SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities and Exchange Act of 1934
Date of Report: (Date of earliest event reported): December 17, 1999
(December 2, 1999)
BLUE DOLPHIN ENERGY COMPANY
(Exact name of registrant as specified in its charter)
DELAWARE 0-15905 73-1268729
(State of Incorporation) (Commission File Number) (IRS Employer
Identification No.)
801 TRAVIS, SUITE 2100
HOUSTON, TEXAS 77002
(Address of Registrant's principal executive offices)
(713) 227-7660
(Registrant's telephone number, including area code)
(NOT APPLICABLE)
(Former name or former address, if changed since last report)
<PAGE>
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS
On December 2, 1999, Blue Dolphin Energy Company, a Delaware corporation
(the "Company"), through its wholly-owned subsidiary Blue Dolphin Exploration
Company, a Delaware corporation ("BDEX"), purchased 39,509,457 shares of common
stock, par value $0.00001 per share (the "Common Stock"), of American Resources
Offshore, Inc., a Delaware corporation ("ARO"), pursuant to an Investment
Agreement dated as of July 30, 1999 by and between BDEX and ARO (the "Investment
Agreement"). The purchase price for the shares of Common Stock was approximately
$4.5 million. The Company funded the purchase price through a private placement
of 1,016,667 shares of its common stock and the issuance of a Convertible
Promissory Note in the principal amount of $1,000,000. As a result of this
transaction, ARO will become a majority-owned subsidiary of the Company. The
Company intends to manage and operate ARO as an independent oil and gas
exploration, development and production company.
Concurrently with the closing of the Investment Agreement, ARO sold an 80%
interest in its Gulf of Mexico Assets to Fidelity Oil Holdings, Inc., a
subsidiary of MDU Resources Group, Inc. ARO's remaining assets consist of an
average 6% non-operated working interest in eight producing properties and one
proved undeveloped property along with leasehold interests in 34 additional
offshore tracts.
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS
(a) Financial Statements
The financial statements contained in American Resources
Offshore, Inc.'s Annual Report on Form 10-K for the year ended
December 31, 1998 filed with the Securities and Exchange
Commission (the "SEC") on April 16, 1999 and Quarterly Report
on Form 10-Q for the quarter ended September 30, 1999 filed
with the SEC on November 15, 1999 are incorporated herein by
reference.
(b) Pro Forma Information
At this time it is impracticable to file the required pro
forma financial information. The required pro forma
information will be filed by amendment hereto as soon as
possible, but not later than sixty (60) days from the date
hereof.
2
<PAGE>
(c) Exhibits
99.1 Investment Agreement, as amended, by and between
American Resources Offshore, Inc. and Blue Dolphin
Exploration Company.
99.2 The financial statements contained in American Resources
Offshore, Inc.'s Annual Report on Form 10-K for the year
ended December 31, 1998 filed with the Securities and
Exchange Commission (the "SEC") on April 16, 1999 and
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1999 filed with the SEC on November 15,
1999.
3
<PAGE>
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.
BLUE DOLPHIN ENERGY COMPANY
Date: December 17, 1999 By: /s/ G. BRIAN LLOYD
--------------------------
G. Brian Lloyd
Vice President, Treasurer
4
<PAGE>
INDEX TO EXHIBITS
EXHIBIT DESCRIPTION OF EXHIBIT
99.1 Investment Agreement, as amended, by and between
American Resources Offshore, Inc. and Blue Dolphin
Exploration Company (incorporated by reference
from the Company's Schedule 13D filed with the
Securities and Exchange Commission on October 22,
1999).
99.2 The financial statements contained in American
Resources Offshore, Inc.'s Annual Report on Form
10-K for the year ended December 31, 1998 filed
with the Securities and Exchange Commission
(the "SEC") on April 16, 1999 and Quarterly Report
on Form 10-Q for the quarter ended September 30,
1999 filed with the SEC on November 15, 1999.
5
EXHIBIT 99.2
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED
DECEMBER 31, 1998, 1997 AND 1996
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED
DECEMBER 31, 1998, 1997 AND 1996
TABLE OF CONTENTS
- -----------------
PAGE NO.
--------
Independent Auditors' Reports F-1
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-5
Consolidated Statements of Stockholders' Equity F-6
Consolidated Statements of Cash Flows F-9
Notes to Consolidated Financial Statements F-12
Oil and Gas Producing Activities (Unaudited) F-37
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
American Resources Offshore, Inc.
We have audited the accompanying consolidated balance sheet of American
Resources Offshore, Inc. and subsidiary as of December 31, 1998, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year ended December 31, 1998. 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 audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of American Resources Offshore,
Inc. and subsidiary as of December 31, 1998, and the results of their operations
and their cash flows for the year ended December 31, 1998 in conformity with
generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As more fully described in Note 20 to
the financial statements, the Company incurred a net loss of $46.2 million in
1998, and has a working capital deficiency of $89.7 million at December 31,
1998. In addition, the Company has not complied with certain covenants of its
debt agreements. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 20. The financial statements do not include
any adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
might result from the outcome of this uncertainty.
Ernst & Young LLP
New Orleans, LA
April 2, 1999
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
American Resources Offshore, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of American
Resources Offshore, Inc. (formerly American Resources of Delaware, Inc.) and
subsidiaries as of December 31, 1997, and the related consolidated statements of
operations, stockholders' equity, and cash flows for the years ended December
31, 1997 and 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of American Resources
Offshore, Inc. (formerly American Resources of Delaware, Inc.) and subsidiaries
as of December 31, 1997, and the results of their operations and their cash
flows for the years ended December 31, 1997 and 1996 in conformity with
generally accepted accounting principles.
KPMG LLP
Houston, TX
March 30, 1998
F-2
(Continued)
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1998 AND 1997
ASSETS
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Current assets:
Cash and cash equivalents .................. $ 255 $ 1,180
Accounts and notes receivable:
Trade .................................... 4,094 4,595
Notes .................................... 99 70
Related party ............................ 495 304
Allowance for doubtful accounts .......... (474) (5)
--------- ---------
4,214 4,964
Deferred tax asset ........................... 298 112
Prepaid expenses and other ................... 689 313
--------- ---------
Total current assets ..................... 5,456 6,569
--------- ---------
Oil and gas properties, at cost
(successful efforts method) ................ 98,161 57,173
Property and equipment, at cost .............. 14,645 12,353
--------- ---------
112,806 69,526
Less accumulated depreciation,
depletion and amortization ................. (44,253) (18,276)
--------- ---------
Net property and equipment ............... 68,553 51,250
Other assets ................................. 2,215 3,747
--------- ---------
Total assets ............................. $ 76,224 $ 61,566
========= =========
(Continued)
F-3
(Continued)
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET (CONTINUED)
DECEMBER 31, 1998 AND 1997
LIABILITIES AND STOCKHOLDERS' EQUITY
1998 1997
-------- --------
(DOLLARS IN THOUSANDS)
Current liabilities:
Current portions of long-term debt ............... 64,033 4,682
Debt in default .................................. 18,500 --
Note payable to related party .................... -- 225
Accounts payable - Trade ......................... 7,162 963
Unearned revenue ................................. 667 820
Accrued expenses and other ....................... 3,589 700
-------- --------
Total current liabilities ..................... 93,951 7,390
Long-term debt, excluding current portions ......... 706 25,393
Unearned revenue ................................... 2,971 2,095
Deferred tax liability ............................. 298 2,166
Stockholders' equity:
Series 1993 8% convertible preferred stock,
par value and liquidation preference $12.00
per share; 1,000,000 shares authorized ......... 1,871 2,182
Common stock, par value $.00001 per share;
50,000,000 shares authorized ................... -- --
Additional paid-in-capital ....................... 22,860 22,500
Retained earnings ................................ (45,720) 553
Treasury stock at cost, representing 201,890
shares of common stock in 1998 and 1997 ........ (713) (713)
-------- --------
Total stockholders' equity .................... (21,702) 24,522
-------- --------
Commitments and contingencies
Total liabilities and stockholders' equity .... $ 76,224 $ 61,566
======== ========
F-4
(Continued)
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
(DOLLARS IN THOUSANDS,
EXCEPT SHARE DATA)
<S> <C> <C> <C>
Operating Revenues:
Oil and gas production $ 26,724 $ 19,457 $ 8,540
Transportation 790 870 1,071
Marketing 7,751 17,499 22,713
Other 872 206 715
------------ ------------ ------------
36,137 38,032 33,039
---------- ---------- ----------
Operating Expenses:
Oil and gas production 4,967 2,584 1,402
Transportation 235 404 316
Marketing 7,910 17,418 22,270
Exploration costs 5,056 785 -
Depreciation, depletion and amortization 18,031 8,606 3,309
Impairment of assets 36,735 5,096 -
Administrative expenses 4,569 3,323 2,324
Other 107 138 206
-------------- ------------ --------------
77,610 38,354 29,827
------------ ---------- ------------
Operating income (loss) (41,473) (322) 3,212
------------ ----------- -------------
Other income (expense):
Interest income 101 46 802
Interest expense (7,437) (2,747) (2,440)
Gain (loss) on sale of assets 236 (22) (175)
Other 3 6 152
--------------- --------------- --------------
(7,097) (2,717) (1,661)
------------ ------------ ------------
Income (loss) before income tax expense (benefit) (48,570) (3,039) 1,551
Income tax expense (benefit) (2,346) (1,192) 639
------------ ------------ -------------
Net income (loss) $ (46,224) $ (1,847) $ 912
Preferred dividends (49) (48) (70)
--- --- ---
Net income (loss) attributable to common shares $ (46,273) $ (1,895) $ 842
============ =========== =============
Per common share:
Basic $ (4.61) $(0.21) $(0.14)
======== ====== =========
Weighted average number of common shares outstanding 10,029,415 9,021,810 6,123,635
========== ========= =========
Diluted $ (4.61) $ (0.21) $0.13
======== ====== =========
</TABLE>
F-5
(Continued)
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1998
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
8% PREFERRED STOCK COMMON STOCK
-------------------------------------- ----------------------- ----------
NUMBER DISCOUNT NUMBER ADDITIONAL
OF PAR ON OF PAR PAID-IN
SHARES VALUE PREFERRED SHARES VALUE CAPITAL
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1997 .................. 269 $ 3,226 $ (1,044) 10,193,676 $ 102 $ 22,500
CONVERSION OF PREFERRED STOCK TO COMMON STOCK
(38) (460) 149 38,335 -- 311
ISSUANCE OF COMMON STOCK DIVIDEND
-- -- -- 19,842 -- 49
NET INCOME .................................. -- -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1998 .................. 231 $ 2,766 $ (895) 10,251,853 $ 102 $ 22,860
========== ========== ========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
RETAINED TREASURY
EARNINGS STOCK TOTAL
---------- ---------- ----------
<S> <C> <C> <C>
BALANCE, DECEMBER 31, 1997 .................. $ 553 $ (713) $ 24,522
CONVERSION OF PREFERRED STOCK TO COMMON STOCK
-- -- --
ISSUANCE OF COMMON STOCK DIVIDEND
(49) -- --
NET INCOME .................................. (46,224) -- (46,224)
---------- ---------- ----------
BALANCE, DECEMBER 31, 1998 .................. $ (45,720) $ (713) $ 21,702
---------- ---------- ==========
</TABLE>
F-6
(Continued)
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1997
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
8% PREFERRED STOCK COMMON STOCK
------------------------------------ -----------------------
NUMBER DISCOUNT NUMBER
OF PAR ON NET OF PAR CONVERTIBLE
SHARES VALUE PREFERRED VALUE SHARES VALUE SECURITIES
---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996 268,851 $ 3,226 $ (1,044) $ 2,182 6,520,296 $ 65 $ 4,998
ISSUANCE OF COMMON STOCK
DIVIDEND ON 8% PREFERRED
STOCK .................... -- -- -- -- 21,508 0 --
CONVERSION OF WARRANTS TO
COMMON STOCK ............. -- -- -- -- 8 0 --
CONVERSION OF CONVERTIBLE
SECURITIES AND DIVIDEND TO
COMMON STOCK ............. -- -- -- -- 3,101,864 31 (4,520)
REDEMPTION OF CONVERTIBLE
SECURITIES ............... -- -- -- -- -- -- (478)
COMMON STOCK ISSUED,
NET OF PLACEMENT COSTS ... -- -- -- -- 500,000 5 --
COMMON STOCK AND OPTIONS
ISSUED FOR PROFESSIONAL .. -- -- -- -- 50,000 1 --
SERVICES
-- -- -- -- -- -- --
EXERCISE OF PUT WARRANTS
TREASURY STOCK PURCHASED .. -- -- -- -- -- -- --
NET INCOME ................ -- -- -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1997 268,851 $ 3,226 $ (1,044) $ 2,182 10,193,676 $ 102 --
========== ========== ========== ========== ========== ========== ==========
</TABLE>
Additional
Paid-in RETAINED TREASURY
CAPITAL EARNINGS STOCK TOTAL
---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1996 $ 16,453 $ 2,537 $ (52) $ 26,118
ISSUANCE OF COMMON STOCK
DIVIDEND ON 8% PREFERRED
STOCK .................... 48 (48) -- --
CONVERSION OF WARRANTS TO
COMMON STOCK ............. -- -- -- --
CONVERSION OF CONVERTIBLE
SECURITIES AND DIVIDEND TO
COMMON STOCK ............. 4,599 (79) -- --
REDEMPTION OF CONVERTIBLE
SECURITIES ............... (100) (11) -- (589)
COMMON STOCK ISSUED,
NET OF PLACEMENT COSTS ... 1,133 -- -- 1,133
COMMON STOCK AND OPTIONS
ISSUED FOR PROFESSIONAL .. 117 -- -- 117
SERVICES
250 -- -- 250
EXERCISE OF PUT WARRANTS
TREASURY STOCK PURCHASED .. -- -- (661) (661)
NET INCOME ................ -- (1,846) -- (1,846)
---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1997 $ 22,500 $ 553 $ (713) $ 24,522
========== ========== ========== ==========
F-7
(Continued)
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1996
(Dollars in thousands, except share data)
<TABLE>
<CAPTION>
6% JUNIOR
8% PREFERRED STOCK PREFERRED STOCK COMMON STOCK
--------------------------------- ---------------------- ---------------------
NUMBER NET OF NUMBER NUMBER
OF PAR DISCOUNT OF PAR OF PAR
SHARES VALUE VALUE SHARES VALUE SHARES VALUE
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 ........ 268,851 $ 3,226 $ 2,182 117,000 $ 1 5,539,215 $ 55
Conversion of preferred stock to
common stock .................. -- -- -- (58,941) -- 224,822 2
Issuance of common stock dividend . -- -- -- -- -- 27,535 --
Issuance of common stock and put
warrants in connection with
property acquisition ........... -- -- -- -- -- 225,000 2
Issuance of common stock, net of
placement costs ................ -- -- -- -- -- 330,000 4
Purchase and retirement of Series B
Preferred Stock ............... -- -- -- (58,059) (1) -- --
Purchase of 10,480 shares of
common stock for treasury ...... -- -- -- -- -- -- --
Issuance of convertible securities,
net of issuance costs .......... -- -- -- -- -- -- --
Issuance of common stock in
connection with convertible
securities .................... -- -- -- -- -- 173,724 2
Stock registration costs .......... -- -- -- -- -- -- --
Net income ........................ -- -- -- -- -- -- --
--------- --------- --------- --------- --------- --------- ---------
Balance, December 31, 1996 ........ 268,851 $ 3,226 $ 2,182 -- -- 6,520,296 $ 65
