<PAGE>
FORM 10-Q/A
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
1-8979
(Commission File Number)
HONDO OIL & GAS COMPANY
(Exact name of registrant as specified in its charter)
Delaware 95-1998768
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
10375 Richmond Ave, Ste. 900, Houston, Texas 77042
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (713) 954-4600
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
--- ---
The registrant has one class of common stock outstanding. As of March 20,
1998, 13,798,424 shares of registrant's $1 par value common stock were
outstanding.
1
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL DISCUSSION
Introduction
------------
Hondo Oil & Gas Company is an independent oil and gas company focusing
on international oil and gas exploration and development. The Company's
principal asset is its interest in the Opon Association Contract (the
"Opon Contract"), an exploration concession for an area in the Middle
Magdalena Valley of Colombia, South America. Significant reserves of
natural gas and condensate were shown to exist in the Opon Contract area
by two discovery wells drilled during 1994 and 1995. In accordance with
the terms of the Opon Contract, Empresa Colombiana de Petroleos
("Ecopetrol") declared a portion of the area commercial in May 1996. A
pipeline and related wellsite facilities to deliver natural gas and
condensate to a market are complete, and production began in December
1997. Deliveries of natural gas to a power plant located at the Opon
Contract area also began in December 1997. During 1997, the Opon No. 6
well encountered mechanical problems during completion operations and
was temporarily suspended to evaluate information and develop plans for
further operations on the well, including workover of the well.* The
associate parties have recently decided to commence production of the
Opon No. 6 well without performing further work. Drilling of the Opon
No. 14 well began in October 1997 and has been completed. If no
problems are encountered, the Opon No. 14 well should be tested in the
Spring of 1998.* The Company will require additional financing to
continue development of the Opon project.
Opon Exploration
----------------
Hondo Magdalena Oil & Gas Limited ("Hondo Magdalena"), a wholly-owned
subsidiary, became involved in the Opon Contract through a farmout
agreement with Opon Development Company ("ODC") in 1991. In August
1993, Hondo Magdalena and ODC entered into a Farmout Agreement under
which Amoco Colombia Petroleum Company ("Amoco Colombia") earned a 60%
participating interest in the Opon Contract. To earn the interest,
Amoco Colombia paid $3.0 million in cash in 1993 and paid all of the
costs related to drilling the Opon No. 3 well in 1994. In addition,
Amoco Colombia paid Hondo Magdalena $5.0 million in October 1994 and
paid all but $2.0 million of Hondo Magdalena's costs for drilling the
Opon No. 4 well in 1995.
The Opon No. 3 well, completed in September 1994, was drilled to a depth
of 12,710 feet at a total cost of approximately $30.0 million. The well
tested at a daily rate of 45 million cubic feet of natural gas and 2,000
barrels of condensate. Downhole restrictions prevented the well from
testing at higher rates. The Opon No. 4 well, completed in September
1995, was drilled to a depth of 11,500 feet at a total cost of
approximately $28.5 million. The well tested at a daily rate of 58
million cubic feet of natural gas and 1,900 barrels of condensate.
These two wells have confirmed the existence of a significant natural
gas field and will supply gas for the contracts described below.
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
2
Presently, Amoco Colombia, Hondo Magdalena and ODC have interests in the
Opon Contract (outside the commercial area described below) of
approximately 60%, 30.9% and 9.1%, respectively. As provided in the
Opon Contract, upon the designation of an area or field as commercial,
Ecopetrol acquires a 50% interest in such area or field and will
reimburse the associate parties for 50% of the direct exploration costs
for each commercial discovery from its share of production. In May
1996, Ecopetrol approved a commercial field of approximately 2,500 acres
around the Opon No. 3 and No. 4 wells. The interests in the commercial
field are approximately 50%, 30%, 15.4%, and 4.6% for Ecopetrol, Amoco
Colombia, Hondo Magdalena, and ODC, respectively. The commercial field
is substantially smaller than that requested, but may be enlarged by
future drilling and/or additional technical information.* The associate
parties submitted an application to declare the area around the Opon No.
6 well commercial in August 1997. Ecopetrol responded in September 1997
that it considered the information presented to be insufficient to
evaluate the application for the extension of the commercial area. The
associate parties are evaluating Ecopetrol's response in light of the
terms of the Opon Contract and have approached Ecopetrol for
clarification of its response. At this date, the area around the Opon
No. 6 well is not a part of the commercial area. Ecopetrol will not pay
for its share of expenditures to enlarge the commercial field until the
new areas are proven and declared commercial. Ecopetrol will
participate in further development costs of the existing commercial
field.
