<PAGE>
U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
----- -----
Commission File No. 0-21472
American Resources Offshore, Inc.
(f/k/a American Resources of Delaware, Inc.)
(Name of small business issuer in its charter)
DELAWARE 86-0713506
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
160 MORGAN STREET, P. O. BOX 87
VERSAILLES, KENTUCKY 40383
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: 606-873-5455
Check whether the issuer: (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
YES xx NO
---- ----
APPLICABLE ONLY TO ISSUERS INVOLVED IN
BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS
Check whether the issuer has filed all documents and reports
required to be filed by Section 12, 13 or 15(d) of the Exchange
Act after the distribution of securities under a plan confirmed
by a court.
YES xx NO
------ ------
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the
Issuer's classes of common equity, as of the last practicable
date:
On September 30, 1998, 10,251,853 shares of the Registrant's
Common Stock, par value $.00001 per share, were issued and
outstanding and 230,516 shares of the Registrant's Series 1993 8%
Convertible Preferred Stock were issued and outstanding.
Transitional Small Business Disclosure Format (check one):
Yes ; No xx .
----- ------
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
FORM 10-Q
INDEX TO FINANCIAL STATEMENTS
Page
Number
------
PART I - FINANCIAL INFORMATION 1
Item 1 - Financial Statements 1
Introduction to the Financial
Statements 1
Condensed Consolidated Balance
Sheets - September 30, 1998
(unaudited) and December 31, 1997 3
Condensed Consolidated Statements of
Operations - Quarter and Nine Months
Ended September 30, 1998 and 1997
(unaudited) 5
Condensed Consolidated Statements of
Cash Flows - Nine Months Ended
September 30, 1998 and 1997
(unaudited) 6
Notes to Condensed Consolidated
Financial Statements (unaudited) 7
Item 2 - Management's Discussion and Analysis
of Financial Condition and Results
of Operations 14
PART II - OTHER INFORMATION 22
Item 1 - Legal Proceedings 22
Item 3 - Defaults Upon Senior Securities 22
Item 6 - Exhibits and Reports on Form 8-K 22
Signature 24
ii
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
The Financial Statements for the nine months ended September
30, 1998 and 1997 include, in the opinion of the Company, all
adjustments (which consist only of normal recurring adjustments)
necessary to present fairly the results of operations for such
periods. Results of operations for the nine months ended
September 30, 1998, are not necessarily indicative of results of
operations which will be realized for the year ending December
31, 1998. The Financial Statements should be read in conjunction
with the Company's Report on Form 10-KSB for the year ended
December 31, 1997.
1
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARIES
----------------
CONDENSED, CONSOLIDATED FINANCIAL
---------------------------------
STATEMENTS
----------
FOR THE QUARTER AND NINE MONTHS ENDED
-------------------------------------
SEPTEMBER 30, 1998 AND 1997
---------------------------
2
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARIES
----------------
CONDENSED, CONSOLIDATED BALANCE SHEETS
--------------------------------------
ASSETS
------
<TABLE>
SEPTEMBER 30
------------
1998 DECEMBER 31
---- -----------
(unaudited) 1997(*)
---------- -------
(Dollars in thousands)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 461 $ 1,181
Accounts and notes
receivable, net 9,628 4,964
Deferred tax asset - 112
Prepaid expenses and other 820 313
-------- --------
Total current assets 10,909 6,570
-------- --------
Oil and gas properties, at cost
(successful efforts method) 136,872 57,173
Property and equipment, at cost 13,859 12,352
-------- --------
150,731 69,525
Less accumulated depreciation,
depletion and amortization (31,011) (18,276)
-------- --------
Net property and equipment 119,720 51,249
-------- --------
Other assets:
Investment in unconsolidated entities 2,547 2,547
Notes receivable 292 407
Deferred financing costs, net 1,273 470
Other assets 239 323
-------- --------
Total other assets 4,351 3,747
-------- --------
$134,980 $61,566
======== ========
</TABLE>
(Continued)
See accompanying notes to condensed, consolidated financial statements.
*Derived from audited financial statements.
3
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARIES
----------------
CONDENSED, CONSOLIDATED BALANCE SHEETS (CONTINUED)
--------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<TABLE>
SEPTEMBER 30,
-------------
1998 DECEMBER 31,
---- ------------
(UNAUDITED) 1997(*)
----------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Current liabilities:
Current maturities of long-term debt $ 64,983 $ 4,682
Debt in default 18,500 -
Note payable to related third party - 225
Accounts payable-trade 26,102 963
Accrued taxes payable 5 175
Unearned revenue 1,666 820
Accrued expenses and other 329 525
------- -------
Total current liabilities 111,585 7,390
------- -------
Long-term debt, excluding current maturities 815 25,393
Unearned revenue 2,212 2,096
Deferred tax liability
Total other liabilities - 2,165
------- -------
3,027 29,654
------- -------
Stockholders' equity:
Series 1993 8% Convertible Preferred Stock,
par value $12.00 per share; 230,516 and
268,851 shares issued and outstanding at
September 30, 1998 and December 31, 1997,
respectively 1,871 2,182
Common Stock, par value $.00001
per share; 50,000,000 shares authorized;
10,251,853 and 10,193,676 shares issued
and outstanding at September 30, 1998 and
December 31, 1997, respectively - -
Additional paid-in capital 22,840 22,500
Retained earnings (deficit) (3,630) 553
Treasury stock (713) (713)
------- -------
Total stockholders' equity 20,368 24,522
------- -------
Commitments and contingencies
------- -------
$134,980 $61,566
======= =======
</TABLE>
See accompanying notes to condensed, consolidated financial statements.