========= ========= ========= ========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
ADDITIONAL
PAID-IN RETAINED TREASURY
CAPITAL EARNINGS STOCK TOTAL
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Balance, December 31, 1995 ........ $ 14,608 $ 1,961 -- $ 18,751
Conversion of preferred stock to
common stock .................. (10) -- -- (10)
Issuance of common stock dividend . 70 (70) -- --
Issuance of common stock and put
warrants in connection with
property acquisition ........... 907 -- -- 907
Issuance of common stock, net of
placement costs ................ 900 -- -- 900
Purchase and retirement of Series B
Preferred Stock ............... (537) (266) -- (803)
Purchase of 10,480 shares of
common stock for treasury ...... -- -- (52) (52)
Issuance of convertible securities,
net of issuance costs .......... -- -- -- 4,998
Issuance of common stock in
connection with convertible
securities .................... 540 -- -- 540
Stock registration costs .......... (25) -- -- (25)
Net income ........................ -- 912 -- 912
--------- --------- --------- ---------
Balance, December 31, 1996 ........ $ 16,453 $ 2,537 $ (52) $ 26,118
========= ========= ========= =========
</TABLE>
F-8
(Continued)
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Operating activities:
Net income (loss) ............................ $(46,224) $ (1,847) $ 912
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation, depletion and amortization ... 18,031 8,889 3,420
Impairment of assets ....................... 36,735 5,096 --
Exploration costs .......................... 5,056 785
Deferred income taxes ...................... (2,054) (1,242) 613
(Gain) loss on sale of assets .............. (236) 22 175
Deferred revenue ........................... 723 (714) 3,590
Other ...................................... 916 330 (173)
Change in operating assets and liabilities:
Change in accounts receivable ............. 310 1,822 (4,033)
Change in prepaid expenses and other ...... (376) 198 (148)
Change in accounts payable ................ 6,199 (3,898) 2,128
Change in accrued expenses and other ...... 2,889 (11) (397)
-------- -------- --------
Net cash provided by operating activities .. $ 21,969 $ 9,430 $ 6,087
-------- -------- --------
Investing activities:
Purchases of oil and gas properties .......... (56,066) (9,699) (17,023)
Purchases of property and equipment .......... (2,711) (669) (3,108)
Proceeds from sales of assets ................ 2,390 4 550
Change in notes receivable ................... 97 209 732
Investment in Common Stock of Century Offshore -- (2,500) --
Other ........................................ -- -- (2)
-------- -------- --------
Net cash used in investing activities ...... $(56,290) $(12,655) $(18,851)
-------- -------- --------
</TABLE>
(Continued)
F-9
(Continued)
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Financing activities:
Proceeds from borrowings from related parties $ -- $ -- $ 250
Proceeds from other borrowings ............... 40,773 11,902 17,612
Proceeds from sale of stock to Den norske .... -- 1,330 --
Payments on borrowings from related parties .. -- (490) (250)
Payments on other borrowings ................. (6,334) (7,048) (10,869)
Increase in deferred financing and convertible
issuance costs .............................. (1,043) (195) (462)
Stock issuance and registration costs ........ -- (197) --
Issuance of common shares, net ............... -- -- 900
Issuance of convertible securities ........... -- -- 6,000
Redemption of convertible securities ......... -- (589) --
Purchase of 6% Junior Preferred Stock ........ -- -- (803)
Purchase of treasury stock ................... -- (661) (53)
Other ........................................ -- -- (35)
-------- -------- --------
Net cash provided by financing activities .. $ 33,396 $ 4,052 $ 12,290
-------- -------- --------
Increase (decrease) in cash ................ (925) 827 (474)
Cash and cash equivalents at beginning of year . 1,180 353 827
-------- -------- --------
Cash and cash equivalents at end of year ....... $ 255 $ 1,180 $ 353
======== ======== ========
</TABLE>
NON-CASH TRANSACTIONS:
During 1998, the Company expanded its holdings in the Gulf by acquiring
properties from TECO for $57.7 million. TECO agreed to seller-finance $18.5
million of the purchase price in the form of a promissory note (see Note 2).
During 1997, holders of $5,538,483 of the Convertible Securities converted the
securities into 3,052,188 shares of Common Stock and received 49,676 shares of
Common Stock dividends related to the Convertible Securities. The remaining
$461,517 was redeemed by the Company for
F-10
(Continued)
<PAGE>
a price of $589,023.
During 1997, the Company entered into an Amendment to Lead Generation Agreement
with Corporate Relations Group (CRG) to provide additional services in the
public relations area. The amendment provided for the termination of options
previously granted to CRG by ARO and the issuance to CRG of 50,000 shares of
registered stock in ARO. The shares were valued at $1.94 per share which
represents the closing bid price on April 21, 1997, the date of the amendment.
During 1996, in connection with the acquisition of certain gas properties and
related equipment, the Company issued 225,000 shares of common stock and 225,000
common stock put warrants with a combined value of $1,157,175 ($907,175 net of
placement costs). The Company also paid cash and assumed certain obligations in
connection with the acquisition, which was consummated on February 26, 1996 (see
Note 2).
In connection with the acquisition of certain gas properties, in July 1996 the
Company extinguished a $6.5 million note receivable as partial consideration.
F-11
(Continued)
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
The Company acquired 58,059 shares of the outstanding 6% Junior Preferred Stock
for $802,900 during 1996. Upon resolution of the Board of Directors, the shares
were retired.
The Company declared stock dividends and issued 19,842, 21,508 and 27,535 shares
of common stock to holders of the Series 1993 and Series B Preferred Stock
during 1998, 1997 and 1996, respectively.
During 1996, 58,941 shares of Series B Preferred Stock were converted into a
total of 224,822 shares of common stock.
During 1996, in connection with the issuance of 4% convertible securities in the
aggregate principal amount of $6,000,000, the Company issued 173,724 shares of
common stock at an average value of $3.11 per share as partial consideration for
placement fees.
F-12
(Continued)
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) GENERAL
American Resources Offshore, Inc. (ARO), (formerly known as American
Resources of Delaware, Inc.), a Delaware corporation organized on
August 14, 1992, was formed to acquire the assets and assume certain
liabilities of Standard Oil and Exploration of Delaware, Inc. (SOE)
pursuant to SOE's Chapter 11 Bankruptcy Joint Plan of Reorganization
which was consummated effective April 22, 1993.
ARO and its wholly-owned subsidiary, Southern Gas Co. of Delaware,
Inc. (Southern Gas), are involved in the production, gathering,
purchasing, processing, transporting and selling of natural gas
primarily in the Gulf Coast Region and the State of Kentucky. These
activities are considered to be one business segment for financial
reporting purposes.
(B) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of ARO
and its Subsidiary, collectively referred to as the Company. All
significant intercompany balances and transactions have been
eliminated in consolidation.
Certain reclassifications have been made to prior year financial
statements to conform with the current year presentation.
(C) CASH EQUIVALENTS
For purposes of the statement of cash flows, the Company considers
any liquid investments with an original maturity of three months or
less when purchased as a cash equivalent.
F-13
(Continued)
<PAGE>
(D) OIL AND GAS PROPERTIES
The Company uses the successful efforts method of accounting for its
oil and gas operations. The costs of unproved leaseholds are
capitalized pending the results of exploration efforts. Significant
unproved leasehold costs are assessed periodically, on a
property-by-property basis, and a loss is recognized to the extent,
if any, that the cost of the property has been impaired. The costs
of individually insignificant unproved leaseholds estimated to be
nonproductive are amortized over estimated holding periods based on
historical experience. As of January 1, 1996, the Company began
assessing the impairment of capitalized costs of proved oil and gas
properties and other long-lived assets in accordance with Statement
of Financial Accounting Standards No. 121 (SFAS No. 121),
"Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of." Under this method, the Company
generally assesses its oil and gas properties on a depletable unit
basis utilizing its current estimate of future revenues and
operating expenses. In the event net undiscounted cash flow is less
than the carrying value, an impairment loss is recorded based on
estimated fair value, which would consider discounted future net
cash flows. Impairments of oil and gas properties held for sale is
included in the balance sheet as accumulated depreciation. Depletion
and amortization and impairments of operating assets are included in
the balance sheet as adjustments to the oil and gas properties asset
account. Exploratory dry holes and geological and geophysical
charges on exploratory projects are expensed. Depletion of proved
leaseholds and amortization and depreciation of the costs of all
development and successful exploratory drilling are provided by the
unit-of-production method based upon estimates of proved and
proved-developed oil and gas reserves, respectively, for each
property. The estimated costs of dismantling and abandoning offshore
site remediation and significant onshore facilities are provided
currently using the unit-of-production method; such costs for other
onshore facilities are insignificant and are expensed as incurred.
Significant changes in the various estimates discussed above could
affect the financial position and results of operations of the
Company.
On sale of an entire interest in an unproved property for cash or
cash equivalent, gain or loss on the sale is recognized, taking into
consideration the amount of any recorded impairment if the property
had been assessed individually. If a partial interest in the
unproved property is sold, the amount received is treated as a
reduction of the cost of the interest retained.
(E) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Expenditures
representing additions or
F-14
(Continued)
<PAGE>
improvements are capitalized. Maintenance and repairs are charged to
expense as incurred. Upon retirement or disposition, costs and
accumulated depreciation are removed from the accounts and the
resulting gain or loss is recognized in income.
Depreciation and amortization are computed using the straight-line
method over the estimated useful lives of the assets.
ESTIMATED
USEFUL
LIVES
(YEARS)
---------
Pipeline support facilities 7-15
Field equipment 7
Other 3-7
(F) GAS MARKETING ACTIVITIES
In the conduct of its marketing activities, the Company enters into
both long-term and short-term contracts to purchase and/or sell at a
future date specified quantities of products at specified prices.
Settlement of such contracts may occur through the purchase, sale
and/or exchange of products in the open market or from production.
Resulting gains or losses, if any, are recorded in the month of
delivery. During 1995, the Company entered into an exclusive
marketing arrangement with Southern Resources, Inc. (SRI), a third
party company, wherein the Company was the exclusive supplier of all
natural gas to be sold by SRI. Under the agreement, after deduction
of certain expenses, the Company was entitled to receive not less
than 50% of the sales margin obtained. Included in the statements of
operations for the first four months of 1997 is the Company's 50%
participation in SRI's marketing revenues and expenses. The
marketing arrangement with SRI was terminated in May 1997.
(G) DRILLING REVENUES
At times, the Company performs drilling and completion services for
drilling programs, primarily under turnkey drilling contracts in
which it utilizes third party contract drillers. Revenue is
recognized upon the completion of the initial producing zone.
(H) PIPELINE TRANSPORTATION REVENUE
Revenue from the transportation of gas is recognized on the
accrual basis as
F-15
(Continued)
<PAGE>
products are transported.
(I) DEFERRED FINANCING COSTS
In connection with obtaining credit facilities, the Company has
capitalized third party costs directly associated with the closing
thereof. The costs are being amortized over the period of the credit
facilities. For the years ended December 31, 1998, 1997 and 1996,
approximately $338,000, $96,000 and $101,000, respectively, have
been amortized to expense in connection with these costs.
(J) INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES
Investments in companies which the Company has less than a 20%
interest are carried at cost less impairment, if any. Dividends
received are included in other income. Dividends received in excess
of the Company's proportionate share of earnings are applied as a
reduction of the cost of the investment.
Investments in companies which the Company has a 20% to 50% interest
are carried at cost, adjusted for the Company's proportionate share
of their undistributed earnings or losses. Earnings or losses are
included in other income.
(K) INCOME TAXES
The Company follows the asset and liability method of accounting for
income taxes. Under this method, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax basis and
operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences
are expected to be recovered or settled. Under the asset and
liability method, 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.
(L) STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock- Based Compensation," (Statement No. 123) encourages, but does
not require companies to record compensation cost for stock-based
employee compensation plans at fair value. The Company has elected
to continue to account for stock- based compensation using the
intrinsic value method prescribed in Accounting
F-16
(Continued)
<PAGE>
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," (APB Opinion 25) and related interpretations.
Accordingly, compensation cost for stock options issued to employees
and directors is measured as the excess, if any, of the quoted
market price of the Company's stock at the date of grant over the
amount an employee must pay to acquire the stock.
(M) EARNINGS PER SHARE
The Company adopted Statement of Financial Accounting Standards No.
128, "Earnings per Share" (SFAS No. 128) in 1997. This statement
establishes standards for computing and presenting earnings per
share and requires, among other things, dual presentation of basic
and diluted earnings per share on the face of the statement of
operations.
The following table provides a reconciliation between basic and
diluted earnings (loss) per share:
WEIGHTED AVERAGE
NET INCOME COMMON SHARES PER SHARE
(LOSS) OUTSTANDING AMOUNT*
---------- ---------- -----------
(THOUSANDS EXCEPT SHARE AMOUNTS)
Year Ended December 31, 1998:
Basic (loss) per share .............. $ (46,224) 10,029,415 $ (4.61)
Diluted (loss) per share ............ $ (46,224) 10,029,415 $ (4.61)
========== ==========
Year Ended December 31, 1997:
Basic (loss) per share .............. $ (1,847) 9,021,810 $ (0.21)
Diluted (loss) per share ............ $ (1,847) 9,021,810 $ (0.21)
========== ==========
Year Ended December 31, 1996:
Basic earnings per share ............ $ 912 6,123,635 $ 0.14
Effect of dilutive potential
common shares ..................... 771,811
----------
Diluted earnings per share .......... $ 912 6,895,446 $ 0.13
========== ==========
*Adjusted for preferred stock dividends of $49,383, $47,647 and
$70,174 for 1998, 1997 and 1996, respectively.