The Opon Contract provides that the Opon Contract area will be reduced
after the end of the exploration period, or September 30, 1995. The
first acreage relinquishment of 50% was completed during 1996. The Opon
Contract area now covers 25,021.5 hectares (61,827 acres). The second
acreage relinquishment was due on September 30, 1997. By agreement with
Ecopetrol, the second relinquishment has been postponed until September
30, 1998. As consideration, the associate parties agreed to perform,
for the full Opon Contract area, surface geological studies and
petrochemical analysis, and to undertake a study to determine the
economic and technical viability of putting the shallow oil producing
wells in the Opon Contract area into production. On September 30, 1999,
the Opon Contract area will be reduced to the area of the commercial
field that is in production or development, plus a reserve zone of five
kilometers in width around the productive limit of such field. The
commercial field plus the zone surrounding such field will become the
area of exploitation. The associate parties designate the acreage to be
released. Additional wells will be required to enlarge the commercial
area and to increase the size of the area of exploitation.*
The Opon No. 6 well commenced drilling in October 1996. This well is
slightly more than 1 kilometer north of the Opon No. 3 well and is
outside the current commercial area. The well is presently estimated to
cost $30.6 million, of which Hondo Magdalena's share is 30.9%.* After
the drilling was completed, several mechanical problems in the
completion and testing of the Opon No. 6 well occurred. After there was
a failure of a portion of the guns during the initial completion attempt
in April 1997, a second set of perforating guns were fired. Cleanup and
testing on the second set of perforations commenced in May 1997 and,
while all the guns fired, the well has not flowed as anticipated. The
associate parties recently decided to connect the well in its present
condition and commence production in hopes debris from past mechanical
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
3
problems will be evacuated. Further workover alternatives will be
evaluated after a production history has been accumulated.*
The associate parties are attempting to negotiate a settlement of claims
against suppliers of services and equipment related to the problems
encountered during completion operations on the Opon No. 6 well, but no
settlement has been reached. The claims relate to the failure of
perforating guns, problems with the installation of the production
tubing and failure of a downhole safety valve provided by Colombian
branches of U.S. and multinational oil service companies. The claims
are based upon contract and purchase order terms providing for
warranties, adequate supervision of assembly of components and other
work, equipment to be in good working order, and work to be performed in
a workmanlike manner. The disputed charges aggregate approximately $1.5
million (net to the Company's interest in the costs of the well).
Consequential losses, depending on how measured, make the claims larger.
If a settlement is not reached, the next step will be either non-binding
mediation or arbitration.* No prediction of the outcome of these
matters can be made at this time.
The Opon No. 14 well, approximately 4 kilometers south of the Opon No. 4
well, commenced drilling in October 1997. The total cost of the well is
estimated to be $23.5 million, of which Hondo Magdalena will bear
30.9%.* The well was planned and intended to confirm the existence of
the La Paz gas and condensate reservoir in the south of the Opon
Contract area.* The well has been drilled to a depth of 12,200 feet.
The associate parties have commenced testing of both the La Paz
formation and the deeper Lisama formation. The associate parties will
review and analyze the results of the Opon No. 14 well prior to making
any decisions about further drilling.*
In July 1995, Hondo Magdalena, ODC, Amoco Colombia and Ecopetrol agreed
to construct a pipeline and wellhead facilities (which were not
contemplated in the Opon Contract). The parties constructed a 16 inch
pipeline approximately 88 kilometers in length from the Opon Contract
area north to Ecopetrol's gas processing plant at El Centro, and from
there to Ecopetrol's refinery at Barrancabermeja. The investment in the
pipeline is to be recovered through a pipeline tariff, but see the
discussion in the next paragraph concerning the action of the
governmental agency on the associate parties' tariff application.*
Ecopetrol has constructed improvements at its El Centro gas processing
plant to handle incremental production from the Opon Contract area.
Ecopetrol will recover its investment through a gas processing fee.
The Comision de Regulacion de Energia y Gas (Commission for the
Regulation of Energy and Gas, "CREG"), an agency of the Ministry of
Mines and Energy of the Colombian government, regulates natural gas
pipelines and the sale of natural gas in Colombia. CREG's regulations
provide the ceiling price for natural gas and the methodology for
establishing pipeline tariffs. Based upon these regulations, Amoco
Colombia, as operator, applied for a pipeline tariff of 60.4 cents per
thousand cubic feet of gas; CREG has responded by rejecting the proposed
tariff, instead approving a tariff of 25.0 cents per thousand cubic feet
of gas. Amoco Colombia has appealed this decision. In the interim, the
associate parties can charge a provisional tariff for shipments to
Ecopetrol, but are precluded from making shipments to buyers on the
national gas grid.
