Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
(mark one)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 1998
or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Transition Period
from to
Commission file number 0-17267
Mallon Resources Corporation
(Exact name of registrant as specified in its charter)
Colorado 84-1095959
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
999 18th Street, Suite 1700 Denver, Colorado 80202
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (303) 293-2333
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
(Title of Class)
Indicate by check mark whether the registrant (l) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days:
[X] Yes [ ] No
As of the close of business on March 24, 1999, the aggregate market value
of the shares of voting stock held by non-affiliates of the registrant, based
upon the sales price for a share of the registrant's Common Stock as reported
on the Nasdaq National Market tier of the Nasdaq Stock Market, was
approximately $43,336,000.
As of March 24, 1999, 7,023,940 shares of the registrant's Common Stock,
par value $0.01 per share, were outstanding.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment hereto. [X]
Documents Incorporated By Reference:
Portions of the registrant's Proxy Statement relating to its 1999 Annual
Meeting of Shareholders are incorporated by reference into Part III of this
Report.
Mallon Resources Corporation
Form 10-K
for the fiscal year ended
December 31, 1998
Table of Contents
PART I Page
Items 1 and 2 Business and Properties 1
General History 1
Overview of Oil and Gas Operations 1
Selected Fields and Areas of Interest 2
Acreage 4
Proved Reserves 4
Drilling Activity 5
Productive Wells 5
Production and Sales 6
Marketing 6
Corporate Offices; Officers, Directors
and Key Employees 6
Laguna Gold Company 8
Cautionary Statement Regarding Forward-Looking
Statements 8
Special Considerations 8
Item 3 Legal Proceedings 15
Item 4 Submission of Matters to a Vote of Security
Holders 15
PART II
Item 5 Market for the Registrant's Common Equity
and Related Stockholder Matters 16
Price Range of Common Stock 16
Holders 16
Dividend Policy 16
Item 6 Selected Financial Data 17
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
Overview 18
Liquidity and Capital Resources 18
Results of Operations 20
Hedging Activities 24
Year 2000 24
Miscellaneous 25
Item 7a Quantitative and Qualitative Disclosure about
Market Risk 25
Commodity Price Risk 25
Interest Rate Risk 26
Item 8 Financial Statements and Supplementary Data 26
Item 9 Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 26
PART III
Item 10 Directors and Executive Officers of the Registrant 27
Item 11 Executive Compensation 27
Item 12 Security Ownership of Certain Beneficial Owners
and Management 27
Item 13 Certain Relationships and Related Transactions 27
PART IV
Item 14 Exhibits, Financial Statements and Reports on
Form 8-K 27
SIGNATURES 29
EXHIBIT INDEX 30
GLOSSARY OF TERMS 31
CONSOLIDATED FINANCIAL STATEMENTS
Index to Consolidated Financial Statements F-1
Report of Independent Public Accountants F-2
Report of Independent Accountants F-3
Consolidated Balance Sheets F-4
Consolidated Statements of Operations F-5
Consolidated Statements of Shareholders' Equity F-6
Consolidated Statements of Cash Flows F-7
Notes to Consolidated Financial Statements F-9
PART I
ITEMS 1 AND 2: BUSINESS AND PROPERTIES
General History
Mallon Resources Corporation, a Colorado corporation (the "Company"), is
engaged in the domestic oil and gas development, exploration and production
business through its wholly-owned subsidiary, Mallon Oil Company ("Mallon
Oil"). Substantially all of the Company's estimated proved reserves are
located in the San Juan and Delaware Basins of New Mexico, where the Company
has been active since 1982. The Company has accumulated significant acreage
positions in these two basins, where the Company believes its technical and
operational experience and its database of information enable it to
effectively exploit and develop its properties.
The Company's common stock is traded on the Nasdaq National Market tier of the
Nasdaq Stock Market under the symbol "MLRC." The Company's executive offices
are at 999 18th Street, Suite 1700, Denver, Colorado 80202 (telephone
303/293-2333). The Company's transfer agent is Securities Transfer
Corporation, Dallas, Texas.
Overview of Oil and Gas Operations
The Company's oil and gas operations are conducted primarily in the State of
New Mexico. The Company's activities are focused in the San Juan Basin of
northwest New Mexico where it has been active since 1984, and in the Delaware
Basin of southeast New Mexico where it has been active since 1982. Due to its
substantial acreage positions and operating experience in these areas, the
Company intends to continue to concentrate its operational efforts on these
two basins for the foreseeable future.
The Company's primary business strategy is to increase its proved oil and gas
reserves and its cash flows by means of its drilling and recompletion
activities in the San Juan and Delaware Basins. The principal components of
this strategy are:
- - Development of Existing Acreage. The Company's primary operating strategy
is to increase its proved reserves through relatively lower-risk activities
such as development drilling, recompletions of existing wells into additional
productive zones, multi-zone completions and enhanced recovery activities.
- - Exploration through Exploitation. Numerous potentially productive
geologic formations tend to be stacked atop one another in the San Juan and
Delaware Basins, allowing the Company to (i) target multiple potential pay
zones in most wells, thus reducing drilling risks, and (ii) conduct
exploration operations in conjunction with its development drilling. Wells
drilled to one horizon offer opportunities to examine up-hole zones or can be
drilled to deeper prospective formations for relatively little additional
cost.
- - Control of Operations. For the year ended December 31, 1998, 91% of the
Company's production on an Mcfe basis was produced from properties operated by
the Company. The Company believes that this level of operating control,
combined with the Company's operating experience in the San Juan and Delaware
Basins, allows the Company to better control ongoing operations and costs,
field development decisions, and the timing and nature of capital
expenditures.
- - Flexible Focus. The Company maintains inventories of both oil and natural
gas properties. It is able to re-direct its development emphasis from one
commodity or the other, as market conditions change. Upon a recovery in crude
oil prices, the Company will be able to rapidly re-direct a portion of its
development efforts to its oil properties.
- - Strategic Acquisitions. The Company makes acquisitions of properties
located within its core areas of operations. The Company believes that its
knowledge of the San Juan and Delaware Basins allows the Company to
effectively identify and evaluate valuable acquisition opportunities.
Strategic acquisitions may include increasing the Company's ownership interest
in fields where the Company has an existing interest or acquiring additional
property interests in the San Juan and Delaware Basins.
In September 1993, in a significant acquisition, the Company purchased its
core group of Delaware Basin properties from Pennzoil Exploration and
Production Company. In January 1997, in an important transaction, the Company
acquired additional interests in some of its key San Juan Basin gas properties
and became operator of those properties.
In October 1996 and December 1997, the Company completed significant
financings in which it sold an aggregate of 4.6 million shares of common stock
for combined net proceeds of $32.8 million. These financings enabled the
Company to accelerate the pace of its development and exploitation of its
inventory of oil and gas properties.
In May 1998, the Company entered into a Minerals Development Agreement with
the Jicarilla Apache Tribe covering 39,360 acres of Tribal land in the San
Juan Basin. The land, which is known as "La Jara Canyon" and is contiguous
to the Company's East Blanco Gas Field in Rio Arriba County, approximately
tripled the Company's net acreage holdings in the East Blanco area.
In March 1999, the Company's initial drilling at La Jara Canyon indicated the
potential presence of substantial natural gas reserves. The Company believes
the discoveries will enable it to continue its rapid pace of reserve growth
over the next several years.
The Company increased its estimated proved reserves from 38.6 Bcfe as of
December 31, 1996, to 91.7 Bcfe as of December 31, 1998, a 138% increase. As
of December 31, 1998, the Company's proved reserves, as estimated by its
independent petroleum engineers, Ryder Scott Company Petroleum Engineers
("Ryder Scott"), consisted of 1.3 MMBbls of crude oil and 84.2 Bcf of
natural gas, with a Pre-tax S.E.C.-10 Value of $43.3 million. At December 31,
1998, the Company owned interests in 283 gross (132.33 net) producing wells
and operated 165, or 58%, of them.
Selected Fields and Areas of Interest
The Company's activities are focused in the San Juan Basin of northwestern New
Mexico and in the Delaware Basin of southeastern New Mexico. At December 31,
1998, these areas accounted for substantially all of the Company's estimated
proved reserves, with 74.6 Bcfe attributable to the Company's San Juan Basin
properties and 17.0 Bcfe attributable to its Delaware Basin properties.
San Juan Basin, Northwestern New Mexico
The Company has been active in the San Juan Basin since 1984, where its
primary areas of interest are the East Blanco (including La Jara Canyon),
Gavilan and Otero areas. At December 31, 1998, the Company owned interests in
74,760 gross (62,460 net) acres of oil and gas leases in the San Juan Basin.
Wells on these leases produce from a variety of zones in the San Jose,
Nacimiento, Ojo Alamo, Pictured Cliffs, Mesaverde, Mancos and Dakota
formations.
East Blanco Area, Rio Arriba County, New Mexico. This area has been under
development by the Company since 1986. All production in the area has been
natural gas. East Blanco wells typically contain reserves in more than one
productive zone, including in the Pictured Cliffs Sandstone at approximately
3,600 feet, the Ojo Alamo Sandstone at approximately 3,000 feet, the
Nacimiento Formation at approximately 2,000 feet and the San Jose Formation at
approximately 1,500 feet. The wells also penetrate the Fruitland Coal
Formation at approximately 3,500 feet, which is productive in fields adjacent
to East Blanco. During 1998, the Company drilled 35 wells and recompleted 25
wells at East Blanco. The new drilling and recompletions were primarily to
put Ojo Alamo, Nacimiento and San Jose gas on production. In late 1998 and
early 1999, the Company also drilled six widely scattered wells to test the La
Jara Canyon acreage block. One development well and three exploratory wells
were successfully completed. One exploratory well is still being tested.
Among the four completed wells, production was established in the San Jose,
Nacimiento, Ojo Alamo, and Pictured Cliffs Formations, at depths ranging
between 1,200 and 3,600 feet. One exploratory well, drilled in the southern-
most portion of the block, was a dry hole. The Company is currently revising
its 1999 drilling program to incorporate the La Jara Canyon acreage. The
Company has identified approximately 240 potential drilling locations on its
East Blanco and La Jara Canyon acreage. Pending completion of its budgeting
process, in 1999 the Company plans to drill approximately 20 wells and
recomplete approximately 30 wells in this area. As of December 31, 1998, the
Company's estimated proved reserves in the East Blanco area were 74 Bcfe, or
81% of the Company's total estimated proved reserves.
Gavilan Field, Rio Arriba County, New Mexico. The Company owns and operates
seven wells on 1,200 gross (1,150 net) acres in this field, with an average
34% working interest. Current production is primarily natural gas from the
Mancos Shale at approximately 6,900 feet and from the Menefee Formation at
approximately 5,400 feet. As of December 31, 1998, Gavilan Field contained
only a marginal portion of the Company's total estimated proved reserves.
Otero Field, Rio Arriba County, New Mexico. The Company owns and operates
three wells on 4,500 gross (3,900 net) acres in this field, with an average
90% working interest. The wells produce oil from the Mancos Shale at
approximately 4,700 feet. Due to depressed crude oil prices, during 1998 the
Company curtailed its planned operations in this area in order to devote more
of its capital to the drilling and recompletion of natural gas wells at East
Blanco. Until there is a significant recovery in crude oil prices, the
Company will continue to limit its activities in this area. As of
December 31, 1998, Otero Field contained only a marginal portion of the
Company's total estimated proved reserves.
Delaware Basin, Southeastern New Mexico
The Delaware Basin has been an area of significant activity for the Company
since 1982, when the Company acquired an interest in the Brushy Draw Field.
Wells in the Delaware Basin produce from a variety of formations, the
principal of which are the Cherry Canyon, Brushy Canyon, Bone Spring, Strawn
and Morrow Formations. These formations each contain multiple potentially
productive zones. The Cherry Canyon, Brushy Canyon and Bone Spring Formations
primarily produce oil at shallow to medium drilling depths, while the deeper
Strawn and Morrow generally produce natural gas. The Company's primary
properties in the Delaware Basin are in the White City, Black River, South
Carlsbad, Lea Northeast, and Quail Ridge Fields. The Company also continues
to assess potential in its Shipp, Lovington Northeast and Brushy Draw
properties. The Company owns interests in 24,800 gross (19,500 net) acres of
oil and gas leases in the Delaware Basin. Due to depressed crude oil prices,
during 1998 the Company significantly curtailed its planned operations in the
Delaware Basin, in order to devote more of its capital to the drilling and
recompletion of natural gas wells in the San Juan Basin. Until there is a
significant recovery in crude oil prices, the Company will continue to limit
its activities in the Delaware Basin.
White City, Black River, and South Carlsbad Fields, Eddy County, New Mexico.
The Company owns and operates a total of 11,600 gross (4,400 net) acres in
these fields, with an average working interest of 34%. These adjacent fields
were the focus of much of the Company's recompletion and development
activities from 1993 through 1997. In 1997, the Company initiated a multiple-
well drilling program to evaluate the shallow Cherry Canyon and Brushy Canyon
Formations, which contain multiple potential zones between 2,500 and 5,300
feet. In 1998, testing of multiple zones in wells penetrating the Cherry
Canyon and Brushy Canyon Formations showed that conventional hydraulic
fracturing stimulation of the zones resulted in unfavorably high water/oil
ratios because of hydraulic fracture induced communication with nearby water
zones. In response to this problem, the Company drilled horizontal boreholes
extending from 800 to 1,100 feet laterally from two existing well bores. The
horizontal boreholes were expected to improve oil production rates, while
avoiding the need for hydraulic fracturing. One of the horizontal laterals
was drilled in the lower Brushy Canyon, and one was drilled in the upper
Cherry Canyon. Neither of the laterals significantly improved oil production
rates. Until there is a significant recovery in crude oil prices, the Company
will limit its activities in this area. As of December 31, 1998, the
Company's estimated proved reserves in these three fields were 4.7 Bcfe, or 5%
of the Company's total estimated proved reserves.
Lea Northeast Field, Lea County, New Mexico. The Company owns and operates
2,400 gross (1,400 net) acres in this field, with an average working interest
of approximately 64%. The Company's Cherry Canyon play in this field began in
1994. In 1998, the Company drilled one well in the Bone Spring at
approximately 9,700 feet. The well, completed as a flowing oil well,
represents a northern extension of the productive limits of the Bone Spring
pool. The Company has delineated 30 additional locations in the field, but
until there is a significant recovery in crude oil prices, the Company does
not plan to drill additional wells on this acreage. As of December 31, 1998,
the Company's estimated proved reserves in Lea Northeast Field were 2.7 Bcfe
or 3% of the Company's total estimated proved reserves.
Quail Ridge, Lea County, New Mexico. Adjacent to Lea Northeast, the Company
controls an approximate 3,400 gross (1,450 net) acre block on which it
operates wells producing from the Bone Spring and Morrow. The Quail Ridge
Field has primarily produced gas from the Morrow at depths of approximately
13,500 feet. The Company currently has an interest in 11 wells in this area
and operates six of them. During 1998, the Company drilled two wells here, as
part of its continuing evaluation of the Cherry Canyon and Brushy Formations
between 5,500 and 8,200 feet, as well as the Bone Spring between 9,600 and
10,200 feet. Both wells were temporarily abandoned, pending further geologic
and engineering evaluations of the area. The Company controls an approximate
36% working interest in this acreage. Until there is a significant recovery
in crude oil prices, the Company does not plan to drill additional wells on
this acreage. As of December 31, 1998, the Company's estimated proved
reserves in Quail Ridge Field were 5.8 Bcfe or 6.4% of the Company's total
estimated proved reserves.
Shipp and Lovington Northeast Fields, Lea County, New Mexico. Shipp and
Lovington Fields are comprised of a collection of individual reservoirs, or
algal mounds, in a Strawn Formation interval at depths of approximately 11,500
feet. The mounds range in size from 100 to 700 acres. The Company has
interests in 33 wells and operates 21 wells in these adjacent fields. During
1996, the Company initiated a low installation cost pilot waterflood project
on one of these mounds, which has yet to show a significant response. Until
there is a significant recovery in crude oil prices, the Company will limit
its activities in this area. The Company's working interest averages 36% in
Lovington Northeast and 53% in Shipp. As of December 31, 1998, these fields
contained only a marginal portion of the Company's total estimated proved
reserves.
Brushy Draw Field, Eddy County, New Mexico. The Company's initial drilling
and field development began here in 1982. Current production is from the base
of the Cherry Canyon Formation, at a depth of approximately 5,000 feet. The
Company operates 14 wells with an average working interest of 64%. As of
December 31, 1998, Brushy Draw Field contained only a marginal portion of the
Company's total estimated proved reserves.
Other Areas
All of the Company's oil and gas operations are currently conducted on-shore
in the United States. In addition to the properties described above, the
Company has properties in the states of Colorado, Oklahoma, Wyoming, North
Dakota and Alabama. While the Company intends to continue to produce its
existing wells in those states, it currently does not expect to engage in any
development activities in those areas.
Acreage
The majority of the Company's producing oil and gas properties are located on
leased land held by the Company for as long as production is maintained. The
Company believes it has satisfactory title to its oil and gas properties based
on standards prevalent in the oil and gas industry, subject to exceptions that
do not detract materially from the value of the properties. The following
table summarizes the Company's oil and gas acreage holdings as of December 31,
1998:
<TABLE>
<CAPTION>
Developed Undeveloped
Area Gross Net Gross Net
<S> <C> <C> <C> <C>
San Juan Basin 10,948 4,623 63,812 57,837
Delaware Basin 22,883 18,855 1,960 662
Other 10,225 3,953 2,931 50
Total 44,056 27,431 68,703 58,549
====== ====== ====== ======
</TABLE>
Much of the Delaware Basin developed acreage relates to deeper natural gas
zones as to which larger spacing rules apply. Most of this developed acreage
is undeveloped as to shallower zones.
Proved Reserves
The following table contains information concerning the Company's estimated
proved oil and gas reserves as of December 31, 1998, based upon a report
prepared by Ryder Scott. All calculations have been made in accordance with
the rules and regulations of the Securities and Exchange Commission (the
"S.E.C.") and give no effect to federal or state income taxes otherwise
attributable to estimated future net revenues from the sale of oil and gas.
The present value of estimated future net revenues has been calculated using a
discount factor of 10%.
<TABLE>
<CAPTION>
December 31, 1998
<S> <C>
Proved Reserves:
Natural gas (MMcf) 84,161
Oil (MBbl) 1,264
Total (MMcfe) 91,745
Proved Developed Reserves:
Natural gas (MMcf) 65,786
Oil (MBbl) 945
Total (MMcfe) 71,456
Pre-tax S.E.C.-10 Value (in thousands) $43,339
</TABLE>
Drilling Activity
The following table sets forth, for each of the last three years, the
development drilling activities conducted by the Company:
<TABLE>
<CAPTION>
Gross Wells Net Wells
Productive Dry Total Productive Dry Total
<S> <C> <C> <C> <C> <C> <C>
1996 4 1 5 2.69 0.34 3.03
1997 (1) 23 3 26 12.99 0.84 13.83
1998 (2) (3) 37 7 44 32.64 5.59 38.23
</TABLE>
__________________
(1) Includes 1 gross (0.0225 net) dry exploratory well.
(2) Includes 2 gross (2 net) dry exploratory wells.
(3) Includes 3 gross (3 net) productive exploratory wells.
From January 1, 1999 through March 24, 1999, the Company engaged in the
drilling of 3 gross (3 net) wells and the recompleting of 2 gross (1.83 net)
wells that are not reflected in the foregoing table.
Productive Wells
The following table summarizes the Company's gross and net interests in
productive wells at December 31, 1998. Net interests represented in the table
are net "working interests" which bear the cost of operations.
<TABLE>
<CAPTION>
Gross Wells Net Wells
Oil Natural Gas Total Oil Natural Gas Total
<S> <C> <C> <C> <C> <C> <C>
San Juan Basin 4 74 78 3.13 65.86 68.99
Delaware Basin 114 69 183 46.63 14.59 61.22
Other 14 8 22 1.48 0.64 2.12
Total 132 151 283 51.24 81.09 132.33
=== === === ===== ===== ======
</TABLE>
In addition, the Company owns interests in four waterflood units in the
Delaware Basin, which contain a total of 550 gross wells (8.5 net wells), and
6 gross (3.31 net) salt water disposal wells.
Production and Sales
The following table sets forth information concerning the Company's total oil
and gas production and sales for each of the last three fiscal years.
<TABLE>
<CAPTION>
Year Ended
December 31,
1998 1997 1996
<S> <C> <C> <C>
Net Production:
Natural gas (MMcf) 5,852 2,350 1,286
Oil (MBbl) 230 196 174
Total (MMcfe) 7,232 3,526 2,330
Average Sales Price Realized (1):
Natural gas (per Mcf) $ 1.72 $ 2.04 $ 2.11
Oil (per Bbl) $12.99 $19.31 $18.05
Per Mcfe $ 1.81 $ 2.43 $ 2.51
Average Cost (per Mcfe):
Production tax and marketing expense $ 0.26 $ 0.32 $ 0.31
Lease operating expense $ 0.47 $ 0.54 $ 0.66
Depletion $ 0.73 $ 0.74 $ 0.83
</TABLE>
___________________
(1) Includes effects of hedging.
Marketing
The Company's natural gas is generally sold on the spot market or pursuant to
short-term contracts. Oil and liquids are generally sold on the open market
to unaffiliated purchasers, generally pursuant to purchase contracts that are
cancelable on 30 days notice. The price paid for this production is generally
an established or posted price that is offered to all producers in the field,
plus any applicable differentials. Prices paid for crude oil and natural gas
fluctuate substantially. Because future prices are difficult to predict, the
Company hedges a portion of its oil and gas sales to protect against market
downturns. The nature of hedging transactions is such that producers forego
the benefit of some price increases that may occur after the hedging
arrangement is in place. The Company nevertheless believes that hedging is
prudent in certain circumstances in order to minimize the risk of falling
prices.
Corporate Offices; Officers, Directors and Key Employees
The Company's principal office is located at 999 18th Street, Suite 1700,
Denver, Colorado 80202. The Company's phone number is (303) 293-2333. The
Company employs 25 employees at this office. The Company maintains field
operations offices in Durango, Colorado, and in Carlsbad, New Mexico, where it
employs a total of 17 individuals.
The following are the members of the Company's Board of Directors and the
Company's executive officers:
Name Age Title(s)
George O. Mallon, Jr. 54 Director, Chairman of the Board and President
Kevin M. Fitzgerald 44 Director and Executive Vice President
Roy K. Ross 48 Director, Executive Vice President, Secretary
and General Counsel
Frank Douglass 65 Director
Roger R. Mitchell 66 Director
Francis J. Reinhardt, Jr. 69 Director
Peter H. Blum 41 Director
Alfonso R. Lopez 50 Vice President - Finance and Treasurer
The directors serve until the next annual meeting of shareholders. Following
are brief descriptions of the business experience of the Company's directors
and executive officers:
George O. Mallon, Jr. has been the President and Chairman of the Board of the
Company since December 1988. He formed Mallon Oil in 1979 and was a co-
founder of Laguna Gold Company ("Laguna") in 1980. He is now a director of
Laguna. Mr. Mallon earned a B.S. degree in Business from the University of
Alabama in 1965 and an M.B.A. degree from the University of Colorado in 1977.
Kevin M. Fitzgerald has been Executive Vice President of the Company since
June 1990. He joined Mallon Oil in 1983 as Petroleum Engineer and served as
Vice President of Engineering from 1987 through December 1988, when he became
President of that company. Mr. Fitzgerald was Vice President, Oil and Gas
Operations for the Company from 1988 through October 1990, when he was named
Executive Vice President. Mr. Fitzgerald earned a B.S. degree in Petroleum
Engineering from the University of Oklahoma in 1978.
Roy K. Ross has been Executive Vice President and General Counsel of the
Company since 1992. He was named Secretary of the Company in 1997. From June
1976 through September 1992, Mr. Ross was an attorney in private practice with
the Denver-based law firm of Holme Roberts & Owen. Mr. Ross is also Executive
Vice President, Secretary, General Counsel and a director of Mallon Oil and
Laguna. He earned his B.A. degree in Economics from Michigan State University
in 1973 and his J.D. degree from Brigham Young University in 1976.
