUES> 7144241
<CGS> 19312861
<TOTAL-COSTS> 20927644
<OTHER-EXPENSES> 1614783
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1139232
<INCOME-PRETAX> (14124349)
<INCOME-TAX> 4351
<INCOME-CONTINUING> (14128700)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (14128700)
<EPS-PRIMARY> (2.54)
<EPS-DILUTED> (2.54)
</TABLE>