At December 31, 1998 and 1997, the stock options, warrants and
Convertible Preferred Stock were not included in the computation of
diluted loss per share because the effect of their assumed exercise
and conversion would have an antidilutive effect on the computation
of diluted loss per share.
At December 31, 1996, the Convertible Preferred Stock was not
included in the computation of diluted earnings per share because
the effect of its assumed
F-17
(Continued)
<PAGE>
exercise and conversion would have an antidilutive effect on the
computation of diluted earnings per share.
(N) USE OF ESTIMATES
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and
disclosure of contingent assets and liabilities to prepare these
consolidated financial statements in conformity with generally
accepted accounting principles. Actual results could differ from the
estimates.
(2) TECO ACQUISITION
On March 5, 1998, the Company purchased interests in 43 leaseblocks in the
Gulf of Mexico from TECO Oil & Gas, Inc. (TECO). The purchase consisted of
an average 30% interest in approximately 198,300 acres containing 5
producing wells and approximately $35 million PV10 of estimated proved
reserves as of December 31, 1997; partnership interests in Louisiana
Offshore Ventures and Texas 3D Ventures and access to approximately 12,500
square miles of 3-D seismic data. Louisiana Offshore Ventures and Texas 3D
Ventures are exploration and development partnerships managed by Houston
Energy Development (HED). HED has specialized in 3-D seismic evaluation
and prospect selection for over ten years and provides the Company with
access to 14 additional geoscientists and 13 state of the art 3-D seismic
workstations. The Company believes that the TECO acquisition provides
ample opportunity to increase reserves, production and cash flow from
development and exploration activities and, with HED, has identified
numerous drilling locations on the acquired properties.
As consideration for the properties, the Company paid $57.7 million, of
which $1.3 million was paid in cash upon execution of the Purchase and
Sale Agreement, $21.4 million was paid from funds borrowed under the
Company's credit facility, and $16.5 million was paid from funds borrowed
under bridge loans provided by DNB Energy Assets, Inc. (DNB), successor to
Den norske Bank, AS (Den norske), $1.5 million of which was due July 1,
1998, with the remainder due September 30, 1998. The balance of
$18,500,000 was in the form of a promissory note in favor of TECO (TECO
Note). The bridge loans from DNB were amended to extend the maturity date
to December 31, 1998. DNB also amended the interest rate to either the
prime rate plus 1% or the LIBOR plus 4%.
The TECO Note currently bears interest at the rate of 16% per annum and
increases 2% each quarter hereafter, with a maximum interest rate of 18%
beginning April 1, 1999. The TECO Note matured on October 1, 1998 and is
secured by a lien on all properties of the Company and its subsidiaries;
however, the lien is second and inferior to the lien of DNB.
F-18
(Continued)
<PAGE>
Additionally, pursuant to the terms of a warrant agreement entered into
between the parties relative to the TECO Note, TECO has been vested with
the rights to acquire 600,000 shares of ARO's common stock at $2.67 per
share, plus additional common stock in ARO equal to fifteen (15%) percent
of ARO's issued and outstanding common stock and options or rights to
purchase common stock for $0.00001 per share, together with the right to
appoint two members to ARO's Board of Directors. TECO has not taken any
action to exercise its warrant rights or make any appointments to ARO's
Board at this time; however, TECO has not waived any of its rights. TECO
has filed a Schedule 13-D and Form 3 with the Securities and Exchange
Commission ("SEC") regarding such rights. TECO's rights to acquire fifteen
(15%) percent of ARO's issued and outstanding common stock and options or
rights to purchase common stock will increase to twenty (20%) percent if
the TECO Note is not paid in full by April 1, 1999.
Assuming the acquisition had occurred on January 1, 1997, the following
unaudited proforma operating data gives effect to the acquisition for the
years ended December 31, 1998 and 1997:
DECEMBER 31, DECEMBER 31,
1998 1997
========= ========
Total revenue ...................... $ 37,143 $ 44,669
========= ========
Net (loss) from operations ......... $ (41,150) $ (3,745)
========= ========
Basic and diluted (loss) per share . $ (4.61) $ (.42)
========= ========
Basic and diluted earnings per share are based on 10,029,415 and 9,021,810
shares outstanding for December 31, 1998 and 1997, respectively.
(3) PROPERTY AND EQUIPMENT
A summary of property and equipment follows:
(DOLLARS IN THOUSANDS)
1998 1997
------- -------
Pipeline support facilities ...... $10,547 $ 8,190
Field equipment .................. 3,460 3,714
Other ............................ 638 449
------- -------
$14,645 $12,353
======= =======
For the years ended December 31, 1998, 1997 and 1996, depreciation
expense on
F-19
(Continued)
<PAGE>
property and equipment was $1.1 million, $1 million and $878,000,
respectively.
(4) OIL AND GAS PROPERTIES
A summary of oil and gas properties follows:
1998 1997
------- -------
(DOLLARS IN THOUSANDS)
Proved properties - Developed - Gulf ............... $29,168 $26,392
Proved properties - Undeveloped - Gulf ............. 8,590 4,193
Unproved properties - Gulf ......................... 35,901 5,326
Proved properties - Developed - Appalachian ........ 21,944 18,704
Unproved properties - Appalachian .................. 2,558 2,558
------- -------
$98,161 $57,173
======= =======
In February 1997, the Company through its wholly owned subsidiary,
Southern Gas, acquired a 25% working interest in onshore Gulf Coast
undeveloped properties located in Greene and Wayne Counties, Mississippi,
for approximately $300,000.
On April 2, 1997, the Company entered into an agreement to acquire a 26.4%
working interest in the Main Pass Block 53 from Great River Oil & Gas
Corporation for approximately $254,000. Drilling was completed during the
third quarter of 1997, and it was determined that the well is not
economically feasible.
In April 1997, the Company purchased from a director of the Company an
overriding royalty interest in the Ship Shoal B-3 well for $150,000 and
also purchased from an officer/director of the Company an overriding
royalty interest in the Ship Shoal B-4 well for $180,000.
In June 1997, the Company entered into a purchase agreement to acquire
interests in 26 natural gas wells from Daugherty Petroleum, Inc., said
wells being located in Whitley and Knox Counties, Kentucky, on the
Company's existing gathering facilities. The wells contain an estimated
1.5 billion cubic feet of natural gas reserves net to the Company, and the
purchase price was approximately $526,000. The purchase transaction was
completed in September 1997.
On September 15, 1997, the Company entered into a Letter of Intent with
Prima Capital, LLC (Prima) providing for the acquisition of an interest in
producing and non-producing oil and gas properties located in Mississippi.
(See Note 15.)
In September 1997, the Company purchased a 4.3% overriding royalty
interest in the Ship
F-20
(Continued)
<PAGE>
Shoal B-4 well for $330,000. The value of the overriding royalty interest
was based on discounted reserve values as determined from the December 31,
1996 reserve report less amounts paid through June 1997.
On December 16, 1997, the Company entered into a Purchase and Sale
Agreement to acquire proved developed and undeveloped oil and gas
properties, platforms, equipment and pipelines located offshore Louisiana
on Ship Shoal Block 222, Ship Shoal Block 225 and West Cameron Block 368
from K.E. Resources, Ltd. The purchase price was $2.5 million, which was
funded from the Company's line of credit with DNB. The transaction was
completed and funded on December 19, 1997.
On December 22, 1997, the Company entered into a Purchase and Sale
Agreement to acquire additional interests in the properties located on
West Cameron Block 368 from Apache Corporation pursuant to a preferential
right of first refusal election. The purchase was $127,000, which was
funded from the Company's line of credit with DNB. This transaction closed
on January 5, 1998.
During the first quarter of 1998, the Company participated in the drilling
of a well on Galveston Block 213, a property purchased in the TECO
acquisition. The well commenced production on May 28, 1998 and is
currently producing at a rate of approximately 10 million cubic feet
equivalent of gas (MMcfe) per day. The Company owns a 33.3% working
interest in the well which is being operated by Basin Exploration, Inc.
On May 6, 1998, the Company entered into a Participation Agreement to
acquire 16.67% working interest in High Island Block 105, offshore Texas.
The well encountered natural gas accumulation in the objective reservoir
and was subsequently cased and perforated for production. Attempted
completion operations were unsuccessful in sustaining production because
of reduced reservoir pressures. The Company believes that production could
be established in this well utilizing stimulation and available
compression facilities on the platform.
In June 1998, the Company participated in the drilling of a successful
well on West Cameron Block 368 on which the Company had existing
production. The well was completed and began producing during the fourth
quarter of 1998. During the third quarter of 1998, the Company completed
an exchange of working interest ownership with Century Offshore Management
Corporation that provides for the Company to increase its working interest
to 95% on a portion of West Cameron Block 368 covering approximately 1,170
acres.
F-21
(Continued)
<PAGE>
During the second quarter of 1998, the Company participated in the
drilling of a successful exploratory well on West Cameron Block 172, a
property purchased in the TECO acquisition. The OCS G1998 #16ST well was
drilled and completed with an initial test rate of 11 MMcf of gas and 200
barrels of condensate per day. A development/acceleration well, the OCS
G1998 #18 well, was drilled in the same fault block and encountered gas
pay in two additional reservoirs. The #18 well was also completed and
tested at an initial rate of 10.2 MMcf of gas and 90 barrels of condensate
per day. Design and construction of a platform and facilities for
development of this discovery were completed in December 1998. The
Company's working interest in the #16ST and #18 wells is 28.72% and 27%,
respectively. Additionally, the #19 well was drilled during the first
quarter of 1999. However, during the first quarter of 1999, ARO was named
a co-defendant in litigation filed by the operator of High Island Block
105 seeking approximately $600,000 for expenses incurred in the drilling
of a well. On March 10, 1999, ARO settled this litigation by agreeing to
convey its interest in the #19 well to the co-defendant in exchange for
approximately $600,000 and a 25% reversionary interest after payout. Those
proceeds were utilized by ARO to settle this litigation. At the time of
this settlement, ARO was in default on its obligation to advance an
additional $733,752 for completion cost of the #19 well and did not have
the capital to make this advance. As ARO would have been caused to
non-consent this operation, it agreed to convey its interest to the
co-defendant, who paid the completion costs.
During the first quarter of 1998, the Company entered into an agreement
with J. M. Huber Corporation (Huber) for the development of Grand Isle
Block 55, offshore Louisiana, wherein two wells were to be drilled. During
the drilling of the initial well, reserves were encountered; however,
control of the well was lost necessitating the well to be shut in and a
sidetrack well to be initiated. The additional costs of the re-drill as
well as the cost of the material and equipment lost in the original well,
estimated to be approximately $3.7 million, was reimbursable by the
Company's insurance program, less deductibles totaling $300,000. During
the third quarter of 1998, the Company successfully completed the side
track well and an additional well from the A Platform on Grand Isle Block
55. Initial production commenced in September 1998 at the rate of
approximately 1,500 barrels of oil per day. Huber did not assign an
ownership interest in the well to the Company based upon Huber's
interpretation of the participation agreement that all trade creditors
must be paid in full prior to any such assignment. As of December 31,
1998, the Company had trade payables of approximately $12 million in
association with the drilling of these wells. During the first quarter of
1999, the Company settled the trade payables by surrendering its interest
in the Grand Isle Block 55 wells to Huber. The financial statements for
the year ended December 31, 1998, do not reflect the operating results
relating to the production from the Huber well. The settlement with Huber
generated an impairment of approximately $1.4 million which is reflected
in the financial statements for the year ended December 31, 1998. The
impairment represents the net cash expenditures made by the
F-22
(Continued)
<PAGE>
Company for the Grand Isle Block 55 well in which the Company does not
have an ownership interest.
For the years ended December 31, 1998, 1997 and 1996, depletion expense on
oil and gas properties was $14,586,951, $7,594,523 and $2,431,633,
respectively, or $1.25, $1.05 and $0.80 per Mcf equivalent.
During 1998, ARO recorded an impairment of oil and gas properties of $34.7
million compared with $5 million during 1997. The impairment includes an
$8.2 million write down of ARO's Appalachian properties based on its
current efforts to sell the Kentucky division of ARO. The Appalachian
impairment allowance is included in ARO's accumulated depreciation,
depletion and amortization. The impairment also includes a $22.5 million
write down of the TECO properties. The write down was primarily the result
of a significant decline in the production on several of the TECO wells
coupled with a substantial decline in oil and gas prices in 1998. Also
included was an additional $4 million impairment on other oil and gas
properties. In addition to the impairments of oil and gas properties, ARO
also recognized a $2 million impairment on its holding of Century stock
(see Notes 8 and 9).
In 1997, the Company recorded an impairment of $1.6 million related to its
Michigan properties and a $2 million impairment related to oil and gas
properties.
F-23
(Continued)
<PAGE>
(5) LONG-TERM DEBT
A summary of long-term debt follows:
DECEMBER 31, DECEMBER 31,
1998 1997
--------------- -------------
(DOLLARS IN THOUSANDS)
Borrowings under the Company's credit facility,
as amended, with DNB, reduction subject to
availability under borrowing base, $48,173,000
available borrowing base as of December 31, 1998,
monthly reduction against the available borrowing
base of $750,000 commencing January 1, 1999,
interest payable monthly at the Floating Rate,
or LIBO Rate plus 2 1/2%, secured by substantially
all of theCompany's oil and gas properties,
equipment and receivables........................ $ 48,173 28,700
Term Loan A, as amended, payable to DNB,
due December 31, 1998, with interest payable
monthly at the Floating Rate plus 1%, or LIBO
Rate plus 4% per annum, secured by substantially
all of the Company's oil and gas properties...... 15,000 -
Term Loan B payable to DNB, due December 31, 1998,
with interest payable monthly at the Floating Rate
plus 1%, or LIBO Rate plus 4% per annum, secured
by substantially all of the Company's oil and
gas properties................................... 550 -
Note payable to TECO, with interest at 14% per annum,
increasing 2% each quarter the note remains unpaid,
with a maximum rate of 18%, due October 1, 1998.. 18,500 -
F-24
(Continued)
<PAGE>
DECEMBER 31, DECEMBER 31,
1998 1997
--------- ---------
Note payable to related party, recourse only
to specific properties, interest payable at
prime rate plus 1% in connection with the purchase
of oil and gas properties from Prima Capital, 987 1,500
LLC............................................
Other notes..................................... 29 100
--------- ---------
83,239 30,300
Less - Current portion.......................... (64,033) (4,907)
Less - Debt in default.......................... (18,500) -
--------- ---------
Long-term debt.................................. $ 706 $ 25,393
========= ========
On September 28, 1995, the Company entered into a $20 million revolving
credit facility through February 1, 2002 with Den norske. By November 1,
1997, the revolving credit facility had been increased to $75 million and
the available borrowing base was increased to $30 million. On March 5,
1998, the borrowing base under the revolving credit facility was assigned
to DNB and increased to $50 million to facilitate the purchase of oil and
gas properties from TECO. As of December 31, 1998, the balance due under
the revolving credit facility was $48,173,000. Additional borrowings under
the credit facility are dependent upon a redetermination of the borrowing
base, which is primarily dependent upon the value of the mortgaged
properties as determined under DNB's internal lending procedures.