Frank Douglass has been a director of the Company since 1988. In 1998, he
retired as a Senior Partner in the Texas law firm of Scott, Douglass &
McConnico, LLP, where he had been a partner since 1976. Mr. Douglass earned a
B.B.A. degree from Southwestern University in 1953 and a L.L.B. degree from
the University of Texas School of Law in 1958.
Roger R. Mitchell has been a director of the Company since 1990. In December
1992, Mr. Mitchell retired, although he continues to provide consulting
services to various businesses on a part-time basis. He earned a B.S. degree
in Business from Indiana University in 1954 and an M.B.A. degree from Indiana
University in 1956.
Francis J. Reinhardt, Jr. has been a director of the Company since 1994. He
is with the New York investment banking firm of Carl H. Pforzheimer & Co.,
where he has been a partner since 1966. He is a member and past president of
the National Association of Petroleum Investment Analysts. Mr. Reinhardt is
also a director of The Exploration Company of Louisiana, a public company
engaged in the oil and gas business. Mr. Reinhardt holds a B.S. degree from
Seton Hall University and an M.B.A. from New York University.
Peter H. Blum became a director of the Company in January 1998. He has been
an energy investment banker since 1982. Since October 1998, Mr. Blum has been
President of McLean Equities Ltd, Inc., a private investment bank. From April
1997 to October 1998, Mr. Blum was Senior Managing Director, head of
investment banking, for the investment banking firm Gaines, Berland Inc. From
1995 to 1997, Mr. Blum held the position of Managing Director, head of energy
banking, with the investment banking firm Rodman & Renshaw, Inc. From 1992 to
1995, Mr. Blum held various positions with the investment banking firm Mabon
Securities, Inc. Mr. Blum earned a B.B.A. degree in accounting from the
University of Wisconsin in 1979.
Alfonso R. Lopez joined the Company in July 1996 as Vice President-Finance and
Treasurer. He was Vice President-Finance for Consolidated Oil & Gas, Inc.
(now Chesapeake Energy Corporation) from 1993 to 1995. Mr. Lopez was a
consultant from 1991 to 1992. From 1981 to 1990, he was Controller for
Decalta International Corporation, a Denver-based exploration and production
company. He served as Controller for Western Crude Oil, Inc. (now Texaco
Trading and Transportation, Inc.) from 1978 to 1981. Mr. Lopez is a certified
public accountant and was with Arthur Young & Company (now Ernst & Young) from
1970 to 1978. Mr. Lopez earned his B.A. degree in Accounting and Business
Administration from Adams State College in Colorado in 1970.
Key Employees
Employees who are instrumental to the Company's success include the following
individuals:
Ray E. Jones is Vice President-Engineering of Mallon Oil. Before joining the
Company in January 1994, Mr. Jones spent eight years with Jerry R. Bergeson &
Associates (now GeoQuest), an independent consulting firm, where he did
reservoir engineering, field studies and reserve evaluations and taught
industry courses in basic reservoir engineering, reservoir simulation and well
testing. Mr. Jones graduated from Colorado School of Mines in 1979 and is a
registered professional engineer.
Randy Stalcup has been the Vice President-Land of Mallon Oil since April 1994.
Prior to joining the Company, Mr. Stalcup was employed by Beard Oil Company
for 13 years, where he was the Acquisition and Unitization Manager from 1989.
Mr. Stalcup, a Certified Professional Landman, earned his B.B.A. degree in
Petroleum Land Management from the University of Oklahoma in 1979.
Wendell A. Bond has been Vice President-Exploration of Mallon Oil since
December 1996. Prior to joining the Company on a full-time basis, Mr. Bond
was an independent geological consultant to the Company since July 1994. Mr.
Bond has more than 25 years of experience in the petroleum industry, both
domestically and internationally. Prior to joining the Company, he was
president of Wendell A. Bond, Inc., a company specializing in petroleum
geological consulting services that he formed in 1988. Prior to 1988, Mr.
Bond had been employed in a variety of positions for several independent and
major oil and gas companies, including Project Geologist for Webb Resources,
District Geologist for Sohio Petroleum and Chief Geologist for Samuel Gary Jr.
& Associates. Mr. Bond earned his B.S. degree in geology from Capital
University, Columbus, Ohio and his M.S. degree in geology from the University
of Colorado.
Donald M. Erickson, Jr. has been Vice President-Operations of Mallon Oil since
February 1997. Mr. Erickson has more than 20 years of experience in oil field
operations. Prior to joining the Company, he was Operations Manager for
Presidio Exploration, Inc. (which was merged into Tom Brown Inc.) from
December 1988 to January 1997. Mr. Erickson earned a Heating and Cooling
Technical Degree from Central Technical Community College in Hastings,
Nebraska in 1975 and has studied Mechanical Engineering at the University of
Denver.
Duane C. Winkler is Operations Manager of Mallon Oil, working out of the
Durango, Colorado, office. Before joining the Company in October 1993, he was
employed by Natural Gas Processing as Production Superintendent from 1986 to
1993. Mr. Winkler, who has more than 25 years of experience in drilling,
completion and production operations, completed his Associates of Engineering
Certificate from Central Wyoming College in 1996.
Laguna Gold Company
The Company currently owns an approximate 45% interest in Laguna, a gold
mining company whose common shares are listed on The Toronto Stock Exchange
under the trading symbol "LGC." Laguna is engaged in the exploration for and
development of precious metals in Costa Rica, where it holds mineral
concessions issued by the Government of Costa Rica. The concessions contain
the Rio Chiquito Deposit, which Laguna is presently in the process of placing
on production. It has announced that it plans to commence commercial
production of gold and silver in the second quarter of 1999.
Cautionary Statement Regarding Forward-Looking Statements
The discussion in this report contains certain forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
significantly from those discussed herein. Factors that could cause or
contribute to such differences include, but are not limited to, those
discussed in "Special Considerations," and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," as well as those
discussed elsewhere in this report. Statements contained in this report that
are not historical facts are forward-looking statements that are subject to
the safe harbor created by the Private Securities Litigation Reform Act of
1995.
Special Considerations
In evaluating the Company and its common stock, readers should consider
carefully, among other things, the following special considerations.
Recent Price Declines and Volatility of Oil and Natural Gas Prices
Prices for oil and natural gas fluctuate widely and recently have declined
significantly. The average price received by the Company for natural gas
decreased to $1.72 per Mcf during 1998 from $2.04 per Mcf during 1997.
Similarly, NYMEX postings for West Texas Intermediate crude oil decreased to
$12.06 per barrel at December 31, 1998 from $17.61 per barrel at December 31,
1997.
Natural gas prices affect us more than oil prices, because most of our
production and reserves are natural gas. On an Mcfe basis, at December 31,
1998, 92% of our estimated proved reserves were natural gas and for 1998 81%
of our total production was natural gas.
Our revenues, profitability and future rate of growth depend substantially
upon the prevailing prices of oil and natural gas. Prices also affect the
amount of cash flow available for capital expenditures and our ability to
borrow money or raise additional capital. We have recently reduced our 1999
capital expenditures budget because of lower oil and gas prices. The amount
we can borrow from banks is subject to redetermination based on current
prices. In addition, we may have a ceiling test write-down when prices
decline. See "Ceiling Limitation Write-downs." Lower prices may also reduce
the amount of oil and natural gas that we can produce economically.
We cannot predict future oil and natural gas prices and prices may decline
further. Factors that can cause this fluctuation include:
- - relatively minor changes in the supply of and demand for oil and natural
gas;
- - market uncertainty;
- - the level of consumer product demand;
- - weather conditions;
- - domestic and foreign governmental regulations;
- - the price and availability of alternative fuels;
- - political conditions in the Middle East;
- - the foreign supply of oil and natural gas;
- - the price of oil and gas imports; and
- - overall economic conditions.
We enter into energy swap agreements and other financial arrangements at
various times to attempt to minimize the effect of oil and natural gas price
fluctuations. We cannot assure you that such transactions will reduce risk or
minimize the effect of any decline in oil or natural gas prices. Any
substantial or extended decline in oil or natural gas prices would have a
material adverse effect on our business and financial results. Energy swap
arrangements may limit the risk of declines in prices, but such arrangements
may also limit further revenues from price increases.
Uncertainty of Estimates of Oil and Gas Reserves
This report contains estimates of our proved oil and gas reserves and the
estimated future net revenues from such reserves. These estimates are based
upon various assumptions, including assumptions required by the S.E.C.
relating to oil and gas prices, drilling and operating expenses, capital
expenditures, taxes and availability of funds. The process of estimating oil
and gas reserves is complex. Such process requires significant decisions and
assumptions in the evaluation of available geological, geophysical,
engineering and economic data for each reservoir. Therefore, these estimates
are inherently imprecise.
Actual future production, oil and gas prices, revenues, taxes, development
expenditures, operating expenses and quantities of recoverable oil and gas
reserves most likely will vary from those estimated. Any significant variance
could materially affect the estimated quantities and present value of reserves
set forth in this report. In addition, we may adjust estimates of proved
reserves to reflect production history, results of exploration and
development, prevailing oil and gas prices and other factors, many of which
are beyond our control.
At December 31, 1998, 22% of our estimated proved reserves were undeveloped.
Recovery of undeveloped reserves requires significant capital expenditures and
successful drilling operations. The reserve data assumes that we will make
significant capital expenditures to develop our reserves. Although we have
prepared estimates of our oil and gas reserves and the costs associated with
these reserves in accordance with industry standards, we cannot assure you
that the estimated costs are accurate, that development will occur as
scheduled or that the results will be as estimated.
You should not assume that the present value of future net revenues referred
to in this report is the current market value of our estimated oil and gas
reserves. In accordance with S.E.C. requirements, the estimated discounted
future net cash flows from proved reserves are generally based on prices and
costs as of the date of the estimate. Actual future prices and costs may be
materially higher or lower than the prices and costs as of the date of the
estimate. Recent significant declines in oil and gas prices have reduced the
Company's present value of future net revenues. See "Recent Price Declines
and Volatility of Oil and Natural Gas Prices." Any changes in consumption by
gas purchasers or in governmental regulations or taxation will also affect
actual future net cash flows. The timing of both the production and the
expenses from the development and production of oil and gas properties will
affect the timing of actual future net cash flows from proved reserves and
their present value. In addition, the 10% discount factor, which is required
by the S.E.C. to be used in calculating discounted future net cash flows for
reporting purposes, is not necessarily the most accurate discount factor. The
effective interest rate at various times and the risks associated with the
Company or the oil and gas industry in general will affect the accuracy of the
10% discount factor.
Effects of Leverage
As of December 31, 1998, our long-term debt was $27.2 million, including $22.1
million outstanding under our revolving credit line with Bank One, Texas, N.A.
Our long-term debt represented 55% of our total capitalization at December 31,
1998.
Our level of debt affects our operations in several important ways, including
the following:
- - a large portion of our cash flow from operations is used to pay interest
on borrowings;
- - covenants contained in the agreements governing our debt limit our ability
to borrow additional funds or to dispose of assets;
- - covenants contained in the agreements governing our debt may affect our
flexibility in planning for, and reacting to, changes in business conditions;
- - a high level of debt may impair our ability to obtain additional financing
in the future for working capital, capital expenditures, acquisitions, general
corporate or other purposes; and
- - the terms of the agreements governing our debt permit our creditors to
accelerate payments upon an event of default or a change of control.
In addition, we may significantly alter our capitalization in order to make
future acquisitions or develop our properties. These changes in
capitalization may significantly increase our level of debt. A high level of
debt increases the risk that the Company may default on its debt obligations.
Our ability to meet our debt obligations and to reduce our level of debt
depends on our future performance. General economic conditions and financial,
business and other factors affect our operations and our future performance.
Many of these factors are beyond our control.
If the Company is unable to repay its debt at maturity out of cash on hand, it
could attempt to refinance such debt, or repay such debt with the proceeds of
an equity offering. We cannot assure you that the Company will be able to
generate sufficient cash flow to pay the interest on its debt or that future
borrowings or equity financing will be available to pay or refinance such
debt. If we are not able to negotiate renewals of our borrowings or to
arrange new financing, we may have to sell significant assets. Any such sale
would have a material adverse effect on our business and financial results.
Factors that will affect our ability to raise cash through an offering of our
capital stock or a refinancing of our debt include financial market conditions
and our value and performance at the time of such offering or other financing.
We cannot assure you that any such offering or refinancing can be successfully
completed. See "Availability of Financing."
Ceiling Limitation Write-downs
We use the full cost method of accounting to report our operations for oil and
gas properties. The Company capitalizes the cost to acquire, explore for and
develop oil and gas properties. Under full cost accounting rules, the net
capitalized costs of oil and gas properties, less related deferred income
taxes, may not exceed a "ceiling limit" based upon the present value of
estimated future net cash flows from proved reserves, discounted at 10%, plus
the lower of cost or fair market value of unproved properties, as adjusted for
related tax effects. If net capitalized costs of oil and gas properties
exceed the ceiling limit, we must charge the amount of the excess to earnings.
This is called a "ceiling limitation write-down." This charge does not impact
cash flow from operating activities, but does reduce our shareholders' equity
and can affect our compliance with various financial covenants. The risk that
we will be required to write down the carrying value of our oil and gas
properties increases when oil and gas prices are low or volatile. In
addition, write-downs may occur if the Company has substantial downward
adjustments to its estimated proved reserves. The recent significant declines
in oil and gas prices increase the risk that we will have a ceiling limitation
write-down in the future, as we did in fourth quarter 1998. See "Recent Price
Declines and Volatility of Oil and Natural Gas Prices." We cannot assure you
that we will not experience additional ceiling limitation write-downs in the
future.
Availability of Financing
We have historically addressed our long-term liquidity needs through the
issuance of debt and equity securities and the use of bank debt and cash from
operating activities. We continue to examine the following alternative
sources of long-term capital:
- - bank borrowings or the issuance of debt securities;
- - the sale of common stock, preferred stock or other equity securities;
- - the issuance of production-based financing or net profits interests;
- - sales of non-strategic properties;
- - sales of prospects and technical information; and
- - joint venture financing.
The availability of capital will depend upon a number of factors, some of
which are beyond our control. These factors include general economic and
financial market conditions, oil and natural gas prices and the value and
performance of the Company. We may be unable to execute our operating
strategy if we cannot obtain additional capital.
Replacement of Reserves
In general, the volume of production from oil and gas properties declines as
reserves are depleted. The decline rates depend on reservoir characteristics.
Our reserves will decline as they are produced unless we acquire properties
with proved reserves or conduct successful development and exploration
activities. Our future natural gas and oil production is highly dependent
upon our level of success in finding or acquiring additional reserves. The
business of exploring for, developing or acquiring reserves is capital
intensive and uncertain. We may be unable to make the necessary capital
investment to maintain or expand our oil and gas reserves if cash flow from
operations is reduced and external sources of capital become limited or
unavailable. We cannot assure you that our future development, acquisition
and exploration activities will result in additional proved reserves or that
we will be able to drill productive wells at acceptable costs.
Industry Risks
Oil and gas drilling and production activities are subject to numerous risks,
many of which are beyond our control. These risks include the following:
- - that no commercially productive oil or natural gas reservoirs will be
found;
- - that oil and gas drilling and production activities may be shortened,
delayed or canceled; and
- - that our ability to develop, produce and market our reserves may be
limited by:
(1) title problems,
(2) weather conditions,
(3) compliance with governmental requirements, and
(4) mechanical difficulties or shortages or delays in the delivery of
drilling rigs and other equipment.
In the past, we have had difficulty securing drilling equipment in certain of
our core areas. We cannot assure you that the new wells we drill will be
productive or that we will recover all or any portion of our investment.
Drilling for oil and natural gas may be unprofitable. Dry wells and wells
that are productive but do not produce sufficient net revenues after drilling,
operating and other costs are unprofitable. In addition, our properties may
be susceptible to hydrocarbon drainage from production by other operators on
adjacent properties.
Our industry also experiences numerous operating risks. These operating risks
include the risk of fire, explosions, blow-outs, pipe failure, abnormally
pressured formations and environmental hazards. Environmental hazards include
oil spills, gas leaks, ruptures or discharges of toxic gases. If any of these
industry operating risks occur, we could have substantial losses. Substantial
losses may be caused by injury or loss of life, severe damage to or
destruction of property, natural resources and equipment, pollution or other
environmental damage, clean-up responsibilities, regulatory investigation and
penalties and suspension of operations. In accordance with industry practice,
we maintain insurance against some, but not all, of the risks described above.
We cannot assure you that our insurance will be adequate to cover losses or
liabilities. Also, we cannot predict the continued availability of insurance
at premium levels that justify its purchase.
Concentration of Assets
At December 31, 1998, 67% of our average daily production, on an Mcfe basis,
was processed through our East Blanco Gas Plant. Our production, revenue and
cash flow will be adversely affected if this plant's operation is shut-down,
curtailed or limited for any reason. Substantially all of the Company's
operations are currently located in two geologic basins in New Mexico.
Because of this geographic concentration, any regional events that increase
costs, reduce availability of equipment or supplies, reduce demand or limit
production, including weather and natural disasters, may impact us more than
if our operations were more geographically diversified.
Gas Marketing, Trading and Credit Risk
The profitability of our natural gas marketing operations depends on our
ability to assess and respond to changing market conditions, including credit
risk. If we are unable to respond accurately to changing conditions in the
gas marketing business, our results of operations could be materially
adversely affected. We try to limit our exposure to price risk by entering
into various hedging arrangements. We are exposed to credit risk because the
counterparties to agreements might not perform their contractual obligations.
Competition
We operate in a highly competitive environment. We compete with major and
independent oil and gas companies for the acquisition of desirable oil and gas
properties and the equipment and labor required to develop and operate them.
We also compete with major and independent oil and gas companies in the
marketing and sale of oil and natural gas. Many of these competitors have
financial and other resources substantially greater than ours.
Drilling Risks
Drilling involves numerous risks, including the risk that drilling efforts
will not find commercially productive oil or gas reservoirs. The cost of
drilling and completing wells is often unpredictable, and drilling operations
may be shortened, delayed or canceled as a result of a variety of risks.
These risks include unexpected drilling conditions, pressure or irregularities
in formations, equipment failures or accidents, weather conditions and
shortages or delays in delivery of equipment. We cannot assure you that our
future drilling activities will be successful.
Acquisition Risks
The successful acquisition of producing properties requires an assessment of a
number of factors beyond our control. These factors include recoverable
reserves, future oil and gas prices, operating costs and potential
environmental and other liabilities. Such assessments are inexact and their
accuracy is inherently uncertain. In connection with such assessments, we
perform a review of the subject properties, which we believe is generally
consistent with industry practices. However, such a review will not reveal
all existing or potential problems. In addition, the review will not permit a
buyer to become sufficiently familiar with the properties to fully assess
their deficiencies and capabilities. We do not inspect every well. Even when
a well is inspected, structural and environmental problems are not necessarily
discovered. We are generally not entitled to contractual indemnification for
pre-closing liabilities, including environmental liabilities. Normally, we
acquire interests in properties on an "as is" basis with limited remedies for
breaches of representations and warranties. In addition, competition for
producing oil and gas properties is intense and many of our competitors have
financial and other resources substantially greater than those available to
us. Therefore, we cannot assure you that we will be able to acquire oil and
gas properties that contain economically recoverable reserves or that we will
acquire such properties at acceptable prices.
Marketability of Oil and Gas Production
The marketability of our production depends in part upon the availability,
proximity and capacity of gas gathering systems, pipelines and processing
facilities. U.S. federal and state regulation of oil and gas production and
transportation, general economic conditions, and changes in supply and demand
all could adversely affect our ability to produce and market oil and natural
gas. If market factors dramatically change, the financial impact on the
Company could be substantial. The availability of markets is beyond our
control. The Company conducts substantially all of its operations in the San
Juan and Delaware Basins in the State of New Mexico and, consequently, is
particularly sensitive to marketing constraints that exist or may arise in the
future in those areas. Historically, due to the San Juan Basin's relatively
isolated location and the resulting limited access of its natural gas
production to the marketplace, natural gas produced in the San Juan Basin has
tended to command prices that are lower than natural gas prices that prevail
in other areas.
Government Regulation
Our oil and gas operations are subject to various U.S. federal, state, tribal
and local governmental regulations. Matters regulated include discharge
permits for drilling operations, drilling and abandonment bonds, reports
concerning operations, the spacing of wells, and unitization and pooling of
properties and taxation. At various times, regulatory agencies have imposed
price controls and limitations on production. In order to conserve supplies
of oil and gas, these agencies have restricted the rates of flow of oil and
gas wells below actual production capacity. We believe that we are in
substantial compliance with all applicable laws and regulations. However, the
requirements of such laws and regulations are frequently changed. We cannot
predict the ultimate cost of compliance with these requirements or their
effect on our operations.
Environmental Matters
The discharge of oil, gas or other pollutants into the air, soil or water may
give rise to liabilities to governmental agencies and third parties, and may
require us to incur costs to remedy such discharges. Oil, natural gas and
other pollutants (including salt water brine) may be discharged in many ways,
including from a well or drilling equipment at a drill site, leakage from
pipelines or other gathering and transportation facilities, leakage from
storage tanks, and sudden discharges from damage or explosions at natural gas
facilities, oil and gas wells or other facilities. Discharged hydrocarbons
and other pollutants may migrate through soil to water supplies or adjoining
property, giving rise to additional liabilities. A variety of federal, state
and local laws and regulations govern the environmental aspects of oil and
natural gas exploration, production and transportation and may, in addition to
other laws and regulations, impose liability in the event of discharges
(whether or not accidental), failure to notify the proper authorities of a
discharge, and other failures to comply with those laws and regulations.
Compliance with environmental quality requirements and reclamation laws
imposed by governmental authorities may necessitate significant capital
outlays, may materially affect the acquisition or operating costs of a given
property, or may cause material changes or delays in our intended activities.
Management does not believe that our environmental, health and safety risks
are materially different from those of comparable companies engaged in similar
businesses. Nevertheless, new or different environmental standards imposed in
the future may adversely affect our activities and there can be no assurance
that significant costs for compliance will not be incurred in the future.
Moreover, no assurance can be given that environmental laws will not, in the
future, result in curtailment of production or material increases in the cost
of exploration, development or production or otherwise adversely affect our
operations and financial condition.
Reliance on Key Personnel
We are dependent upon our executive officers and key employees. The
unexpected loss of services of one or more of these individuals could have a
detrimental effect on us. We do not maintain key man insurance on any of our
executive officers or key employees. In addition, our continued growth and
expansion will depend upon, among other factors, the successful retention of
skilled and experienced management and technical personnel.
Lack of Profitable Operations
We recorded net losses for 1994, 1995, 1996, 1997 and 1998 of $1,631,000,
$1,929,000, $1,837,000, $3,704,000, and $18,186,000, respectively. Our
ability to continue in business and maintain our financing arrangements would
be adversely affected by a continued lack of profitability.
Absence of Dividends
We have never paid cash dividends on the common stock and we do not anticipate
paying any cash dividends in the foreseeable future. In addition, our
revolving line of credit contains a prohibition on the payment of cash
dividends without the bank's consent.
Anti-Takeover Provisions
In April 1997, we adopted a Shareholder Rights Plan (the "Rights Plan"). The
Rights Plan is designed to insure that all shareholders receive fair value for
their common stock in the event of any takeover of the Company and to guard
against the use of partial tender offers or other coercive tactics to gain
control of the Company without offering fair value to the shareholders. While
the Rights Plan is not intended to prevent an acquisition of the Company on
terms that are favorable and fair to all shareholders, its existence may
discourage potential purchasers. We are not aware of any plan or intention by
any person to attempt a takeover of the Company.
Our Restated Articles of Incorporation impose restrictions on changes in
control of the Company. The existence of these provisions may discourage a
party from making a tender offer for or otherwise seeking to obtain control of
the Company.
Series B Preferred Stock - Right to Elect Directors in Certain Circumstances
Under the terms of our Series B Preferred Stock, if we do not pay dividends on
the Series B Preferred Stock for three quarterly dividend periods, then, until
such dividends have been paid in full, the holders of Series B Preferred Stock
have the right to elect two additional members to the Board of Directors.
While any such directors would not constitute a majority of the Board of
Directors, it is probable that they would attempt to influence the Board of
Directors, as a whole, to support the satisfaction of the claims of the
holders of the Series B Preferred Stock.