*Derived from audited financial statements.
4
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARIES
----------------
CONDENSED, CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
- -----------------------------------------------------------
<TABLE>
QUARTER ENDED NINE MONTHS ENDED
------------- -----------------
SEPTEMBER 30 SEPTEMBER 30
------------ ------------
1998 1997 1998 1997
---- ---- ---- ----
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Operating revenues:
Oil and gas production $ 6,702 $ 4,812 $21,429 $13,457
Transportation 206 222 596 657
Marketing 1,804 1,956 5,796 15,356
Other 319 90 746 137
------ ------ ------ ------
9,031 7,080 28,567 29,607
------ ------ ------ ------
Operating expenses:
Oil and gas production 1,331 716 4,184 1,834
Exploration costs 1,314 381 2,324 434
Transportation 50 120 180 322
Marketing 1,905 1,929 5,865 15,330
Depreciation, depletion and
amortization 4,156 2,008 12,666 5,510
Impairment of assets - - 2,168 -
Administrative expenses 889 862 2,476 2,442
Other 26 54 78 114
------ ------ ------ ------
9,671 6,070 29,941 25,986
------ ------ ------ ------
Operating income (loss) (640) 1,010 (1,374) 3,621
Other income (expense):
Interest expense (2,122) (666) (5,249) (2,021)
Other 26 11 78 38
------- ------- ------- -------
(2,096) (655) (5,171) (1,983)
------- ------- ------- -------
Income (loss) before income
tax expense (benefit) (2,736) 355 (6,545) 1,638
Income tax expense (benefit) (790) 142 (2,391) 655
------- ------- ------- -------
Net income (loss) (1,946) 213 (4,154) 983
Preferred dividends (21) (26) (49) (48)
------- ------- ------- -------
Net income (loss) attributable
to common shares $(1,967) $ 187 $(4,203) $ 935
======= ======= ======= =======
Per common share:
Basic $ (.20) $ 0.02 $ (.42) $ 0.11
======= ======= ======= =======
Weighted average number of
common shares outstanding 10,045 9,928 10,022 8,626
======= ======= ======= =======
Diluted $ (.20) $ 0.02 $ (.42) $ 0.10
======= ======= ======= =======
Weighted average number of
common shares and dilutive
potential common shares
10,045 9,928 10,022 9,073
======= ======= ======= =======
</TABLE>
5
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARIES
CONDENSED, CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
<TABLE>
NINE MONTHS ENDED
SEPTEMBER 30
-----------------
1998 1997
---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Net cash provided by operating
activities $31,373 $ 5,966
------- -------
Investing activities:
Purchase of oil and gas properties (84,484) (4,313)
Purchases of property and equipment (1,920) (489)
Payments on notes receivable 137 231
Issuance of notes receivable (35) (35)
Proceeds from sale of assets 1,251 4
------- -------
Net cash used in
investing activities (85,051) (4,602)
------- -------
Financing activities:
Proceeds from borrowings 59,273 3,236
Payments on borrowings (5,275) (4,704)
Redemption of convertible securities - (589)
Proceeds from issuance of common stock - 1,330
Increase in deferred financing costs (1,040) (140)
Other - (199)
------- -------
Net cash provided by (used in)
financing activities 52,958 (1,066)
------- -------
Increase (decrease) in cash (720) 298
Cash and cash equivalents at
beginning of period 1,181 353
------- -------
Cash and cash equivalents at
end of period $ 461 $ 651
======= =======
</TABLE>
NON-CASH TRANSACTIONS:
The Company declared stock dividends and issued 19,842 and 21,508
shares of Common Stock to holders of the Series 1993 and Series B
Preferred Stock during the nine months ended September 30, 1998
and 1997, respectively.
During the nine months ended September 30, 1997, holders of
$5,538,483 ($4,519,914 net of placement costs) of an aggregate of
$6,000,000 of Convertible Securities converted the securities
into 3,052,188 shares of Common Stock and received 49,676 shares
of Common Stock dividends related to the Convertible Securities.
The remaining $461,517 was redeemed by the Company for a price of
$589,023.
6
See accompanying notes to condensed, consolidated financial
statements.
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARIES
----------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
(1) GENERAL
American Resources Offshore, Inc. (f/k/a American
Resources of Delaware, Inc.) (ARO or the Company), a
Delaware corporation organized on August 14, 1992, is
an independent oil and gas company engaged in the
acquisition, exploration, development and production of
oil and gas properties offshore Louisiana and onshore
Mississippi (Gulf Coast Region) and in southeastern
Kentucky (Appalachian Region). The Company also
gathers and markets natural gas in the Appalachian
Region. These activities are considered to be one
business segment for financial reporting purposes.
The accompanying condensed, consolidated financial
statements include the accounts of ARO and its
subsidiaries, collectively referred to as the Company.
All significant intercompany balances and transactions
have been eliminated in consolidation in order to make
the financial statements, in the opinion of management,
not misleading.
The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance
with instructions to Form 10-Q and, therefore, do not
include all disclosures required by generally accepted
accounting principles. However, in the opinion of
management, these statements include all adjustments,
which are of a normal recurring nature, necessary to
present fairly the financial position at September 30,
1998 and December 31, 1997 and the results of
operations and changes in cash flows for the periods
ended September 30, 1998 and 1997. These financial
statements should be read in conjunction with the
financial statements and notes to the financial
statements in the 1997 Form 10-KSB of the Company that
was filed with the Securities and Exchange Commission (SEC).
Basic and diluted income (loss) per common share were
computed after consideration of dividend requirements
on Preferred Stock, using the weighted average number
of shares outstanding and the weighted average number
of common shares and dilutive potential common shares
outstanding, respectively, during each of the years
presented. Outstanding stock options and warrants are
potential Common Stock equivalents and have been
considered when the effect is dilutive.