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
4
Contracts, covering the sale of natural gas, the sale of condensate and
natural gas liquids, the processing of the gas stream, and
transportation of natural gas and liquids are complete and have been
signed by all parties. The contracts provide for: (i) the sale of 100
million cubic feet of natural gas per day for the life of the Opon
Contract at the regulated price determined semi-annually by a formula
based upon the average price received by Ecopetrol for exported fuel oil
during the prior two six-month periods (currently US$1.15 per million
British Thermal Units); (ii) the sale of condensate and natural gas
liquids at market-related and market-indexed prices; and (iii) the
processing of the gas stream at Ecopetrol's El Centro gas processing
plant for a fee of $0.159 per thousand cubic feet of gas. Ecopetrol, as
purchaser, pays the pipeline tariff for the natural gas sold by the
associate parties.
In March 1997, Hondo Magdalena, ODC, Amoco Colombia and Ecopetrol, as
sellers, signed a contract with Termo Santander de Colombia E.S.P., as
purchaser ("Termo Santander"), to supply, subject to the conditions
noted below, natural gas to its electric generation plant at the Opon
Contract area. Under the contract, the sellers will supply natural gas
requested by the purchaser up to 60 million cubic feet per day. The
sellers will receive $4.2 million per year for making the gas available
for purchaser's call. Purchaser will pay 60% of the government-
regulated price (described above) for the natural gas it takes. The
sellers will also receive additional bonus payments if the power plant
achieves a price for its electrical power in excess of certain target
rates. Condensate associated with the natural gas that is delivered to
the purchaser will be separately sold to Ecopetrol. The contract
provides for substantial penalties, decreasing over the life of the
contract, to the sellers for the failure to deliver gas. The
commencement of the contract is conditioned upon a determination by the
sellers that there are sufficient reserves to supply natural gas to the
purchaser for the entire term of the agreement. In order to begin
deliveries before the condition concerning the sufficiency of reserves
is satisfied, an interim agreement for the sale of gas to Termo
Santander was signed on November 20, 1997. The interim agreement will
be effective until January 1, 1999, or until sufficient reserves are
determined through additional work on the Opon No. 6 well or the
successful completion of the Opon No. 14 well.* The gas sales price
under the interim agreement will be equivalent to the price, including
pipeline tariff, that would have been received if the same gas were sold
under the contract with Ecopetrol described in the preceding paragraph.
The pipeline and wellsite facilities were completed in June 1997.
Ecopetrol completed the improvements to the El Centro gas processing
plant in November 1997. Production from the Opon field began on
December 1, 1997, with gas supplied to Termo Santander for testing the
first of two turbines at the power plant. The first shipment of gas
through the pipeline occurred on December 5, 1997.
The associate parties have submitted invoices to Ecopetrol under the gas
sales agreement for payments under the take-or-pay clause, which
provides that Ecopetrol will pay 200% of the gas price for the Company's
share of 100 million cubic feet per day if the gas pipeline is completed
and ready and the El Centro gas plant improvements have not been
completed. The associate parties believe the pipeline was complete on
June 25, 1997, and submitted invoices accordingly. Ecopetrol has
indicated that it will not pay these invoices. The Company has not
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
5
accrued its $5.2 million invoice in its financial statements. The
associate parties are reviewing their legal options to pursue the
collection of these invoices, which could include negotiation of a
settlement and arbitration in a Colombian forum.*
Amoco Colombia has submitted budgets to Hondo Magdalena and ODC for
calendar years 1996, 1997 and 1998. Hondo Magdalena approved capital
expenditures for wells and the pipeline projects, and certain other
expenditures, but did not approve the proposed overhead. As of this
date, no final budget has been approved for calendar years 1996, 1997 or
1998. The parties are currently at an impasse in resolving the dispute
about overhead. Hondo Magdalena has paid invoices from Amoco Colombia,
including disputed overhead and has charged the full overhead amount to
expense. It is management's opinion that the Company is not obligated
to pay for overhead unless charged pursuant to an approved budget;
however the Company has paid Amoco Colombia's invoices, under protest
and subject to audit, in the hope of resolving the dispute. If the
dispute cannot be resolved, the joint operating agreement among Amoco
Colombia, Hondo Magdalena and ODC provides for arbitration of disputes.