Reductions of the credit facility are also dependent upon the borrowing
base. Commencing January 1, 1999, monthly principal reductions are
$750,000. The borrowing base will be redetermined semi-annually on each
October 1st and April 1st prior to February 1, 2002.
On March 5, 1998, DNB also provided bridge loans totaling $16 million in
order for the Company to complete the acquisition of the TECO properties.
The bridge loans, as amended, matured on December 31, 1998. DNB has not
yet demanded payment nor has it agreed to extend the terms of the bridge
loans.
Under the credit agreement with DNB, the Company is required to maintain
certain financial ratios relating to debt coverage ratio, current ratio,
tangible net worth, general and administrative expenses and quarterly
interest ratio. At December 31, 1998, the Company was not in compliance
with all of the required financial ratios; however, DNB agreed to
temporarily waive the compliance requirements at year-end 1998.
Additionally, at December 31, 1998, the Company was not in compliance with
other required financial
F-25
(Continued)
<PAGE>
covenants in the credit agreement; and the Company has also not made the
monthly principal reductions required in 1999. Therefore, this debt is
classified as current in the accompanying balance sheets.
Also in order to complete the acquisition of the TECO properties, on March
5, 1998, the Company executed a note in favor of TECO in the amount of
$18.5 million (see Note 2). The TECO Note matured on October 1, 1998; and
by letter dated October 2, 1998, TECO declared the Company in default.
However, TECO is a party to an agreement between the Company and DNB which
substantially limits TECO's remedies against the Company unless the Bank
is paid in full or declares a default and takes affirmative action against
the Company. Additionally, pursuant to the terms of a warrant agreement
entered into between the parties relative to the TECO Note, TECO has been
vested with the rights to acquire 600,000 shares of ARO's common stock at
$2.67 per share, plus additional common stock in ARO equal to fifteen
(15%) percent of ARO's issued and outstanding common stock and options or
rights to purchase common stock for $0.00001 per share, together with the
right to appoint two members to ARO's Board of Directors. TECO has not
taken any action to exercise its warrant rights or make any appointments
to ARO's Board at this time; however, TECO has not waived any of its
rights. TECO has filed a Schedule 13-D and Form 3 with the SEC regarding
such rights. TECO's rights to acquire fifteen (15%) percent of ARO's
issued and outstanding common stock and options or rights to purchase
common stock will increase to twenty (20%) percent if the TECO Note is not
paid in full by April 1, 1999.
(6) CONVERTIBLE SECURITIES PRIVATE PLACEMENT
In 1996, the Company privately placed 4% convertible securities in the
aggregate principal amount of $6,000,000 ($4,997,554 net of placement
costs) with a required conversion of one year from date of issuance. The
securities were convertible at the option of the holders into shares of
common stock valued at the lesser of (1) the closing bid price of the
common stock as reported on NASDAQ on the date of issuance of the
security, or (2) 75% of the average closing bid prices of the common stock
as reported on NASDAQ for the five trading days prior to the date of
conversion (the Conversion Price). As of June 9, 1997, securities totaling
$5,538,483 had been converted into 3,101,864 shares of common stock
inclusive of 4% dividend shares paid as of the date of conversion, and the
remaining $461,517 had been redeemed by the Company pursuant to its rights
under the security documents. The Company was not required to pay any
liquidated damages or additional interest as a result of the conversion or
redemption of the securities.
The shares of common stock into which the securities were convertible were
registered under an S-3 Registration Statement which was effective on
January 23, 1997.
F-26
(Continued)
<PAGE>
(7) INDEPENDENT CONTRACTOR AGREEMENTS
On November 27, 1996, the Company entered into a five year corporate
relations agreement with Corporate Relations Group, Inc. (CRG), Winter
Park, Florida, to assist the Company with its shareholder relations. As
consideration for the agreement, the Company paid CRG $550,000 cash and
granted CRG a one year option to purchase 100,000 shares of common stock
for $3.00 per share, a two year option to purchase 100,000 shares of
common stock for $3.60 per share, a three year option to purchase 100,000
shares of common stock for $4.20 per share, a five year option to purchase
100,000 shares of common stock for $4.80 per share, and a five year option
to purchase 100,000 shares of common stock for $6.00 per share. The
options had a fair value of approximately $1.27 per share. On April 21,
1997, the Company entered into an Amendment to Lead Generation Agreement
with CRG to provide additional services in the public relations area. The
Amendment also provided for the immediate termination of the 500,000
options previously granted to CRG by the Company and the issuance to CRG
of 50,000 shares of registered stock in the Company. The shares were
valued at $1.94 per share which represents the closing bid price on April
21, 1997. The cost was amortized during 1997 due to the timing of the
services being performed.
(8) CENTURY/SETTLE TRANSACTIONS
Under a letter agreement dated October 17, 1994, the Company had the right
to acquire a 10% equity interest in Settle Oil and Gas Company (Settle)
for $4,000,000 (the Settle Securities). Due to the fact that the Company
was not in a position to acquire this equity interest, the Agreement was
subsequently amended to permit a third party to acquire the Settle
Securities for $2.5 million. The funds used to effect the foregoing
acquisition were borrowed by the third party from Prima, a limited
liability company of which an officer/director of the Company is a member.
The third party is also a member of Prima and the principal stockholder of
Southern Resources, Inc. Prima, in turn, borrowed the funds it used to
provide the foregoing loan from a bank in Lexington, Kentucky. In
connection with this transaction, the Company entered into a Put Agreement
with Prima, dated March 15, 1995, which provided that, in the event Prima
obtained title to the Settle Securities, Prima had the right to require
the Company to purchase the Settle Securities for $4,000,000 (the Prima
Put) payable in cash and common stock.
On July 21, 1995, a reorganization plan was approved by the Bankruptcy
Court and resulted in the merger of Settle into Century Offshore
Management Corporation (Century). Any and all references to Settle
subsequent to July 21, 1995, refer to the merged entity which retained the
name of Century.
The Put Agreement with Prima was terminated in July 1995, and a new
agreement, as
F-27
(Continued)
<PAGE>
amended, providing for the Company's ability to call the Century
Securities from the third party member of Prima for $4,000,000 was
substituted therefor (the Call Agreement). The Call Agreement also
provided for non-refundable monthly installments of $31,250 (as originally
required under the Put Agreement) until such time as a total of $1,000,000
was advanced under the Call Agreement (including payments previously made
under the Put Agreement). In the event the Company elected to call the
Century Securities, the advance payments would be credited toward the
purchase price. Additionally, a $500,000 certificate of deposit held as
collateral for Prima's loan was liquidated by the Company and the funds
were advanced to Prima under the potential Call Agreement. Prima used the
$500,000 to purchase shares of Series B Preferred Stock from a third
party, which Preferred Stock it subsequently converted to common stock. In
the event the Company exercised the Call option, the $500,000 would be
credited towards the purchase. The Company's right to call the Settle
Securities began January 15, 1997 and ended December 31, 1997.
On November 4, 1997, the Board of Directors approved the exercise of the
Company's rights under the Call Agreement; and all funds due pursuant
thereto had been paid on or before December 31, 1997. The investment is
reported on the Balance Sheet in "Other Assets: Investment in
Unconsolidated Subsidiaries." See Note 9 regarding impairment of this
asset.
On July 3, 1995, the Company made an unsecured working capital loan to
Settle in the amount of $900,000. At December 31, 1996, the outstanding
balance on the loan was $183,053. The loan bore interest at the rate of
10% per annum and was payable in 21 equal monthly installments of $46,894
commencing on July 31, 1995, and on the last day of each month thereafter
until paid in full. The note was paid in full during 1997.
(9) INVESTMENT IN UNCONSOLIDATED SUBSIDIARIES
On December 30, 1994, the Company invested in the formation of a new
Limited Liability Company (the LLC) whose purpose was to perform contract
drilling services for the Company and third parties. The LLC was
capitalized at $250,000 with the Company providing $110,000 for a 44%
ownership. Century and certain of Century's officers and directors were
also members of the LLC, with a combined ownership interest of 45%. In
October 1997, the operating committee voted to liquidate the LLC. As of
December 31, 1998, the remaining investment is $47,451. During 1998 and
1997, the Company recognized losses of $0 and $234,409, respectively.
In 1997, the Company acquired 2,471.3 shares of the common stock of
Century under the Call Agreement (see Note 8) for $4 million. Due to the
subsequent decline in oil and gas prices, the Company determined there was
an other than temporary decline in the carrying value of the Century
common stock. In 1998 and 1997, the Company recorded
F-28
(Continued)
<PAGE>
impairments of $2.0 million and $1.5 million, respectively, to its
investment in Century, resulting in a net book value of $.5 million and
$2.5 million, respectively. The impairment of the Century stock was
determined by comparing the carrying value of the stock on the Company's
books, after the exercise of the Century "Call Agreement," to the
estimated fair value of the stock based on the most recent sale activity.
(10) UNEARNED REVENUE
On May 22, 1996, the Company conveyed an approximate 2.2 billion cubic
feet (Bcf) volumetric production payment in Appalachian wells recently
purchased from AKS through a facility sponsored by William Energy Services
Company, a subsidiary of the Williams Companies, Inc. and structured by
NationsBank. The Company received $4,300,000 ($4,147,300 after related
costs) for the production payment, which has an anticipated six year term.
Of the funds received, $2,500,000 was used to reduce the Company's credit
facility with its primary lender. The Company used the remainder of the
funds for working capital and further acquisition and development
activities in the Gulf Coast Region.
As a result of the transaction, the Company has recorded unearned revenue
which is being recognized as the required volumes are delivered under the
production payment
conveyance.
ARO sells all of its current Gulf Coast Region gas production through H&N
Gas, Ltd. ARO utilizes forward sales contracts for a significant portion
of its Gulf Coast Region gas production to achieve more predictable cash
flows and to reduce the effect of fluctuations in gas prices. During 1998,
ARO's Gulf Coast Region production averaged 28.8 MMcfe per day. At March
15, 1999, ARO had forward sales arrangements through August 1999 with
respect to 20 MMcfe per day at an average price of $1.86 per thousand
cubic feet ("Mcf"). During 1998, ARO sold call options for 20 MMcfe per
day at a call price of $2.70 per Mcf, which expire in March 2000. In
exchange for establishing a ceiling of $2.70 per Mcf over the option term,
ARO received an average option premium of $0.14 per Mcf on the volumes
contracted for under the call option agreement. These contracts were
terminated in January 1999 at a profit of $680,114. ARO continuously
reevaluates its sales contracts in light of market conditions, commodity
price forecasts, capital spending plans and debt service requirements.
(11) INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31,
1998, 1997 and 1996 is summarized as follows:
F-29
(Continued)
<PAGE>
1998 1997 1996
------- ------- -------
(DOLLARS IN THOUSANDS)
Current tax expense ................ $ 1 $ 49 $ 6
======= ======= =======
Deferred tax (benefit) ............. $ (292) $(1,242) $ 613
======= ======= =======
The Company's effective tax benefit (5%) in 1998 is less than the
effective tax rate because of changes to its valuation allowance for
deferred tax assets. The Company's effective tax benefit (39%) in 1997 and
effective tax rate (41%) in 1996 are different from the U.S. federal
income tax rate of 34% primarily because of state income taxes.
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1998 and 1997 are presented as follows:
1998 1997
-------- --------
(DOLLARS IN THOUSANDS)
Deferred tax assets:
Net operating loss carryforwards ................. $ 6,970 $ 2,425
Basis differences in oil and gas properties ...... 11,978 --
Basis differences in unconsolidated investee ..... 1,400 600
Allowance for doubtful accounts .................. 298 110
Other ............................................ 17 50
-------- --------
Total gross deferred tax assets ............... 20,663 3,185
Less - Valuation allowance ......................... (19,239) (638)
-------- --------
Net deferred tax assets ....................... 1,424 2,547
Deferred tax liabilities:
Basis differences in oil and gas properties ...... $ -- $ 3,226
Basis differences in property and equipment ...... 1,308 1,371
Other ............................................ 116 4
-------- --------
Deferred tax liabilities ...................... 1,424 4,601
-------- --------
Net deferred tax asset (liability) ............ $ 0 $ (2,054)
======== ========
Current deferred tax asset ......................... $ 298 $ 112
======== ========
Non-current deferred tax liability ................. $ 298 $ 2,166
======== ========
In assessing the realizability of deferred tax assets, management
considers whether it is
F-30
(Continued)
<PAGE>
more likely than not that some portion or all of the deferred tax assets
will not be realized. The Company has established a valuation allowance
for such deferred tax assets to the extent such amounts are not likely to
be utilized to offset existing deferred tax liabilities reversing in the
same period.
At December 31, 1998, the Company had approximately $34.7 million and
$35.5 million of net operating loss (NOL) carryforwards available to
offset future taxable income for federal and state purposes, respectively.
The carryforwards expire from 1999 to 2018.
The Tax Reform Act of 1986 significantly limits the amount of NOL
available to offset future taxable income when a change of ownership
occurs. Such a limitation of the NOL in a given year could prevent the
Company from realizing the full benefit of the NOL within the 15 year
statutory limit. The Company had one change in ownership prior to 1997.
The Company believes that the limitations, if any, would not have a
significant impact on the consolidated financial statements.
(12) FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair
values of the Company's financial instruments at December 31, 1998.
Financial Accounting Standards Board Statement No. 107 (FASB No. 107),
"Disclosures About Fair Value of Financial Instruments," defines the fair
value of a financial instrument as the amount at which the instrument
could be exchanged in a current transaction between willing parties.
CARRYING FAIR
AMOUNT VALUE
Financial assets: -------- -------
Cash and cash equivalents $ 255 $ 255
Trade accounts receivable 4,094 4,094
Related party receivables 495 495
Notes receivable 380 380
Century Stock 500 500
Financial liabilities:
Trade accounts payable 7,162 7,162
Related party note 987 987
Accrued expenses 556 556
Long-term debt 706 706
The following table presents the carrying amounts and estimated fair
values of the Company's financial instruments at December 31, 1997. FASB
No. 107, defines the fair
F-31
(Continued)
<PAGE>
value of a financial instrument as the amount at which the instrument
could be exchanged in a current transaction between willing parties.