ITEM 3: LEGAL PROCEEDINGS
In December 1998, Del Mar Drilling Company, Inc. ("Plaintiff") filed a civil
action against Mallon Oil in the 118th Judicial District Court of Howard
County, Texas. Plaintiff's Original Petition seeks damages for an alleged
breach of contract in the amount of $348,100, plus interest, costs, and
attorney's fees. The Company has engaged the law firm in Midland, Texas, to
defend it in this matter. The case has been removed to the 142nd Judicial
District Court in Midland County, Texas, where it is Case Number CV-42.482.
The matter arises out of a contract for oil and gas drilling services
performed by Plaintiff. Plaintiff did not have the equipment necessary to
perform the work required under the contract, and, due to its financial
limitations, was unable to acquire the requisite equipment. The Company
leased the necessary equipment from a third party to enable Plaintiff to
proceed. In using the leased equipment, Plaintiff damaged it. The Company
sought to offset the amounts it paid to the third party equipment provider as
lease payments and damage reimbursements against the contract amount payable
to Plaintiff. Plaintiff refused to recognize the offsets, and claims the full
contract amount. The Company believes the Plaintiff's case is without merit,
and intends to defend itself, vigorously. The final outcome of this matter
cannot yet be predicted.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None.
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Price Range of Common Stock
The common stock is traded on the Nasdaq National Market tier of the Nasdaq
Stock Market under the symbol "MLRC." The following table sets forth, for the
periods indicated, the high and low sale prices of the common stock as
reported on the Nasdaq National Market.
<TABLE>
<CAPTION>
High Low
<S> <C> <C>
Year Ending December 31, 1997:
First Quarter $ 10.5000 $ 7.1250
Second Quarter 9.7500 6.7500
Third Quarter 12.3750 7.3750
Fourth Quarter 13.0000 7.8125
Year Ending December 31, 1998:
First Quarter $ 9.4690 $ 7.2500
Second Quarter 12.8750 9.0000
Third Quarter 12.6250 7.8750
Fourth Quarter 9.5000 6.3750
Year Ending December 31, 1999:
First Quarter (through March 24) $ 8.7500 $ 5.9380
</TABLE>
Holders
As of March 24, 1999, there were approximately 600 shareholders of record of
the common stock.
Dividend Policy
The Company does not intend to pay cash dividends on the common stock in the
foreseeable future. The Company instead intends to retain its earnings to
support the growth of the Company. Any future cash dividends would depend on
future earnings, capital requirements, the Company's financial condition and
other factors deemed relevant by the Board of Directors. Under the terms of
the Company's primary credit facility, the Company may not pay dividends
without the consent of the bank.
ITEM 6: SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial data for each
of the years in the five-year period ended December 31, 1998. This
information should be read in conjunction with the Consolidated Financial
Statements and "Management's Discussion of Financial Condition and Results of
Operations," included elsewhere herein.
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997(1) 1996 1995 1994
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Selected Statements of Operations Data:
Revenues:
Oil and gas sales $ 13,069 $ 8,582 $ 5,854 $ 4,800 $ 4,629
Other 109 69 512 470 106
13,178 8,651 6,366 5,270 4,735
Costs and expenses:
Oil and gas production 5,273 3,037 2,249 1,868 2,024
Mining project expenses -- -- 1,014 838 459
Depreciation, depletion and amortization 5,544 2,725 2,095 2,340 2,409
Impairment of oil and gas properties 16,842 24 264 -- --
Impairment of mining properties -- 350 -- -- --
General and administrative 2,562 2,274 1,845 1,467 1,342
Interest and other 1,143 701 842 433 132
31,364 9,111 8,309 6,946 6,366
Minority interest in loss of consolidated
subsidiary -- -- 266 -- --
Equity in loss of affiliate -- (3,244) -- -- --
Loss before extraordinary item (18,186) (3,704) (1,677) (1,676) (1,631)
Extraordinary loss on early retirement of debt -- -- (160) (253) --
Net loss (18,186) (3,704) (1,837) (1,929) (1,631)
Dividends on preferred stock and accretion (120) (185) (376) (360) (258)
Preferred stock conversion inducement -- (403) -- -- --
Gain on redemption of preferred stock -- -- 3,743 -- --
Net income (loss) attributable to common
shareholders (2) $(18,306) $(4,292) $ 1,530 $(2,289) $(1,889)
Basic loss per share (3):
Loss attributable to common shareholders
before extraordinary item $ (2.61) $ (0.92) $ (0.82) $ (1.05) $ (0.99)
Extraordinary loss -- -- (0.06) (0.13) --
Net loss attributable to common
shareholders (4) $ (2.61) $ (0.92) $ (0.88) $ (1.18) $ (0.99)
Weighted average shares outstanding 7,015 4,682 2,512 1,947 1,916
Selected Other Data:
Capital expenditures $36,354 $20,169 $ 6,339 $ 3,995 $ 2,379
Selected Balance Sheet Data:
Working capital (deficit) $(3,782) $ 1,190 $ 5,365 $ (476) $(1,764)
Total assets 58,452 51,426 41,400 31,635 28,226
Long-term debt (5) 27,183 1 3,511 10,037 --
Mandatorily redeemable preferred stock 1,329 1,317 3,900 3,844 3,804
Shareholders' equity 22,164 40,196 21,904 11,760 13,549
</TABLE>
____________________
(1) As a result of reducing its ownership interest in Laguna, the Company
accounted for its investment in Laguna as of and for the years ended
December 31, 1998 and 1997 using the equity method of accounting. Pursuant to
the rules of the S.E.C., the Company may not restate financial information
prior to 1997 to reflect the use of the equity method. Accordingly, the
Company's results for 1996, 1995, and 1994 are consolidated with Laguna's.
(2) At December 31, 1997, the Company reduced the carrying value of its
investment in and advances to Laguna to zero, due primarily to Laguna's write-
down of its mining assets because of continued depressed gold prices. After
1997, Laguna's financial results will no longer negatively impact the
Company's financial results. The effect of all Laguna-related transactions in
1997 reduced the Company's earnings by $3,634,000.
(3) As adjusted for four-to-one reverse stock split.
(4) The gain on the redemption of the Series A Convertible Preferred Stock
(the "Series A Stock") in 1996 resulted in net income attributable to common
shareholders for the year ended December 31, 1996 of $1,530,000. However,
because the Series A Stock is reflected as if converted, the gain on
redemption is deducted from net income attributable to common shareholders for
purposes of calculating per share data, resulting in a net loss attributable
to common shareholders of $2,213,000, or $0.88 per share, for the year ended
December 31, 1996.
(5) Long-term debt includes long-term debt net of current maturities, notes
payable-other and lease obligations net of current portion.
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion is intended to assist in understanding the Company's
historical consolidated financial position at December 31, 1998 and 1997, and
results of operations and cash flows for each of the years ended December 31,
1998, 1997 and 1996. The Company's historical Consolidated Financial
Statements and notes thereto included elsewhere in this report contain
detailed information that should be referred to in conjunction with the
following discussion. The financial information discussed below is
consolidated information, which includes the accounts of Laguna in 1996. As
discussed in Note 3 to the Company's consolidated financial statements,
because the Company's interest in Laguna was reduced from an approximate 56%
interest at the beginning of the year ended December 31, 1997, to less than a
majority interest by the end of the year, the Company de-consolidated Laguna
from the Company's financial statements and accounted for its investment in
Laguna using the equity method of accounting. Pursuant to applicable S.E.C.
rules, a restatement of years prior to 1997 to reflect the de-consolidation is
not permitted.
Overview
The Company's revenues, profitability and future rate of growth will be
substantially dependent upon its drilling success in the San Juan and Delaware
Basins, and prevailing prices for oil and gas, which are in turn dependent
upon numerous factors that are beyond the Company's control, such as economic,
political and regulatory developments and competition from other sources of
energy. The energy markets have historically been volatile, and there can be
no assurance that oil and gas prices will not be subject to wide fluctuations
in the future. A substantial or extended decline in oil or gas prices could
have a material adverse effect on the Company's financial position, results of
operations and access to capital, as well as the quantities of oil and gas
reserves that the Company may economically produce.
Liquidity and Capital Resources
The Company's operations are capital intensive. Historically, the Company's
principal sources of capital have been cash flow from operations, a revolving
line of credit and proceeds from sales of common and preferred stock. The
Company's principal uses of capital have been for the exploration,
acquisition, development and exploitation of oil and gas properties.
During fourth quarter 1997, the Company realized net proceeds of $19.6 million
from the sale of 2.3 million shares of common stock in a public offering. A
portion of the proceeds were used to repay substantially all of the Company's
long-term bank debt. At the beginning of 1998, the Company had $1.2 million
in net working capital, including $6.7 million in cash and cash equivalents,
and virtually no long-term debt.
The Company's 1998 oil and gas capital expenditures were $36.0 million and its
net cash provided by operations was $5.1 million. The remainder of 1998's
capital expenditures were funded primarily through borrowings under the
Company's revolving line of credit (described below) and two term loans
negotiated during 1998. The Company closed 1998 with a working capital
deficit of $3.8 million and long-term debt of $27.2 million.
The Company is currently in the process of securing additional capital to
enable it to continue its active drilling and development program through
1999. The following sources of capital are under active consideration:
- - bank borrowings or the issuance of debt securities;
- - the sale of preferred stock or other equity securities;
- - the issuance of production-based financing or net profits interests; and
- - joint venture financing.
The Company is working with its bank to establish a drilling line of credit,
which would be in addition to its current credit relationships. A drilling
line, if arranged, would bear a higher interest rate than the revolving line
of credit described below. There is no assurance that the Company will be
able to obtain the financing it seeks upon satisfactory terms.
During 1998, the Company completed 34 of 39 development wells and three of
five exploratory wells drilled. In addition, the Company recompleted 30 wells
in 1998. In first quarter 1999, two exploratory wells were successfully
completed and one exploratory well is still being tested. The Company is in
the process of establishing its budget for 1999 to incorporate the results
from the drilling of six wells on its La Jara Canyon acreage in the San Juan
Basin and the capital that it will have available.
In March 1996, the Company established a revolving line of credit (the
"Revolver") with Bank One, Texas, N.A. (the "Bank"). The borrowing base under
the Revolver is subject to redetermination every six months, or at such other
times as the Bank may determine. The Revolver, which is secured by
substantially all of the Company's oil and gas properties, expires April 1,
2001. In October 1998, the Revolver's borrowing base was established at $30
million. At December 31, 1998, borrowings under the Revolver were $22.1
million, leaving available additional borrowings of $7.9 million. As of
March 24, 1999, the outstanding balance under the Revolver was $26.4 million,
leaving available additional borrowings of $3.6 million. The Revolver
requires that the Company maintain certain financial and other covenants,
including a minimum current ratio, a minimum net equity, and a debt service
ratio. At December 31, 1998, the Company was not in compliance with the
minimum net equity and the debt service ratio covenants. The Bank has agreed
to waive the Company's non-compliance with both the minimum net equity and the
debt service ratio covenants for the quarter ended December 31, 1998.
Moreover, the Bank has agreed to waive any non-compliance with the debt service
ratio that may occur during calendar year 1999 and to amend the minimum net
equity covenant in such a way that management believes that, based on its
current projections, the Company will meet it for all reporting periods in 1999.
In addition to the Revolver, during 1998, the Company negotiated two term
loans with its bank. The Company drew $155,000 on the first term loan to
finance the purchase of land and a building for the Company's field office in
Carlsbad, New Mexico. Principal and interest of 8.5% is payable quarterly,
beginning October 1, 1998. The Company drew $6.5 million under the second
term loan to finance equipment for the Company's gas processing plant.
Principal and interest payments are payable monthly, beginning on November 30,
1998, over 5 years. Interest on the $6.5 million term loan is LIBOR plus 2%.
The Company entered into a 5-year interest rate swap agreement that will
effectively fix the interest rate on the term loan at 7.88%. The $6.5 million
notional amount of the interest rate swap declines monthly by the amount of
principal payments. The Company paid a total of $222,000 in principal
payments during 1998 on the two term loans.
Mandatory redemption of the Company's Series B Mandatorily Redeemable
Convertible Preferred Stock (the "Series B Stock") was to begin in April 1997,
when 20% of the outstanding shares, or 80,000 shares, were to be redeemed for
$800,000. In March 1997, the Company extended an offer to all holders of the
Series B Stock to convert their shares into shares of common stock at a
conversion price of $9.00, rather than the $11.31 conversion price otherwise
then in effect. The market price of a share of the common stock during the
term of the offer ranged from $7.88 to $8.50. Holders of 252,675 shares of
Series B Stock elected to convert their shares into 280,747 shares of common
stock. In addition, the Company redeemed 12,125 shares of Series B Stock at
$10.00 per share. After these transactions, 135,200 shares of Series B Stock
remain outstanding and the Company has no further obligation to redeem any
shares until April 2000. The Company will be required to redeem 55,200 shares
in April 2000, and the remaining 80,000 shares in April 2001. The Series B
Stock is convertible to common stock automatically if the common stock trades
at a price in excess of 140% of the then applicable conversion price for each
day in a period of 10 consecutive trading days. The conversion price, as
adjusted, is currently $10.30.
Results of Operations
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
(In thousands, except per unit data)
<S> <C> <C> <C>
Operating Results from Oil and Gas Operations:
Oil and gas revenues $13,069 $8,582 $5,854
Production tax and marketing expense 1,901 1,122 715
Lease operating expense 3,372 1,915 1,534
Depletion 5,303 2,604 1,924
Depreciation 140 21 --
Impairment 16,842 24 264
Net Production:
Natural gas (MMcf) 5,852 2,350 1,286
Oil (MBbl) 230 196 174
Total (MMcfe) 7,232 3,526 2,330
Average Sales Price Realized (1):
Natural gas (per Mcf) $1.72 $2.04 $2.11
Oil (per Bbl) $12.99 $19.31 $18.05
Per Mcfe $1.81 $2.43 $2.51
Average Cost Data (per Mcfe):
Production tax and marketing expense $0.26 $0.32 $0.31
Lease operating expense $0.47 $0.54 $0.66
Depletion $0.73 $0.74 $0.83
</TABLE>
________________
(1) Includes effects of hedging. See "Hedging Activities."
Year Ended December 31, 1998 Compared with Year Ended December 31, 1997
Revenues. Total revenues for the year ended December 31, 1998 increased 52%
to $13,178,000 from $8,651,000 for the year ended December 31, 1997. Oil and
gas sales for the year ended December 31, 1998 increased 52% to $13,069,000
from $8,582,000. The increase was due to higher oil and gas production due to
the Company's successful drilling and recompletion program in 1998. Oil
production for the year ended December 31, 1998 increased 17% to 230,000
barrels from 196,000 barrels for the year ended December 31, 1997 and gas
production for the year ended December 31, 1998 increased 149% to 5,852,000
Mcf from 2,350,000 Mcf for the year ended December 31, 1997. These increases
were somewhat offset by a decline in average oil and gas prices realized in
1998 from those realized in 1997. Average oil prices for the year ended
December 31, 1998 decreased 33% to $12.99 per barrel from $19.31 per barrel
for the year ended December 31, 1997 and average gas prices for the year ended
December 31, 1998 decreased 16% to $1.72 per Mcf from $2.04 per Mcf for the
year ended December 31, 1997.
Oil and Gas Production Expenses. Oil and gas production expenses for the year
ended December 31, 1998 increased 74% to $5,273,000 from $3,037,000 for the
year ended December 31, 1997. The increase was primarily attributable to
increased operating costs related to new wells drilled in 1998 and expansion
and operation of the gas processing plant. Production tax and marketing
expense per Mcfe decreased $0.06, or 19%, to $0.26 for the year ended
December 31, 1998 from $0.32 for the year ended December 31, 1997. Lease
operating expense per Mcfe decreased $0.07, or 13%, to $0.47 for the year
ended December 31, 1998 from $0.54 for the year ended December 31, 1997. LOE
per Mcfe in 1998 is lower due to higher average production rates per well for
new wells and a higher proportion of gas production in 1998, which is less
costly to produce than oil.
Depreciation, Depletion and Amortization. Depreciation, depletion and
amortization for the year ended December 31, 1998 increased 103% to $5,544,000
from $2,725,000 for the year ended December 31, 1997 due to increased oil and
gas production. Depletion per Mcfe for the year ended December 31, 1998
decreased slightly to $0.73 from $0.74 for the year ended December 31, 1997,
due to a higher ratio of reserve increases to capital expenditures in 1998.
Due to the impairment of oil and gas properties charge in fourth quarter 1998,
discussed below, the depletion rate per Mcfe is expected to decline in future
periods.
Impairment of Oil and Gas Properties. Impairment of oil and gas properties
was $16,842,000 for the year ended December 31, 1998 compared to $24,000 for
the year ended December 31, 1997. Under the full cost accounting rules of the
S.E.C., the Company reviews the carrying value of its oil and gas properties
each quarter on a country-by-country basis. Net capitalized costs of oil and
gas properties, less related deferred income taxes, may not exceed the present
value of estimated future net revenues from proved reserves, discounted at
10%, plus the lower of cost or fair market value of unproved properties, as
adjusted for related tax effects. Application of these rules generally
requires pricing future production at the unescalated oil and gas prices in
effect at the end of each fiscal quarter and requires a write-down if the
"ceiling" is exceeded, even if prices declined for only a short period of
time. The Company made a non-cash charge in fourth quarter 1998 to write down
its U.S. oil and gas properties by $16,842,000. In applying the "ceiling
test," the Company used December 31, 1998 oil and gas prices of $10.03 per
barrel of oil and $1.43 per Mcf of gas. The full cost ceiling is not intended
to represent an estimate of the fair market value of the Company's oil and gas
properties. In light of continuing depressed prices for oil and natural gas,
it is possible that the Company may incur additional ceiling test write-downs
in the future. The impairment amount of $24,000 in 1997 relates to additional
charges that came in after the Company impaired the costs incurred in 1996
related to an exploration venture in Belize, which drilled a dry hole. The
Company currently operates only in the continental United States.
Impairment of Mining Properties. In second quarter 1997, the Company reduced
its note receivable from Laguna by $350,000, including accrued interest, in
exchange for an overriding royalty interest in Laguna's mineral properties.
Due to continued depressed gold prices, in fourth quarter 1997, the Company
impaired this amount.
General and Administrative Expenses. General and administrative expenses for
the year ended December 31, 1998 increased 13% to $2,562,000 from $2,274,000
for the year ended December 31, 1997 due to the hiring of additional personnel
because of expanded operations. For the year ended December 31, 1998, the
Company capitalized $884,000 more of general and administrative expenses
directly related to its drilling program than was capitalized for the year
ended December 31, 1997.
Interest and Other Expenses. Interest and other expenses for the year ended
December 31, 1998 increased 63% to $1,143,000 from $701,000 for the year ended
December 31, 1997. The increase is primarily due to higher outstanding
borrowings under the Company's revolving line of credit and term loans in
1998.
Equity in Loss of Affiliate. As a result of reducing its ownership interest
in Laguna, for the years ended December 31, 1998 and 1997, Mallon accounted
for its investment in Laguna using the equity method of accounting. In fourth
quarter 1997, due to continued depressed gold prices, Laguna wrote down its
mineral assets by $9,319,000. As a result, Mallon impaired 100% of its
investment in and advances to Laguna. The Company's share of Laguna's 1997
net loss was in excess of the carrying value of its investment in and advances
to Laguna by $2,733,000. The Company's share of Laguna's 1997 losses, up to
the carrying amount of its investment in and advances to Laguna, totaled
$3,244,000. The Company will not reflect its share of Laguna's future losses
and may only reflect its share of Laguna's future earnings to the extent that
they exceed the Company's share of Laguna's 1997 and future net losses not
recognized.
Income Taxes. The Company incurred net operating losses ("NOLs") for U.S.
Federal income tax purposes in 1998 and 1997, which can be carried forward to
offset future taxable income. Statement of Financial Accounting Standards
No. 109 requires that a valuation allowance be provided if it is more likely
than not that some portion or all of a deferred tax asset will not be
realized. The Company's ability to realize the benefit of its deferred tax
asset will depend on the generation of future taxable income through
profitable operations and the expansion of the Company's oil and gas producing
activities. The market and capital risks associated with achieving the above
requirement are considerable, resulting in the Company's decision to provide a
valuation allowance equal to the net deferred tax asset. Accordingly, the
Company did not recognize any tax benefit in its consolidated statement of
operations for the years ended December 31, 1998 and 1997. At December 31,
1998, the Company had an NOL carryforward for U.S. Federal income tax purposes
of $19,000,000, which will begin to expire in 2001.
Net Loss. Net loss for the year ended December 31, 1998 increased 391% to
$18,186,000 from $3,704,000 for the year ended December 31, 1997 as a result
of the factors discussed above. Of the net loss for the year ended December
31, 1998, $16,842,000 relates to a non-cash write down of oil and gas
properties discussed above. Of the net loss for the year ended December 31,
1997, $3,634,000 relates to Laguna losses and impairments. As discussed
above, the Company will not reflect its share of Laguna's losses in the future
and may only reflect its share of Laguna's future earnings to the extent that
they exceed the Company's share of Laguna's 1997 and future losses not
recognized. The Company paid the 8% dividend of $108,000 and $161,000 on its
$1,329,000 and $1,317,000 face amount Series B Mandatorily Redeemable
Convertible Preferred Stock ("Series B Preferred Stock") in each of the years
ended December 31, 1998 and 1997, respectively, and realized accretion of
$12,000 and $24,000, respectively. Beginning in April 1997, preferred
dividend payments were reduced as a result of the conversion into common stock
and redemption of Series B Preferred Stock, as discussed in Note 6 of the
consolidated financial statements. The excess of the fair value of the common
stock issued at the $9.00 conversion price over the fair value of the common
stock that would have been issued at the $11.31 conversion price, totaling
$403,000, has been reflected on the consolidated statement of operations for
the year ended December 31, 1997 as an increase to the net loss attributable
to common shareholders. Net loss attributable to common shareholders for the
year ended December 31, 1998 was $18,306,000 compared to net loss attributable
to common shareholders of $4,292,000 for the year ended December 31, 1997.
Year Ended December 31, 1997 Compared with Year Ended December 31, 1996
Revenues. Total revenues for the year ended December 31, 1997 increased 36%
to $8,651,000 from $6,366,000 for the year ended December 31, 1996. Oil and
gas sales for the year ended December 31, 1997 increased 47% to $8,582,000
from $5,854,000. The increase was primarily due to higher oil and gas
production and higher oil prices. Oil production for the year ended
December 31, 1997 increased 13% to 196,000 barrels from 174,000 barrels for
the year ended December 31, 1996, and gas production for the year ended
December 31, 1997 increased 83% to 2,350,000 Mcf from 1,286,000 Mcf for the
year ended December 31, 1996, due to the Company's successful drilling and
recompletion program in 1997. Average oil prices for the year ended
December 31, 1997 increased 7% to $19.31 per Bbl from $18.05 per Bbl for the
year ended December 31, 1996. However, average gas prices for the year ended
December 31, 1997 decreased 3% to $2.04 per Mcf from $2.11 per Mcf for the
year ended December 31, 1996. The Company recognized a $329,000 gain on the
sale of Laguna common stock for the year ended December 31, 1996.
Oil and Gas Production Expenses. Oil and gas production expenses for the year
ended December 31, 1997 increased 35% to $3,037,000 from $2,249,000 for the
year ended December 31, 1996. The increase was primarily attributable to
increased operating costs related to new wells drilled in 1997. Oil and gas
production expenses per Mcfe decreased $0.11, or 11%, to $0.86 for the year
ended December 31, 1997 from $0.97 for the year ended December 31, 1996.
Production tax and marketing expense per Mcfe increased $0.01, or 3%, to $0.32
for the year ended December 31, 1997 from $0.31 for the year ended
December 31, 1996. However, lease operating expense per Mcfe decreased $0.12,
or 18%, to $0.54 for the year ended December 31, 1997 from $0.66 for the year
ended December 31, 1996.