Certain reclassifications have been made to the prior
period financial statements to conform with the current
period presentation.
(2) PROPERTY AND EQUIPMENT
On March 5, 1998, the Company purchased interests in 43
leaseblocks in the Gulf of Mexico from TECO Oil & Gas,
Inc. (TECO). The purchase consists of an average 30%
interest in approximately 198,300 acres containing 5
producing wells and approximately $35 million PV10 of
proved reserves as of December 31, 1997; partnership
interests in Louisiana Offshore Ventures and Texas 3D
Ventures and access to approximately 13,500 square
miles of 3-D seismic data. Louisiana Offshore Ventures
and Texas 3D Ventures are exploration and development
partnerships managed by Houston Energy Development
(HED). HED has specialized in 3-D seismic evaluation
and prospect selection for over ten years and provides
the Company with access to 14 additional geoscientists
and 13 state of the art 3-D seismic workstations. The
Company believes that the TECO acquisition provides
ample opportunity to increase reserves, production and
cash flow from development and exploration activities
and, with HED, has identified in excess of 35 initial
drilling locations on the acquired properties.
As consideration for the properties, the Company paid
$57,680,000, of which $1,300,000 was paid in cash upon
execution of the Purchase and Sale Agreement, $21,380,000
was paid from funds borrowed under the Company's credit
facility, and $16.5 million was paid from funds borrowed
under bridge loans
7
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARIES
----------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
provided by DNB Energy Assets, Inc. (DNB), successor to Den
norske Bank, AS (Den norske), $1.5 million of which was due
July 1, 1998, with the remainder due September 30, 1998.
The balance of $18,500,000 was in the form of a promissory
note in favor of TECO (TECO Note). The bridge loans from
DNB have been amended to extend the maturity date to
December 31, 1998. DNB has also amended the interest rate
to either the prime rate plus 1% or the LIBOR plus 4% and
further agreed to amend the terms of the Company's credit
facility to waive the payment of principal and the current
ratio covenant compliance requirement through December 31,
1998. Additionally, DNB decreased the interest coverage
ratio to 2.25:1.
The TECO Note currently bears interest at the rate of 14%
per annum and increases 2% each quarter hereafter, with a
maximum interest rate of 18%. The TECO Note matured on
October 1, 1998 and is secured by a lien on all properties
of the Company and its subsidiaries. In addition to the
TECO Note, the parties entered into a warrant agreement
(TECO Warrant Agreement) granting TECO warrants to acquire
600,000 shares of common stock of the Company (First
Warrants) at a price of $2.67 per share if the TECO Note is
not paid in full by October 1, 1998. Additionally, the TECO
Warrant Agreement granted TECO warrants to acquire common
stock equal to 10% of the Company's outstanding common stock
and options if the TECO Note is not paid in full by October
1, 1998. This percentage will increase by an additional 5%
if the TECO Note is not paid in full by January 1, 1999, and
by an additional 5% if the TECO Note is not paid in full by
April 1, 1999 (collectively, Secondary Warrants). The price
per share of common stock evidenced by the Secondary
Warrants is $.00001. The Company filed Forms 8-K and 8-K/A
regarding this transaction with the SEC on January 16, 1998,
March 16, 1998, May 19, 1998 and May 29, 1998.
The Company has not made any payments on the TECO Note;
therefore, TECO has been vested with the rights to acquire
ten (10%) percent of the Company's issued and outstanding
shares and options, together with the right to appoint two
members to the Company's Board of Directors. By letter
dated October 2, 1998, TECO notified the Company that its
nonpayment of principal and interest constitutes an Event of
Default under the Credit Agreement. TECO has not taken any
action to exercise its warrant rights or make any
appointments to the Company's Board at this time; however,
TECO has not waived any of its rights under the Credit
Agreement or Warrant Agreement. TECO has filed a Schedule
13-D and Form 3 with the SEC regarding such rights. Upon
vesting of TECO's warrant rights, the Company will record a
decrease in the TECO indebtedness which will be amortized as
additional interest expense and an increase in equity, such
amount to be calculated based upon the fair market value of
the warrants.
Assuming the acquisition had occurred on January 1, 1997,
the following unaudited proforma operating data gives effect
to the acquisition for the nine months ended September 30,
1998 and the year ended December 31, 1997:
<TABLE>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Total revenue $29,336 $44,669
====== ======
Net (loss) from operations $(4,413) $(3,745)
====== ======
Basic (loss) per share $ (.44) $ (.42)
====== ======
Diluted (loss) per share $ (.44) $ (.42)
====== ======
</TABLE>
8
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARIES
----------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
During the first quarter of 1998, the Company entered into
an agreement with J. M. Huber Corporation (Huber) for the
development of Grand Isle Block 55, offshore Louisiana,
wherein two wells were to be drilled. During the drilling
of the initial well, reserves were encountered; however,
control of the well was lost necessitating the well to be
shut in and a sidetrack well to be initiated. The
additional costs of the re-drill as well as the cost of the
material and equipment lost in the original well, estimated
to be approximately $3.7 million, is reimbursable by the
Company's insurance program, less deductibles totaling
$300,000. Confirmation of coverage was received by the
Company from the underwriters on July 22, 1998, and the
Company has received $2.8 million to date. The remaining
$600,000 is expected to be received within the next 60 days.