CARRYING FAIR
AMOUNT VALUE
Financial assets: -------- ------
Cash and cash equivalents $ 1,180 $1,180
Trade accounts receivable 4,595 4,595
Related party receivables 304 304
Notes receivable 477 477
Century Stock 2,500 2,500
Financial liabilities:
Trade accounts payable 963 963
Related party note 1,500 1,500
Accrued expenses 525 525
Long-term debt 28,800 28,800
The carrying amounts shown in the tables are included in the consolidated
balance sheet under the indicated captions.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments:
CASH AND CASH EQUIVALENTS, TRADE ACCOUNTS RECEIVABLE, RELATED PARTY
RECEIVABLES, CURRENT INSTALLMENTS OF LONG-TERM DEBT, TRADE ACCOUNTS
PAYABLE, RELATED PARTY PAYABLE AND ACCRUED EXPENSES: The carrying
amounts approximate fair value because of the short maturity of
those instruments.
NOTES RECEIVABLE: The fair value is determined as the present value
of expected cash flows discounted at the interest rate currently
offered by the Company, which management believes approximates rates
which would be offered by local lending institutions for loans of
similar terms to companies with comparable credit risk.
LONG-TERM DEBT: The fair value of the Company's long-term debt
carries market interest rates; therefore, the current value
approximates market value.
(13) COMMON STOCK PRIVATE PLACEMENTS
In July 1997, pursuant to a Securities Purchase Agreement, the Company's
primary lender, Den norske, purchased 500,000 shares of common stock of
the Company for a price of $2.66 per share, for a total of $1,330,000
($1,132,911 net of placement costs).
F-32
(Continued)
<PAGE>
The Company and Den norske also entered into a Registration Rights
Agreement wherein Den norske was granted certain demand and piggyback
registration rights with respect to the shares purchased.
(14) STOCKHOLDERS' EQUITY
The Company has authorized fifty million (50,000,000) shares of Common
Stock. Outstanding at December 31, 1998 and 1997 are 10,251,853 and
10,193,676 shares, respectively.
The Company has authorized one million (1,000,000) shares of Series 1993
Preferred Stock and two million (2,000,000) shares of Series Preferred
Stock subject to designation by the Board of Directors:
Series 1993 Preferred Stock is convertible into one share of common stock
with a liquidation preference of $12 per share. Dividends are payable
semiannually at the rate of 8% per share based upon the total number of
shares outstanding. Out0standing at December 31, 1998 and 1997 are 230,516
and 268,851 shares, respectively.
Series B Preferred Stock, designated by the Board of Directors, was
convertible into common stock based on a conversion factor of $10.00
divided by 73% of the common stock's closing bid price on the conversion
date. The Series B Preferred Stock had a liquidation preference of $10.00
per share, but was junior to the Series 1993 Preferred Stock. Dividends
were payable quarterly at the rate of 6% in cash or common stock, at the
Company's option. There were 1,000,000 shares authorized and zero shares
outstanding at December 31, 1997. During the first quarter of 1997, the
Company's Board of Directors adopted a resolution eliminating Series B
Preferred Stock and returning the 1,000,000 shares to the status of
authorized but unissued Preferred Stock, without designation. The
Certificate eliminating the Series B Preferred Stock was filed in the
Office of the Secretary of State of Delaware on April 16, 1997.
The Company paid dividends on the Series 1993 Preferred Stock through the
issuance of 19,842 and 21,508 shares of common stock in 1998 and 1997,
respectively.
In April 1997, due to a decline in the market price of the Company's
common stock to a level below its book value, the Board of Directors
authorized the Company to repurchase up to $2 million of the Company's
common stock in market transactions from time to time at prices deemed to
be favorable by the Company. As of December 31, 1998 and 1997, the Company
had acquired 201,890 and 141,410 shares at an average price of $3.54 and
$2.91, respectively, per share.
F-33
(Continued)
<PAGE>
During the fourth quarter of 1997, the Company acquired 50,000 shares of
its common stock from AKS for $5.00 per share pursuant to the put
provisions contained in a Purchase & Sale Agreement dated December 27,
1995.
On January 15, 1999, the Board of Directors declared dividends payable in
common stock on January 22, 1999, to holders of the Series 1993 Preferred
Stock totaling 9,220 shares.
The Company has registered on a Form S-8 registration statement, as
amended, 650,000 shares of common stock to be issued pursuant to its 1994
Employee Stock Compensation Plan (ESC). The ESC provides for stock
compensation through the award of the Company's common stock to persons
whose experience, ability and services are considered valuable. At
December 31, 1998, 321,000 shares have been issued under the ESC at prices
ranging from $1.94 to $8.00 per share.
The Company has reserved and registered under a Form S-8 registration
statement 2,000,000 shares of common stock to be issued pursuant to a 1994
Compensatory Stock Option Plan (CSO). The CSO is a nonstatutory stock
option plan intended as an employment incentive to aid in attracting and
retaining in the employ or service of the Company persons of experience
and ability and whose services are considered valuable.
F-34
(Continued)
<PAGE>
The Company applies APB Opinion 25 in accounting for the CSO and non-plan
options. Accordingly, no compensation cost has been recognized for the CSO
and non-plan options granted in 1998, 1997 or 1996. Had compensation cost
been determined on the basis of fair value pursuant to FASB 123, net
income and earnings per share would have been reduced as follows:
1998 1997 1996
------- ----- ----
(DOLLARS IN THOUSANDS)
INCOME (LOSS) BEFORE INCOME
TAX EXPENSE (BENEFIT)
As reported $(46,224) $(1,847) $ 912
======= ===== ====
Proforma $(46,224) $(1,994) $ 464
======= ===== ====
BASIC EARNINGS PER SHARE
As reported $ (4.61) $ (0.21) $0.14
======== ====== ====
Proforma $ (4.61) $ (0.23) $0.06
======== ====== ====
DILUTED EARNINGS PER SHARE
As reported $ (4.61) $ (0.21) $0.13
======== ====== ====
Proforma $ (4.61) $ (0.23) $0.06
======== ====== ====
The fair value of each option granted is estimated on the grant date using
the Black-Scholes option-pricing model with the following weighted average
assumptions:
1998 1997 1996
---- ---- ----
Dividend Yield N/A -- --
Risk-free interest rate N/A 5.00% 5.73%
Expected life N/A 5 YRS. 4 YRS.
Expected volatility N/A 69.47% 69.47%
A summary of the status of CSO and non-plan options granted to employees,
consultants, officers and directors for the purchase of the Company's
common stock follows:
F-35
(Continued)
<PAGE>
<TABLE>
<CAPTION>
CSO NON-PLAN
------------------------ ------------------------
WEIGHTED WEIGHTED
NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE
SHARES PRICE SHARES PRICE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Balance, December 31, 1997 ....... 1,976,410 $ 5.12 1,143,987 $ 3.83
Granted .......................... -- -- -- --
Exercised ........................ -- -- -- --
Terminated ....................... (237,500) (3.37) (190,000) (3.79)
---------- ---------- ---------- ----------
Balance, December 31, 1998 ....... 1,738,910 $ 5.36 953,987 $ 3.83
========== ========== ========== ==========
Weighted average fair value of
options granted during 1998 .... N/A
==========
</TABLE>
At December 31, 1998, 1,738,910 CSO options and 783,987 non-plan options
were fully vested. The remaining 170,000 non-plan options will vest over
the next one to two years.
<TABLE>
<CAPTION>
CSO NON-PLAN
------------------------ ------------------------
WEIGHTED WEIGHTED
NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE
SHARES PRICE SHARES PRICE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Balance, December 31, 1996 ....... 1,943,910 $ 5.16 1,426,320 $ 4.14
Granted .......................... 37,500 3.00 300,000 3.00
Exercised ........................ -- -- -- --
Terminated ....................... (5,000) (6.00) (582,333) (4.16)
---------- ---------- ---------- ----------
Balance, December 31, 1997 ....... 1,976,410 $ 5.12 1,143,987 $ 3.83
========== ========== ========== ==========
Weighted average fair value of
options granted during 1997 .... $ 1.31
==========
</TABLE>
At December 31, 1997, 1,918,577 CSO options and 843,987 non-plan options
were fully vested. The remaining 57,833 CSO options and 300,000 non-plan
options will vest over the next one to three years.
F-36
(Continued)
<PAGE>
<TABLE>
<CAPTION>
CSO NON-PLAN
------------------------ ------------------------
WEIGHTED WEIGHTED
NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE
SHARES PRICE SHARES PRICE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Balance, December 31, 1995
Granted .......................... 1,484,410 $ 5.42 1,226,320 $ 3.78
Exercised
Terminated ....................... 498,500 4.50 600,000 4.35
---------- ---------- ---------- ----------
Balance, December 31, 1996 ....... (39,000) (6.45) (400,000) (3.38)
---------- ---------- ---------- ----------
Weighted average fair value of
options granted during 1996..... 1,943,910 $ 5.16 1,426,320 $ 4.14
========== ========== ========== ==========
$ 1.66
==========
</TABLE>
The following is a summary of the status of CSO and non-plan options
outstanding at December 31, 1998:
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
------------------------------------ ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE REMAINING EXERCISE EXERCISE
PRICE RANGE NUMBER LIFE PRICE NUMBER PRICE
----------- ------ ---------- ------- ------ ---------
$3.00 - $3.50 537,986 4.3 $3.24 367,986 $3.34
$4.00 - $4.50 1,242,487 2.5 4.24 1,242,487 4.24
$6.00 - $8.00 912,424 5.6 6.54 912,424 6.54
The following is a summary of the status of CSO and non-plan options
outstanding at December 31, 1997:
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
----------------------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE REMAINING EXERCISE EXERCISE
PRICE RANGE NUMBER LIFE PRICE NUMBER PRICE
----------- ------ ---------- ------- ------ ------
$3.00 - $3.60 815,486 4.5 $3.20 515,486 $3.32
$4.00 - $4.80 1,392,487 3.8 4.25 1,334,654 4.44
$6.00 - $8.00 912,424 6.6 6.54 912,424 6.54
F-37
<PAGE>
At December 31, 1998, the Company has reserved 2,180,686 shares of common
stock which are issuable upon the exercise of the following warrants:
In connection with a common stock private placement closed in 1995,
the Company has issued 41.17 Class A Warrants and 41.17 Class B
Warrants. Each Class A and Class B Warrant is convertible to 5,000
shares of common stock. The Class A Warrants have exercise prices of
$3.50 and $5.00 per share, respectively. The Warrants are
exercisable for thirty-six months, commencing October 8, 1997. The
Company has a call right on the Class A and Class B Warrants at a
share price of $5.50 and $7.00, respectively.
The Company has outstanding 200,000 common stock warrants issued in
connection with various consulting agreements. Each Warrant is
convertible into one share of common stock at an exercise price of
$2.75 per share. The warrants expire in May 2000.
In connection with a common stock private placement closed in 1996,
the Company issued 100 1996 Class A Warrants. Each 1996 Class A
Warrant is convertible to 1,650 shares of common stock. The 1996
Class A Warrants are exercisable through October 8, 1999, and have
an exercise price of $4.00 per share.
In conjunction with the purchase of properties from TECO, the
parties entered into a warrant agreement (TECO Warrant Agreement)
granting TECO warrants to acquire 600,000 shares of common stock of
the Company (First Warrants) at a price of $2.67 per share if the
TECO Note was not paid in full by October 1, 1998. Additionally, the
TECO Warrant Agreement granted TECO warrants to acquire common stock
equal to 10% of the Company's outstanding common stock and options
if the TECO Note was not paid in full by October 1, 1998. This
percentage will increase by an additional 5% if the TECO Note is not
paid in full by January 1, 1999, and by an additional 5% if the TECO
Note is not paid in full by April 1, 1999 (collectively, Secondary
Warrants). The price per share of common stock evidenced by the
Secondary Warrants is $.00001. As of December 31, 1998, TECO had
been vested with 600,000 First Warrants and 1,380,504 Secondary
Warrants, all of which are exercisable through July 1, 1999.
The weighted average price of the 2,180,686 shares of common stock
reserved upon exercise of all outstanding warrants is $2.09.
F-38
(Continued)
<PAGE>
(15) RELATED PARTY TRANSACTIONS
Significant related party transactions which are not disclosed elsewhere
in these consolidated financial statements are discussed in the following
paragraphs (see Notes 4, 5, 8, 14, 16, and 19).
In 1998, 1997 and 1996, the Company, pursuant to the terms of an
employment and stock option agreement, has paid or accrued compensation to
the Company's Chairman of $25,500, $40,000 and $60,000, respectively. The
Chairman has been assisting Management in various financing transactions.
In 1998, 1997 and 1996, the Company paid $189,260, $279,421and $276,500,
respectively, to purchase gas from a company owned 20% by a director of
the Company and which participated as a joint venture partner in drilling
various wells in the Appalachian area.
The Company paid or accrued interest of approximately $21,500 during 1996
related to advances and notes payable from Southern Gas Holding Co., Inc.
(SGH), a company primarily owned by a director of the Company. At December
31, 1998 and 1997, the Company has made advances to SGH totaling $464,106
and $230,784, respectively, which the principal of SGH intends to secure
with assets of . However, due to a significant decrease in the value of
the collateral, ARO has fully reserved the receivable from SGH as of
December 31, 1998.
On September 15, 1997, the Company entered into a Letter of Intent with
Prima, a limited liability company in which an officer/director owns a 20%
interest, providing for the acquisition of an interest in certain
producing and non-producing oil and gas properties (the Properties)
located in Mississippi. The purchase price for the Properties was
$2,800,000 payable $1,300,000 on or before closing which occurred October
10, 1997, and the balance of $1,500,000 in an interest bearing note with
recourse only to the Properties, with interest thereon at 1 1/2% over
Prime, payable interest only until March 1998 and amortizing thereafter
over a two year period. The Company already owned up to 3.5% interest in
the Properties; and after reviewing an independent geologist's report on
the Properties, the Letter of Intent was approved by a majority of the
disinterested directors of the Company at a special meeting of the Board
of Directors held on September 15, 1997. As of December 31, 1998 and 1997,
the balance due Prima under the note was approximately $987,160 and $1.5
million, respectively.
(16) LEASES
Future minimum rental payments for operating leases with noncancelable
lease terms in
F-39
(Continued)
<PAGE>
excess of one year are as follows:
YEARS ENDING
DECEMBER 31,
-------------
1999 $106,970
2000 96,874
2001 15,304
-------
$219,148
=======
The Company rents equipment and office space under various operating
leases. Rental expense for the years ended December 31, 1998, 1997 and
1996, was approximately $145,000, $52,000 and $61,200, respectively.