Mining Project Expenses. As discussed above, the Company de-consolidated
Laguna in fourth quarter 1997. Because all of the mining project expenses for
the year ended December 31, 1997 were Laguna's, none are reflected on the
Company's consolidated statement of operations for 1997. Mining project
expenses for the year ended December 31, 1996 of $1,014,000 reflect Laguna's
drilling program in new exploration areas and business development expenses
related to reviewing other mineral concessions.
Depreciation, Depletion and Amortization. Depreciation, depletion and
amortization for the year ended December 31, 1997 increased 30% to $2,725,000
from $2,095,000 for the year ended December 31, 1996 due to increased oil and
gas production. Depletion per Mcfe for the year ended December 31, 1997
decreased 11% to $0.74 from $0.83 for the year ended December 31, 1996,
primarily due to a higher ratio of increases in oil and gas reserves to
capital expenditures.
Impairment of Oil and Gas Properties. Impairment of oil and gas properties
was $24,000 during the year ended December 31, 1997 compared to $264,000 for
the year ended December 31, 1996. In fiscal 1996, the Company acquired a
2.25% working interest in an exploration venture to drill one or more wells
offshore Belize. As of December 31, 1996, the Company had incurred and
capitalized $264,000 related to this venture. The joint venture drilled a dry
hole subsequent to December 31, 1996. Accordingly, the Company reduced the
carrying amount of its capitalized costs by $264,000. During 1997, additional
costs related to this dry hole of $24,000 were incurred and impaired.
Impairment of Mining Properties. In second quarter 1997, the Company reduced
its note receivable from Laguna by $350,000, including accrued interest, in
exchange for an overriding royalty interest in Laguna's mineral properties.
Due to continued depressed gold prices, in fourth quarter 1997, the Company
impaired this amount.
General and Administrative Expenses. General and administrative expenses for
the year ended December 31, 1997 increased 23% to $2,274,000 from $1,845,000
for the year ended December 31, 1996 due primarily to the hiring of additional
personnel because of expanded operations. During the year ended December 31,
1997, the Company capitalized $562,000 of general and administrative expenses
directly related to its drilling program. No such costs were capitalized
during 1996 because general and administrative expenses directly related to
its drilling program were minimal.
Interest and Other Expenses. Interest and other expenses for the year ended
December 31, 1997 decreased 17% to $701,000 from $842,000 for the year ended
December 31, 1996. The decrease was primarily due to lower outstanding
borrowings in 1997.
Minority Interest. Minority interest in loss of consolidated subsidiary in
1996 of $266,000 represents the minority interest share in the Laguna loss.
Equity in Loss of Affiliate. During the latter part of 1996 and throughout
most of 1997, Mallon held approximately 56% of the common stock of Laguna. In
fourth quarter 1997, Mallon contributed 2,450,000 shares of its Laguna stock
to induce a new management team to join Laguna. After this transaction,
Mallon owned approximately 46% of Laguna. As a result of reducing its
ownership interest in Laguna, Mallon accounted for its investment in Laguna at
December 31, 1997 using the equity method of accounting. Pursuant to the
rules of the S.E.C., Mallon may not restate prior year financial information
to reflect the use of the equity method. Accordingly, the Company's results
for 1996 are consolidated with Laguna's.
In fourth quarter 1997, due to continued depressed gold prices, Laguna wrote
down its mineral assets by $9,319,000. As a result, Mallon impaired 100% of
its investment in and advances to Laguna. The Company's share of Laguna's
1997 net loss was in excess of the carrying value of its investment in and
advances to Laguna by $2,733,000. The Company's share of Laguna's 1997
losses, up to the carrying amount of its investment in and advances to Laguna,
totaled $3,244,000, and is reflected as "equity in loss of affiliate" on the
Company's 1997 consolidated statement of operations. The Company will not
reflect its share of Laguna's future losses and may only reflect its share of
Laguna's future earnings to the extent that they exceed the Company's share of
Laguna's 1997 and future net losses not recognized.
Income Taxes. The Company incurred net operating losses ("NOLs") for U.S.
Federal income tax purposes in 1997 and 1996, which can be carried forward to
offset future taxable income. Statement of Financial Accounting Standards
No. 109 requires that a valuation allowance be provided if it is more likely
than not that some portion or all of a deferred tax asset will not be
realized. The Company's ability to realize the benefit of its deferred tax
asset will depend on the generation of future taxable income through
profitable operations and the expansion of the Company's oil and gas producing
activities. The market and capital risks associated with achieving the above
requirement are considerable, resulting in the Company's decision to provide a
valuation allowance equal to the net deferred tax asset. Accordingly, the
Company did not recognize any tax benefit in its consolidated statement of
operations for the years ended December 31, 1997 and 1996. At December 31,
1997, the Company disclosed an NOL carryforward for U.S. Federal income tax
purposes of $27,100,000. When filing its 1997 Federal income tax return, the
Company elected to capitalize intangible drilling and development costs
incurred in 1997, and amortize the costs over five years. The costs were
capitalized in order to preserve them as deductions for alternative minimum
tax purposes. This treatment reduced the NOL carryforward as of December 31,
1997, to $16,500,000, which will begin to expire in 2001.
Extraordinary Loss. The Company incurred an extraordinary loss of $160,000
during the year ended December 31, 1996, as a result of the refinancing of its
credit facility with a new lender.
Net Loss. Net loss for the year ended December 31, 1997 increased 102% to
$3,704,000 from $1,837,000 for the year ended December 31, 1996 as a result of
the factors discussed above. Of the net loss for the year ended December 31,
1997, $3,634,000 relates to Laguna losses and impairments. As discussed
above, the Company will not reflect its share of Laguna's losses in the future
and may only reflect its share of Laguna's future earnings to the extent that
they exceed the Company's share of Laguna's 1997 and future losses not
recognized. The Company paid the 8% dividend of $161,000 and $320,000 on its
$1,317,000 and $4,000,000 face amount Series B Mandatorily Redeemable
Convertible Preferred Stock ("Series B Preferred Stock") in each of the years
ended December 31, 1997 and 1996, respectively, and realized accretion of
$24,000 and $56,000, respectively. Beginning in April 1997, preferred
dividend payments were reduced as a result of the conversion into common stock
and redemption of Series B Preferred Stock, as discussed in Note 8 of the
consolidated financial statements. The excess of the fair value of the common
stock issued at the $9.00 conversion price over the fair value of the common
stock that would have been issued at the $11.31 conversion price, totaling
$403,000, has been reflected on the consolidated statement of operations for
the year ended December 31, 1997 as an increase to the net loss attributable
to common shareholders. Net loss attributable to common shareholders for the
year ended December 31, 1997 was $4,292,000 compared to net income
attributable to common shareholders of $1,530,000 for the year ended
December 31, 1996. Net income attributable to common shareholders in 1996
included a $3,743,000 gain on the redemption of Series A Convertible Preferred
Stock in October 1996.
Hedging Activities
The Company uses hedging instruments to manage commodity price risks. The
Company has used energy swaps and other financial arrangements to hedge
against the effects of fluctuations in the sales prices for oil and natural
gas. Gains and losses on such transactions are matched to product sales and
charged or credited to oil and gas sales when that product is sold.
Management believes that the use of various hedging arrangements can be a
prudent means of protecting the Company's financial interests from the
volatility of oil and gas prices.
The Company recognized hedging gains (losses) of $481,000 ($615,000) and
($490,000) for the years ended December 31, 1998, 1997 and 1996, respectively.
These gains (losses) are included in oil and gas sales in the Company's
consolidated statements of operations.
In December 1998, the Company terminated an energy swap entered into earlier
in the year for 1999 production and received proceeds of $909,000, all of
which is included in deferred revenue on the Company's December 31, 1998
balance sheet.
Year 2000
The following Year 2000 statements constitute a Year 2000 Readiness Disclosure
within the meaning of the Year 2000 Information and Readiness Disclosure Act
of 1998.
Year 2000 issues result from the inability of certain electronic hardware and
software to accurately calculate, store or use a date subsequent to
December 31, 1999. These dates can be erroneously interpreted in a number of
ways; e.g., the year 2000 could be interpreted as the year 1900. This
inability could result in a system failure or miscalculations that could in
turn cause operational disruptions. These issues could affect not only
information technology ("IT") systems, such as computer systems used for
accounting, land and engineering, but also systems that contain embedded
chips.
The Company has completed an assessment of its IT systems to determine whether
these systems are Year 2000 compliant. The Company has determined that these
systems are either compliant or with relatively minor modifications or
upgrades (many of which would have been made in any event as part of the
Company's continuing effort to enhance its IT systems) will be compliant. All
necessary modifications and upgrades and the testing thereof are expected to
be completed by the end of the second quarter of 1999.
The Company is assessing its non-information systems to ascertain whether
these systems contain embedded computer chips that will not properly function
subsequent to December 31, 1999. These systems include office equipment, the
automatic wellhead equipment used to operate wells, the Company-owned gas
gathering pipelines, and the Company's gas processing plant in the San Juan
Basin. All of these systems have been determined to be Year 2000 compliant
based on information provided by third party vendors.
To date, the Company has relied upon its internal staff to assess its Year
2000 readiness. The costs associated with assessing the Company's Year 2000
internal compliance and related systems modification, upgrading and testing
are not currently expected to exceed $50,000. Costs incurred through
December 31, 1998 have been minimal.
The Company is in the process of communicating with certain of its significant
suppliers, service companies, gas gatherers and pipelines, electricity
providers and financial institutions to determine the vulnerability of the
Company to third parties' failure to address their Year 2000 issues. While
the Company has not yet received definitive responses indicating all such
entities are Year 2000 compliant, it has not received information suggesting
the Company is vulnerable to potential Year 2000 failure by these parties.
These communications are expected to continue into the second quarter of 1999.
At this time, the Company has not developed any contingency plans to address
third party non-compliance with Year 2000 matters. However, should its
communications with any third parties indicate significant vulnerability,
development of contingency plans will be considered.
The Company does not anticipate any significant disruptions of its operations
due to Year 2000 issues. Among the potential "worst case" problems the
Company could face would be the loss of electricity used to power well pumps
and compressors that would result in wells being shut-in, or the inability of
a third party gas gathering company or pipeline to accept gas from the
Company's wells or gathering lines which would also result in the Company's
wells being shut-in. A disruption in production would result in the loss of
income.
Miscellaneous
The Company's oil and gas operations are significantly affected by certain
provisions of the Internal Revenue Code of 1986, as amended (the "Code"), that
are applicable to the oil and gas industry. Current law permits the Company's
intangible drilling and development costs to be deducted currently, or
capitalized and amortized over a five year period. The Company, as an
independent producer, is also entitled to a deduction for percentage depletion
with respect to the first 1,000 Bbls per day of domestic crude oil (and/or
equivalent units of domestic natural gas) produced (if such percentage
depletion exceeds cost depletion). Generally, this deduction is 15% of gross
income from an oil and gas property, without reference to the taxpayer's basis
in the property. The percentage depletion deduction may not exceed 100% of
the taxable income from a given property. Further, percentage depletion is
limited in the aggregate to 65% of the Company's taxable income. Any
depletion disallowed under the 65% limitation, however, may be carried over
indefinitely.
Inflation has not historically had a material impact on the Company's
financial statements, and management does not believe that the Company will be
materially more or less sensitive to the effects of inflation than other
companies in the oil and gas industry.
The Company and its operations are subject to numerous risks and
uncertainties. A discussion of some of these risks is set forth, above, in
Items 1 and 2, under the heading "Special Considerations."
ITEM 7a: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Commodity Price Risk
The Company uses commodity derivative financial instruments, including swaps,
to reduce the effect of natural gas price volatility on a portion of its
natural gas production. Commodity swap agreements are generally used to fix a
price at the natural gas market location or to fix a price differential
between the price of natural gas at Henry Hub and the price of gas at its
market location. Settlements are based on the difference between a fixed and
a variable price as specified in the agreement. The following table
summarizes the Company's derivative financial instrument position on its
natural gas production as of December 31, 1998. The fair value of these
instruments reflected below is the estimated amount that the Company would
receive (or pay) to settle the contracts as of December 31, 1998. Actual
settlement of these instruments when they mature will differ from these
estimates reflected in the table. Gains or losses realized from these
instruments hedging the Company's production are expected to be offset by
changes in the actual sales price received by the Company for its natural gas
production. See "Hedging Activities" above.
<TABLE>
<CAPTION>
Year MMBtu Fixed Price per MMBtu Fair Value
<S> <C> <C> <C>
1999 354,000 $2.06 $122,000
2000 5,400,000 $2.02 $225,000
</TABLE>
In addition, the Company had an energy swap agreement in place at December 31,
1998, that counteracts the agreement included above with respect to 354,000
MMBtu of gas for 1999. Under this swap agreement, the Company must pay the
counterparty if the fixed price of $1.785 exceeds the floating price (based on
El Paso Natural Gas - San Juan). The fair value of this swap agreement was
$(25,000) at December 31, 1998.
At December 31, 1998, the Company also had two basis swaps in place to fix the
differential between the NYMEX price and the index price at which the hedged
gas is to be sold for 7,200,000 MMBtu in 1999 with a fair value of $(181,000).
Interest Rate Risk
The table below provides information about the Company's derivative financial
instruments and other financial instruments sensitive to changes in interest
rates, including interest rate swaps and debt obligations. For debt
obligations, the table presents principal cash flows and related weighted
average interest rates by expected maturity dates and for interest rate swaps,
the table presents notional amounts and weighted average interest rate by
contractual maturity dates. Notional amounts are used to calculate the
contractual payments to be exchanged under the contract. Weighted average
variable rates are based on implied forward rates in the yield curve as of
December 31, 1998.
Expected Maturity
(In thousands)
<TABLE>
<CAPTION>
Fair
1999 2000 2001 2002 2003 Thereafter Value
<S> <C> <C> <C> <C> <C> <C> <C>
Long-term debt:
Fixed rate $ 15 $ 15 $ 120 -- $ 150
Average interest rate 8.5% 8.5% 8.5% -- -- --
Variable rate $1,300 $1,300 $23,360 $1,300 $1,083 -- $28,343
Average interest rate 7.6% 7.6% 7.2% 7.6% 7.6% --
Interest rate swap:
Variable to fixed $1,300 $1,300 $1,300 $1,300 $1,083 -- $ (114)
Average pay rate 7.9% 7.9% 7.9% 7.9% 7.9% --
Average receive rate 7.0% 7.0% 7.2% 7.3% 7.4% --
</TABLE>
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements that constitute Item 8 follow
the text of this Annual Report on Form 10-K. An index to the Consolidated
Financial Statements appears at page F-1.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
In July 1997, the Company solicited bids for audit work on its financial
statements for the next three years. As a result of that process, the Audit
Committee of the Company's Board of Directors selected Arthur Andersen LLP as
its independent certified public accounting firm for such period. There were
no disagreements with the Company's prior accounting firm,
PricewaterhouseCoopers LLP, on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure, and
PricewaterhouseCoopers LLP's reports did not contain any adverse or qualified
opinions during such accounting firm's engagement. The Company had no prior
business dealings or consultations with Arthur Andersen LLP.
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors
The information set forth under the caption "Election of Directors" in the
Company's Proxy Statement for its June 8, 1999, Annual Meeting of
Shareholders, which is to be filed with the S.E.C. pursuant to Regulation 14A
under the Securities Exchange Act of 1934, is incorporated herein by
reference.
Executive Officers
Information concerning executive officers is set forth in Item 1 of Part I of
this report. Additional information concerning executive officers set forth
in the Company's Proxy Statement for its June 8, 1999, Annual Meeting of
Shareholders, which is to be filed with the S.E.C. pursuant to Regulation 14A
under the Securities Exchange Act of 1934, is incorporated herein by
reference.
ITEM 11: EXECUTIVE COMPENSATION
The information set forth under the caption "Executive Compensation" in the
Company's Proxy Statement for its June 8, 1999, Annual Meeting of
Shareholders, which is to be filed with the S.E.C., pursuant to Regulation 14A
under the Securities Exchange Act of 1934, is incorporated herein by
reference.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth under the caption "Principal Shareholders" in the
Company's Proxy Statement for its June 8, 1999, Annual Meeting of
Shareholders, which is to be filed with the S.E.C., pursuant to Regulation 14A
under the Securities Exchange Act of 1934, is incorporated herein by
reference.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth under the caption "Certain Relationships and Related
Party Transactions" in the Company's Proxy Statement for its June 8, 1999,
Annual Meeting of Shareholders, which is to be filed with the S.E.C., pursuant
to Regulation 14A under the Securities Exchange Act of 1934, is incorporated
herein by reference.
PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
(1) Financial Statements
See the accompanying "Index to Consolidated Financial Statements" at page F-1,
which lists the documents that are filed as a part of this report.
(2) Financial Statements Schedules
The Financial Statements for the year ended December 31, 1998, of Laguna Gold
Company are filed as financial statement schedules to this Report.
(3) Exhibits
See the Exhibit Index that follows the signature page to this report and is
incorporated herein by this reference.
(b) Reports on Form 8-K:
Since September 30, 1998, the Company has filed the following Periodic Reports
on Form 8-K:
Date of Report Item(s) Reported
November 11, 1998 "Other Events" - Options re-priced
November 11, 1998 "Other Events" - 3rd Quarter Results
December 4, 1998 "Other Events" - Borrowing Base Redetermination
March 4, 1999 "Other Events" - Year-end Reserves
March 9, 1999 "Other Events" - Drilling Results
March 15, 1999 "Other Events" - 1998 Results
(c) Exhibits:
See the Exhibit Index that follows the signature page to this report and is
incorporated herein by this reference.
(d) Financial statements of 50-percent-or-less-owned persons:
The Financial Statements for the year ended December 31, 1998, of Laguna Gold
Company are filed as financial statement schedules to this Report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
x
Mallon Resources Corporation
Date: April 7, 1999 By: /s/ George O. Mallon, Jr.
George O. Mallon, Jr.
Principal Executive Officer
Date: April 7, 1999 By: /s/ Alfonso R. Lopez
Alfonso R. Lopez
Principal Financial Officer
Principal Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
Date: April 7, 1999 By: /s/ George O. Mallon, Jr.
George O. Mallon, Jr.
Director
Date: April 7, 1999 By: /s/ Kevin M. Fitzgerald
Kevin M. Fitzgerald
Director
Date: April 7, 1999 By: /s/ Roy K. Ross
Roy K. Ross
Director
Date: April 7, 1999 By: /s/ Francis J. Reinhardt, Jr.
Francis J. Reinhardt, Jr.
Director
EXHIBIT INDEX
Exhibit Number
Document Description
Location
*3.01 Amended and Restated Articles of Incorporation of the Company (1)
*3.02 Bylaws of the Company (1)
*3.03 Statement of Designations--Series B Preferred Stock (2)
*3.04 Shareholder Rights Agreement (3)
*10.01 Bank One--Loan Agreement dated March 20, 1996 (4)
*10.02 Equity Participation Plan, amended November 2, 1990 (5)
*10.03 Stock Compensation Plan for Outside Directors (6)
*10.04 1997 Equity Participation Plan (7)
*10.05 Employment Contract of George O. Mallon, Jr. (8)
*10.06 Employment Contract of Kevin M. Fitzgerald (8)
*10.07 Employment Contract of Roy K. Ross (8)
*16.01 Letter re: Change in Certifying Accountant (9)
*21.01 Subsidiaries (10)
____________________________
* These exhibits were filed in previous filings with the S.E.C. identified
below.
1. Incorporated by reference from Mallon Resources Corporation Exhibits to
Registration Statement on Form S-4 (S.E.C. File No. 33-23076) filed on
August 15, 1988.
2. Incorporated by reference from Mallon Resources Corporation (S.E.C. File
No. 0-17267) Form 8-K filed on August 24, 1995.
3. Incorporated by reference from Mallon Resources Corporation (S.E.C. File
No. 0-17267) Form 8-K filed on April 22, 1997.
4. Incorporated by reference from Mallon Resources Corporation (S.E.C. File
No. 0-17267) Form 8-K filed on March 20, 1996.
5. Incorporated by reference from Mallon Resources Corporation (S.E.C. File
No. 0-17267) Form 10-K for fiscal year ended December 31, 1990.
6. Incorporated by reference from Mallon Resources Corporation Exhibits to
Registration Statement on Form S-8 (S.E.C. File No. 33-39635) filed on
March 28, 1991.
7. Incorporated by reference from Mallon Resources Corporation (S.E.C. File
No. 0-17267) definitive proxy statement for annual meeting of shareholders
held June 6, 1997.
8. Incorporated by reference from Mallon Resources Corporation (S.E.C. File
No. 0-17267) Form 8-K filed on April 22, 1997.
9. Incorporated by reference from Mallon Resources Corporation (S.E.C. File
No. 0-17267) Form 8-K filed on August 11, 1997.
10. Incorporated by reference from Mallon Resources Corporation (S.E.C. File
No. 0-17267) Form 10-K for fiscal year ended December 31, 1990.
GLOSSARY OF TERMS
Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used herein
in reference to crude oil or other liquid hydrocarbons.
Bcf. Billion cubic feet.
Btu. British thermal unit, which is the heat required to raise the
temperature of a one-pound mass of water from 58.5 to 59.5 degrees Fahrenheit.
Development location. A location on which a development well can be
drilled.
Development well. A well drilled within the proved area of an oil or gas
reservoir to the depth of a stratigraphic horizon known to be productive in an
attempt to recover proved undeveloped reserves.
Dry hole. A well found to be incapable of producing either oil or gas in
sufficient quantities to justify completion as an oil or gas well.
Estimated future net revenues. Revenues from production of oil and gas,
net of all production-related taxes, lease operating expenses and capital
costs.
Exploratory well. A well drilled to find and produce oil or gas in an
unproved area, to find a new reservoir in a field previously found to be
productive of oil or gas in another reservoir, or to extend a known reservoir.
Gross acres. An acre in which a working interest is owned.
Gross well. A well in which a working interest is owned.
MBbl. One thousand barrels of crude oil or other liquid hydrocarbons.
Mcf. One thousand cubic feet.
Mcfe. One thousand cubic feet of natural gas equivalent, determined using
the ratio of six Mcf of natural gas (including natural gas liquids) to one Bbl
of crude oil or condensate.
MMBbl. One million barrels of crude oil or other liquid hydrocarbons.
MMBtu. One million Btus.
MMcf. One million cubic feet.
MMcfe. One million cubic feet of natural gas equivalent.
Net acres or net wells. The sum of the fractional working interests owned
in gross acres or gross wells.
Pre-tax S.E.C.-10 Value or present value of estimated future net revenues.
Estimated future net revenues discounted by a factor of 10% per annum, before
income taxes and with no price or cost escalation or de-escalation, in
accordance with guidelines promulgated by the S.E.C.
Production costs. All costs necessary for the production and sale of oil
and gas, including production and ad valorem taxes.
Productive well. A well that is producing oil or gas or that is capable of
production.
Proved developed reserves. Reserves that can be expected to be recovered
through existing wells with existing equipment and operating methods.
Proved reserves. The estimated quantities of crude oil, natural gas and
natural gas liquids which geological and engineering data demonstrate with
reasonable certainty to be recoverable in future years from known reservoirs
under existing economic and operating conditions.
Proved undeveloped reserves. Reserves that are expected to be recovered
from new wells on undrilled acreage, or from existing wells where a relatively
major expenditure is required for recompletion.
Recompletion. The completion for production of an existing wellbore in
another formation from that in which the well has previously been completed.
S.E.C. The United States Securities and Exchange Commission.
Undeveloped acreage. Lease acreage on which wells have not been drilled or
completed to a point that would permit the production of commercial quantities
of oil and gas regardless of whether such acreage contains proved reserves.
Working interest. The operating interest which gives the owner the right
to drill, produce and conduct operating activities on the property and a share
of production.
Index to Consolidated Financial Statements
Page
Report of Independent Public Accountants F-2
Report of Independent Accountants F-3
Consolidated Balance Sheets F-4
Consolidated Statements of Operations F-5
Consolidated Statements of Shareholders' Equity F-6
Consolidated Statements of Cash Flows F-7
Notes to Consolidated Financial Statements F-9
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
Mallon Resources Corporation:
We have audited the accompanying consolidated balance sheets of Mallon
Resources Corporation (a Colorado corporation) and subsidiaries as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, shareholders' equity and cash flows for the years then ended.