During the third quarter of 1998, the Company successfully
completed the side track well and an additional well from
the A Platform on Grand Isle Block 55. Initial production
commenced in September 1998 at the rate of approximately
1,500 barrels of oil per day. Huber has not assigned an
ownership interest in the well to the Company based upon
Huber's interpretation of the participation agreement that
all trade creditors must be paid in full prior to any such
assignment. The Company currently has trade payables of
approximately $12 million in association with the drilling
of these wells.
(3) LONG-TERM DEBT
A summary of long-term debt follows:
<TABLE>
September 30, December 31,
1998 1997
------------- ------------
(Dollars in thousands)
<S> <C> <C>
Borrowings under the Company's credit
facility, as amended, with DNB,
reduction subject to availability
under borrowing base, $48,173,000
available borrowing base as of
September 30, 1998, monthly reduction
against the available borrowing base
of $750,000 commencing January 1, 1999,
interest payable monthly at the
Floating Rate, or LIBO Rate plus
2 1/2%, secured by oil and gas
properties, equipment and receivables. $48,173 $28,700
Term Loan A, as amended, payable to
DNB, due December 31, 1998, with
interest payable monthly at the
Floating Rate plus 1%, or LIBO
Rate plus 4% per annum, secured by
oil and gas properties. 15,000 -
Term Loan B payable to DNB, due
December 31, 1998, with interest
payable monthly at the Floating
Rate plus 1%, or LIBO Rate plus
4% per annum, secured by oil and
gas properties. 1,500 -
Note payable to TECO Oil & Gas, Inc.,
with interest at 14% per annum,
increasing 2% each quarter the
note remains unpaid, with a
9
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARIES
----------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
maximum rate of 18%, due October 1,
1998. 18,500 -
Note payable to related party, recourse
only to specific properties, interest
payable at prime rate plus 1% in
connection with the purchase of oil
and gas properties from Prima Capital,
LLC. 1,093 1,500
Other notes 32 100
------- ------
84,298 30,300
Less - Current portion (64,983) (4,907)
Less - Debt in default (18,500) -
------- ------
Long-term debt $ 815 $25,393
====== ======
</TABLE>
On September 28, 1995, the Company entered into a
$20,000,000 revolving credit facility through February 1,
2002 with Den norske. By November 1, 1997, the revolving
credit facility had been increased to $75,000,000 and the
available borrowing base was increased to $30,000,000. On
March 5, 1998, the borrowing base under the revolving credit
facility was assigned to DNB and increased to $50,000,000 to
facilitate the purchase of oil and gas properties from TECO
Oil & Gas, Inc. (TECO). As of September 30, 1998, the
balance due under the revolving credit facility was
$48,173,000. Additional borrowings under the credit
facility are dependent upon a redetermination of the
borrowing base, which is primarily dependent upon the value
of the mortgaged properties as determined under DNB's
internal lending procedures. Reductions of the credit
facility are also dependent upon the borrowing base.
Commencing January 1, 1999, monthly principal reductions are
$750,000. The borrowing base will be redetermined semi-
annually on each October 1st and April 1st prior to February
1, 2002.
On March 5, 1998, DNB also provided bridge loans totaling
$16,500,000 in order for the Company to complete the
acquisition of the TECO properties. The bridge loans, as
amended, mature on December 31, 1998.
Under the credit agreement with DNB, the Company is required
to maintain certain financial ratios relating to debt
coverage ratio, current ratio, tangible net worth, general
and administrative expenses and quarterly interest ratio.
At September 30, 1998, the Company was in compliance with
all of the required financial covenants except current
ratio. The Company has obtained a waiver of the compliance
requirement from DNB.
Also in order to complete the acquisition of the TECO
properties, on March 5, 1998, the Company executed a note in
favor of TECO in the amount of $18,500,000 which matured
October 1, 1998 (see Note 2).
10
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARIES
----------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
(4) STOCKHOLDERS' EQUITY
On January 15, 1998, the Board of Directors declared
dividends payable in Common Stock on January 22, 1998, to
holders of the Series 1993 Preferred Stock totaling 10,621
shares.
On July 15, 1998, the Board of Directors declared dividends
payable in Common Stock on July 22, 1998, to holders of the
Series 1993 Preferred Stock totaling 9,221 shares.
The following tables illustrate the reconciliation of the
numerators and denominators of the basic and diluted
earnings per common share computations for (loss) income
related to the unexercised stock options outstanding for the
quarter and nine months ended September 30, 1998 and 1997,
respectively.
<TABLE>
Quarter ended Quarter Ended
September 30, 1998 September 30, 1997
------------------- ------------------
thousands except Per Share Per Share
per share amounts Loss Shares Amount Income Shares Amount
---- ------ -------- ------ ------ ---------
<S> <C> <C> <C> <C> <C> <C>
Basic earnings per share
Income (Loss) available to
common stockholders $(1,967) 10,045 $(.20) $187 9,928 $.02
---- ---
Potential common shares - - - -
------ ------ --- -----
Diluted earnings per share
Income (Loss) available to
common stockholders and
assumed conversion $(1,967) 10,045 $(.20) $187 9,928 $.02
------ ------ ---- --- ----- ---
Nine Months ended Nine Months Ended
September 30, 1998 September 30, 1997
-------------------- ------------------
thousands except Per Share Per Share
per share amounts Loss Shares Amount Income Shares Amount
---- ------ -------- ------ ------ ---------
Basic earnings per share
(Loss) Income available to
common stockholders $(4,203) 10,022 $(.42) $935 8,626 $.11
---- ---
Potential common shares - - - 447
------ ------ --- -----
Diluted earnings per share
(Loss) Income available to
common stockholders and
assumed conversion $(4,203) 10,022 $(.42) $935 9,073 $.10
------ ------ ---- --- ----- ---
</TABLE>
(5) COMMITMENTS AND CONTINGENCIES
The Kentucky Revenue Cabinet has assessed the Company's
wholly-owned subsidiary, Southern Gas Company of Delaware,
Inc. (Southern Gas), for outstanding sales tax of
approximately $1,500,000, plus penalties and interest,
allegedly owed to the Commonwealth of Kentucky by Southern
Gas Company ("SGC"), a dissolved entity, prior to Southern
11
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARIES
----------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
Gas' acquisition of the assets of SGC. Southern Gas has
denied the liability and believes it will be successful in
its defense of this assessment. Southern Gas' defenses to
the assessment and/or in support of reduction of the
assessment include, but are not limited to, that credit
should be received for all gas delivered to (1) interstate
customers; (2) customers who resold the product; (3) direct
pay customers; and (4) industries where the consumable
materials are utilized in the manufacturing process. Based
on these defenses, as well as the assertion by Southern Gas
that it is not responsible for the debts of SGC, management
intends to vigorously defend its position and believes that
any resulting liability will not have a significant impact
on the Company's financial condition, operations or
liquidity.