Included in 1998, 1997 and 1996 is $37,800 paid to an officer/director of
the Company related to office space rental. The lease agreement was
effective through February 28, 1998 at a monthly rate of $3,100 and is
currently operating on a month-to-month basis.
(17) DEFINED CONTRIBUTION PLAN
The Company maintains a Defined Contribution Plan (the Plan) for all
full-time employees of the Subsidiaries. Employees are entitled to make
contributions based on their percentage of compensation.
The Company provides a matching contribution up to 5% of each employee's
compensation. For the years ended December 31, 1998, 1997 and 1996,
approximately $69,000, $44,250 and $32,500, respectively, were recognized
as a general and administrative expense for contributions to the Plan.
(18) SIGNIFICANT CUSTOMER CONCENTRATION
The Company's primary market areas are the Appalachian Region of Kentucky
and the Gulf Coast Region. For the years ended December 31, 1998, 1997 and
1996, most of the Company's gas sales are on credit to major industrial or
local distributing companies. Trade receivables are not generally
collateralized; however, the Company's customers' historical and future
credit positions are thoroughly analyzed prior to extending credit. In
certain instances, the Company will require a letter of credit.
APPALACHIAN REGION:
Approximately 86%, 27% and 31% of the Company's gas sales in 1998, 1997
and 1996,
F-40
(Continued)
<PAGE>
respectively, are subject to fixed pricing contracts, while the remainder
are based on spot prices. The Company presently uses its marketing
operations to provide gas supplies to customers solely to meet delivery
requirements when internal production will not suffice. The Company
provides gas supplies to industrial end users and local distributing
companies primarily for commercial use.
Marketing Revenues from major customers are summarized below:
(DOLLARS IN THOUSANDS)
1998 1997 1996
---- ---- ----
$ % $ % $ %
----- ----- ----- ----- ------ -----
Company A - - 9,506 53 15,650 69
Company B 3,481 45 3,119 18 2,543 11
Company C 1,151 15 - - - -
GULF COAST REGION:
The Company sells all of its current Gulf Coast gas production through H&N
Gas, Ltd. The Company sells more than 10% of its Gulf Coast oil production
to Citgo Petroleum Corporation, Texon Corporation, Conoco and through
contracts administered by I.P. Petroleum Company.
(19) COMMITMENTS AND CONTINGENCIES
In December 1995, the Company entered into a severance agreement with its
former President and Chief Executive Officer who resigned effective
December 31, 1995. Under the agreement, the executive was paid $85,000 and
received the sum of $10,000 per month through March 31, 1998. In return,
the executive surrendered 515,590 CSO common stock options under a
Severance Plan which had exercise prices between $6.00 and $8.00 per share
and expired between March 18, 2003, and February 1, 2005. In return, the
executive received 643,987 common stock options at an exercise price of
$4.00 per share and which expire on November 29, 2000. He also retains
46,203 CSO common stock options immediately exercisable, previously issued
to him, at $3.50 per share which expire on October 11, 2002. The Company
also agreed to provide for payment of an office lease through October
1996, and assigned a 1% gross overriding royalty interest in certain oil
and gas properties.
During 1997, the Kentucky Revenue Cabinet assessed Southern Gas for
outstanding sales tax of approximately $1.5 million, plus penalties and
interest, allegedly owed to the Commonwealth of Kentucky by Southern Gas
Company ("SGC"), a dissolved company, prior to Southern Gas' acquisition
of the assets of SGC. During the first quarter of 1999,
F-41
(Continued)
<PAGE>
the Company received notification from the Kentucky Revenue Cabinet that
the Cabinet had accepted the Company's Offer in Settlement in the amount
of $47,499 for any and all outstanding sales and tangible property taxes.
In the normal course of business, the Company enters into short-term
supply and purchase agreements. These agreements can stipulate either a
fixed contract price or a floating price based on spot prices.
Management attempts to schedule deliveries to mitigate any possible
adverse effects of changing prices; however, gas prices are susceptible to
change due to industry supply and demand positions.
(20) GOING CONCERN ASSUMPTION
As of December 31, 1998, the Company had current liabilities in excess of
current assets of approximately $6.3 million (excluding current portion of
long-term debt), was not in compliance with its primary credit facility
and bridge loans with DNB in the approximate amounts of $48 million and
$15.6 million, respectively, and was in default under its $18.5 million
loan with TECO. As more particularly described in Item 1, "Description of
Business--Overview," of this Report on Form 10-K, this situation is
primarily the result of: i) the lack of available outside funding to
complete the scheduled refinancing of interim loans and capital
expenditures associated with the acquisition and development of properties
from TECO; ii) the decline of production in oil and gas prices; iii) the
more than 60% decline in the Company's two largest producing fields; and
iv) the approximately $16 million in trade payables incurred as a result
of the capital requirements for the development of additional wells, a
substantial portion of which were settled subsequent to year-end 1998 for
less than face value and reflected in the December 31, 1998 financial
statements.
It is important to note that DNB has not yet demanded payment nor has it
agreed to extend the term of the bridge loans; and TECO is a party to an
agreement between the Company and DNB which substantially limits TECO's
remedies against the Company unless the Bank is paid in full or declares a
default and takes affirmative action against the Company (see Note 5 for
further discussion).
The Company has taken the following measures in an attempt to remedy the
above deficiencies:
On October 29, 1998, the Company's wholly-owned subsidiary, American
Resources Offshore, Inc., was merged into the Company for the purpose of
reducing administrative expenses.
F-42
(Continued)
<PAGE>
During the fourth quarter of 1998, the Board of Directors authorized and
the Company entered into discussions with third parties for the sale of
its Appalachian properties. In the event the Company sells these
properties, the proceeds will be used to reduce its outstanding
indebtedness to DNB, which would also result in a substantial reduction of
interest expenses. Further, the sale of these properties would result in
an additional reduction of the Company's administrative expenses.
During the first quarter of 1999, the Company settled approximately $12
million of trade payables incurred as a result of the capital requirements
for the development of additional wells by surrendering its interest in
its Grand Isle Block 55 wells to the operator of the wells.
ARO's Management continues to explore all possible alternatives for the
restructuring of the company, including the refinancing of debt and
possible business combinations with third parties.
The financial statements do not include any adjustments at December 31,
1998, to reflect the recoverability and classification of assets or the
amounts and classification of liabilities that might result from the
outcome of the Company's uncertain immediate future.
F-43
(Continued)
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
The following supplemental information regarding oil and gas activities of the
Company is presented pursuant to the disclosure requirements promulgated by the
Securities and Exchange Commission (SEC) and Statement of Financial Accounting
Standards No. 69 (SFAS No. 69), "Disclosures About Oil and Gas Producing
Activities."
1998 1997 1996
--------- --------- ---------
(Dollars in thousands)
CAPITALIZED COSTS RELATING TO OIL AND
GAS PRODUCING ACTIVITIES:
Proved undeveloped oil and gas
properties .......................... $ 8,590 $ 4,193 $ 4,193
Proved oil and gas properties ......... 51,112 45,096 38,257
Unproved oil and gas properties ....... 38,459 7,884 5,686
Support equipment and facilities ...... 10,547 8,190 8,062
--------- --------- ---------
108,708 65,363 56,198
Less accumulated depreciation, depletion,
amortization, and impairment .......... (67,453) (16,737) (5,704)
--------- --------- ---------
Net capitalized costs ............... $ 41,255 $ 48,626 $ 50,494
========= ========= =========
COSTS INCURRED IN OIL AND GAS PRODUCING
PROPERTY ACQUISITION, EXPLORATION AND
DEVELOPMENT ACTIVITIES:
Property acquisition costs:
Proved .............................. $ 19,119 $ 3,715 $ 18,440
Unproved ............................ 43,005 3,794 2,925
Exploration costs ..................... -- 929 --
Development costs ..................... 9,834 1,357 3,315
--------- --------- ---------
$ 71,958 $ 9,795 $ 24,680
========= ========= =========
RESULTS OF OPERATIONS FOR OIL AND GAS
ACTIVITIES:
Oil and gas sales ..................... $ 26,724 $ 19,457 $ 8,540
Gain (loss) on sale of oil and gas
properties .......................... -- -- (152)
Exploration costs ..................... (5,056) (785) --
Production costs ...................... (4,967) (2,584) (1,402)
Depreciation, depletion, and .......... (13,403) (7,676) (2,432)
amortization......................... (34,735) (3,596) --
--------- --------- ---------
Impairment of oil and gas properties
Results of operations for oil and gas
producing activities (excluding
corporate overhead) ................ $ (31,437) $ 4,816 $ 4,554
========= ========= =========
F-44
(Continued)
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Reserve Quantity Information for the Year Ended December 31, 1998, 1997 and
1996:
The following estimates of proved developed and proved undeveloped reserve
quantities, and related standardized measure of discounted net cash flow, are
estimates only and have been provided by Richard M. Russell & Associates, Inc.
(Kentucky/Appalachian Region properties); Netherland, Sewell & Associates, Inc.
(Gulf Coast Region properties of South Timbalier 148 and Ship Shoal 150); Ryder
Scott Company (all Gulf Coast Region properties except South Timbalier 148 and
Ship Shoal 150); and McConnell Consulting, Inc. (Michigan properties),
independent engineering consulting firms. The amounts do not purport to reflect
realizable values or fair market values of the Company's reserves. The Company
emphasizes that reserve estimates are inherently imprecise and that estimates of
new discoveries are more imprecise than those of currently producing oil and gas
properties. Accordingly, these estimates are expected to change as future
information becomes available. All of the Company's reserves are located in the
United States, and primarily in the State of Kentucky and the Gulf Coast Region.
The success of future development efforts and the amount, timing and costs
thereof may significantly increase or decrease the Company's total unproved and
proved developed reserve volumes, the "Standardized Measure of Discounted Future
Net Flows," and the components and changes therein.
Proved reserves are estimated reserves of crude oil (including condensate and
natural gas liquids), and natural gas that geological and engineering data
demonstrate with reasonable certainty to be recoverable in future years from
known reservoirs under existing economic and operating conditions. Proved
developed reserves are those expected to be recovered through existing wells,
equipment, and operating methods. Gas volumes are expressed in millions of cubic
feet and oil reserves in thousands of barrels.
F-45
(Continued)
<PAGE>
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ------------------ ------------------
OIL GAS OIL GAS OIL GAS
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Proved developed and undeveloped reserves:
Beginning of year ...................... 1,385 35,917 1,202 35,692 756 24,741
Revisions of previous
estimated ............................. (407) (6,787) 137 (4,378) (45) (2,346)
Purchases of minerals in
place ................................. 269 25,911 268 3,714 691 18,373
Extensions and discoveries ............. 50 5,506 204 5,468 -- --
Production ............................. (374) (9,428) (426) (4,579) (200) (1,830)
Sales and transfers of
minerals in place ..................... (38) (1,888) -- -- -- (3,246)
------- ------- ------- ------- ------- -------
Total proved developed &
undeveloped reserves .................... 885 49,231 1,385 35,917 1,202 35,692
======= ======= ======= ======= ======= =======
Proved developed reserves:
Beginning of year ...................... 1,092 30,175 909 29,033 756 19,702
End of year ............................ 665 38,702 1,092 30,175 909 29,033
======= ======= ======= ======= ======= =======
</TABLE>
F-46
(Continued)
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS AND CHANGES THEREIN
RELATING TO PROVED OIL AND GAS RESERVES AS OF DECEMBER 31, 1998, 1997 AND
1996:
The standardized measure of discounted future net cash flows is computed by
applying year-end prices of oil and gas (with consideration of price changes
only to the extent provided by contractual arrangements) to the estimated future
production of proved gas reserves, less estimated future expenditures (based on
year-end costs) to be incurred in developing and producing the proved reserves,
less estimated future income tax expenses (based on year-end statutory tax
rates, with consideration of future tax rates already legislated) to be incurred
on pre-tax net cash flows less tax basis of the properties and available
credits, and assuming continuation of existing economic conditions. The
estimated future net cash flows are then discounted using a rate of 10% a year
to reflect the estimated timing of the future cash flows.
The average crude oil price at year-end 1998 and 1997 used for this calculation
was $9.53 and $16.47, respectively, per barrel. The average natural gas price
used was $2.13 and $2.83, respectively, for Gulf Coast, $2.46 and $2.45,
respectively, for Kentucky Region and $0 and $2.41, respectively, for Michigan.
In general, oil and natural gas prices declined in early 1997 and continued to
decline in 1998.
At December 31, 1998, 1997 and 1996, the Company's future discounted net cash
flow from proved reserves was located as follows:
KENTUCKY GULF COAST MICHIGAN TOTAL
------- ------- ------- -------
(DOLLARS IN THE THOUSANDS)
1998 $13,389 $38,033 -- $51,422
1997 $18,636 $29,092 $ 45 $47,773
1996 $16,972 $41,679 $ 1,299 $59,950
======= ======= ======= =======
At December 31, 1998, 1997 and 1996, the South Timbalier 148 Field accounted for
approximately 14%, 38% and 0%, respectively, of the Company's future net cash
flows from proved reserves in the Gulf Coast Region. Other fields with a
significant percentage of proved
F-47
(Continued)
<PAGE>
reserved at December 31, 1998, were West Cameron 172 and South Timbalier 211,
with 21.4% and 20%, respectively, of proved reserves. Both West Cameron 172 and
South Timbalier 211 were a part of the TECO acquisition in 1998. At December 31,
1998, 1997 and 1996, the Gausdale Field accounted for approximately 61%, 67% and
58% of the Company's future net cash flows from proved reserves in the Kentucky
Region.
F-48
(Continued)
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Standard measure of discounted future net cash flows at December 31:
Future cash inflows .............................................. $ 110,468 $ 113,391 $ 124,117
Future production costs .......................................... (20,206) (20,925) (16,015)
Future development costs ......................................... (10,703) (6,982) (8,893)
Future taxes ..................................................... (1,679) (2,759) (2,501)
--------- --------- ---------
77,880 82,725 96,708
Future net cash flows, 10% annual
discount for estimated timing of cash
flows ............................................................. (26,458) (34,952) (36,758)
--------- --------- ---------
Standardized measure of discounted
future net cash flows relating to
proved gas reserves ........................................... $ 51,422 $ 47,773 $ 59,950
========= ========= =========
<CAPTION>
The following reconciles the change in the standardized measure of discounted future net cash flows
during the years 1998, 1997 and 1996:
1998 1997 1996
--------- --------- ---------
Beginning of year .................................................. $ 47,773 $ 59,950 $ 29,448
Sales of gas produced, net of production
costs ............................................................. (21,833) (16,874) (7,138)
Net changes in prices and production costs ......................... (8,315) (8,580) 4,933
Extensions and discoveries ......................................... 4,436 9,476 --
Revisions of previous quantity estimates ........................... (7,422) (4,970) (2,660)
Change from purchases of minerals in place ......................... 35,666 3,947 36,341
Change from sale and transfers of minerals in
place ............................................................. (2,812) -- (2,362)
Changes in future development ...................................... (1,295) -- --
Changes in future taxes ............................................ 937 (117) 42
Accretion of discount .............................................. 4,777 3,811 2,656
Changes in timing and other ........................................ (490) 1,130 (1,310)
--------- --------- ---------
End of year ................................................... $ 51,422 $ 47,773 $ 59,950
========= ========= =========
</TABLE>
The change from purchases of minerals in place reflects the Company's
acquisition of properties from TECO in 1998 and the South Timbalier 148 lease
block located offshore Louisiana and various fields located in Kentucky from AKS
in 1996.