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 Mallon
Resources Corporation and its subsidiaries as of December 31, 1998 and 1997,
and the results of their operations and their cash flows for the years then
ended in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Denver, Colorado
April 5, 1999
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Mallon Resources Corporation
In our opinion, the accompanying consolidated statements of operations and of
cash flows for the year ended December 31, 1996 present fairly, in all
material respects, the results of operations and cash flows of Mallon
Resources Corporation and its subsidiaries for the year ended December 31,
1996, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for the
opinion expressed above. We have not audited the consolidated financial
statements of Mallon Resources Corporation for any period subsequent to
December 31, 1996.
PRICEWATERHOUSECOOPERS LLP
March 18, 1997
Denver, Colorado
MALLON RESOURCES CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
ASSETS
December 31,
1998 1997
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 1,733 $ 6,741
Accounts receivable:
Oil and gas sales 1,076 1,464
Joint interest participants, net of allowance of $43 and $8, respectively 650 2,406
Related parties 89 72
Other - 7
Inventories 375 327
Other 32 46
Total current assets 3,955 11,063
Property and equipment:
Oil and gas properties, full cost method 93,624 63,148
Natural gas processing plant 8,275 2,760
Other property and equipment 989 665
102,888 66,573
Less accumulated depreciation, depletion and amortization (48,748) (26,393)
54,140 40,180
Notes receivable-related parties 89 18
Other, net 268 165
Total Assets $ 58,452 $ 51,426
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 4,424 $ 6,797
Undistributed revenue 945 813
Current portion of installment obligation, less unamortized discount of $22 in 1997 - 378
Drilling advances 1 135
Accrued taxes and expenses 148 4
Deferred revenue 909 -
Current portion of long-term debt 1,310 -
Current portion of lease obligation - 1,746
Total current liabilities 7,737 9,873
Long-term debt 27,183 1
Accrued expenses 39 39
Total non-current liabilities 27,222 40
Total liabilities 34,959 9,913
Commitments and contingencies (Note 5)
Series B Mandatorily Redeemable Convertible Preferred Stock, $0.01 par value, 500,000
shares authorized, 135,200 shares issued and outstanding, liquidation preference and
mandatory redemption of $1,352,000 1,329 1,317
Shareholders' equity:
Common Stock, $0.01 par value, 25,000,000 shares authorized, 7,021,065 and 6,995,264
shares issued and outstanding, respectively 70 70
Additional paid-in capital 74,103 73,937
Accumulated deficit (52,009) (33,811)
Total shareholders' equity 22,164 40,196
Total Liabilities and Shareholders' Equity $ 58,452 $ 51,426
======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
MALLON RESOURCES CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
For the Years Ended
December 31,
1998 1997 1996
<S> <C> <C> <C>
Revenues:
Oil and gas sales $ 13,069 $ 8,582 $ 5,854
Gain on sale of subsidiary stock - - 329
Interest and other 109 69 183
13,178 8,651 6,366
Costs and expenses:
Oil and gas production 5,273 3,037 2,249
Mining project expenses - - 1,014
Depreciation, depletion and amortization 5,544 2,725 2,095
Impairment of oil and gas properties 16,842 24 264
Impairment of mining properties - 350 -
General and administrative, net 2,562 2,274 1,845
Interest and other 1,143 701 842
31,364 9,111 8,309
Minority interest in loss of consolidated subsidiary - - 266
Equity in loss of affiliate - (3,244) -
Loss before extraordinary item (18,186) (3,704) (1,677)
Extraordinary loss on early retirement of debt - - (160)
Net loss (18,186) (3,704) (1,837)
Dividends on preferred stock and accretion (120) (185) (376)
Preferred stock conversion inducement - (403) -
Gain on redemption of preferred stock - - 3,743
Net (loss) income attributable to common shareholders $(18,306) $(4,292) $ 1,530
======== ======= =======
Basic loss per share:
Loss attributable to common shareholders before extraordinary item $ (2.61) $ (0.92) $ (0.82)
Extraordinary loss - - (0.06)
Net loss attributable to common shareholders $ (2.61) $ (0.92) $ (0.88)
======== ======= =======
Basic weighted average common shares outstanding 7,015 4,682 2,512
======== ======= =======
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
MALLON RESOURCES CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands, except share amounts)
<TABLE>
<CAPTION>
Series A Additional
Preferred Stock Common Stock Paid-In Accumulated
Shares Amount Shares Amount Capital Deficit Total
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 1,100,918 $ 5,730 1,950,226 $ 19 $38,965 $(32,954) $ 11,760
Employee stock options exercised - - 10,570 - - - -
Stock issued to directors - - 2,016 - 12 - 12
Stock issued to consultants - - 121,750 2 792 - 794
Employee stock options granted - - - - 306 - 306
Issuance of common stock in
public offering - - 2,300,000 23 13,166 - 13,189
Purchase of Series A preferred
stock (1,100,918) (5,730) - - 3,743 - (1,987)
Other - - - - 43 - 43
Dividends on preferred stock - - - - (320) - (320)
Accretion of preferred stock - - - - - (56) (56)
Net loss - - - - - (1,837) (1,837)
Balance, December 31, 1996 - - 4,384,562 44 56,707 (34,847) 21,904
Employee stock options exercised - - 3,650 - - - -
Stock issued to directors - - 1,305 - 6 - 6
Employee stock options granted - - - - 82 - 82
Issuance of common stock in
public offering - - 2,300,000 23 19,566 - 19,589
De-consolidation of Laguna Gold
Company - - - - (4,808) 4,764 (44)
Issuance of restricted common
stock to officers - - 25,000 - 62 - 62
Issuance of common stock in
exchange for Series B
preferred stock - - 280,747 3 2,483 - 2,486
Dividends on preferred stock - - - - (161) - (161)
Accretion of preferred stock - - - - - (24) (24)
Net loss - - - - - (3,704) (3,704)
Balance, December 31, 1997 - - 6,995,264 70 73,937 (33,811) 40,196
Employee stock options granted - - - - 195 - 195
Employee stock options exercised - - 13,657 - 12 - 12
Stock issued to directors - - 729 - - - -
Conversion of warrants - - 11,415 - - - -
Issuance of restricted common stock
to officers - - - - 67 - 67
Dividends on preferred stock - - - - (108) - (108)
Accretion of preferred stock - - - - - (12) (12)
Net loss - - - - - (18,186) (18,186)
Balance, December 31, 1998 - $ - 7,021,065 $ 70 $74,103 $(52,009) $ 22,164
========= ======= ========= ==== ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
MALLON RESOURCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
For the Years Ended
December 31,
1998 1997 1996
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(18,186) $ (3,704) $ (1,837)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation, depletion and amortization 5,544 2,725 2,095
Impairment of mining properties - 350 -
Impairment of oil and gas properties 16,842 24 264
Minority interest in loss of consolidated subsidiary - - (266)
Equity in loss of affiliate - 3,244 -
Gain on sale of subsidiary stock - - (329)
Stock compensation expense 196 101 327
Non-cash portion of extraordinary loss - - 160
Amortization of discount on installment obligation 22 22 -
Write-off of notes receivable-related parties - - 46
Provision for losses on accounts receivable 35 - -
Other - 40 -
Changes in operating assets and liabilities:
Decrease (increase) in:
Accounts receivable 2,097 (1,098) (1,443)
Inventory and other current assets (169) (176) (176)
Increase (decrease) in:
Trade accounts payable and undistributed revenue (2,240) 4,579 890
Accrued taxes and expenses 147 (36) 28
Deferred revenue 909 - -
Drilling advances (132) (333) (118)
Net cash provided by (used in) operating activities 5,065 5,738 (359)
Cash flows from investing activities:
Increase in short-term investments - - (2,786)
Additions to property and equipment (35,977) (17,251) (4,109)
Proceeds from sale of property and equipment 40 - -
Proceeds from sale of subsidiary stock - - 372
Purchase of subsidiary stock - (55) -
Increase in notes receivable-related parties (71) (1) -
Other - (47) -
Net cash used in investing activities (36,008) (17,354) (6,523)
Cash flows from financing activities:
Proceeds from long-term debt 28,714 6,340 10,570
Payments of long-term debt (222) (9,608) (17,301)
Payment of installment obligation (400) (377) -
Payment of lease obligations (2,061) (76) (23)
Debt issue costs paid - - (83)
Net proceeds from sale of common stock in public offering - 19,589 13,189
Purchase of Series A preferred stock - - (1,987)
Net proceeds from sale of subsidiary special warrants - - 4,339
Payment of preferred dividends (108) (161) (320)
Redemption of preferred stock - (121) -
Proceeds from stock option exercises 12 - -
Net cash provided by financing activities 25,935 15,586 8,384
Net (decrease) increase in cash and cash equivalents (5,008) 3,970 1,502
Cash and cash equivalents, beginning of year 6,741 2,771 1,269
Cash and cash equivalents, end of year $ 1,733 $ 6,741 $ 2,771
======== ======== ========
</TABLE>
(Continued)
The accompanying notes are an integral part of these
consolidated financial statements.
MALLON RESOURCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Continued)
<TABLE>
<CAPTION>
For the Years Ended
December 31,
1998 1997 1996
<S> <C> <C> <C>
Supplemental cash flow information:
Cash paid for interest $ 1,066 $ 659 $ 837
======== ======== ========
Non-cash transactions:
Issuance of common stock in exchange for consultants' accounts payable $ - $ - $ 794
Acquisition of equipment under lease obligations 315 1,785 -
Acquisition of Red Rock Ventures, Inc. for subsidiary common stock
and notes payable - - 2,230
Installment obligation (less unamortized discount) in exchange for property
and equipment - 733 -
Reduction of note receivable from affiliate in exchange for mining properties - 350 -
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
MALLON RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Nature of Operations:
Mallon Resources Corporation ("Mallon" or the "Company") was incorporated on
July 18, 1988 under the laws of the State of Colorado. The Company engages in
oil and gas exploration and production through its wholly-owned subsidiary,
Mallon Oil Company ("Mallon Oil"), whose oil and gas operations are conducted
primarily in the State of New Mexico. Mallon operates its business and
reports its operations as one business segment. The Company also has an
interest in Laguna Gold Company ("Laguna"), a gold mining company whose
operations are conducted in Costa Rica.
Principles of Consolidation:
The 1998 and 1997 consolidated financial statements include the accounts of
Mallon Oil and all of its wholly-owned subsidiaries. For the year ended
December 31, 1996, the consolidated financial statements also include the
accounts of Laguna and all of its wholly-owned subsidiaries. Prior to
December 1997, the Company owned approximately 56% of Laguna's common stock
and included the accounts of Laguna in its consolidated financial statements.
In December 1997, the Company reduced its investment in Laguna to
approximately 46%. Therefore, the Company accounted for its investment in
Laguna as of and for the years ended December 31, 1998 and 1997 using the
equity method of accounting. Pursuant to the rules of the Securities and
Exchange Commission (the "Commission"), a restatement of years prior to 1997
reflecting the de-consolidation of Laguna is not allowed. At December 31,
1998, the Company owned approximately 45% of Laguna. All significant
intercompany transactions and accounts have been eliminated from the
consolidated financial statements.
Cash, Cash Equivalents and Short-term Investments:
Cash and cash equivalents include investments that are readily convertible
into cash and have an original maturity of three months or less. All short-
term investments are held to maturity and are reported at cost.
Fair Value of Financial Instruments:
The Company's on-balance sheet financial instruments consist of cash, cash
equivalents, accounts receivable, notes receivable, inventories, accounts
payable, other accrued liabilities and long-term debt. Except for long-term
debt, the carrying amounts of such financial instruments approximate fair
value due to their short maturities. At December 31, 1998 and 1997, based on
rates available for similar types of debt, the fair value of long-term debt
was not materially different from its carrying amount. The Company's off-
balance sheet financial instruments consist of derivative instruments which
are intended to manage commodity price and interest rate risks (see Notes 4
and 11).
Inventories:
Inventories, which consist of oil and gas lease and well equipment, are valued
at the lower of average cost or estimated net realizable value.
Oil and Gas Properties:
Oil and gas properties are accounted for using the full cost method of
accounting. Under this method, all costs associated with property
acquisition, exploration and development are capitalized, including general
and administrative expenses directly related to these activities. All such
costs are accumulated in one cost center, the continental United States.
Proceeds on disposal of properties are ordinarily accounted for as adjustments
of capitalized costs, with no gain or loss recognized, unless such adjustment
would significantly alter the relationship between capitalized costs and
proved oil and gas reserves. Net capitalized costs of oil and gas properties,
less related deferred income taxes, may not exceed the present value of
estimated future net revenues from proved reserves, discounted at 10 percent,
plus the lower of cost or fair market value of unproved properties, as
adjusted for related tax effects (see Note 2).
Depletion is calculated using the units-of-production method based upon the
ratio of current period production to estimated proved oil and gas reserves
expressed in physical units, with oil and gas converted to a common unit of
measure using one barrel of oil as an equivalent to six thousand cubic feet of
natural gas (see Note 2).
Estimated abandonment costs (including plugging, site restoration, and
dismantlement expenditures) are accrued if such costs exceed estimated salvage
values, as determined using current market values and other information.
Abandonment costs are estimated based primarily on environmental and
regulatory requirements in effect from time to time. At December 31, 1998 and
1997, in management's opinion, the estimated salvage values equaled or
exceeded estimated abandonment costs.
Other Property and Equipment:
Other property and equipment is recorded at cost and depreciated over the
estimated useful lives (generally three to seven years) using the straight-
line method. Costs incurred relating to a natural gas processing plant are
being depreciated over twenty-five years using the straight-line method. The
cost of normal maintenance and repairs is charged to expense as incurred.
Significant expenditures that increase the life of an asset are capitalized
and depreciated over the estimated useful life of the asset. Upon retirement
or disposition of assets, related gains or losses are reflected in operations.
Impairment of Long-Lived Assets:
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of" prescribes that an impairment loss be recognized in the event
that facts and circumstances indicate that the carrying amount of an asset may
not be recoverable, and an estimate of future undiscounted net cash flows is
less than the carrying amount of the asset. Impairment is recorded based on an
estimate of future discounted net cash flows.
Gas Balancing:
The Company uses the entitlements method of accounting for recording natural
gas sales revenues. Under this method, revenue is recorded based on the
Company's net working interest in field production. Deliveries of natural gas
in excess of the Company's working interest are recorded as liabilities while
under-deliveries are recorded as receivables.
Concentration of Credit Risk:
As an operator of jointly owned oil and gas properties, the Company sells oil
and gas production to numerous oil and gas purchasers and pays vendors for oil
and gas services. The risk of non-payment by the purchaser is considered
minimal and the Company does not generally obtain collateral for sales to
them. Joint interest receivables are subject to collection under the terms of
operating agreements which provide lien rights, and the Company considers the
risk of loss likewise to be minimal.
The Company is exposed to credit losses in the event of non-performance by
counterparties to financial instruments, but does not expect any
counterparties to fail to meet their obligations. The Company generally does
not obtain collateral or other security to support financial instruments
subject to credit risk but does monitor the credit standing of counterparties.
Stock-Based Compensation:
As required, the Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation" in 1996. As permitted under SFAS No. 123, the Company has
elected to continue to measure compensation cost using the intrinsic value
based method of accounting prescribed by APB Opinion No. 25, "Accounting for
Stock Issued to Employees." The Company has made pro forma disclosures of net
income (loss) and net income (loss) per share as if the fair value based
method of accounting as defined in SFAS No. 123 had been applied (see Note 9).
General and Administrative Expenses:
General and administrative expenses are reported net of amounts allocated to
working interest owners of the oil and gas properties operated by the Company,
and net of amounts capitalized pursuant to the full cost method of accounting.
Foreign Currency Translation:
Management has determined that the U.S. dollar is the functional currency for
Laguna's Costa Rican operations. Accordingly, the assets, liabilities and
results of operations of the Costa Rican subsidiaries are measured in U.S.
dollars. Transaction gains and losses are not material for any of the periods
presented.
Hedging Activities:
The Company's use of derivative financial instruments is limited to management
of commodity price and interest rate risks. Gains and losses on such
transactions are accounted for as part of the transaction being hedged. If an
instrument is settled early, any gains or losses are deferred and recognized
as part of the transaction being hedged (see Notes 4 and 11).
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No.
133 establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value. SFAS No. 133 requires that changes in
the derivative's fair value be recognized currently in earnings unless
specific hedge accounting criteria are met. Special accounting for qualifying
hedges allows a derivative's gains and losses to offset related results on the
hedged item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting. SFAS No. 133 is effective for fiscal years beginning after
June 15, 1999, but early adoption is permitted. SFAS No. 133 cannot be
applied retroactively.
The Company has not yet quantified the impact of adopting SFAS No. 133 on its
financial statements and has not determined the timing or method of adoption
of SFAS No. 133. However, SFAS No. 133 could increase volatility in earnings
and other comprehensive income.
Comprehensive Income:
The Company adopted SFAS No. 130, "Reporting Comprehensive Income,"
beginning with the first quarter of 1998. There are no components of
comprehensive income which have been excluded from net income and, therefore
no separate statement of comprehensive income has been presented.
Per Share Data:
In fourth quarter 1997, the Company adopted SFAS No. 128, "Earnings per
Share," which establishes new standards for computing and presenting earnings
per share. SFAS No. 128 is intended to simplify the standard for computing
earnings per share and requires the presentation of basic and diluted earnings
per share on the face of the income statement, including a restatement of all
prior periods presented. Under the provisions of SFAS No. 128, basic earnings
per share is computed by dividing income available to common shareholders by
the weighted average number of common shares outstanding for the period.
Diluted earnings per share reflects the potential dilution that could occur if
the Company's outstanding stock options and warrants were exercised
(calculated using the treasury stock method) or if the Company's Series B
Convertible Preferred Stock were converted to common stock. The adoption of
SFAS 128 had no effect on the Company's prior period earnings per share data.
The consolidated statement of operations for 1998, 1997 and 1996 reflect only
basic earnings per share because the Company was in a loss position for all
years presented and all common stock equivalents are anti-dilutive.
The gain on the redemption of the Series A Convertible Preferred Stock (the
"Series A Stock") in fourth quarter 1996 resulted in net income attributable
to common shareholders for the quarter and the year ended December 31, 1996.
Consequently, the Series A Stock, which is a common stock equivalent, is
included in the per share calculation as if converted on October 1, 1996 and
outstanding through the redemption date. However, because the Series A Stock
is reflected as if converted, the gain on redemption is deducted from net
income attributable to common shareholders for purposes of calculating per
share data, resulting in a net loss attributable to common shareholders of
$2,213,000 for the year ended December 31, 1996.
Use of Estimates and Significant Risks:
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make
significant estimates and assumptions that affect the amounts reported in
these financial statements and accompanying notes. The more significant areas
requiring the use of estimates relate to oil and gas and mineral reserves,
fair value of financial instruments, future cash flows associated with long-
lived assets, valuation allowance for deferred tax assets, and useful lives
for purposes of calculating depreciation, depletion and amortization. Actual
results could differ from those estimates.
The Company and its operations are subject to numerous risks and
uncertainties. Among these are risks related to the oil and gas business
(including operating risks and hazards and the regulations imposed thereon),
risks and uncertainties related to the volatility of the prices of oil and
gas, uncertainties related to the estimation of reserves of oil and gas and
the value of such reserves, the effects of competition and extensive
environmental regulation, and many other factors, many of which are
necessarily out of the Company's control. The nature of oil and gas drilling
operations is such that the expenditure of substantial drilling and completion
costs are required well in advance of the receipt of revenues from the
production developed by the operations. Thus, it will require more than
several quarters for the financial success of that strategy to be
demonstrated. Drilling activities are subject to numerous risks, including the
risk that no commercially productive oil or gas reservoirs will be
encountered.
Reclassifications:
Certain prior year amounts in the consolidated financial statements have been
reclassified to conform to the presentation used in 1998.
NOTE 2. OIL AND GAS PROPERTIES
Under the full cost accounting rules of the Commission, the Company reviews
the carrying value of its oil and gas properties each quarter on a country-by-
country basis. Under full cost accounting rules, net capitalized costs of oil
and gas properties, less related deferred income taxes, may not exceed the
present value of estimated future net revenues from proved reserves,
discounted at 10 percent, plus the lower of cost or fair market value of
unproved properties, as adjusted for related tax effects. Application of
these rules generally requires pricing future production at the unescalated
oil and gas prices in effect at the end of each fiscal quarter and requires a
write-down if the "ceiling" is exceeded, even if prices declined for only a
short period of time. The Company made a charge in the fourth quarter of 1998
to write down its oil and gas properties by $16,842,000. In applying the
"ceiling test," the Company used December 31, 1998 oil and gas prices of
$10.03 per barrel of oil and $1.43 per Mcf of gas.
In January 1997, the Company acquired certain oil and gas properties for
consideration of $1,300,000 in cash and conveyance of its interest in certain
other oil and gas properties. Cash consideration of $500,000 was paid at
closing in January 1997. Installment obligation payments of $400,000 were
made on December 31, 1998 and 1997. The installment obligations included an
imputed interest rate of 6%. There was no gain or loss relative to the
conveyance of the interest in the oil and gas properties.
In 1996, Mallon Oil acquired a 2.25% working interest in an exploration
venture to drill one or more wells offshore Belize. As of December 31, 1996,
the Company had capitalized costs relating to the Belize venture of
approximately $264,000. Subsequent to December 31, 1996, the joint venture
drilled a dry hole. Accordingly, the Company reduced the carrying amount of
its capitalized costs by $264,000 at December 31, 1996. During 1997,
additional costs related to this dry hole of $24,000 were incurred and
impaired. These amounts are reflected as impairment of oil and gas properties
in the Company's consolidated statements of operations.
NOTE 3. LAGUNA GOLD COMPANY
Laguna's principal precious metals property is the Rio Chiquito project
located in Guanacaste Province, Costa Rica, where it holds exploration and
exploitation concessions.
In May 1996, Laguna sold 5,000,000 Special Warrants for $1.00 per Warrant in a
private placement for proceeds of $4,339,000, net of offering costs of
$661,000. As discussed below, in September 1996, the Special Warrants were
registered with the Ontario (Canada) Securities Commission.
In June 1996, Laguna acquired Red Rock Ventures, Inc. ("Red Rock") for
2,000,000 shares of Laguna's common stock, valued at $1.00 per share, and
Convertible Secured Promissory Notes in the aggregate principal amount of
$230,000, for a total consideration of $2,230,000. The notes bear interest at
5% per annum. Principal and accrued interest are due December 31, 2000. The
notes are convertible into shares of Laguna's common stock, at the holder's
option. The note is collateralized by a general security agreement
encumbering all of the assets of Laguna. Red Rock's sole asset at the time of
the merger was a 10% interest in the Rio Chiquito gold project, in which
Laguna held a 90% interest and now holds 100%. After the issuance of the
2,000,000 shares of Laguna's common stock to Red Rock, the Company's share of
Laguna was reduced from 80% to 72%. The acquisition was accounted for as a
purchase.
In September 1996, Laguna completed the registration of the Special Warrants
with the Ontario (Canada) Securities Commission. The completion of this
registration caused the conversion of all of the 25,000 outstanding shares of
the Laguna Series A Stock into 3,600,000 shares of common stock. (By its
original terms, each share of Laguna's Series A Stock was convertible into 100
shares of Laguna common stock. After giving effect to the March 1996 1.44-for-
1 split of Laguna's common stock, each share of Laguna's Series A Stock became
convertible into 144 shares of Laguna common stock). Also in September 1996,
the Company sold 400,000 of its shares of Laguna common stock and realized a
gain of $329,000. After the conversion of the Special Warrants into Laguna
common stock and the sale by the Company of Laguna common stock, the Company
owned 14,000,000 of Laguna's 25,000,000 shares of issued and outstanding
common stock, or 56%. Laguna's common stock is listed on The Toronto Stock
Exchange.