Hondo Magdalena, on behalf of itself and ODC, has conducted audits of
the joint account with Amoco Colombia for 1994, 1995, and 1996. Attempts
to resolve the audit exceptions for 1994 and 1995 have been ineffective.
In March 1998, the Company submitted audit exceptions of $1.9 million
(gross charges to the joint account) to arbitration. The report for the
1996 audit was submitted to Amoco Colombia in March 1998. The Company
has not accrued in its financial statements any potential recoveries
which may arise from these audits.
Discontinued Operations
-----------------------
Two of the Company's former business segments, refining and marketing
operations and real estate operations were discontinued in 1991. No
change in the status of these discontinued operations from that reported
in the Company's 1997 Annual Report on Form 10-K occurred during the
current period.
RESULTS OF OPERATIONS
Results of continuing operations for the quarter ended December 31, 1997
amounted to a net loss of $3.2 million, or 23 cents per share. The
Company reported a net loss from continuing operations of $2.4 million,
or 18 cents per share, for the quarter ended December 31, 1996. No
losses from discontinued operations were reported for either period.
In the current period, the Company reported operating revenue for the
first time since 1993. The Company's Colombian operations began
delivering gas to Ecopetrol in December 1997. Due to a number of
startup operations, the revenue was considerably lower, and operating
expenses in relation to that revenue, were higher, than will be expected
in the future.
The level of the Company's debts to Lonrho Plc and to Amoco Colombia
under the Funding Agreement have increased by approximately $30.0
million between December 31, 1996 and December 31, 1997. Interest
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
6
expense increased by only $0.5 million between the quarters because the
majority of the charges from the Funding Agreement are capitalized.
LIQUIDITY AND CAPITAL RESOURCES
During the quarter ended December 31, 1997, cash inflows of $3.1 million
arose from borrowings from Lonrho Plc. The Company utilized cash of
$1.5 million and $0.1 million to finance continuing and discontinued
operations, respectively, $2.2 million for capital expenditures, and
made scheduled debt repayments of $0.3 million. At December 31, 1997,
the Company had cash balances of $0.1 million.
The Company has had an obligation to Phillips Petroleum arising from a
1992 decision to plug and abandon certain California offshore wells in
which the Company owns a working interest. In December 1997, the
Company entered into an agreement to settle the $1.1 million obligation
(included in accounts payable on the balance sheet) by issuing 178,848
shares of common stock valued at a price of $6.91 per share (the average
closing price for the ten days prior to filing of the registration
statement). In addition, the agreement granted a warrant to purchase
29,808 additional shares from the Company at a price of $1.00 per share
if the price of the Company's common stock is below $5.415 per share for
20 consecutive business days. A registration statement on Form S-3 was
filed on January 7, 1998, but is not effective and closing will not
occur, nor will the shares and warrants be issued, until the
registration statement has become effective. Phillips has the right to
terminate the agreement if the registration statement has not been
declared effective before March 31, 1998.
In December 1993, the Company restructured the terms of its debts to
Lonrho Plc. The revised terms included reduction of interest rates to a
fixed rate of 6% and provisions allowing the Company to offer payment of
future interest in shares of its common stock, and allowing Lonrho Plc
to either accept such payment in kind or add the amount of the interest
due to principal. The ability to pay interest in kind or capitalize
interest allows the Company to service its debt while cash resources are
scarce.
The Company obtained a facility loan of $13.5 million in a Revolving
Credit Agreement dated as of June 28, 1996, between the Company and
Thamesedge, Ltd., a subsidiary of Lonrho Plc. Under a December 1996
letter agreement, as consideration for extension of maturities and
certain other financial undertakings, the Company granted to Lonrho a
security interest in all of the shares of Hondo Magdalena.
In July 1997, the Company and Thamesedge, Ltd. agreed to amend and
restate the June 1996 Revolving Credit Agreement. Under the Amended and
Restated Revolving Credit Agreement dated as of July 2, 1997, Thamesedge
agreed to make additional advances of $7.0 million to the Company,
making the total amount of the loan $20.5 million. The interest rate
remains 13%, due semi-annually; as provided in other debts to Thamesedge
and described above, the Company may make interest payments in shares of
its common stock. The loan now matures January 1, 1999. As additional
consideration for the loan, the Company agreed to give Lonrho an option
to convert $7.0 million of existing debt with an interest rate of 6%
into the Company's shares at $7.70 per share (110% of the closing price
on July 1, 1997). The option to convert was approved by the Company's
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
7
shareholders at its annual meeting in March 1998. As of December 31,
1997, $17.7 million of this facility has been drawn.