On May 13, 1998, the Company and Southern Gas were named as
defendants in litigation filed by Wright Enterprises
asserting successor liability to certain alleged obligations
of SGC. Based upon the allegations set forth in the
complaint, the Company believes there is a strong likelihood
that it will be successful in the defense of this matter;
and the litigation will have no material impact on the
Company's financial condition, operating results or cash
flows.
In the normal course of business, the Company enters into
short-term supply and purchase agreements. These agreements
can stipulate either a fixed contract price or a floating
price based on spot prices.
Management attempts to schedule deliveries to mitigate any
possible adverse effects of changing prices; however, gas
prices are susceptible to change due to industry supply and
demand positions.
(6) SUBSEQUENT EVENTS
During the third quarter of 1998, the Board of Directors of
the Company authorized management to entertain bids for the
sale of the Company's Appalachian properties. The Company
has commenced discussions with third parties; however, the
Company can make no assurance that those discussions will
result in the divestiture of the properties.
Effective October 29, 1998, the Company's wholly-owned
subsidiary, American Resources Offshore, Inc., was merged
into the Company; and the Company changed its name to
American Resources Offshore, Inc.
12
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARIES
----------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
(7) LIQUIDITY
As of October 31, 1998, the Company had current liabilities
in excess of current assets (exclusive of current maturities
of long-term debt) of approximately $17 million, is in
default under the TECO Note with a current arrearage of
approximately $19.5 million and has immediate needs with
regard to its capital expenditure budget. Based upon its
current cash position, the Company will be unable to satisfy
these commitments without generating additional funds. In
an attempt to remedy these deficiencies, on October 29,
1998, the Company's wholly-owned subsidiary, American
Resources Offshore, Inc., was merged into the Company for
the purpose of reducing administrative expenses.
Additionally, the Company has entered into discussions with
third parties for the divestiture of its Appalachian
properties. In the event the Company divests itself of
these properties, the proceeds will be used to reduce its
outstanding indebtedness to DNB, thereby resulting in a
substantial reduction of interest expense. Further, the
sale of these properties would allow the Company to effect
an additional reduction of its administrative expenses. The
Company plans to continue to review its options for the
generation of additional funds and has not eliminated any
alternatives. There can be no assurance that the Company
will be able to obtain sufficient funds to meet its current
cash needs and other obligations as they become due, which
could result in material adverse consequences.
13
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995:
This Quarterly Report on Form 10-Q includes "forward looking
statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, (the "Exchange Act). All statements
other than statements of historical facts included in this Report
on Form 10-Q, including without limitation, statements under
"Management's Discussion and Analysis of Financial Condition and
Results of Operations," regarding the planned capital
expenditures, increases in oil and gas production, the number of
anticipated wells to be drilled in 1998 and thereafter, the
Company's financial position, business strategy and other plans
and objectives for future operations, are forward-looking
statements. Although the Company believes that the expectations
reflected in such forward-looking statements are reasonable, it
can give no assurance that such expectations will prove to have
been correct. There are numerous uncertainties inherent in
estimating quantities of proved oil and natural gas reserves and
in projecting future rates of production and timing of
development expenditures, including many factors beyond the
control of the Company. Reserve engineering is a subjective
process of estimating underground accumulations of oil and
natural gas that cannot be measured in an exact way, and the
accuracy of any reserve estimate is a function of the quality of
available data and of engineering and geological interpretation
and judgment. As a result, estimates made by different engineers
often vary from one another. In addition, results of drilling,
testing and production subsequent to the date of an estimate may
justify revisions of such estimate and such revisions, if
significant, would change the schedule of any further production
and development drilling. Accordingly, reserve estimates are
generally different from the quantities of oil and natural gas
that are ultimately recovered. Additional important factors that
could cause actual results to differ materially from the
Company's expectations are disclosed elsewhere in this Form 10-Q
and in the Form 8-K which the Company filed with the Securities
and Exchange Commission on July 25, 1997.
RECENT DEVELOPMENTS
On March 5, 1998, the Company purchased interests in 43
leaseblocks in the Gulf of Mexico from TECO Oil & Gas, Inc.
(TECO). The purchase consists of an average 30% interest in
approximately 198,300 acres containing 5 producing wells and
approximately $35 million PV10 of proved reserves as of December
31, 1997; partnership interests in Louisiana Offshore Ventures
and Texas 3D Ventures and access to approximately 13,500 square
miles of 3-D seismic data. Louisiana Offshore Ventures and Texas
3D Ventures are exploration and development partnerships managed
by Houston Energy Development (HED). HED has specialized in 3-D
seismic evaluation and prospect selection for over ten years and
provides the Company with access to 14 additional geoscientists
and 13 state of the art 3-D seismic workstations. The Company
believes that the TECO acquisition provides ample opportunity to
increase reserves, production and cash flow from development and
exploration activities and, with HED, has identified in excess of
35 initial drilling locations on the acquired properties.