As discussed above, during the latter part of 1996 and throughout most of
1997, Mallon held approximately 56% of the common stock of Laguna. In fourth
quarter 1997, in order to induce a new management team to join Laguna, Mallon
contributed the following: (1) 2,450,000 shares of its Laguna common stock;
(2) options for three years to purchase from Mallon 1,000,000 shares of its
Laguna common stock for a purchase price of $1.00 per share; and (3) a
commitment to grant up to 975,000 of additional shares of its Laguna common
stock upon the occurrence of certain events. For the year ended December 31,
1997, Laguna reflected $210,000 of stock compensation expense for the items
discussed above. The Company reflected 100% of these items on its 1997
consolidated statement of operations ($170,000 is included as part of the
equity in loss of affiliate and $40,000 is included in interest and other
expense). After this transaction, Mallon held approximately 46% of Laguna's
outstanding common stock. In March 1998, Laguna converted its note payable to
Mallon (see below), and issued approximately 1,750,000 shares of Laguna common
stock to Mallon. After this transaction, Mallon held approximately 49% of
Laguna's outstanding common stock. Because Mallon impaired 100% of its
investment in and advances to Laguna at December 31, 1997, the conversion of
the note will have no future negative impact on Mallon's earnings, as
discussed below.
As a result of reducing its ownership interest in Laguna, Mallon accounted for
its investment in Laguna as of and for the years ended December 31, 1998 and
1997 using the equity method of accounting. Pursuant to the rules of the
Commission, Mallon may not restate financial information prior to 1997 to
reflect the use of the equity method. Accordingly, the Company's results for
1996 are consolidated with Laguna's.
In second quarter 1997, the Company reduced its note receivable from Laguna by
$350,000, including accrued interest, in exchange for an overriding royalty
interest in Laguna's mineral properties. Due to depressed gold prices, in
fourth quarter 1997 the Company impaired this amount, which is reflected as
"impairment of mining properties" on its 1997 consolidated statement of
operations.
During 1998, the Company contributed 525,000 of its shares of Laguna common
stock to Laguna's management team in partial satisfaction of its commitment to
contribute up to 975,000 shares as discussed above. In addition, in July
1998, the Company contributed 500,000 shares of its Laguna common stock to the
lead investor in Laguna's private placement of $6.5 million of 10% corporate
notes due June 30, 2001. After these transactions, at December 31, 1998, the
Company held approximately 45% of Laguna's outstanding common stock.
A summary of the results of operations and assets, liabilities and
shareholders' equity of Laguna follows:
<TABLE>
<CAPTION>
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Results of operations:
Revenues $ 237 $ 91 $ 130
Net loss (1,259) (10,702) (1,102)
Assets, liabilities and shareholders' equity (end of period):
Current assets 4,232 485 2,942
Other assets 3,624 999 9,394
Total assets 7,856 1,484 12,336
Current liabilities 999 62 160
Other liabilities 6,086 2,167 2,410
Shareholders' equity 771 (745) 9,766
</TABLE>
In March 1998, Laguna wrote down its mineral assets, effective December 31,
1997, by approximately $9,319,000, due to continued depressed gold prices. As
a result, Mallon impaired 100% of its note receivable from Laguna totaling
$1,919,000, including accrued interest. The Company's share of Laguna's 1997
net loss was in excess of the carrying value of its investment in and advances
to Laguna by approximately $2,733,000. The Company's share of Laguna's 1997
losses, up to the carrying amount of its investment in and advances to Laguna,
totaled $3,244,000 and is reflected as "equity in loss of affiliate" on the
Company's 1997 consolidated statement of operations. The Company will not
reflect its share of Laguna's future losses and may only reflect its share of
Laguna's future earnings to the extent that they exceed the Company's share of
Laguna's 1997 and future net losses not recognized.
NOTE 4. NOTES PAYABLE AND LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
1998 1997
(In thousands)
<S> <C> <C>
Revolving line of credit $ 22,060 $ 1
Equipment loan 6,283 --
Unsecured loan 150 --
28,493 1
Less current portion (1,310) -
Total $ 27,183 $ 1
======== ====
</TABLE>
In March 1996, the Company established a $35,000,000 credit facility (the
"Facility") with Bank One, Texas, N.A. (the "Bank"). The significant terms of
the Facility, as it has been amended, are as follows:
- - The Facility established two separate lines of credit: a primary
revolving line of credit (the "Revolver") and an equipment loan commitment
(the "Equipment Loan") of $6.5 million to be used to refinance existing
equipment and finance the acquisition of new equipment.
- - The borrowing base under the Revolver is subject to redetermination every
six months, at May 1 and November 1, or at such other times as the Bank may
determine.
- - The interest rate on amounts drawn under the Revolver is, at the
Company's election, either the Bank's base rate, or LIBOR plus a margin
ranging from 1.125% to 1.875%, depending on the total Revolver balance
outstanding. For the debt outstanding under the Revolver at December 31, 1998
and 1997, the rate was 7.20% and 9.25%, respectively. The interest rate on
the Equipment Loan is LIBOR plus 2%. An interest rate swap for the Equipment
Loan brings its effective rate to 7.88%, as discussed below.
- - A monthly reduction in the commitment under the Revolver, subject to
borrowing base redeterminations, may be required. However, debt service
payments equal to the amount of the monthly reduction are not required unless
the balance outstanding under the Facility exceeds the reduced commitment
amount.
- - Amounts drawn under the Equipment Loan converted to a 5-year term loan on
October 30, 1998, with monthly payments of $108,333, plus interest, starting
November 30, 1998.
- - The Company must pay a fee of 0.375% per annum on the daily average of
the unused amount of the borrowing base. If the borrowing base is increased,
the Company will pay a fee of 0.25% per annum of the amount of such increase
over the previously established borrowing base. The Company may voluntarily
reduce the Revolver's borrowing base.
- - The Facility is collateralized by substantially all of the Company's oil
and gas properties.
- - The Company is obligated to maintain certain financial and other
covenants, including a minimum current ratio, minimum net equity and a debt
service ratio. The Company is restricted with respect to additional debt,
payment of cash dividends on common stock, loans or advances to others,
certain investments, sale or discount of receivables, hedging transactions,
sale of assets and transactions with affiliates.
- - The Facility expires on April 30, 2001.
Initial amounts drawn under the Revolver were used to retire the Company's
prior line of credit and related accrued interest. The remaining $160,000
balance of unamortized loan origination fees on the prior line of credit was
written off and is reflected as extraordinary loss on early retirement of debt
for the year ended December 31, 1996.
Effective October 1998, the borrowing base was increased to $30,000,000 with
no monthly reduction in the commitment under the Revolver. The outstanding
balance under the Facility at December 31, 1998 was $22,060,000, resulting in
available borrowings of $7,940,000. At December 31, 1998, the Company was not
in compliance with the minimum net equity and debt service ratio covenants of
the Facility. The Bank has agreed to waive the Company's non-compliance with
both the minimum net equity and the debt service ratio covenants for the
quarter ended December 31, 1998. Moreover, the Bank has agreed to waive any
non-compliance with the debt service ratio that may occur during calendar year
1999 and to amend the minimum net equity covenant in such a way that
management believes that, based on its current projections, the Company will
meet it for all reporting periods in 1999.
Subsequent to December 31, 1998, in connection with the Bank's waiver of the
Company's non-compliance with certain covenants mentioned above, the following
provisions of the Revolver were amended:
- - Beginning May 1, 1999, the borrowing base will be subject to
redetermination quarterly, at February 1, May 1, August 1 and November 1 of
each year, or at such other times as the Bank may determine.
- - Effective March 31, 1999, the Company will pay a fee of 0.625% per annum
on the daily average of the unused amount of the borrowing base. If the
borrowing base is increased, the Company will pay a fee of 0.50% per annum of
the amount of such increase over the previously established borrowing base.
- - Effective March 31, 1999, the interest rate on amounts drawn under the
Revolver is, at the Company's election, either the Bank's base rate plus 0.25%
or LIBOR plus a margin ranging from 1.375% to 2.125%, depending on the total
Revolver balance outstanding.
- - In consideration of the waivers and amendments mentioned above, the
Company will pay the Bank a fee of $25,000.
During 1998, the Company repaid $217,000 of the Equipment Loan.
Effective October 30, 1998, the Company entered into a 5-year interest rate
swap agreement which will effectively fix the interest rate on the Equipment
Loan at 7.88%. The notional amount of the interest rate swap is $6,500,000
and declines monthly by the amount of principal payments. During 1998, the
Company included $8,000 of loss on this swap in interest expense. The fair
value of the Company's interest rate swap agreement at December 31, 1998 was
approximately ($114,000).
In July 1998, the Company negotiated an unsecured term loan for up to $205,000
with Bank One, Colorado, N.A. to finance the purchase of land and a building
for the Company's field office. The Company drew $155,000 on this loan during
1998. Principal and interest (at 8.5%) is payable quarterly beginning
October 1, 1998. The Company repaid $5,000 of this loan during 1998. In
March 1999, the due date of the loan was extended from July 1999 to April
2002.
Outstanding debt at December 31, 1998 is payable as follows:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
1999 $ 1,315
2000 1,315
2001 23,480
2002 1,300
2003 1,083
Thereafter -
$ 28,493
========
</TABLE>
NOTE 5. COMMITMENTS AND CONTINGENCIES
Operating Leases:
The Company leases office space, vehicles and software under non-cancelable
leases which expire in 2002. Rental expense is recognized on a straight-line
basis over the terms of the leases. The total minimum rental commitments at
December 31, 1998 are as follows:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
1999 $ 281
2000 267
2001 217
2002 23
2003 -
Thereafter -
$ 788
=====
</TABLE>
Rent expense was $170,000, $99,000 and $125,000 for the years ended
December 31, 1998, 1997 and 1996, respectively.
Lease Obligations:
During 1997, the Company was the lessee of certain equipment under lease
obligations expiring in 1998. Included in the natural gas processing plant at
December 31, 1997 were $1,785,000 of assets under lease and related
accumulated depreciation of $18,000. The equipment under lease was purchased
in 1998.
Contingencies:
In December 1998, Del Mar Drilling Company, Inc. ("Plaintiff") filed a civil
action against Mallon Oil. Plaintiff seeks damages for an alleged breach of
contract in the amount of $348,100, plus interest, costs, and attorney's fees.
The matter arises out of a contract for oil and gas drilling services
performed by Plaintiff. The Company believes the Plaintiff's case is without
merit, and intends to defend itself, vigorously. The final outcome of this
matter cannot yet be predicted, however, management of the Company does not
believe the final results of the lawsuit will have a material adverse effect
on the Company's financial position or results of operations.
In 1993, the Minerals Management Service ("MMS") commenced an audit of
royalties payable on certain oil and gas properties in which the Company owns
an interest. The operator of the properties contested certain deficiencies.
In 1997, the Company purchased an additional interest in these properties and
as part of the purchase agreement, agreed to take over the defense of the MMS
claims and assume ultimate financial responsibility for the operator's share
of this matter, up to a $100,000 limit. The audit is not complete and the
Company is unable to estimate the amount of liability. However, management of
the Company does not believe the final results of the audit will have a
material adverse effect on the Company's financial position or results of
operations.
NOTE 6. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
In April 1994, the Company completed the private placement of 400,000 shares
of Series B Mandatorily Redeemable Convertible Preferred Stock, $0.01 par
value per share (the "Series B Stock"). The Series B Stock bears an 8%
dividend payable quarterly, and is convertible into shares of the Company's
common stock at a current adjusted conversion price of $10.30 per share.
Proceeds from the placement were $3,774,000, net of stock issue costs of
$226,000. In connection with the Series B Stock, dividends of $108,000,
$161,000 and $320,000 were paid in 1998, 1997 and 1996, respectively.
Accretion of preferred stock issue costs was $12,000, $24,000 and $56,000 in
1998, 1997 and 1996, respectively.
Mandatory redemption of the Company's Series B Stock was to begin in April
1997, when 20% of the outstanding shares, or 80,000 shares, were to be
redeemed for $800,000. The Company extended an offer to all holders of the
Series B Stock to convert their shares into shares of the Company's common
stock at a conversion price of $9.00, rather than the $11.31 conversion price
otherwise then in effect. In April 1997, holders of 252,675 shares of Series B
Stock elected to convert their shares into 280,747 shares of the Company's
common stock. The excess of the fair value of the common stock issued at the
$9.00 conversion price over the fair value of the common stock that would have
been issued at the $11.31 conversion price, totaling $403,000, is reflected on
the statement of operations for the year ended December 31, 1997 as an
increase to the net loss attributable to common shareholders for preferred
stock conversion inducement. In addition, the Company redeemed 12,125 shares
of Series B Stock at $10.00 per share. After these transactions, 135,200
shares of Series B Stock remain outstanding and the Company has no further
obligation to redeem any shares until April 2000. The Company will be
required to redeem 55,200 shares in April 2000 and the remaining 80,000 shares
in April 2001. The Series B Stock is convertible to common stock
automatically if the common stock trades at a price in excess of 140% of the
then applicable conversion price for each day in a period of 10 consecutive
trading days.
NOTE 7. CAPITAL
Preferred Stock:
The Board of Directors is authorized to issue up to 10,000,000 shares of
preferred stock having a par value of $.01 per share, to establish the number
of shares to be included in each series, and to fix the designation, rights,
preferences and limitations of the shares of each series.
In October 1996, the Company purchased all of the 1,100,918 shares outstanding
at December 31, 1995 of the Company's Series A Convertible Preferred Stock
(the "Series A Stock") from Bank of America National Savings and Trust
Association for a purchase price of approximately $1,886,000. In connection
with the purchase, the Company also paid fees and expenses of $101,000. The
difference between the carrying value of the Series A Stock and the purchase
price was credited to additional paid-in capital.
Common Stock:
The Company has reserved approximately 131,262 shares, as adjusted, of common
stock for issuance upon possible conversion of the remaining Series B Stock.
In December 1997, the Company sold 2,300,000 shares of its common stock in a
public offering at $9.25 per share. The Company received proceeds of
approximately $19,589,000, net of offering costs of $1,686,000. The net
proceeds were used primarily to finance the drilling and development of the
Company's New Mexico oil and gas properties.
In October 1996, the Company sold 2,300,000 shares of its common stock in a
public offering at $6.50 per share. The Company received proceeds of
approximately $13,189,000, net of offering costs of $1,761,000. The net
proceeds were used primarily to finance the drilling and development of the
Company's New Mexico oil and gas properties and a portion was used to retire
all outstanding shares of its Series A Stock (see above).
Warrants:
The Company has outstanding warrants to purchase an aggregate of 238,023
shares of common stock, as described below.
Warrants to purchase an aggregate of 78,023 shares of the Company's common
stock at an adjusted exercise price of $8.01 per share were issued in June
1995 to the holders of Laguna's Series A Preferred Stock in connection with
the private placement of that stock. The warrants expire June 30, 2000.
In October 1996, in connection with its offering of common stock, the Company
issued warrants to purchase 160,000 shares of common stock to the managing
underwriter, with an exercise price of $7.80 per share. In October 1998, the
Trustee-in-Bankruptcy for the holder of 40,000 warrants sold them to several
members of the Company's Board of Directors. On December 11, 1998, the
exercise price of all of the outstanding warrants was reduced to $6.88 per
share, the closing price of the Company's stock on that day. The repricing of
the warrants was done in conjunction with the repricing of the Company's stock
options as discussed in Note 9. The warrants expire on October 16, 2000.
In August 1995, the Company issued warrants to purchase an aggregate of 31,824
shares of common stock at an adjusted exercise price of $7.86 per share to an
affiliate of Midland Bank plc, New York Branch, as an "equity kicker" in
connection with the establishment of a now terminated line of credit with that
bank. In May 1998, the holder of the warrants opted to convert them into
shares of common stock through a cashless conversion whereby they received
11,415 shares of common stock, which were the equivalent in value to the
difference between the 31,824 shares of common stock at the defined current
market price of $12.25 per share and the exercise price of $7.86 per share.
NOTE 8. SHAREHOLDER RIGHTS PLAN
In April 1997, the Company's Board of Directors declared a dividend on its
shares of common stock (the "Common Shares") of preferred share purchase
rights (the "Rights") as part of a Shareholder Rights Plan (the "Plan"). The
Plan is designed to insure that all shareholders of the Company receive fair
value for their Common Shares in the event of a proposed takeover of the
Company and to guard against the use of partial tender offers or other
coercive tactics to gain control of the Company without offering fair value to
the Company's shareholders. At the present time, the Company knows of no
proposed or threatened takeover, tender offer or other effort to gain control
of the Company. Under the terms of the Plan, the Rights will be distributed as
a dividend at the rate of one Right for each Common Share held. Shareholders
will not actually receive certificates for the Rights, but the Rights will
become part of each Common Share. All Rights expire on April 22, 2001.
Each Right will entitle the holder to buy shares of common stock at an
exercise price of $40.00. The Rights will be exercisable and will trade
separately from the Common Shares only if a person or group acquires
beneficial ownership of 20% or more of the Company's Common Shares or
commences a tender or exchange offer that would result in such a person or
group owning 20% or more of the Common Shares. Only when one or more of these
events occur will shareholders receive certificates for the Rights.
If any person actually acquires 20% or more of Common Shares - other than
through a tender or exchange offer for all Common Shares that provides a fair
price and other terms for such shares - or if a 20% or more shareholder
engages in certain "self-dealing" transactions or engages in a merger or other
business combination in which the Company survives and its Common Shares
remain outstanding, the other shareholders will be able to exercise the Rights
and buy Common Shares of the Company having twice the value of the exercise
price of the Rights. In other words, payment of the $40.00 per Right exercise
price will entitle the holder to acquire $80.00 worth of Common Shares.
Additionally, if the Company is involved in certain other mergers where its
shares are exchanged, or certain major sales of assets occur, shareholders
will be able to purchase the other party's common shares in an amount equal to
twice the value of the exercise price of the Rights.
The Company will be entitled to redeem the Rights at $.01 per Right at any
time until the tenth day following public announcement that a person has
acquired a 20% ownership position in Common Shares of the Company. The Company
in its discretion may extend the period during which it can redeem the Rights.
NOTE 9. STOCK COMPENSATION
At December 31, 1998, the Company had two stock-based compensation plans. In
addition, stock compensation information for 1996 includes Laguna's plan. As
discussed in Note 3, the Company de-consolidated Laguna in the fourth quarter
of 1997. Therefore, no stock compensation information is presented for 1998
or 1997 related to Laguna's plan. As permitted under SFAS No. 123, the
Company has elected to continue to measure compensation costs using the
intrinsic value method of accounting prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees." Under that method, the difference
between the exercise price and the estimated market value of the shares at the
date of grant is charged to compensation expense, ratably over the vesting
period, with a corresponding increase in shareholders' equity. Compensation
costs charged against income for all plans were $128,000, $38,000 and $327,000
for 1998, 1997 and 1996, respectively.
Under the Mallon Resources Corporation 1988 Equity Participation Plan (the
"1988 Equity Plan"), 250,000 shares of common stock have been reserved in
order to provide for incentive compensation and awards to employees and
consultants. The 1988 Equity Plan provides that a three-member committee may
grant stock options, awards, stock appreciation rights, and other forms of
stock-based compensation in accordance with the provisions of the 1988 Equity
Plan. The options vest over a period of up to four years and expire over a
maximum of 10 years from the date of grant.
In June 1997, the shareholders approved the Mallon Resources Corporation 1997
Equity Participation Plan (the "1997 Plan") under which shares of common
stock have been reserved to provide employees, consultants and directors of
the Company with incentive compensation. The 1997 Plan is administered by a
Committee of the Board of Directors who may, in its sole discretion, select
the participants, and determine the number of shares of common stock to be
subject to incentive stock options, non-qualified options, stock appreciation
rights and other stock awards in accordance with the provisions of the 1997
Plan. The aggregate number of shares of common stock that may be issued under
the 1997 Plan is equal to 11% of the number of outstanding shares of common
stock from time to time. This authorization may be increased from time to
time by approval of the Board of Directors and by the ratification of the
shareholders of the Company. In 1998, the Committee approved the grant of
271,842 stock options at fair market value. In 1997, the Committee approved
the grant of 501,850 stock options of which 481,850 were granted at fair
market value and 20,000 were granted with an exercise price of $0.01 each.
The options vest over a period of up to five years and expire over a maximum
of 10 years from the date of grant.
On December 11, 1998, the Company's Board of Directors reduced the exercise
price of substantially all outstanding options to purchase shares of the
Company's common stock to $6.88 per share, the closing price of the stock on
that day. A total of 230,629 options with an original exercise price of $7.50
and 478,850 options with an original exercise price of $8.38 were repriced.
Under the Laguna Gold Company Equity Participation Plan (the "Laguna Equity
Plan"), shares of Laguna common stock have been reserved for issuance in order
to provide for incentive compensation and awards to employees and consultants.
The number of shares reserved is the lesser of 10% of the number of shares of
Laguna common stock outstanding from time to time, or 8,000,000 shares. The
Laguna Equity Plan provides that stock options, stock bonuses, stock
appreciation rights and other forms of stock-based compensation may be granted
in accordance with the provisions of the Laguna Equity Plan. The options vest
over a period of up to four years, and expire over a maximum of ten years from
the date of grant. If, though not expressly approved by a majority of the
members of Laguna's Board of Directors, a controlling interest in Laguna or
substantially all of its assets are sold, or if Laguna is merged into another
company, or if control of Laguna's Board of Directors is obtained, the options
vest in full.
The following table summarizes activity with respect to the outstanding stock
options under the 1988 Equity Plan, the 1997 Plan and the Laguna Equity Plan
(for periods consolidated):
<TABLE>
<CAPTION>
Company Laguna
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
<S> <C> <C> <C> <C>
Outstanding at December 31, 1995 59,845 $0.04 1,620,000 $ 0.01
Granted 21,944 0.04 880,000 1.00
Exercised (10,570) 0.04 - -
Forfeited (1,643) 0.04 - -
Outstanding at December 31, 1996 69,576 0.04 2,500,000 $ 0.36
========= ======
Granted 501,850 6.88
Exercised (3,650) 0.04
Forfeited (19,500) 0.04
Outstanding at December 31, 1997 548,276 6.06
Granted 282,784 6.36
Exercised (13,657) 0.89
Forfeited - -
Outstanding at December 31, 1998 817,403 $6.25
======= =====
Options exercisable:
December 31, 1996 45,326 $0.04 1,845,000 $ 0.35
======= ===== ========= ======
December 31, 1997 160,277 $5.89
======= =====
December 31, 1998 497,304 $6.16
======= =====
</TABLE>
The weighted average remaining contractual life of the options outstanding
under both the 1988 Equity Plan and 1997 Plan at December 31, 1998 is
approximately 8.5 years.
In 1992, the Company granted to a consultant an option to purchase 12,500 of
the Company's common shares at $26.00 per share, exercisable from November
1993 through October 1997. The options expired unexercised. In 1994, the
Company granted this individual an additional option to purchase 6,250 shares
at $16.00 per share, exercisable from January 1995 to December 1998. The
option granted in 1994 expired in 1998 unexercised. These options were not
part of either the 1988 Equity Plan or the 1997 Plan.
The Stock Compensation Plan for Outside Directors provides that the Company's
outside directors will be compensated by periodically granting them shares of
the Company's $0.01 par value common stock worth $1,000 for each board
meeting, but no less than $4,000 per year, for each outside director. The
Company expensed $-0-, $6,000 and $12,000 for the years 1998, 1997 and 1996,
respectively, in relation to the Stock Compensation Plan. In July 1997, the
Company started compensating the outside directors in cash and discontinued
the stock grants under this plan. In 1998, 10,942 stock options under this
plan were issued to the outside directors at fair market value. All available
awards under this plan have been granted.
In April 1997, the Company granted a total of 25,000 shares of restricted
common stock to three of its officers as an inducement to continue in its
employ. The fair market value of the shares at the date of grant will be
charged ratably over the vesting period of three years. The Company charged
$68,000 and $63,000 against income in 1998 and 1997, respectively, related to
this grant. The grant of restricted stock is not a part of the Company's
equity plans.