In August 1997, Thamesedge Ltd. assigned all of its interest in the
Company's indebtedness to London Australian & General Property Company
Limited ("LAGP"), a subsidiary of Lonrho Plc. In December 1997, the
Company restructured the terms of certain debt to LAGP, and obtained an
additional funding commitment of $7.0 million for fiscal 1998. Also in
December 1997, Lonrho Plc committed to provide $3.2 million to the
Company for payment of a contingent liability arising from the 1993 sale
of the Company's Fletcher refinery, should the contingency become
payable. The Company extended all of the above described indebtedness
due on January 1, 1998 to January 15, 1999 and amended the notes by
adding a cross-default provision and a new event of default. The new
event of default requires the Company to furnish to LAGP by October 1,
1998 a reserve report that shows a minimum of 13 billion cubic feet of
gas increase over the 1997 proved reserve figure. In the event of a
default under this new provision, LAGP has the right to declare all the
loans in default and demand payment. Based on advice of the Company's
engineering consultants given at the time the loan amendments were
executed, management believes the results of drilling the Opon No. 14
well will be sufficient to meet this requirement.* However, please
refer to Risks of Oil and Gas Exploration in the Cautionary Statements
below. The new $7.0 million commitment from Lonrho Plc for fiscal 1998
will be added to the July 1997 Amended and Restated Revolving Credit
Agreement under the same terms and conditions as the existing agreement
explained above and is currently being drafted and negotiated with
execution anticipated in March 1998.* The Company presently owes Lonrho
Plc $106.5 million, of which $99.8 million is due January 15, 1999.
In May 1995, Hondo Magdalena, ODC and Amoco Colombia entered into a
Funding Agreement for Tier I Development Project costs (the "Funding
Agreement") to finance costs associated with the construction of a
pipeline from the Opon Contract area, certain wellsite facilities, a
geological and geophysical work program, and for related overheads.
The Funding Agreement provides that Hondo Magdalena may repay the
amounts financed up to 365 days after the date of first production and
sales, along with an equity premium computed on a 22% annualized
interest rate. The equity premium is computed monthly on Hondo
Magdalena's share of expenditures (including any amounts to be later
recouped from Ecopetrol after commerciality). Alternatively, from the
date of first production and sales until 90 days thereafter, Hondo
Magdalena may elect to repay 125% of its share (excluding any amounts to
be later recouped from Ecopetrol after commerciality) of the total costs
accumulated up to the date of repayment. If the financed amounts are
not repaid within 365 days after the date of first production and sales,
an additional penalty of 100% of the amount then due would be recovered
out of Hondo Magdalena's revenues. Hondo Magdalena's revenues from
production of the first 80 million cubic feet of natural gas per day and
corresponding condensate and natural gas liquids are pledged to secure
its obligations under the Funding Agreement. The associate parties have
agreed that the date of first production is January 13, 1998. The
Company does not presently have commitments or funds to repay the
Funding Agreement within either the 90 or 365 day option periods.* If
the Company does not secure financing to repay the Funding Agreement
prior to 365 days after the date of first production and sales, it will
incur the 100% penalty and will pay the increased amount out of
production, as described above.*
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
8
Based upon the Company's budget and current information, management
believes existing cash, available facilities, Lonrho commitments, net
proceeds from the sale of Opon gas (from production greater than the
pledged first 80 million cubic feet of natural gas per day and
associated liquids) and the Funding Agreement will be sufficient to
finance the Company's known obligations (the pipeline and related
facilities, estimated completion expenses of the Opon No. 6 well,
estimated drilling and completion expenses of the Opon No. 14 well,
overhead obligations unrelated to capital projects and other business
activities), estimated to be $16.8 million, during fiscal 1998.*
However, management believes the Company will need additional cash to
participate in the drilling of additional wells in Colombia and/or to
participate in other capital projects, that are not now budgeted or
committed.* If the Company becomes obligated for the drilling of an
additional well, the Company has the option to not participate in the
drilling of wells under the sole risk provisions of the joint operating
agreement among Amoco Colombia, Hondo Magdalena and ODC. These
provisions provide for penalties of 200% to 1000% (depending on the
nature of the well) of the costs attributable to the Company. These sole
risk provisions do not apply to other capital projects if the projects
are approved in accordance with the operating agreement. In
management's view, use of this sole risk election would be a last resort
to preserve the Company's existing interest in the Opon Contract area
because of the substantial penalties that would be incurred by not
participating.