As consideration for the properties, the Company paid
$57,680,000, of which $1,300,000 was paid in cash upon execution
of the Purchase and Sale Agreement, $21,380,000 was paid from
funds borrowed under the Company's credit facility, and $16.5
million was paid from funds borrowed under bridge loans provided
by DNB Energy Assets, Inc. (DNB), successor to Den norske Bank,
AS (Den norske), $1.5 million of which was due July 1, 1998, with
the remainder due September 30, 1998. The balance of $18,500,000
was in the form of a promissory note in favor of TECO (TECO
Note). The bridge loans from DNB have been amended to extend the
maturity date to December 31, 1998. DNB has also amended the
interest rate to either the prime rate plus 1% or the LIBOR plus
4% and further agreed to amend the terms of the Company's credit
facility to waive the payment of principal and the current ratio
covenant compliance requirement through December 31, 1998.
Additionally, DNB decreased the interest coverage ratio to
2.25:1.
The TECO Note currently bears interest at the rate of 14%
per annum and increases 2% each quarter hereafter, with a maximum
interest rate of 18%. The TECO Note matured on October 1, 1998
and is secured by a lien on all properties of the Company and its
subsidiaries. In addition to the TECO Note, the parties entered
into a warrant agreement (TECO Warrant Agreement) granting TECO
warrants to acquire 600,000 shares of
14
<PAGE>
common stock of the Company (First Warrants) at a price of $2.67
per share if the TECO Note is not paid in full by October 1,
1998. Additionally, the TECO Warrant Agreement granted TECO
warrants to acquire common stock equal to 10% of the Company's
outstanding common stock and options if the TECO Note is not paid
in full by October 1, 1998. This percentage will increase by an
additional 5% if the TECO Note is not paid in full by January 1,
1999, and by an additional 5% if the TECO Note is not paid in
full by April 1, 1999 (collectively, Secondary Warrants). The
price per share of common stock evidenced by the Secondary
Warrants is $.00001. The Company filed Forms 8-K and 8-K/A
regarding this transaction with the Securities and Exchange
Commission (SEC) on January 16, 1998, March 16, 1998, May 19,
1998 and May 29, 1998. Upon vesting of TECO's warrant rights,
the Company will record a decrease in the TECO indebtedness which
will be amortized as additional interest expense and an increase
in equity, such amount to be calculated based upon the value
of the warrants.
The Company has not made any payments on the TECO Note.
Therefore, TECO has been vested with the rights to acquire ten
(10%) percent of the Company's issued and outstanding shares and
options, together with the right to appoint two members to the
Company's Board of Directors. By letter dated October 2, 1998,
TECO notified the Company that its nonpayment of principal and
interest constitutes an Event of Default under the Credit
Agreement. TECO has not taken any action to exercise its warrant
rights or make any appointments to the Company's Board at this
time; however, TECO has not waived any of its rights under the
Credit Agreement or Warrant Agreement. TECO has filed a Schedule
13-D and Form 3 with the SEC regarding such rights.
During the first quarter of 1998, the Company entered into
an agreement with J. M. Huber Corporation (Huber) for the
development of Grand Isle Block 55, offshore Louisiana, wherein
two wells were to be drilled. During the drilling of the initial
well, reserves were encountered; however, control of the well was
lost necessitating the well to be shut in and a sidetrack well to
be initiated. The additional costs of the re-drill as well as
the cost of the material and equipment lost in the original well,
estimated to be approximately $3.7 million, is reimbursable by
the Company's insurance program, less deductibles totaling
$300,000. Confirmation of coverage was received by the Company
from the underwriters on July 22, 1998, and the Company has
received $2.8 million to date. The remaining $600,000 is
expected to be received within the next 60 days. During the
third quarter of 1998, the Company successfully completed the
side track well and an additional well from the A Platform on
Grand Isle Block 55. Initial production commenced in September
1998 at the rate of approximately 1,500 barrels of oil per day.
Huber has not assigned an ownership interest in the well to the
Company based upon Huber's interpretation of the participation
agreement that all trade creditors must be paid in full prior to
any such assignment. The Company currently has trade payables of
approximately $12 million in association with the drilling of
these wells.
During the first quarter of 1998, the Company participated
in the drilling of a well on Galveston Block 213, a property
purchased in the TECO acquisition. The well commenced production
on May 28, 1998 and is currently producing at a rate of
approximately 13 mmcfe of gas per day. The Company owns a 33.3%
working interest in the well which is being operated by Basin
Exploration, Inc.
In April 1998, the Company entered into a Participation
Agreement with Westport Oil & Gas Company, Inc. to develop
Vermillion Block 220, offshore Louisiana. The parties commenced
the drilling of a well; and after review of the drilling results,
the Company has elected not to complete the well.
On May 6, 1998, the Company entered into a Participation
Agreement to acquire 16.67% working interest in High Island Block
105, offshore Texas. The well encountered natural gas
accumulation in the objective reservoir and was subsequently
cased and perforated for production. Attempted completion
operations were unsuccessful in sustaining production because of
reduced reservoir pressures. The Company believes that
production could be established in this well utilizing
stimulation and available compression facilities on the platform.