Had compensation expense for the Company's 1998, 1997 and 1996 grants of
stock-based compensation been determined consistent with the fair value based
method under SFAS No. 123, the Company's net loss, net loss attributable to
common shareholders, and the net loss per share attributable to common
shareholders would approximate the pro forma amounts below:
<TABLE>
<CAPTION>
1998 1997 1996
Reported Pro Forma As Reported Pro Forma As Reported Pro Forma
<S> <C> <C> <C> <C> <C> <C>
Net loss $(18,186) $(19,107) $(3,704) $(4,048) $(1,837) $(1,869)
Net income (loss) attributable to
common shareholders (see Note 1) (18,306) (19,227) (4,292) (4,636) 1,530 1,498
Net loss per share attributable to
common shareholders (2.61) (2.74) (0.92) (0.99) (0.88) (0.89)
</TABLE>
The fair value of each option is estimated as of the grant date, using the
Black-Scholes option-pricing model, with the following assumptions:
<TABLE>
<CAPTION>
1998 1997 1996
Company Laguna Company Laguna Company
Laguna
<S> <C> <C> <C> <C> <C> <C>
Risk-free interest rate 4.75% N/A 6.0% N/A 5.8% 6.5%
Expected life (in years) 4 N/A 4 N/A 4 4
Expected volatility 64.6% N/A 59.0% N/A 61.0% 76.0%
Expected dividends 0.0% N/A 0.0% N/A 0.0% 0.0%
Weighted average fair value
of options granted $3.59 N/A $4.49 N/A $1.66 $0.52
</TABLE>
NOTE 10. BENEFIT PLANS
Effective January 1, 1989, the Company and its affiliates established the
Mallon Resources Corporation 401(k) Profit Sharing Plan (the "401(k) Plan").
The Company and its affiliates match contributions to the 401(k) Plan in an
amount up to 25% of each employee's monthly contributions. The Company may
also contribute additional amounts at the discretion of the Compensation
Committee of the Board of Directors, contingent upon realization of earnings
by the Company which, at the sole discretion of the Compensation Committee,
are adequate to justify a corporate contribution. For the years ended
December 31, 1998, 1997 and 1996, the Company made matching contributions of
$28,000, $22,000 and $16,000, respectively. No discretionary contributions
were made during any of the three years ended December 31, 1998.
The Company maintains a program which provides bonus compensation to employees
from oil and gas revenues which are included in a pool to be distributed at
the discretion of the Chairman of the Board. For the years ended December 31,
1998, 1997 and 1996, a total of $130,000, $89,000 and $74,000, respectively,
was distributed to employees.
NOTE 11. HEDGING ACTIVITIES
The Company periodically enters into commodity derivative contracts and fixed-
price physical contracts to manage its exposure to oil and gas price
volatility. Commodity derivatives contracts, which are generally placed with
major financial institutions or with counterparties of high credit quality
that the Company believes are minimal credit risks, may take the form of
futures contracts, swaps or options. The oil and gas reference prices of
these commodity derivatives contracts are based upon crude oil and natural gas
futures which have a high degree of historical correlation with actual prices
received by the Company. The Company accounts for its commodity derivatives
contracts using the hedge (deferral) method of accounting. Under this method,
realized gains and losses from the Company's price risk management activities
are recognized in oil and gas revenue when the associated production occurs
and the resulting cash flows are reported as cash flows from operating
activities. Gains and losses from commodity derivatives contracts that are
closed before the hedged production occurs are deferred until the production
month originally hedged. In the event of a loss of correlation between
changes in oil and gas reference prices under a commodity derivatives contract
and actual oil and gas prices, a gain or loss would be recognized currently to
the extent the commodity derivatives contract did not offset changes in actual
oil and gas prices.
The following table indicates the Company's outstanding energy swaps at
December 31, 1998:
<TABLE>
<CAPTION>
Fixed Market Price
Product Production Price Duration Reference
<S> <C> <C> <C> <C>
Gas 6,000 MMBtu/day $2.06 1/99-2/99 El Paso Natural Gas (San Juan)
Gas 450,000 MMBtu/month $2.02 1/00-12/00 El Paso Natural Gas (San Juan)
</TABLE>
For the years ended December 31, 1998, 1997 and 1996, the Company's gains
(losses) under its swap agreements were $481,000, $(615,000) and $(490,000),
respectively, and are included in oil and gas sales in the Company's
consolidated statements of operations. At December 31, 1998, the estimated
net amount the Company would have received to terminate its outstanding energy
swaps and basis swaps, described below, was approximately $141,000.
In addition, the Company has an energy swap agreement at December 31, 1998
which counteracts the agreement above for 6,000 MMBtu/day of gas for January
and February 1999 whereby the Company must pay the counterparty if the fixed
price of $1.785 exceeds the floating price (based on El Paso Natural Gas - San
Juan).
In December 1998, the Company terminated an energy swap entered into earlier
in the year for 1999 production and received proceeds of $909,000, all of
which is included in deferred revenue on the Company's December 31, 1998
balance sheet.
The Company also uses basis swaps in connection with energy swaps to fix the
differential between the NYMEX price and the index price at which the hedged
gas is to be sold. At December 31, 1998, there were two basis swaps in place,
for a monthly volume of 450,000 MMBTU through December 1999.
NOTE 12. MAJOR CUSTOMERS
Sales to customers in excess of 10% of total revenues for the years ended
December 31, 1998, 1997 and 1996 were:
<TABLE>
<CAPTION>
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Customer A $6,610 $ - $ -
Customer B 2,155 1,887 1,750
Customer C - 1,335 1,513
</TABLE>
NOTE 13. INCOME TAXES
The Company incurred a loss for book and tax purposes in all periods
presented. There is no income tax benefit or expense for the years ended
December 31, 1998, 1997 or 1996.
Deferred tax assets (liabilities) are comprised of the following as of
December 31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
(In thousands)
<S> <C> <C>
Deferred Tax Assets:
Net operating loss carryforward $ 7,098 $10,096
Oil, gas and other property basis differences 3,600 -
Other 171 172
Total deferred tax assets 10,869 10,268
Deferred Tax Liabilities:
Oil, gas and other properties basis differences - (5,527)
Net deferred tax assets 10,869 4,741
Less valuation allowance (10,869) (4,741)
Net deferred tax assets $ - $ -
======== =======
</TABLE>
At December 31, 1998, for Federal income tax purposes, the Company had a net
operating loss ("NOL") carryforward of approximately $19,000,000, which
expires in varying amounts between 2001 and 2018.
NOTE 14. SEGMENT INFORMATION
The Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" in 1998. SFAS No. 131 changes the way
the Company reports information about its operating segments. The Company's
reportable business segments have been identified based on the differences in
products provided. In 1998 and 1997, the Company has one reportable segment -
oil and gas exploration and production. In 1996, the Company also had a gold
mining segment which operated in Costa Rica. As discussed in Note 3, in 1997
the Company deconsolidated Laguna Gold Company and wrote-down its investment
in Laguna to zero; therefore, information for Laguna is not included in the
Company's consolidated financial statements for 1998 or 1997. Refer to Note
16 for information on the Company's oil and gas exploration and production
activities for 1998 and 1997.
Summarized financial information for the Company's reportable segments for
1996 is shown below (in thousands):
<TABLE>
<CAPTION>
1996 Oil and Gas Mining Corporate Total
<S> <C> <C> <C> <C>
Revenues from external customers $ 5,854 $ - $ - $ 5,854
Interest revenues 44 130 - 174
Interest expense 831 7 - 838
Depreciation, depletion and amortization 1,924 79 92 2,095
Impairment of oil and gas properties 264 - - 264
Total assets 28,781 12,356 263 41,400
Long-lived assets 22,814 9,365 263 32,442
</TABLE>
NOTE 15. RELATED PARTY TRANSACTIONS
The accounts receivable from related parties consists primarily of joint
interest billings to directors, officers, shareholders, employees and
affiliated entities for drilling and operating costs incurred on oil and gas
properties in which these related parties participate with Mallon Oil as
working interest owners. These amounts will generally be settled in the
ordinary course of business, without interest.
During the years ended December 31, 1998, 1997 and 1996, the Company paid
legal fees of $-0-, $4,000 and $2,000, respectively, to a law firm of which a
director of the Company is a senior partner.
In 1997, the Company paid $72,500 of fees to two investment banking firms in
which one of the Company's current directors was a principal. In addition,
one of these investment banking firms earned commissions and other fees of
approximately $388,000 in connection with the Company's December 1997 public
stock sale. At the time such amounts were paid or earned, the individual was
not a director of the Company.
In 1996, the Company paid an investment banking firm, in which a director is a
partner, a commission and other expenses of $101,000 in connection with the
Company's purchase of its Series A Stock.
NOTE 16. SUPPLEMENTARY INFORMATION ON OIL AND GAS OPERATIONS
Certain historical costs and operating information relating to the Company's
oil and gas producing activities for the years ended December 31, 1998, 1997
and 1996 are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Capitalized Costs Relating to Oil and Gas Activities:
Oil and gas properties (2)(4) $ 93,624 $ 63,148 $ 46,175
Natural gas processing plant 8,275 2,760 -
Accumulated depreciation, depletion and
amortization (48,297) (26,011) (23,361)
$ 53,602 $ 39,897 $ 22,814
======== ======== ========
Costs Incurred in Oil and Gas Producing Activities:
Property acquisition costs $ 1,459 $ 1,847 $ 60
Exploration costs 2,091 59(1) 264(1)
Development costs:
Gas plant processing 5,497 2,760 -
Pipeline 3,970 - -
Salt water disposal 1,527 - -
Drilling 21,447 15,067 2,138
Full cost pool credits - - (38)
$ 35,991 $ 19,733 $ 2,424
======== ======== ========
Results of Operations from Oil and Gas Producing Activities:
Oil and gas sales $ 13,069 $ 8,582 $ 5,854
Lease operating expense (5,273) (3,037) (2,249)
Depletion and depreciation (5,443) (2,625) (1,924)
Impairment of oil and gas properties (16,842) (24) (264)
Results of operations from oil and gas
producing activities $(14,489) $ 2,896 $ 1,417
======== ======== ========
</TABLE>
Estimated Quantities of Proved Oil and Gas Reserves (unaudited):
Set forth below is a summary of the changes in the net quantities of the
Company's proved crude oil and natural gas reserves estimated by independent
consulting petroleum engineering firms for the years ended December 31, 1998,
1997 and 1996. All of the Company's reserves are located in the continental
United States.
<TABLE>
<CAPTION>
Oil Gas
(MBbls) (MMcf)
<S> <C> <C>
Proved Reserves
Reserves, December 31, 1995 1,813 19,921
Extensions, discoveries and additions 75 667
Production (174) (1,286)
Revisions (7) 4,983
Reserves, December 31, 1996 1,707 24,285
Acquisitions of reserves in place - 3,968
Extensions, discoveries and additions 340 29,858
Production (196) (2,350)
Revisions (470) (5,889)
Reserves, December 31, 1997 1,381 49,872
Acquisitions of reserves in place 17 1,119
Extensions, discoveries and additions 7 43,510
Production (230) (5,852)
Revisions 89 (4,488)
Reserves, December 31, 1998 1,264 84,161
====== ======
Pro forma reserves at December 31, 1996(3) 1,707 28,388
====== ======
Proved Developed Reserves
December 31, 1996 1,225 18,403
====== ======
December 31, 1997 1,110 24,709
====== ======
December 31, 1998 945 65,786
====== ======
Pro forma at December 31, 1996 (3) 1,225 20,521
====== ======
</TABLE>
Standardized Measure of Discounted Future Net Cash Flows and Changes Therein
Relating to Proved Oil and Gas Reserves (unaudited):
The following summary sets forth the Company's unaudited future net cash flows
relating to proved oil and gas reserves, based on the standardized measure
prescribed in SFAS No. 69, for the years ended December 31, 1998, 1997 and
1996:
<TABLE>
<CAPTION>
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Future cash in-flows $133,311 $119,335 $129,963
Future production and development costs (61,477) (40,008) (46,374)
Future income taxes - (11,140) (18,150)
Future net cash flows 71,834 68,187 65,439
Discount at 10% (28,495) (27,022) (29,428)
Standardized measure of discounted future net
cash flows, end of year $ 43,339 $ 41,165 $ 36,011
======== ======== ========
Pro forma standardized measure of discounted
future net cash flows, end of year(3) $ 38,320
========
</TABLE>
Future net cash flows were computed using yearend prices and yearend statutory
income tax rates (adjusted for permanent differences, operating loss
carryforwards and tax credits) that relate to existing proved oil and gas
reserves in which the Company has an interest. The Company's oil and gas
hedging agreements at December 31, 1998 described in Note 11, do not have a
material effect on the determination of future oil and gas sales.
The following are the principal sources of changes in the standardized measure
of discounted future net cash flows for the years ended December 31, 1998,
1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Standardized measure, beginning of year $41,165 $36,011 $21,038
Net revisions to previous quantity estimates and other(3,159) 2,022 3,266
Extensions, discoveries, additions, and changes in
timing of production, net of related costs 21,189 27,642 2,204
Purchase of reserves in place 617 1,720 -
Net change in future development costs 461 (793) 580
Sales of oil and gas produced, net of production costs(5,545) (5,545) (3,605)
Net change in prices and production costs (22,643) (23,496) 20,487
Accretion of discount 4,529 341 2,029
Net change in income taxes 6,725 3,263 (9,988)
Standardized measure, end of year $43,339 $41,165 $36,011
======= ======= =======
Pro forma standardized measure, end of year(3) $38,320
=======
</TABLE>__________
(1) Offshore Belize - all other items relate to U.S. operations.
(2) At December 31, 1998, the net book value of the Company's oil and gas
properties exceeded the net present value of the underlying reserves by
$16,842,000. Accordingly, the Company wrote-down its oil and gas properties
at December 31, 1998. At December 31, 1997 and 1996, the net present value of
the underlying reserves exceeded the net book value of the Company's oil and
gas properties.
(3) In December 1996, the Company entered into a purchase and sale agreement to
acquire certain oil and gas properties for cash consideration of $1,300,000.
The Company assumed operations of those properties on December 31, 1996 and
the ownership changed on January 1, 1997. Pro forma proved reserves include
4,103 Mmcf and pro forma proved developed reserves include 2,118 Mmcf, and pro
forma standardized measure includes $2,309,000, as if the ownership had
changed on December 31, 1996.
(4) Includes $1,828,000 of unevaluated property cost not being amortized at
December 31, 1998, of which $855,000, $580,000 and $123,000 were incurred in
1998, 1997 and 1996, respectively. The Company anticipates that substantially
all unevaluated costs will be classified as evaluated costs within 5 years.
There are numerous uncertainties inherent in estimating quantities of proved
oil and gas reserves and in projecting the future rates of production,
particularly as to natural gas, and timing of development expenditures. Such
estimates may not be realized due to curtailment, shut-in conditions and other
factors which cannot be accurately determined. The above information
represents estimates only and should not be construed as the current market
value of the Company's oil and gas reserves or the costs that would be
incurred to obtain equivalent reserves.
** FINANCIAL STATEMENT SCHEDULE **
LAGUNA GOLD COMPANY
FINANCIAL SECTION
Expressed in U.S. Dollars, unless otherwise stated.
PAGE
REPORTS OF INDEPENDENT PUBLIC ACCOUNTANTS 2
CONSOLIDATED BALANCE SHEETS -
December 31, 1998 and 1997 4
CONSOLIDATED STATEMENTS OF OPERATIONS -
For the Years Ended December 31, 1998, 1997 and 1996 5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
For the Years Ended December 31, 1998, 1997 and 1996 6
CONSOLIDATED STATEMENTS OF CASH FLOWS -
For the Years Ended December 31, 1998, 1997 and 1996 7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8
LAGUNA GOLD COMPANY
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Laguna Gold Company:
We have audited the accompanying consolidated balance sheets of Laguna Gold
Company (a Colorado corporation) and subsidiaries as of December 31, 1998 and
1997, and the related consolidated statements of operations, stockholders'
equity (deficit) and cash flows for the years then ended. 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 financial statements referred to above present fairly, in
all material respects, the financial position of Laguna Gold Company and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.
/s/ Arthur Andersen LLP
Denver, Colorado
March 12, 1999
LAGUNA GOLD COMPANY
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
Laguna Gold Company
In our opinion, the accompanying consolidated statements of operations and of
cash flows for the year ended December 31, 1996 present fairly, in all
material respects, the results of operations and cash flows of Laguna Gold
Company and its subsidiaries for the year ended December 31, 1996, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for the
opinion expressed above. We have not audited the consolidated financial
statements of Laguna Gold Company for any period subsequent to December 31,
1996.
/s/ PRICEWATERHOUSECOOPERS LLP
March 17, 1997
Denver, Colorado
LAGUNA GOLD COMPANY
CONSOLIDATED BALANCE SHEETS
At December 31, 1998 and 1997
(In thousands of U.S. dollars, except share and per share amounts)
___________
<TABLE>
<CAPTION>
1998 1997
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 3,984 $ 435
Notes receivable 200 --
Accounts receivable 31 19
Inventories -- 12
Other 17 19
Total current assets 4,232 485
Mineral properties 416 254
Mining equipment 612 737
Construction in progress 2,708 --
Less accumulated depreciation, depletion
and amortization (139) --
3,597 991
Other assets 27 8
Total Assets $ 7,856 $ 1,484
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued liabilities $ 999 $ 62
Long-term liabilities:
Notes payable, net 5,824 1,856
Other convertible notes payable 230 230
Accrued interest 32 81
6,086 2,167
Commitments and contingencies (Note 10)
Stockholders' equity (deficit):
Series A Convertible Preferred Stock,
$0.01 par value, 25,000 shares authorized,
no shares issued and outstanding -- --
Common Stock, $0.01 par value, 200,000,000
shares authorized; 27,329,703 and 25,000,000
shares issued and outstanding, respectively 273 250
Additional paid-in capital 17,488 14,736
Accumulated deficit (16,990) (15,731)
Total stockholders' equity (deficit) 771 (745)
Total Liabilities and Stockholders'
Equity (Deficit) $ 7,856 $ 1,484
======== ========
</TABLE>
Approved on behalf of the Board:
Stephen R. Stine, Director Roy K. Ross, Director
The accompanying notes are an integral part of these
consolidated financial statements.
LAGUNA GOLD COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, 1998, 1997 and 1996
(In thousands of U.S. dollars, except per share amounts)
_______________
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Revenues:
Interest and other $ 237 $ 91 $ 130
Costs and expenses:
Write down of mining assets -- 9,319 --
General and administrative 675 985 624
Exploration 181 234 410
Depreciation and amortization 143 139 78
Interest and other 497 116 120
1,496 10,793 1,232
Net loss $(1,259) $(10,702) $(1,102)
======= ======== =======
Net loss per common share $ (0.05) $ (0.43) $ (0.06)
======= ======== =======
Weighted average common shares
outstanding (000's) 26,648 25,000 18,590
======= ======== =======
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
LAGUNA GOLD COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(In thousands of U.S. dollars, except share amounts)
<TABLE>
<CAPTION>
Total
Additional Stockholder
Preferred Stock Common Stock Paid-in Accumulated Equity
Shares Amount Shares Amount Capital Deficit (Deficit)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 25,000 $ 1 10,000,000 $100 $ 8,219 $ (3,927) $ 4,393
1.44-for-one common stock
split -- -- 4,400,000 44 (44) -- --
Adjusted balance,
December 31, 1995 25,000 1 14,400,000 144 8,175 (3,927) 4,393
Capital contribution by Mallon
Resources Corporation -- -- -- -- 111 -- 111
Stock option compensation expense -- -- -- -- 25 -- 25
Sale of Special Warrants -- -- -- -- 4,339 -- 4,339
Issuance of common stock -- -- 2,000,000 20 1,980 -- 2,000
Conversion of Series A Preferred
Stock to common stock (25,000) (1) 3,600,000 36 (35) -- --
Issuance of common stock for
Special Warrants -- -- 5,000,000 50 (50) -- --
Net loss -- -- -- -- -- (1,102) (1,102)
Balance, December 31, 1996 -- -- 25,000,000 250 14,545 (5,029) 9,766
Stock option compensation expense -- -- -- -- 191 -- 191
Net loss -- -- -- -- -- (10,702) (10,702)
Balance, December 31, 1997 -- -- 25,000,000 250 14,736 (15,731) (745)
Stock option compensation expense -- -- -- -- 39 -- 39
Conversion of note payable due
Mallon Resources Corporation
to common stock -- -- 1,744,703 17 1,902 -- 1,919
Stock options exercised -- -- 585,000 6 -- -- 6
Fair value of warrants issued
with corporate notes -- -- -- -- 811 -- 811
Net loss -- -- -- -- -- (1,259) (1,259)
Balance, December 31, 1998 -- $-- 27,329,703 $273 $17,488 $(16,990) $ 771
======= === ========== ==== ======= ======== =======
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
LAGUNA GOLD COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 1998, 1997 and 1996
(In thousands of U.S. dollars)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (1,259) $(10,702) $(1,102)
Adjustments to reconcile net loss to net cash used in operating activities:
Write down of mining assets -- 9,319 --
Depreciation and amortization 143 139 78
Amortization of debt discount 135 -- --
Loss (gain) on sale of assets 33 (12) --
Loss on theft of assets 6 -- --
Allocated general and administrative expenses -- -- 111
Stock option compensation expense 39 191 25
Changes in operating assets and liabilities:
Decrease (increase) in:
Accounts receivable (12) 36 (49)
Notes receivable (200) -- --
Inventories 12 6 12
Other assets (17) 38 (25)
Increase (decrease) in:
Accounts payable and accrued liabilities 612 (98) (102)
Exploration advance -- -- (99)
Accrued interest 338 108 110
Net cash used in operating activities (170) (975) (1,041)
Cash flows from investing activities:
Short-term investments -- 2,786 (2,786)
Construction in progress (2,708) -- --
Additions to property and equipment (182) (1,439) (1,635)
Proceeds from sale of assets 103 16 --
Net cash (used in) provided by investing activities (2,787) 1,363 (4,421)
Cash flows from financing activities:
Proceeds from sale of special warrants -- -- 4,339
Proceeds from exercise of common stock options 6 -- --
Proceeds from private placement 6,500 -- --
Net cash provided by financing activities 6,506 -- 4,339
Net increase (decrease) in cash and cash equivalents 3,549 388 (1,123)
Cash and cash equivalents, beginning of year 435 47 1,170
Cash and cash equivalents, end of year $ 3,984 $ 435 $ 47
======== ======== =======
Supplemental non-cash transactions:
Conversion of note payable to Mallon Resources
Corporation by issuance of common stock $ 1,919 $ -- $ --
======== ======== =======
Fair value of warrants issued with corporate notes $811,000 $ -- $ --
======== ======== =======
Sale of 1% net smelter return royalty by forgiveness of a portion
of the principal amount of a convertible note payable and
accrued interest to Mallon Resources Corporation $ -- $ 350 $ --
======== ======== =======
Acquisition of Red Rock Ventures, Inc. for common stock and
notes payable $ -- $ -- $ 2,230
======== ======== =======
Capital contribution by Mallon Resources Corporation by
forgiveness of account payable $ -- $ -- $ 111
======== ======== =======
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. ORGANIZATION
Laguna Gold Company (the "Company" or "Laguna") is a Denver based company
engaged in the exploration for and development of precious mineral properties
in Costa Rica and Panama. The Company was incorporated under the laws of the
State of Colorado on October 15, 1980. In December 1988, the Company became a
wholly-owned subsidiary of Mallon Resources Corporation ("Mallon"). At
December 31, 1998, Mallon owned approximately 45% of the Company's outstanding
common stock.
Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation:
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries, Laguna Costa Rica Corp., a Colorado
corporation, Corporacion de Minerales Mallon, S.A., a Costa Rica corporation,
Industrial Platoro, S.A., a Costa Rica corporation, and Compania Minera Veta
Charcones, a Costa Rica corporation. All significant intercompany
transactions and accounts have been eliminated in consolidation.
Cash and Cash Equivalents:
Cash and cash equivalents include investments which are readily convertible
into cash and have an original maturity of three months or less. Investments
are held to maturity and are reported at the lower of cost or market.
Fair Value of Financial Instruments:
The Company's on-balance sheet financial instruments consist of cash and cash
equivalents, notes receivable, accounts receivable and accounts payable and
long-term debt. Except for long-term debt, the carrying amounts of such
financial instruments approximate fair value due to their short maturities.
At December 31, 1998 and 1997, based on rates available for similar types of
debt, the fair value of long-term debt was not materially different from its
carrying amount.
Inventories:
Inventories, which consist of mining materials and supplies, are valued at the
lower of average cost or estimated net realizable value.