Cash flow from operations which commenced in December 1997 is not
expected to be a significant source of free funds since pursuant to the
Funding Agreement, Amoco receives the proceeds from the first 80 million
cubic feet of gas per day and associated liquids.* Any additional free
cash flow (as defined in the Company's loan agreements with Lonrho Plc)
is committed to existing loan obligations. Management is reviewing
several options for raising funds including sale of the Company's 15.4%
interest in the pipeline.* Any proceeds realized from a sale of the
pipeline must be applied first to repayment of the Funding Agreement.
Management continues to pursue discussions with a number of financial
institutions regarding debt or equity financing of the Company's future
obligations for the Opon project but has received no commitments.*
Additional deliverability from current drilling projects and adequate
production capability through the pipeline infrastructure are important
factors in obtaining third party financing.* In the interim, the
Company must continue to rely on the financial support of Lonrho.*
Recently, in its annual report, Lonrho stated that it intends to sell
its investment in the Company. The Company has relied upon Lonrho to
provide funds for capital investment and operations when such funds have
not been available from third parties. If and when Lonrho sells its
investment in the Company, the Company will need to find another source
of financing, from outside sources or a new controlling shareholder.
The Company cannot predict the effect that a sale of Lonrho's interest
to a third party will have on the Company's ability to secure financing.
While the Company will continue to seek permanent financing in the near-
term, there can be no assurance that the Opon Project will be
successfully developed or that additional debt or equity funds will
become available.* Furthermore, the success of the Opon No. 14 well is
critical to obtaining third party financing (either debt or equity) and
for the decision by the associate parties to continue the development of
the Opon project.*
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
9
Cautionary Statements
---------------------
The Company believes that this report contains certain forward-looking
statements, as defined in the Private Securities Litigation Reform Act
of 1995, including, without limitation, statements containing the words
"believes," "anticipates," "estimates," "expects," "may" and words of
similar import, or statements of management's opinion. Such forward
looking statements involve known and unknown risks, uncertainties and
other factors which may cause the actual results, performance or
achievements of the Company to be materially different from any future
results, performance or achievements expressed or implied by such
forward-looking statements. Such factors include, among others, the
following:
Substantial Reliance On Single Investment. The Company's success
currently is dependent on its investment in the Opon project, a oil and
gas exploration concession in Colombia, South America. The Opon project
began producing natural gas and condensate in December 1997 and is the
Company's only source of operating revenue.
Ecopetrol's Inherent Conflict of Interest and Role. Ecopetrol is a
quasi-governmental corporate organization wholly-owned by the Colombian
government, a party to the Opon Contract and a purchaser of natural gas
and liquid hydrocarbons under contracts for the sale of production from
the Opon field. At present, the price of natural gas is set by law
enacted by the legislature of Colombia in 1983. The regulated price of
natural gas could be changed in the future by governmental action. The
participation of Ecopetrol, a government-owned company, in the Opon
project as a producer and as a purchaser, and the power of the
government of Colombia to set the price of natural gas creates an
inherent conflict of interest in Ecopetrol and the government.
Disputes with Ecopetrol, including a recent disagreement about the
obligation to make take-or-pay payments under a gas sales agreement,
must be resolved in non-judicial or judicial proceedings in Colombia.
These conflicts may affect the value of the Company's interest in the
Opon project.
Under the terms of the Opon Contract, an application for commerciality
must be submitted to, and approved by, Ecopetrol before production of
the wells in that area can begin. Ecopetrol cannot prevent the other
contract parties from producing discovered hydrocarbons by disapproving
the application, but Ecopetrol can delay the commencement of production
for up to one year by requiring additional work (which can cost no more
than $1.0 million).
Marketing Of Natural Gas. The Company must secure additional markets
and sales contracts for natural gas in Colombia in order to increase
production and cash flow from the Opon project. This will depend on the
continued development of gas markets and an infrastructure for the
delivery of natural gas in Colombia. Also, other producers of natural
gas in Colombia will compete for the natural gas market and for access
to limited pipeline transportation facilities.