15
<PAGE>
During the second quarter of 1998, the Company participated
in the drilling of a successful exploratory well on West Cameron
Block 172, a property purchased in the TECO acquisition. The OCS
G1998 #16ST well has been drilled and completed with an initial
test rate of 11 million cubic feet (mmcf) of gas and 200 barrels
of condensate per day. A development/acceleration well, the OCS
G1998 #18 well, was drilled in the same fault block and
encountered gas pay in two additional reservoirs. The #18 well
has also been completed and tested at an initial rate of 10.2
mmcf of gas and 90 barrels of condensate per day. Design and
construction of a platform and facilities for development of this
discovery are in progress with initial production anticipated by
early 1999. Additional prospective fault blocks are identified,
and two additional wells are planned on the Block. The Company's
working interest in the #16ST and #18 wells is 28.72% and 27%,
respectively.
In June 1998, the Company participated in the drilling of a
successful well on West Cameron Block 368 on which the Company
had existing production. It is anticipated that the well will be
completed and begin producing during the fourth quarter of 1998.
During the third quarter of 1998, the Company completed an
exchange of working interest ownership with Century Offshore
Management Corporation that provides for the Company to increase
its working interest to 95% on a portion of West Cameron Block
368 covering approximately 1,170 acres.
The Company has entered into an agreement to provide
drilling services for Chevron USA for which it receives a monthly
fee. Pursuant to the terms of the agreement, the Company is
required to advance payment of all costs and expenses incurred in
the drilling operations and is reimbursed for all such costs and
expenses on a monthly basis. During the third quarter of 1998,
the Company completed its obligations pursuant to the terms of
this agreement.
On August 31, 1998, the Company also entered into a farmout
agreement with Chevron, USA for the development of a portion of
South Timbalier Block 21 Field covering approximately 14,300
acres. The Agreement requires the Company to commence operations
in the Field 90 days therefrom. The Company will not commence
these operations unless it secures the funding necessary to
comply with the terms of the agreement. At this time, the
Company has not secured the necessary funds.
During the third quarter of 1998, the Board of Directors of
the Company authorized management to entertain bids for the sale
of the Company's Appalachian properties. The Company has
commenced discussions with third parties; however, the Company
can make no assurance that those discussions will result in the
divestiture of the properties.
Effective October 29, 1998, the Company's wholly-owned
subsidiary, American Resources Offshore, Inc., was merged into
the Company; and the Company changed its name to American
Resources Offshore, Inc.
ADOPTION OF NEW ACCOUNTING PRINCIPLES
Effective January 1, 1998, the Company adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" (SFAS NO. 130). The adoption of SFAS No. 130 had no
impact on the Company's financial statements for the quarter and
nine months ended September 30, 1998.
In June 1997, the Financial Accounting Standards Board
(FASB) also issued Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related
Information" (SFAS No. 131). This statement establishes
standards for reporting information about operating segments in
annual financial statements and requires selected information
about operating segments be included in interim reports issued to
shareholders. SFAS No. 131 is effective for financial statements
for periods beginning after December 15, 1997. As SFAS No. 131
establishes standards for reporting and display, the Company does
not expect the adoption of this statement to have a material
impact on its financial condition or results of operations.
16
<PAGE>
In June 1998, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This statement
establishes standards of accounting for and disclosures of
derivative instruments and hedging activities. This statement is
effective for fiscal years beginning after June 15, 1999. The
Company has not yet determined the impact of this statement on
the Company's financial condition or results of operations.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS
ENDED SEPTEMBER 30, 1997
REVENUES. Total revenues for the Company decreased 3.5% to
$28.6 million for the first nine months of 1998 from $29.6
million for the comparable period in 1997. Marketing revenues
decreased approximately $9.6 million, or 62%, primarily due to
the termination of the gas sales contract with Southern
Resources, Inc., resulting from the Company's decision to focus
on exploration and development activities. However, due to the
small profit margins and administrative expenses associated with
the Southern Resources gas sales contract, the termination had no
significant adverse effect on the Company's net income due to a
corresponding $9.5 million reduction in marketing expense.
OIL AND GAS PRODUCTION REVENUE. Oil and gas production
revenue increased 59% to $21.4 million in the first nine months
of 1998, due primarily to production attributable to wells
acquired and drilled on acreage acquired in the TECO acquisition.
The increase in oil and gas production revenue was partially
offset by reduced oil and gas prices.
The following table summarizes production volumes, average
sales prices and period to period comparisons for the Company's
oil and gas operations for the periods indicated:
<TABLE>
NINE MONTHS ENDED
SEPTEMBER 30, % INCREASE
-----------------
1998 1997 (DECREASE)
---- ---- ----------
<S> <C> <C> <C>
Production volumes:
Natural gas (MMcf) 7,431 3,286 126
Oil (MBbls) 322 294 10
Total (MMcfe) 9364 5,048 85
Average sale prices:*
Natural gas (per Mcf) 2.34 2.41 (3)
Oil (per Bbl) 12.58 18.80 (33)
Per Mcfe 2.29 2.67 (14)
Expenses (per Mcfe):
Lease operating (including
production taxes) .45 .36 25
Depreciation, depletion
and amortization 1.35 1.09 24
Administrative .26 .48 (46)
</TABLE>
*Includes effect of hedging.
OIL AND GAS PRODUCTION EXPENSE. Oil and gas production
expense increased 128% to $4.2 million, in the first nine months
of 1998 due primarily to operating costs associated with
increased production. Oil and gas production expense was $0.45
per Mcfe for the first nine months of 1998 compared to $0.36 for
the same period in 1997, an increase of 25%.
17
<PAGE>
EXPLORATION COSTS. During the nine months ended September
30, 1998, costs of approximately $2.3 million were attributable
to dry hole expense and the purchase of seismic data, analysis of
such data and other directly allocable geological and geophysical
costs which must be expensed under the Company's accounting
method. Exploration costs for the nine months ended September
30, 1997 were approximately $434,000.