Property and Equipment:
The Company expenses general prospecting costs and exploration costs on
unevaluated mining properties. When, based on management's evaluation of
geological studies, resource and reserve reports (both Company and third party
reports), metallurgical studies, environmental issues, estimated capital
requirements, estimated mining and production costs, estimated commodity
prices, and other matters, it appears likely that a mineral property can be
economically developed, the costs incurred to acquire and develop such
property, including costs to further delineate the ore body, are capitalized.
When commercially profitable ore reserves are developed and operations
commence, deferred costs will be amortized using the units-of-production
method over the life of the mine. Upon abandonment or sale of projects, all
capitalized costs relating to the specific project are removed from the
accounts in the year abandoned or sold and any gain or loss is recognized.
Mining equipment is depreciated using the units-of-production method, except
during suspended operations. When not in production, this equipment is
depreciated at approximately 2% per year. Other property and equipment is
recorded at cost, and depreciated over their estimated useful lives (five to
seven years) using the straight-line method.
The cost of normal maintenance and repairs is charged to expense as incurred.
Significant expenditures that increase the life of an asset are capitalized
and depreciated over the estimated useful life of the asset. Upon retirement
or disposition of assets, related gains or losses are reflected in operations.
The Company analyzes the realizability of its long-lived assets in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of." SFAS No. 121 prescribes that an impairment loss is
recognized in the event that facts and circumstances indicate that the
carrying amount of an asset may not be recoverable, and an estimate of future
undiscounted cash flows is less than the carrying amount of the asset.
Impairment is recorded based on an estimate of future discounted cash flows.
(See Note 4.)
Income Taxes:
Income taxes are calculated in accordance with the provisions set forth in
SFAS No. 109, "Accounting for Income Taxes." Under SFAS No. 109, deferred
income taxes are determined using an asset and liability approach. This
method gives consideration to the future tax consequences associated with
differences between the financial accounting and the tax basis of assets and
liabilities, as determined through income tax filings by the Company with
relevant tax authorities, and gives immediate effect to changes in income tax
laws.
Stock-Based Compensation:
The Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation,"
in 1996. As permitted under SFAS No. 123, the Company has elected to continue
to measure compensation cost using the intrinsic value based method of
accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to
Employees." The Company has made pro forma disclosures of net loss and loss
per share as if the fair value based method of accounting as defined in SFAS
No. 123 had been applied. (See Note 11.)
Foreign Currency Translation:
Management has determined that the U.S. dollar is the functional currency for
Costa Rican operations. Accordingly, the assets, liabilities and results of
operations of the Costa Rica subsidiaries are measured in U.S. dollars.
Transaction gains and losses are not material for any of the periods
presented.
Per Share Data:
The Company adopted SFAS 128, "Earnings Per Share" beginning in the fourth
quarter of 1997. All prior period earnings per share have been restated to
conform to the provisions of the statement. Basic earnings per share is
computed based on the weighted average number of common shares outstanding.
Diluted earnings per share is computed based on the weighted average number of
common shares outstanding adjusted for the incremental shares attributed to
outstanding options to purchase common stock. All options to purchase common
shares were excluded from the computation of diluted earnings per share in all
years presented because they were antidilutive as a result of the Company's
net loss in those years.
Use of Estimates and Significant Risks:
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make
significant estimates and assumptions that affect the amounts reported in
these financial statements and accompanying notes. The more significant areas
requiring the use of estimates relate to mineral reserves, fair value of
financial instruments, future cash flows associated with long-lived assets,
valuation allowance for deferred tax assets, and useful lives for depreciation
and amortization. Actual results could differ from those estimates.
The Company and its operations are subject to numerous risks and
uncertainties. Among these are risks related to the mining business
(including operating risks and hazards and the regulations imposed thereon),
risks and uncertainties related to the volatility of the prices of metals,
uncertainties related to the estimation of reserves of minerals and the value
of such reserves, the effects of competition and extensive environmental
regulation, the uncertainties related to foreign operations, and many other
factors, many of which are necessarily out of the Company's control.
Exploration activities are subject to numerous risks, including the risk that
no ore bodies will be encountered.
New Accounting Pronouncements:
The FASB issued SFAS No. 130 "Reporting Comprehensive Income" in June 1997
which established standards for reporting and displaying comprehensive income
and its components in a full set of general purpose financial statements. In
addition to net income, comprehensive income includes all changes in equity
during a period, except those resulting from investments by and distributions
to owners. The Company adopted SFAS 130 in the first quarter of 1998, and the
adoption had no impact on the consolidated financial statements.
In June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information" ("SFAS 131") was issued and establishes standards for
reporting information about operating segments in annual and interim financial
statements. SFAS 131 also establishes standards for related disclosures about
product and services, geographic areas and major customers. SFAS 131 is
effective for fiscal years beginning after December 15, 1997, and was adopted
in fiscal 1998. However, the Company currently has only one reportable
segment.
Start-Up Costs:
American Institute of Certified Public Accounts Statement of Position 98-5
("SOP 98-5") provides guidance on the financial reporting of start-up and
organizations costs. SOP 98-5 broadly defines start-up activities and
requires the costs of such start-up activities and organization costs to be
expensed as incurred. SOP 98-5 is effective for fiscal years beginning after
December 15, 1998 and the initial application is reported as a cumulative
effect of a change in accounting principles. The Company will adopt this
policy January 1, 1999 and management does not expect the adoption of this
will have a material cumulative effect on its consolidated financial
statements.
Note 3. PRIVATE PLACEMENT FINANCING
On July 7, 1998, the Company completed a private placement financing. The
Company issued US$6.5 million of 10% corporate notes due June 30, 2001. Of
the $6.5 million financing, $6.0 million was raised from related parties.
Three directors participated in the private placement in the amount of
$150,000 and a private company participated in the amount of $5.85 million.
In conjunction with the $5.85 million investment, Harry H. Stine, president
and owner of Stine Seed Company, the private company investor, became a
director of Laguna. The remaining $500,000 of the private placement came from
an institutional fund. The corporate notes were issued with detachable
warrants to purchase 11.05 million shares of Laguna common stock at an
exercise price of US$0.04 during year 1 through year 4. The exercise price in
year 5 is US$0.05. The proceeds from the private placement are being used to
construct processing facilities at the Company's Rio Chiquito Mine and the
Company anticipates starting commercial production of gold and silver in the
second quarter of 1999.
The corporate notes totaling $6.5 million related to the private placement
financing are reported in the consolidated financial statements net of the
unamortized debt discount of approximately $676,000. The original discount of
$811,000 at July 7, 1998 is a result of the relative fair value allocated to
the 11,050,000 warrants attached to the corporate notes and 500,000 Laguna
common shares awarded to the lead investor. The relative fair value
associated with the warrants was computed using the Black-Scholes model and
the value for the common shares awarded was based on the current share price
on July 7,1998. No principal payments are due until June 30, 2001. The first
interest payment of $650,000 is due June 30, 1999 and the remaining interest
payments are due semi-annually on December 31 and June 30 in the amount of
$325,000 each through June 30, 2001.
With the construction of the Rio Chiquito Mine almost complete and our cash
position of US$4.0 million as of December 31, 1998, the Company anticipates
having sufficient cash to meet all requirements through the critical start-up
period. The Company's cash on hand is expected to service the upcoming debt
interest payment ($650,000 due June 30, 1999) and cover all operating costs
until revenue is generated from our precious metal sales in the beginning of
June 1999. However, if gold prices decline further, the Company may need to
initiate reductions in its workforce and other areas of costs to reduce future
financial requirements.
Note 4. WRITE-DOWN OF MINING ASSETS
The Company evaluates its long-lived assets for write-down when events or
changes in circumstances indicate that the related carrying amount may not be
recoverable. If the sum of estimated future cash flows on an undiscounted
basis is less than the carrying amount of the related asset, an asset write-
down is considered necessary. The related write-down is measured by comparing
estimated future cash flows on a discounted basis to the carrying amount of
the assets. Effective December 31, 1997, the Company's Board of Directors
approved a write-down for a portion of its long-lived assets based upon an
analysis completed in March 1998. The Company recognized a write-down of $8.8
million and $0.5 million affecting its mineral properties and mining
equipment, respectively. The write-down was required primarily as a result of
the sustained depressed gold price.
Note 5. MINERAL PROPERTIES
The Company's principal precious metals property is the Rio Chiquito project
located in Guanacaste Province, Costa Rica where the Company holds 18
exploration concessions and one exploitation concession covering 277 square
kilometers. The Company believes that it has valid rights to the Rio Chiquito
concessions, and that all necessary exploration work has been performed to
retain title to the concessions. The Company owns 100% of the project.
Note 6. CONSTRUCTION IN PROGRESS
Upon receiving financing in July 1998, the Company purchased property,
equipment, materials and supplies. These costs, including labor, relate to
the construction of the mine, crusher, heap leach pad, solution ponds, gold
recovery plant and related facilities.
Note 7. SHARE CAPITAL
The Company's authorized capital consists of 200,000,000 shares of $.01 par
value common stock and 1,000,000 shares of preferred stock, par value $.01 per
share, with designations, rights, preferences and limitations as may be
determined by the Company's Board of Directors. In June 1995, the Company
privately placed 25,000 shares of its Series A Convertible Preferred Stock for
$2,400,000. The shares of Series A Convertible Preferred Stock were
convertible into 3,600,000 shares of the Company's common stock and this
conversion occurred automatically upon the Company's successful initial public
offering in September 1996, as discussed below. Each share of Series A
Convertible Preferred Stock included detachable warrants to purchase shares of
Mallon's common stock at an adjusted exercise price of $8.04 per share. The
warrants expire in June 2000.
In May 1996, the Company sold 5,000,000 Special Warrants for $1.00 per
Warrant. The Company received proceeds of $4,339,000, net of offering costs
of $661,000. In September 1996, the Company completed the registration of the
Special Warrants with The Ontario Securities Commission. Upon exercise, each
Special Warrant is convertible into one share of the Company's common stock
and one Common Share Purchase Warrant. Each Common Share Purchase Warrant
entitled the holder to purchase one share of common stock for $1.50 (subject
to adjustment) on or before November 24, 1997. In connection with the sale of
the Special Warrants, the Company issued to the underwriters non-assignable
warrants that entitle the holders to purchase 500,000 shares of the Company's
common stock on or before November 24, 1997 at $1.00 per share. As of
November 24, 1997, none of the Common Share Purchase Warrants nor the Special
Warrants were exercised and subsequently all the warrants expired.
Until June 1996, the Company owned a 90% interest in the Rio Chiquito
concessions, and Red Rock, a private company, owned a 10% interest. In June
1996, the Company acquired Red Rock for 2,000,000 shares of the Company's
common stock, valued at $1.00 per share, and convertible secured promissory
notes in the aggregate principal amount of $230,000, for a total consideration
of $2,230,000. The notes bear interest at 5% per annum. Principal and
accrued interest are due December 31, 2000. The notes are convertible into
shares of the Company's common stock, at the holder's option. The initial
conversion price, which is subject to anti-dilution adjustments, is $1.10.
The notes are collateralized by a general security agreement encumbering all
of the assets of the Company. Red Rock's sole asset at the time of the merger
was a 10% interest in the Rio Chiquito concessions. After the acquisition,
the Company owns a 100% interest in the concessions. The acquisition was
accounted for as a purchase.
Note 8. INCOME TAXES
The Company incurred a loss for book and tax purposes in all periods
presented. There is no income tax benefit or expense for the years ended
December 31, 1998, 1997 and 1996.
Deferred tax assets consisted of the following as of December 31, 1998 and
1997 (In thousands of U.S. dollars):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Net operating loss carryforward $ 1,382 $ 1,070
Mining properties basis differences 5,057 4,903
6,439 5,973
Less valuation allowance (6,439) (5,973)
$ -- $ --
======= =======
</TABLE>
At December 31, 1998, for U.S. Federal income tax purposes, the Company had a
net operating loss ("NOL") carryforward of approximately $3,700,000, which
expires in varying amounts between 2005 and 2018.
Note 9. RELATED PARTY TRANSACTIONS
In June 1997, Mallon discontinued its allocation of G&A to the Company since
Laguna was no longer sharing office space, expenses or employees. The G&A
allocation from Mallon to the Company for 1997 was $58,000. During 1997, none
of the G&A allocation was recorded as a capital contribution by Mallon. As of
December 31, 1998 and 1997, approximately $1,227 and $10,000 were due from
Mallon, respectively. As of December 31, 1998 and 1997, $908 and $1,700 were
payable to Mallon, respectively. Subsequent to year end, the intercompany
receivable and payable have been collected and paid, respectively.
In December 1995, the Company exchanged its intercompany payable to Mallon of
$5,639,000 for a $2,070,000 Convertible Secured Promissory Note ("Note") to
Mallon. The difference of $3,569,000 was recorded as a capital contribution
by Mallon. The Note accrued interest at 5% per annum, and principal and
accrued interest was due December 31, 2000. The Note was convertible into
shares of the Company's common stock, at either the Company's or Mallon's
option. The conversion price, which was subject to anti-dilution adjustments,
was $1.10. The Note was collateralized by a general security agreement
encumbering all of the assets of the Company. The intercompany payable to
Mallon arose principally through the purchase of mineral properties and the
allocation of common expenses. Mallon did not charge interest on the
intercompany payable prior to the exchange noted above. In March 1998, the
Company exercised its option under the terms of the Note to pay off all of the
principal and accrued interest due under the Note as of December 31, 1997 with
shares of its $0.01 par value per share common stock. The total principal and
accrued interest due under the Note as of December 31, 1997, was $1,919,173.
Accordingly, the Company authorized 1,744,703 shares of its common stock to be
issued to Mallon in full satisfaction of all of its obligations under the
Note.
In April 1997, the Company sold to Mallon a 1% net smelter return royalty
burdening the Rio Chiquito concessions in exchange for the forgiveness by
Mallon of a portion of the principal amount of the Note and accrued interest.
Total consideration was $350,000, of which approximately $214,000 was
principal and $136,000 was accrued interest.
In January 1998, the Company entered into a sublease agreement with Mallon.
Note 10. COMMITMENTS AND CONTINGENCIES
In October 1996, the Company entered into a new lease for its corporate
office. The lease expires in February 2002. The lease agreement provides for
a base rent of $3,361 per month for the entire term of the lease and the
payment of the Company's proportionate share of the real estate taxes and
operating expenses. Future minimum lease payments are as follows (In
thousands of U.S. dollars):
<TABLE>
<CAPTION>
Year Amount
<S> <C>
1999 $ 44
2000 41
2001 40
2002 7
2003 --
$132
====
</TABLE>
For the year ended December 31, 1998, the Company's rent expense was $27,837,
net of $14,724 received from Mallon on sublet of office. For the year ended
December 31, 1997, the Company's rent expense was included in the general and
administrative expense allocated from Mallon. In January 1998, the Company
began subletting approximately one-third of the Company's office space to
Mallon for a period of 12 months at a rate of $1,227 per month. The sublease
rate is based on current office lease rates. Since January 1, 1999, the
Company is continuing to sublet to Mallon on a month-to-month basis at the
rate of $1,249 per month.
Under the terms of the Costa Rican Labor Code, the Company may be obligated to
make certain payments in the event of the death or dismissal of Costa Rican
employees. No estimate of this liability can be made at this time. It is the
policy of the Company to expense any such payments as incurred.
The Company has future reclamation commitments related to its current mine
operations. The Company is in the process of reclaiming areas where mining is
completed. The Company will continue this practice throughout the mine life.
When mining is completed, the Company will reclaim the remaining areas of the
mine.
Note 11. STOCK BASED COMPENSATION
Under the Laguna Gold Company Equity Participation Plan (the "Equity Plan"),
shares of common stock have been reserved for issuance in order to provide for
incentive compensation and awards to employees and consultants. The number of
shares reserved is 5,000,000 shares of common stock. The Equity Plan provides
that stock options, stock bonuses and stock appreciation rights and other
forms of stock-based compensation may be granted in accordance with the
provisions of the Equity Plan. Effective January 1, 1995, options to purchase
a total of 1,620,000 shares of the Company's common stock were granted to four
officers of the Company, exercisable at a price of $0.01 per share. Of these
options, 718,750 vested immediately. The remainder of the options vest over a
period of up to four years. The maximum term for the options is ten years
from the date of grant. The options vest in full if controlling interest in
the Company or substantially all of its assets are sold, or if the Company is
merged into another company, or if control of the Company's Board is obtained
by a person or persons not expressly approved by a majority of the members of
the Board. As permitted under SFAS No. 123, the Company has elected to
continue to measure compensation expense using the intrinsic value method of
accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to
Employees." Under that method, the difference between the exercise price and
the estimated fair value of the shares at the date of grant is charged to
compensation expense, ratably over the vesting period. As of December 31,
1998, 585,000 options have been exercised. As a result of the options
exercised during 1998, the number of common shares available under the
Company's Equity Plan is reduced by 585,000 shares from 5,000,000 to
4,415,000.
In July and August 1996, under the Equity Plan, options to purchase a total of
880,000 shares of the Company's common stock were granted to officers and
directors of the Company, exercisable at a price of $1.00 per share. Of these
options, 630,000 vested immediately. The remainder of the options vest over
periods of up to four years. To date, none of these options have been
exercised.
In August 1997, under the Equity Plan, options to purchase 225,000 shares of
the Company's common stock with an exercise price of $0.01 per share were
forfeited.
In September 1997, under the Equity Plan, options to purchase 160,000 shares
of the Company's common stock were granted to officers of the Company,
exercisable at a price of $0.16 per share. Of these options, 40,000 vested
immediately. The remainder of the options vest over periods of up to three
years. To date, none of these options have been exercised.
In January 1998, under the Equity Plan, options to purchase 919,999 shares of
the Company's common stock were granted to employees of the Company,
exercisable at a price of $0.045 per share. Of these options, 246,667 vested
immediately. The remainder of options vest at various times or upon the
occurrence of various events. These grants were subject to stockholder
ratification at the Company's June 1998 annual meeting, which was received in
June 1998.
In March 1998, the Company's Board of Directors approved, subject to
stockholder ratification at the Company's June 1998 annual meeting, an
increase in the number of shares available for issuance under the Company's
Equity Plan from 2.5 million shares to 5.0 million shares. In addition, the
Board of Directors approved, subject to stockholder ratification, that the
exercise price of all options held by current employees and directors of the
Company be reduced to US$0.045 per share. The increase in the number of
shares available for issuance under the Company's Equity Plan and the re-
pricing of options received stockholder ratification in June 1998.
From July through December 1998, under the Equity Plan, options to purchase
330,000 shares of the Company's common stock were granted to employees of the
Company, exercisable at a price of $0.03-$0.07 per share. Of these options,
80,000 vested immediately. The remainder of options vest over periods of up
to two years.
In January and July 1998, 225,000 and 360,000, respectively, of common stock
options were exercised by former officers of the Company at an exercise price
of $0.01 per share.
Changes during 1998, 1997 and 1996 in options outstanding under the Equity
Plan were as follows:
Option Price
<TABLE>
<CAPTION>
Shares Per Share
(000's)
<S> <C> <C>
Outstanding at December 31, 1995 1,620 $0.01
Granted 880 $1.00
Exercised -- --
Forfeited -- --
Outstanding at December 31, 1996 2,500 $0.01-$1.00
Granted 160 0.16
Exercised -- --
Forfeited 225 0.01
Outstanding at December 31, 1997 2,435 $0.01-$1.00
Granted 1,249 $0.03-$0.07
Exercised 585 $0.01
Forfeited 317 $0.04-$0.06
Outstanding at December 31, 1998 2,782 $0.03-$1.00
Options exercisable:
December 31, 1996 1,845 $0.01-$1.00
December 31, 1997 2,203 $0.01-$1.00
December 31, 1998 2,072 $0.01-$1.00
</TABLE>
The weighted average remaining contractual life of the options under the
Equity Plan is 8.35 years.
Had compensation expense for the Company's 1998, 1997 and 1996 grants of stock
options been determined consistent with the fair value method under SFAS No.
123, the Company's net loss and loss per common share would approximate the
pro forma amounts below (in thousands of U.S. dollars, except per share
amounts):
<TABLE>
<CAPTION>
1998 1997 1996
As Pro As Pro As Pro
Reported Forma Reported Forma Reported Forma
<S> <C> <C> <C> <C> <C> <C>
Net loss $(1,259) $(1,312) $(10,702) $(10,752) $(1,102) $(1,399)
Net loss per common
Share $(0.05) $(0.05) $(0.43) $(0.43) $(0.06) $(0.08)
</TABLE>
The fair value of each option is estimated as of the grant date using the
Black-Scholes option-pricing model with the following assumptions.
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Risk-free interest rate 5.12% 5.88% 6.50%
Expected life (in years) 4 4 4
Expected volatility 318.70% 133.28% 75.50%
Expected dividend yield 0.00% 0.00% 0.00%
Weighted average fair value of
options granted $0.04 $0.16 $0.52
</TABLE>
In December 1997, Mallon granted to new management an option for three years
to purchase from Mallon 1.0 million shares of Laguna common stock owned by
Mallon ("Mallon's Laguna Common Stock") for a purchase price of US$1.00 per
share (see below). The grant of the 1.0 million options to new management
from Mallon is not reflected in the SFAS 123 disclosures above.
In December 1997, the Company engaged a new management team. Part of
management's compensation package was stock compensation effective
December 30, 1997. The compensation package provided the following: (1) a
grant of 2.4 million shares of Mallon's Laguna Common Stock; (2) a grant to
new management of an option for three years to purchase from Mallon 1.0
million shares of Mallon's Laguna Common Stock for a purchase price of US$1.00
per share; and (3) a grant of 975,000 shares of Mallon's Laguna Common Stock
to new management upon the occurrence of certain events. For the years ended
December 31, 1998 and 1997, the Company's statement of operations reflects
stock compensation expense of approximately $39,000 for Item 3 discussed above
and approximately $210,000 for items (1) and (2) discussed above.
Note 12. DIFFERENCE BETWEEN UNITED STATES AND CANADIAN
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
The consolidated financial statements have been prepared with accounting
principles generally accepted in the United States. Had the Company followed
accounting principles generally accepted in Canada, there would not have been
any significant effect on earnings or financial statement presentation.
Note 13. SUBSEQUENT EVENTS
The Company's Import/Export Agreement allows the Company to import mining
equipment and supplies free of import taxes and custom duties and to receive a
10% bonus on the export of precious metals precipitates revenues. In November
1998, the Company's Import/Export Agreement was unexpectedly canceled by the
Costa Rican government. Subsequently, the Company appealed this action
through the proper governmental agencies. During this period of dispute, all
import taxes and custom duties associated with equipment and supplies imported
(approximately $270,000) were required to be paid by the Company and held in
escrow in a Costa Rican bank account. In February 1999, the appeal was
resolved in favor of the Company with regard to exoneration of taxes on
equipment and supplies imported. The Company voluntarily renounced the 10%
bonus credit on gold and silver revenues in order to get the tax exoneration
reinstated.
The value of the bonus credit given up is approximately $150,000. Subsequent
to the favorable February 1999 resolution, the Company has collected
approximately $222,000 of the $270,000 amount in escrow. The Company expects
to collect the remaining $48,000 by the end of March 1999. The Import/Export
Agreement with the Costa Rican government ends in September 1999. Presently,
the Company is in the process of applying for a new agreement to replace the
expiring Import/Export Agreement. The Company expects the new agreement to be
in place by October 1999.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE COMPANY'S FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 1,733
<SECURITIES> 0
<RECEIVABLES> 1,858
<ALLOWANCES> 43
<INVENTORY> 375
<CURRENT-ASSETS> 3,955
<PP&E> 102,888
<DEPRECIATION> 48,748
<TOTAL-ASSETS> 58,452
<CURRENT-LIABILITIES> 7,737
<BONDS> 0
<COMMON> 70
1,329
0
<OTHER-SE> 22,094
<TOTAL-LIABILITY-AND-EQUITY> 58,452
<SALES> 13,069
<TOTAL-REVENUES> 13,178
<CGS> 0
<TOTAL-COSTS> 30,186
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 35
<INTEREST-EXPENSE> 1,143
<INCOME-PRETAX> (18,186)
<INCOME-TAX> 0
<INCOME-CONTINUING> (18,186)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (18,306)
<EPS-PRIMARY> (2.61)
<EPS-DILUTED> (2.61)
</TABLE>