10
Foreign Operations. The Company's operations in Colombia are subject to
political risks inherent in all foreign operations, including: (i) loss
of revenue, property, and equipment as a result of unforeseen events
such as expropriation, nationalization, war and insurrection, (ii) risks
of increases in taxes and governmental royalties, (iii) renegotiation of
contracts with governmental entities, as well as, (iv) changes in laws
and policies governing operations of foreign-based companies in
Colombia. Guerrilla activity in Colombia has disrupted the operation of
oil and gas projects, including those at the Opon Contract area.
Security in the area has been improved and the associate parties have
taken steps to enhance relations with the local population through a
community relations program. The government continues its efforts
through negotiation and legislation to reduce the problems and effects
of insurgent groups, including regulations containing sanctions such as
impairment or loss of contract rights on companies and contractors if
found to be giving aid to such groups.
Colombia is among several nations whose progress in stemming the
production and transit of illegal drugs is subject to annual
certification by the President of the United States. In February 1997,
the President of the United States announced that Colombia again would
neither be certified nor granted a national interest waiver. The
consequences of the failure to receive certification generally include
the following: all bilateral aid, except anti-narcotics and humanitarian
aid, has been or will be suspended; the Export-Import Bank of the United
States and the Overseas Private Investment Corporation will not approve
financing for new projects in Colombia; U. S. representatives at
multilateral lending institutions will be required to vote against all
loan requests from Colombia, although such votes will not constitute
vetoes; and the President of the United States and Congress retain the
right to apply future trade sanctions. Each of these consequences of
the failure to receive such certification could result in adverse
economic consequences in Colombia and could further heighten the
political and economic risks associated with the Company's operations in
Colombia.
Risks Of Oil And Gas Exploration. Inherent to the oil and gas industry
is the risk that future wells will not find hydrocarbons where
information from prior wells and engineering and geological data
indicate hydrocarbons should be found. Further, existing wells can
deplete faster than anticipated, potentially causing revisions to
reserve estimates and increasing costs due to replacement wells. Also,
because of the limited number of wells in the Opon Contract area (there
are presently two producing wells), the impact of the loss of a single
well would potentially affect the Company's production capability.
Operations in the Opon Contract area are subject to the operating risks
normally associated with exploration for, and production of oil and gas,
including blowouts, cratering, and fires, each of which could result in
damage to, or destruction of, the oil and gas wells, formations or
production facilities or properties. In addition, there are greater
than normal mechanical drilling risks at the Opon Contract area
associated with high pressures in the La Paz and other formations.
These pressures may: cause collapse of the well bore, impede the drill
string while drilling, or cause difficulty in completing a well with
casing and cement. These potential problems were substantially overcome
in the drilling of the Opon No. 3, No. 4, No. 6, and No. 14 wells by the
use of a top-drive drilling rig, heavy-weight and oil-based drilling
fluids and other technical drilling enhancements.
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Acreage Relinquishments. The terms of the Opon Contract include
provisions which require the associate parties to relinquish portions of
the concession acreage which have not been found to contain hydrocarbons
in commercial quantities. Management believes the relinquishments of
acreage to date have not deprived the associate parties of significant
undiscovered reserves. Ecopetrol has agreed to extend contractual
relinquishment requirements in light of current exploration activity on
more than one occasion. Nonetheless, there can be no assurances that
Ecopetrol will agree to additional extensions in the future, or that
other factors (including for example: lack of capital, rig availability
or political unrest) will prevent the parties from completing assessment
of unproved acreage before the acreage must be released.
Laws And Regulations. The Company may be adversely affected by new laws
or regulations in the United States or Colombia regarding its operations
and/or environmental compliance, or by existing laws and regulations.
The Colombian governmental agency responsible for setting pipeline
tariffs has set a tariff substantially lower than that requested by the
Company. This action will be appealed, but no prediction can be made
about the outcome and the final determination of the tariff. A
reduction of the tariff will impair the Company's ability to recover its
investment in the pipeline through tariff revenue and/or sale of the
pipeline. For additional information, see Other Factors Affecting the
Company's Business in Item 1, Business of the Company's 1997 Annual
Report on Form 10-K.