F-49
(Continued)
<PAGE>
The Financial Statements of American Resources Offshore, Inc. ("ARO") for
the nine months ended September 30, 1999 and 1998 include, in the opinion of the
Company, all adjustments (which consist only of normal recurring adjustments)
necessary to present fairly the results of operations for such periods. Results
of operations for the nine months ended September 30, 1999, are not necessarily
indicative of results of operations which will be realized for the year ending
December 31, 1999. The Financial Statements should be read in conjunction with
ARO's Report on Form 10-K for the year ended December 31, 1998.
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
CONDENSED, CONSOLIDATED FINANCIAL
---------------------------------
STATEMENTS
----------
FOR THE NINE MONTHS ENDED
-------------------------
SEPTEMBER 30, 1999 AND 1998
---------------------------
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
CONDENSED, CONSOLIDATED BALANCE SHEETS
--------------------------------------
ASSETS
------
SEPTEMBER 30,
1999 DECEMBER 31,
(UNAUDITED) 1998(*)
--------- ---------
(DOLLARS IN THOUSANDS)
Current assets:
Cash and cash equivalents .................. $ 601 $ 255
Accounts and notes receivable, net ......... 2,429 4,214
Deferred tax asset ......................... -- 298
Prepaid expenses and other ................. 1,362 689
--------- ---------
Total current assets .................... 4,392 5,456
--------- ---------
Oil and gas properties, at cost
(successful efforts method) ................. 79,997 98,161
Property and equipment, at cost .............. 197 14,645
--------- ---------
80,194 112,806
Less accumulated depreciation,
depletion and amortization ................. (34,474) (44,253)
--------- ---------
Net property and equipment .............. 45,720 68,553
--------- ---------
Other assets ................................. 167 2,215
--------- ---------
Total Assets ............................ $ 50,279 $ 76,224
========= =========
(Continued)
*Derived from audited financial statements.
See accompanying notes to condensed, consolidated financial statements.
2
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
CONDENSED, CONSOLIDATED BALANCE SHEETS (CONTINUED)
--------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
---------------------------------------------------------
SEPTEMBER 30,
1999 DECEMBER 31,
(UNAUDITED) 1998(*)
-------- --------
(DOLLARS IN THOUSANDS)
Current liabilities
Current portion of long-term debt ................ $ -- $ 64,033
Debt in default .................................. 70,462 18,500
Accounts payable-Trade ........................... 1,678 7,162
Unearned revenue ................................. 215 667
Accrued interest ................................. 7,931 2,979
Accrued expenses and other ....................... 1,932 610
-------- --------
Total current liabilities ..................... 82,218 93,951
-------- --------
Long-term debt, excluding current portion .......... -- 706
Unearned revenue ................................... -- 2,971
Deferred tax liability ............................. -- 298
Stockholders' equity (capital deficiency):
Series 1993 8% convertible preferred stock,
par value and liquidation preference
$12.00 per share; 1,000,000 shares
authorized .................................... 1,871 1,871
Common stock, par value $.00001 per share;
50,000,000 shares authorized .................. -- --
Additional paid-in capital ....................... 22,867 22,860
Retained earnings (deficit) ...................... (55,964) (45,720)
Treasury stock at cost ........................... (713) (713)
-------- --------
Total stockholders' equity
(capital deficiency) ........................ (31,939) (21,702)
-------- --------
Commitments and contingencies
-------- --------
Total liabilities and stockholders'
equity (capital deficiency) ................. $ 50,279 $ 76,224
======== ========
*Derived from audited financial statements.
See accompanying notes to condensed, consolidated financial statements.
3
<PAGE>
AMERICAN RESOURCES OF DELAWARE, INC.
------------------------------------
CONDENSED, CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
-----------------------------------------------------------
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
------------------------------------------------------------
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------- --------------------
1999 1998 1999 1998
-------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Operating revenues:
Oil and gas production ....... $ 2,828 $ 6,702 $ 12,282 $ 21,429
Transportation ............... -- 206 368 596
Marketing .................... -- 1,804 3,795 5,796
Other ........................ 153 319 2,125 746
-------- -------- -------- --------
2,981 9,031 18,570 28,567
-------- -------- -------- --------
Operating expenses:
Oil and gas production ....... 862 1,331 2,306 4,184
Exploration costs ............ 1,625 1,314 2,416 2,324
Transportation ............... -- 50 115 180
Marketing .................... 148 1,905 4,192 5,865
Depreciation, depletion
and amortization ............ 2,445 4,156 9,420 12,666
Impairment of assets ......... 319 -- 365 2,168
Administrative expenses ...... 955 889 3,266 2,476
Other ........................ -- 26 56 78
-------- -------- -------- --------
6,354 9,671 22,136 29,941
-------- -------- -------- --------
Operating income (loss) ........ (3,373) (640) (3,566) (1,374)
Other income (expense):
Interest expense ............. (2,007) (2,122) (6,560) (5,249)
Gain on sale of assets ....... 194 141
Other ........................ 12 26 (252) 78
-------- -------- -------- --------
(1,801) (2,096) (6,671) (5,171)
-------- -------- -------- --------
Income (loss) before
income tax expense
(benefit) ................ (5,174) (2,736) (10,237) (6,545)
Income tax expense (benefit) ... -- (790) -- (2,391)
-------- -------- -------- --------
Net income (loss) ......... (5,174) (1,946) (10,237) (4,154)
Preferred dividends ............ (7) (21) (7) (49)
-------- -------- -------- --------
Net income (loss) attributable
to common shares ............... $ (5,181) $ (1,967) $(10,244) $ (4,203)
======== ======== ======== ========
Per common share:
Basic ........................ $ (0.42) $ (0.20) $ (0.92) $ (0.42)
======== ======== ======== ========
Weighted average number of
common shares outstanding ..... 12,442 10,045 11,195 10,022
======== ======== ======== ========
Diluted ...................... $ (0.42) $ (0.20) $ (0.92) $ (0.42)
======== ======== ======== ========
Weighted average number of
common shares and dilutive
potential common shares ........ 12,442 10,045 11,195 10,022
======== ======== ======== ========
4
See accompanying notes to condensed, consolidated financial statements.
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
CONDENSED, CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
-----------------------------------------------------------
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
1999 1998
-------- --------
(DOLLARS IN THOUSANDS)
Net cash provided by (used in) operating
activities ......................................... $ (161) $ 31,373
-------- --------
Investing activities:
Purchases of oil and gas property
and equipment ................................... (300) (86,404)
Proceeds from sale of assets ....................... 601 1,251
Other .............................................. 483 102
-------- --------
Net cash provided by (used in)
investing activities .......................... $ 784 $(85,051)
-------- --------
Financing activities:
Proceeds from borrowings ........................... -- 59,273
Payments on borrowings ............................. (277) (5,275)
Deferred financing costs ........................... -- (1,040)
-------- --------
Net cash provided by (used by)
financing activities .......................... $ (277) $ 52,958
-------- --------
Increase (decrease) in cash ..................... 346 (720)
Cash and cash equivalents at beginning of period ..... 255 1,181
-------- --------
Cash and cash equivalents at end of period ........... $ 601 $ 461
======== ========
NON-CASH TRANSACTIONS:
The Company declared stock dividends and issued 18,442 and 19,842 shares of
Common Stock to holders of the Series 1993 and Series B Preferred Stock during
the nine months ended September 30, 1999 and 1998, respectively.
See accompanying notes to condensed, consolidated financial statements.
5
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
(1) GENERAL
American Resources Offshore, Inc. (ARO or the Company) (formerly known as
American Resources of Delaware, Inc.), a Delaware corporation organized on
August 14, 1992, is an independent oil and gas company engaged in the
acquisition, exploration, development and production of oil and gas
properties offshore Louisiana and offshore Texas (Gulf Coast Region). These
activities are considered to be one business segment for financial
reporting purposes. Until July 1, 1999, the Company was also engaged in the
acquisition, exploration, development and production of oil and gas in
southeastern Kentucky (Appalachian Region) as well as gathered and marketed
natural gas in the Appalachian Region.
The Company sold its Appalachian oil and gas operations effective July 1,
1999 and the capital stock of its subsidiary effective at the close of
business on September 30, 1999 (see Note 2).
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with instructions to Form 10-Q and, therefore,
do not include all disclosures required by generally accepted accounting
principles. However, in the opinion of management, these statements include
all adjustments, which are of a normal recurring nature, necessary to
present fairly the financial position at September 30, 1999 and December
31, 1998 and the results of operations and changes in cash flows for the
periods ended September 30, 1999 and 1998. These financial statements
should be read in conjunction with the financial statements and notes to
the financial statements in the 1998 Form 10-K of the Company which was
filed with the Securities and Exchange Commission.
Basic and diluted income per common share were computed after consideration
of dividend requirements on Preferred Stock, using the weighted average
number of shares outstanding and the weighted average number of common
shares and dilutive potential common shares outstanding, respectively,
during each of the years presented. Outstanding stock options and warrants
are potential Common Stock equivalents and have been considered when the
effect is dilutive.
Certain reclassifications have been made to the prior period financial
statements to conform with the current period presentation.
(2) PROPERTY AND EQUIPMENT
On March 5, 1998, the Company purchased interests in 41 leaseblocks in the
Gulf of Mexico from TECO Oil & Gas, Inc. (TECO). The purchase consists of
an average 30% interest in approximately 198,300 acres containing 5
producing wells and approximately $35 million PV10 of proved reserves as of
December 31, 1997; partnership interests in Louisiana Offshore Ventures and
Texas 3D Ventures and access to approximately 12,500 square miles of 3-D
seismic data. ARO has participated in the drilling and completion of six
wells on the properties since they were acquired. The development and
completion of three of these wells, Galveston 213 and West Cameron 172 #16
and #18 wells, has resulted in current production in excess of 6 million
cubic feet of gas equivalent per day (MMcfe/d).
Currently, 4 wells acquired from TECO are producing 7 MMcfe/d.
6
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
During the third quarter of 1999, the Company entered into an agreement to
sell its Appalachian oil and gas operations to Nami Resources Company, LLC
(Nami Resources), an unrelated third party, effective July 1, 1999 in
exchange for the assumption of $12.5 million of indebtedness from DNB. This
transaction was completed and is more fully discussed in the Proxy
Statement for the Company's 1999 Annual Meeting of Stockholders (the 1999
Proxy Statement). The 1999 Proxy Statement was filed with the Securities &
Exchange Commission on November 4, 1999 and sets a date of December 1, 1999
for the Annual Meeting of Stockholders. The Company recognized a gain of
approximately $990,000 during the third quarter of 1999 in connection with
the sale.
On August 3, 1999, the Company executed a Purchase and Sale Agreement for
the divestiture of an undivided 80% interest in its Gulf of Mexico
properties to Fidelity Oil Holdings, Inc. (Fidelity) and an Investment
Agreement for the sale of a 75% ownership interest in the Company through
the issuance of new shares of common stock to Blue Dolphin Exploration
Company (BDEX). The total purchase price for the Company's stock and Gulf
of Mexico properties is approximately $30.25 million and is subject to
adjustments for operations of the Company from the effective date of
January 1, 1999. The Closing of these transactions is subject to numerous
conditions, including but not limited to, shareholder approval,
simultaneous closing of each transaction, satisfaction of all debts and
obligations of the Company as of December 31, 1998 and the consent of the
Company's primary lender, DNB Energy Assets, Inc. (DNB), successor to Den
norske Bank, AS (Den norske). In order to assure that the Company's
representations in the Investment Agreement will be accurate post-closing,
BDEX will acquire a portion of the secured indebtedness from DNB at a
nominal cost to BDEX. At a post-closing date to be determined, the
Company's indebtedness will be cancelled once BDEX has confirmed that the
Company has complied fully with its representations, warranties, and
obligations. There are no assurances the Company will be able to satisfy
this requirement; and in that event, BDEX would have the right to enforce
the secured indebtedness. Additionally, prior to closing, the Company has
significant restrictions on its operations pursuant to the terms of the
Investment Agreement, a copy of which is attached to the Company's Report
on Form 8-K filed on August 6, 1999. This transaction is more fully
discussed in the Company's 1999 Proxy Statement. The Company anticipates
that the closing of the Fidelity and BDEX transaction will occur during the
fourth quarter of this year.
Pursuant to the terms of the Company's Investment Agreement with BDEX,
effective at the close of business on September 30, 1999, the Company sold
the capital stock of its wholly-owned subsidiary, Southern Gas Co. of
Delaware, Inc. (Southern) to Southern Gas Holding, LLC (Holding), a
Kentucky limited liability company which is owned by Leonard K. Nave and a
family trust in which Mr. Nave is the trustee. Due to the sale of the
Appalachian oil and gas operations to Nami Resources, the only remaining
assets of Southern were volumetric production payments receivable and tax
refunds receivable with an aggregate book value of $226,000. However,
Southern is a party to litigation filed in Federal Bankruptcy Court by
Wright Enterprises, has continuing obligations under the sale to Nami
Resources, has liabilities of approximately $68,000 and has unknown
contingent liabilities. Mr. Nave is a director of the Company. Holding
acquired the shares for a nominal amount in return for a full indemnity for
all past operations and activities, a full release from lease obligations
on the office in Versailles, Kentucky, and a termination and release of any
severance rights from Mr. Nave.
7
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
(3) LONG-TERM DEBT
A summary of long-term debt follows:
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- --------------
(DOLLARS IN THOUSANDS)
Borrowings under the Company's
credit facility, as amended,
with DNB, reduction subject to
availability under borrowing base,
$51,223,000 available borrowing
base as of September 30, 1999;
commencing January 1, 1999,
interest payable monthly at the
Floating Rate, or LIBO Rate
plus 2 1/2%; secured by oil
and gas properties, equipment and
receivables............................... $ 51,223 $ 48,173
Term Loan A payable to DNB, due
December 31, 1998, with interest
payable monthly at the Floating Rate
plus 1%, or LIBO Rate plus 4% per
annum; secured by oil and gas
properties................................ - 15,000
Term Loan B payable to DNB, due
December 31, 1998, with interest
payable monthly at the Floating Rate
plus 1%, or LIBO Rate plus 4% per
annum; secured by oil and gas
properties................................ - 550
Note payable to TECO Oil & Gas,
Inc., with a current interest
rate of 18% per annum. The
note matured October 1, 1998............... 18,500 18,500
Note payable to related party,
recourse only to specific properties,
interest payable at prime rate plus 1%
in connection with the purchase of oil and gas
properties from Prima Capital, LLC......... 739 987
Other notes - 29
------------- --------------
70,462 83,239
Less - Current portion - (64,033)
Less - Debt in default 70,462 (18,500)
------------- --------------
Long-term debt $ - $ 706
============= ==============
8
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
On September 28, 1995, the Company entered into a $20 million revolving
credit facility through February 1, 2002 with Den norske Bank, AS (Den
norske). By November 1, 1997, the revolving credit facility had been
increased to $75 million and the available borrowing base was increased to
$30 million. On March 5, 1998, the borrowing base under the revolving
credit facility was assigned to DNB Energy Assets, Inc. (DNB), successor to
Den norske, and increased to $50 million to facilitate the purchase of oil
and gas properties from TECO. As of June 15, 1999, the Company was not in
compliance with the required financial covenants in the credit agreement;
and the Company had also not made the monthly principal reductions required
in 1999. Therefore, the Bank declared the Company to be in default under
its credit facility on that date.
On March 5, 1998, DNB also provided bridge loans totalling $16.5 million in
order for the Company to complete the acquisition of the TECO properties.
The bridge loans, as amended, matured on December 31, 1998. On June 15,
1999, DNB also declared ARO to be in default under the bridge loans which
had a balance due of $15.6 million.
Effective August 1, 1999, the Company and DNB entered into a Third
Amendment to First Amended and Restated Credit Agreement which combined the
original promissory notes under the credit facility and bridge loans, with
a current outstanding principal balance of $63,723,000, into two promissory
notes: i) a note in the amount of $51,223,000 which is the primary
obligation of the Company; and ii) a note in the amount of $12,500,000
which is the primary obligation of Southern and guaranteed by the Company.
Under the terms of the Guaranty Agreement entered into between the Company
and DNB, the Company would be released from its guarantee of the Southern
note at such time as the Appalachian oil and gas operations of Southern
were sold. The sale of Southern's Appalachian oil and gas operations was
completed; therefore, the Company is no longer a guarantor of the loan. Due
to the fact that the Company's debt to DNB continues to be in default, it
is classified as current in the accompanying balance sheets.
In order to complete the acquisition of the TECO properties, on March 5,
1998, the Company executed a note in favor of TECO in the amount of $18.5
million (the TECO Note). As of September 30, 1999, the TECO Note bears
interest at the rate of 18% per annum. The TECO Note matured on October 1,
1998, and is secured by a second lien on all properties of the Company. On
March 6, 1999, TECO sold the TECO Note to R. Hale Energy Services, Inc.
(Hale Energy). Effective July 26, 1999, the Company entered into a
Settlement Agreement with Hale Energy under which Hale Energy agreed to
release the Company from all of its liabilities relating to the TECO Note
in exchange for approximately $990,400 cash to be paid at or prior to the
closing of the transaction with Fidelity and BDEX (see Note 2).
In addition to the TECO Note, the parties entered into a warrant agreement,
more particularly described in Note 4 hereof, which grants TECO certain
rights to acquire stock in the Company, together with the right to appoint
two members to the Company's Board of Directors. The Company has not made
any payments on the TECO Note; therefore, by letter dated October 2, 1998,
TECO notified the Company that its nonpayment of principal and interest
constitutes an Event of Default under the Credit Agreement. Therefore, this
debt is classified as current in the accompanying balance sheets. As of
September 30, 1999, TECO has exercised its rights to acquire 2,751,852
shares of common stock in the Company. The warrant agreement expired by its
own terms on July 1, 1999, and TECO has waived its right to appoint members
to the Company's Board of Directors.
9
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
(4) STOCKHOLDERS' EQUITY
The Company has authorized fifty million (50,000,000) shares of Common
Stock. Outstanding at September 30, 1999 and December 31, 1998 are
13,022,147 and 10,251,853 shares,
respectively.
The Company has authorized one million shares (1,000,000) shares of Series
1993 Preferred Stock and two million shares (2,000,000) of Series Preferred
Stock subject to designation by the Board of Directors:
Series 1993 Preferred Stock is convertible into one share of common
stock with a liquidation preference of $12 per share. Dividends are
payable semiannually at the rate of 8% per annum in common stock.
230,516 shares are outstanding at September 30, 1999 and December 31,
1998.
On January 15, 1999 and July 15, 1999, the Board of Directors declared
dividends payable in Common Stock on January 22, 1999 and July 22, 1999,
respectively, to holders of the Series 1993 Preferred Stock totaling 9,221
shares and 9,221 shares, respectively.
In conjunction with the purchase of properties from TECO, the parties
entered into a warrant agreement (TECO Warrant Agreement) granting TECO
warrants to acquire 600,000 shares of common stock of the Company (First
Warrants) at a price of $2.67 per share if the TECO Note was not paid in
full by October 1, 1998. Additionally, the TECO Warrant Agreement granted
TECO warrants to acquire common stock equal to 10% of the Company's
outstanding common stock and options if the TECO Note was not paid in full
by October 1, 1998. This percentage increased by an additional 5% on
January 1, 1999, and by an additional 5% on April 1, 1999 (collectively,
Secondary Warrants). The price per share of common stock evidenced by the
Secondary Warrants is $.00001. On June 15, 1999, TECO exercised its rights
under the Warrant Agreement to acquire 2,004,693 shares of the Company's
common stock. By letter dated June 29, 1999, TECO exercised the balance of
its Secondary Warrants for 747,159 common shares, and the shares were
issued on July 28, 1999. Therefore, a total of 2,751,852 common shares were
issued to TECO pursuant to the TECO Warrant Agreement. The 600,000 First
Warrants expired by their own terms on July 1, 1999.
The following tables illustrate the reconciliation of the numerators and
denominators of the basic and diluted earnings per common share
computations for (loss) income related to the unexercised stock options
outstanding for the quarter ended September 30, 1999 and 1998,
respectively.
10
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
Quarter ended Quarter Ended
September 30, 1999 September 30, 1998
------------------ ------------------
Per Per
thousands except Net Share Net Share
per share amounts (Loss) Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
Basic earnings
(loss) per share
Income (Loss)
available to common
stockholders $(5,181) 12,442 $(0.42) $(1,967) 10,045 $(0.20)
------ ------
Potential common shares - - - -
------- ------ ------- ------
Diluted earnings
per share
Income (Loss)
available to common
stockholders $(5,181) 12,442 $(0.42) $(1,967) 10,045 $(0.20)
======= ====== ====== ======= ====== ======
(5) INCOME TAXES
The Company has not recorded a tax benefit in the period ended September
30, 1999 because there is a net operating loss carryover for financial
statement purposes.
(6) COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company enters into short-term supply
and purchase agreements. These agreements can stipulate either a fixed
contract price or a floating price based on spot prices.
ARO sells substantially all of its current Gulf Coast Region gas production
through the respective operators of the wells. ARO utilizes forward sales
contracts for a significant portion of its Gulf Coast Region gas production
to achieve more predictable cash flows and to reduce the effect of
fluctuations in gas prices. During the third quarter of 1999, ARO's Gulf
Coast Region production averaged 17.1 MMcfe per day. At September 30, 1999,
ARO had forward sales arrangements through August 2000 with respect to 5
MMcfe per day at an average price of $2.75 per thousand cubic feet ("Mcf").
During 1998, ARO sold call options for 20 MMcfe per day at a call price of
$2.70 per Mcf, expiring in March 2000. In exchange for establishing a
ceiling of $2.70 per Mcf over the option term, ARO received an average
option premium of $0.14 per Mcf on the volumes contracted for under the
call option agreement. These contracts were terminated in January 1999 at a
profit of $680,114. Effective April 1, 1999, the Company entered into call
options for 10 MMcf of gas per day at a call price of $2.75, expiring March
31, 2001. In exchange for establishing a ceiling of $2.75 over the option
term, ARO received an average option premium of $0.055 per Mcf on the
volumes contracted for under the call option agreement. On July 23, 1999,
the Company terminated these contracts at no profit or loss. Effective
October 1, 1999, the Company entered into call options for 5 MMcf of gas
per day at a call price of $3.25, expiring September 30, 2000. In exchange
for establishing a ceiling price of $3.25 over the option term, ARO
received an average option premium of $0.1175 per Mcf. In total, a loss of
$222,126, included in production revenues, was recognized in the first nine
months of 1999 relating to losses from hedging transactions. In the first
nine months of 1998, a profit of $996,494 was recognized.
11
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
ARO continuously reevaluates its sales contracts in light of market
conditions, commodity price forecasts, capital spending plans and debt
service requirements.
Management attempts to schedule deliveries to mitigate any possible adverse
effects of changing prices; however, gas prices are susceptible to change
due to industry supply and demand positions.
(7) GOING CONCERN ASSUMPTION
As of September 30, 1999, the Company has current liabilities in excess of
current assets of approximately $78 million and is in default under its
loan with DNB in the approximate amount of $51 million as well as in
default under its $18.5 million loan with TECO.
The Company has taken the following measures in an attempt to remedy the
above deficiencies:
On October 29, 1998, the Company's wholly-owned subsidiary, American
Resources Offshore, Inc., was merged into the Company for the purpose
of reducing administrative expenses; and the Company assumed the name
of American Resources Offshore, Inc. at that time.
During the fourth quarter of 1998, the Board of Directors authorized
and the Company entered into discussions with third parties for the
sale of its Appalachian properties. During the third quarter of 1999,
the Company entered into an agreement to sell its Appalachian oil and
gas operations to Nami Resources, an unrelated third party, effective
July 1, 1999 in exchange for the assumption of $12.5 million of
indebtedness from DNB. This transaction was completed and is more
fully discussed in the Company's 1999 Proxy Statement.
During the first quarter of 1999, the Company settled approximately
$12 million of trade payables incurred as a result of the capital
requirements for the development of additional wells by surrendering
its interest in its Grand Isle Block 55 wells to the operator of the
wells. This settlement was reflected in the Company's December 31,
1998 financial statements.
On August 3, 1999, the Company executed a Purchase and Sale Agreement
for the divestiture of an undivided 80% interest in its Gulf of Mexico
properties to Fidelity and an Investment Agreement for the sale of a
75% ownership interest in the Company through the issuance of new
shares of common stock to BDEX. The total purchase price for the
Company's stock and Gulf of Mexico properties is approximately $30.25
million and is subject to adjustments for operations of the Company
from the effective date of January 1, 1999. The Closing of these
transactions is subject to numerous conditions, including but not
limited to, shareholder approval, simultaneous closing of each
transaction, satisfaction of all debts and obligations of the Company
as of December 31, 1998 and the consent of the Company's primary
lender, DNB. In order to assure that the Company's representations in
the Investment Agreement will be accurate post-closing, BDEX will
acquire a portion of the secured indebtedness from DNB at a nominal
cost to BDEX. At a post-closing date to be determined, the Company's
indebtedness will be cancelled once BDEX has confirmed that the
Company has complied fully with its representations, warranties, and
obligations. There are no assurances the Company will be able to
satisfy this requirement; and in that event, BDEX would have the right
to enforce
12
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
the secured indebtedness. Additionally, prior to closing, the Company
has significant restrictions on its operations pursuant to the terms
of the Investment Agreement, a copy of which is attached to the
Company's Report on Form 8-K filed on August 6, 1999. This transaction
is more fully discussed in the Company's 1999 Proxy Statement. The
Company anticipates that the closing of the Fidelity and BDEX
transaction will occur during the fourth quarter of this year.
Pursuant to the terms of the Company's Investment Agreement with BDEX,
effective at the close of business on September 30, 1999, the Company
sold the capital stock of Southern to Holding, a Kentucky limited
liability company which is owned by Leonard K. Nave and a family trust
in which Mr. Nave is the trustee. Due to the sale of the Appalachian
oil and gas operations to Nami Resources, the only remaining assets of
Southern were volumetric production payments receivable and tax
refunds receivable with an aggregate book value of $226,000. However,
Southern is a party to litigation filed in Federal Bankruptcy Court by
Wright Enterprises, has continuing obligations under the sale to Nami
Resources, has liabilities of approximately $68,000 and has unknown
contingent liabilities. Mr. Nave is a director of the Company. Holding
acquired the shares for a nominal amount in return for a full
indemnity for all past operations and activities, a full release from
lease obligations on the office in Versailles, Kentucky, and a
termination and release of any severance rights from Mr. Nave.
In July 1999, as part of its restructuring efforts, the Company
reduced its New Orleans office staff to one geologist and one
accountant and moved to a smaller office within the same building.
Effective July 26, 1999, the Company entered into a Settlement
Agreement with Hale Energy, the assignee of the TECO Note, under which
Hale Energy agreed to release the Company from all of its liabilities
relating to the TECO Note in exchange for approximately $990,400 cash
to be paid at or prior to the closing of the transaction with Fidelity
and BDEX.
In August 1999, the Company withdrew as a participant in Louisiana
Offshore Ventures and Texas 3D Ventures, exploration and development
partnerships managed by Houston Energy Development. This action will
result in a savings to the Company of more than $1 million annually.
Effective August 1, 1999, the Company and DNB entered into a Third
Amendment to First Amended and Restated Credit Agreement which
combined the original promissory notes under the credit facility and
bridge loans, with a current outstanding principal balance of
$63,723,000, into two promissory notes: i) a note in the amount of
$51,223,000 which is the primary obligation of the Company; and ii) a
note in the amount of $12,500,000 which is the primary obligation of
Southern and guaranteed by the Company. Under the terms of the
Guaranty Agreement entered into between the Company and DNB, the
Company would be released from its guarantee of the Southern note at
such time as the Appalachian oil and gas operations of Southern were
sold. As discussed above, the sale of Southern's Appalachian oil and
gas operations was completed; therefore, the Company is no longer a
guarantor of the loan.
13
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
During the second and third quarters of 1999, the Company settled
approximately $3.2 million of trade payables incurred as a result of
work performed on properties owned by Chevron Corporation, USA.
The financial statements do not include any adjustments at September 30,
1999, to reflect the recoverability and classification of assets or the
amounts and classification of liabilities that might result from the
outcome of the Company's uncertain immediate future.
14