Highly Leveraged. As of December 31, 1997, the Company owed debts to
its principal shareholder, Lonrho Plc, of $106.5 million, of which $99.8
million is due January 15, 1999. The terms of this debt require the
Company to increase its September 30, 1997 proved reserves of 52.5
billion cubic of gas by 13.0 billion cubic feet of gas by October 1,
1998 to avoid an acceleration of the maturity of all of the debt to that
date. Acquisition of the additional reserves is dependent on the
results of drilling of the Opon No. 14 well and additional work to be
performed on the Opon No. 6 well, if any. As more fully described above
under Risks of Oil and Gas Exploration, there can be no assurances that
the additional work will discover the reserves necessary to prevent the
debts from being accelerated. The Company does not have the resources
to repay the indebtedness when it is due. Over the past five years,
Lonrho Plc has demonstrated a willingness to extend the repayment terms
of the Company's debts. However, there can be no assurances that Lonrho
Plc will continue to extend the maturity of the Company's debts in the
future. See Limited Capital and Change of Control and Financial Support
Shareholder, below.
Limited Capital. At December 31, 1997, the Company had a deficiency in
net assets of $96.4 million. The Company's principal asset, its
investment in the Opon project, will require additional capital for
further exploration works (additional exploratory wells and the related
surface facilities to put newly discovered hydrocarbons into production)
if the associate parties elect to proceed beyond the works currently in
progress. The Opon project commenced production in December 1997.
However, net revenue from the sale of the first 80 million cubic feet of
natural gas per day and associated condensate (estimated to be
approximately 60% to 80% of the Company's net revenue) is pledged to
repayment of amounts advanced by the operator under a Funding Agreement.
Cash from operations after Funding Agreement repayments will not be
sufficient to fund Colombian operating costs and capital expenditures,
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and U.S. overhead, during fiscal 1998. The Company has been unable to
secure financing from sources other than its principal shareholder.
Management believes successful completion of the Opon No. 14 well is
critical to obtaining third party financing. See Highly Leveraged,
above, and Change of Control and Financial Support Shareholder, below.
Change of Control and Financial Support of Shareholder. In a Schedule
13D amendment filed October 15, 1997 by Lonrho Plc and its affiliates,
the filing parties said that Lonrho Plc had retained Morgan Stanley &
Co. Incorporated to assess and implement strategic alternatives with
respect to Lonrho's direct and indirect investment in the Company.
Lonrho Plc said such strategic alternatives could include, without
limitation, a possible recapitalization of the Company or a sale or
business combination involving the Company or Lonrho's direct and
indirect equity interest in the Company (including the sale or
assumption of the debt obligations of the Company to affiliates of
Lonrho). Recently, in its annual report, Lonrho stated that it
intends to sell its investment in the Company. The Company has relied
upon Lonrho to provide funds for capital investment and operations when
such funds have not been available from third parties, and at December
31, 1997, was indebted to Lonrho in the amount of $106.5 million. If
and when Lonrho sells its investment in the Company, the Company will
need to find another source of financing, from outside sources or a new
controlling shareholder. The Company cannot predict the effect that a
sale of Lonrho's interest to a third party will have on the Company's
ability to secure financing. See Highly Leveraged and Limited Capital,
above.
Limited Revenues and Losses From Operations. The Opon Project commenced
production in December 1997. The Company reported its first operating
revenue of $0.1 million for the quarter ended December 31, 1997. This
is the only operating revenue the Company has had since it sold its
domestic operations in 1992. The Company experienced losses of
$12,388,000, $12,657,000 and $11,906,000 for the years ended September
30, 1997, 1996 and 1995, respectively. The Company anticipates
continued losses through fiscal 1998. See Results of Operations.
Continuation Of American Stock Exchange Listing. Because of continuing
losses and decreases in shareholders' equity, the Company does not fully
meet all of the guidelines of the American Stock Exchange for continued
listing of its shares. For additional information, see Item 5, Market
For Registrant's Equity and Related Shareholder Matters in the Company's
1997 Annual Report on Form 10-K. Management has kept the Exchange fully
informed regarding the Company's present status and future plans.
Although the Company does not or may not meet all of the guidelines, to
date, the American Stock Exchange has chosen to allow the Company's
shares to remain listed. However, no assurances can be given that the
Company's shares will remain listed on the Exchange in the future. If
the Company's shares are delisted from the Exchange, there may be
significantly reduced liquidity and a concomitant decrease in stock
price.
Given these uncertainties, prospective investors are cautioned not to
place undue reliance on such forward-looking statements. The Company
disclaims any obligation to update any such factors or to publicly
announce the result of any revisions to any of the forward-looking
statements contained herein to reflect future events or developments.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HONDO OIL & GAS COMPANY
(Registrant)
Date: March 23, 1998 /s/ Stanton J. Urquhart
----------------- -----------------------
Stanton J. Urquhart
Vice President and Controller
The above officer of the registrant has signed this report as its duly
authorized representative and as its chief accounting officer.
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