IMPAIRMENT OF ASSETS. As of January 1, 1996, the Company
began assessing the impairment of capitalized costs of proved oil
and gas properties and other long-lived assets in accordance with
Statement of Financial Accounting Standards No. 121 (SFAS No.
121), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of." SFAS No. 121 requires that
an impairment loss be recognized whenever the carrying amount of
an asset exceeds the sum of the estimated future undiscounted
cash flows of the asset. For each asset determined to be
impaired, an impairment loss equal to the difference between the
carrying value and the fair value of the asset was recognized.
With respect to the Company's oil and gas properties, fair value,
on a depletable basis, was estimated to be the present value of
expected future cash flows computed by applying estimated future
natural gas and oil prices, as determined by management, to
estimated future production of oil and gas reserves over the
economic lives of the reserves. During the first nine months of
1998, the Company recorded a non-cash charge of $2.2 million
representing impairment of non-core oil and gas properties.
ADMINISTRATIVE EXPENSE. Administrative expense increased 1%
to $2.5 million in the first nine months of 1998, and was $.26
per Mcfe, a decrease of 46% from the prior year. The per unit
decrease occurred as the result of increased production volumes,
principally attributable to new Gulf Coast Region wells.
Subsequent to September 30, 1997, the Company expanded its Gulf
Coast operations by forming ARO and staffing it with technical
personnel experienced in Gulf Coast Region exploration and
development activities.
DEPRECIATION, DEPLETION AND AMORTIZATION (DD&A) EXPENSE.
DD&A expense increased 130% to $12.7 million in the first nine
months of 1998 and was $1.35 per Mcfe, an increase of 24% from
the prior year. The increase resulted primarily from the TECO
acquisition and increased depletion attributable to the
acquisition costs and successful drilling activities.
INTEREST EXPENSE. Interest expense increased 160% to $5.2
million, in the first nine months of 1998, due to additional
borrowings to fund the TECO acquisition and expanded exploration
and development activities.
NET INCOME. Due to the factors described above, net income
decreased to a loss of $4.2 million for the nine months ended
September 30, 1998.
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE
MONTHS ENDED SEPTEMBER 30, 1997
REVENUES. Total revenues for the Company increased 28% to
$9 million for the third quarter of 1998 compared with $7.1
million in 1997, due primarily to an increase in production.
Marketing revenues decreased 8%.
OIL AND GAS PRODUCTION REVENUE. Oil and gas production
revenue increased 39% in the third quarter of 1998 to $6.7
million due primarily to the production attributable to wells
acquired and drilled on acreage acquired in the TECO acquisition.
The increase in production was partially offset by reduced oil
prices.
The following table summarizes production volumes, average
sales prices and period to period comparisons for the Company's
oil and gas operations for the periods indicated:
18
<PAGE>
<TABLE>
Three Months Ended
September 30, % Increase
------------------
1998 1997 (Decrease)
---- ---- ---------
<S> <C> <C> <C>
Production volumes:
Natural gas (MMcf) 2,326 1,170 99
Oil (MBbls) 102 116 (12)
Total (MMcfe) 2,937 1,868 57
Average sale prices:*
Natural gas (per Mcf) 2.37 2.38 --
Oil (per Bbl) 11.61 17.26 (33)
Per Mcfe 2.28 2.58 (12)
Expenses (per Mcfe):
Lease operating (including
production taxes) .45 .38 18
Depreciation, depletion
and amortization 1.41 1.08 31
Administrative .30 .46 (35)
</TABLE>
*Includes effect of hedging.
OIL AND GAS PRODUCTION EXPENSE. Oil and gas production
expense increased 86% to $1.3 million in the third quarter
of 1998 due primarily to increased production volumes and
operating costs associated with the Company's active
participation in the exploration and development of the
properties acquired in the TECO acquisition. Oil and gas
production expense was $0.45 per Mcfe in the third quarter
of 1998 as compared to $0.38 in 1997, an increase of 18%.
EXPLORATION COSTS. During the third quarter of 1998,
costs of approximately $1.3 million were attributable to dry
hole expense and the purchase of seismic data, analysis of
such data and other directly allocable geological and
geophysical costs which must be expensed under the Company's
accounting method. Exploration costs for the third quarter
of 1997 were approximately $381,000.
IMPAIRMENT OF ASSETS. As of January 1, 1996, the
Company began assessing the impairment of capitalized costs
of proved oil and gas properties and other long-lived assets
in accordance with Statement of Financial Accounting
Standards No. 121 (SFAS No. 121), "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of." SFAS No. 121 requires that an impairment
loss be recognized whenever the carrying amount of an asset
exceeds the sum of the estimated future undiscounted cash
flows of the asset. For each asset determined to be
impaired, an impairment loss equal to the difference between
the carrying value and the fair value of the asset was
recognized. With respect to the Company's oil and gas
properties, fair value, on a depletable basis, was estimated
to be the present value of expected future cash flows
computed by applying estimated future natural gas and oil
prices, as determined by management, to estimated future
production of oil and gas reserves over the economic lives
of the reserves. In the third quarter of 1998, the Company
did not record any impairment to oil and gas properties.
ADMINISTRATIVE EXPENSE. Administrative expense
increased 3% to $889,000 in the third quarter of 1998 and
was $.30 per Mcfe, a decrease of 35% from the prior year.
This expense increased primarily due to the establishment of
the Company's Gulf Coast Region office in late 1996 and the
expanded staffing of that office during the fourth quarter
of 1997. The per unit decrease occurred as the result of
increased production volumes, principally attributable to
new Gulf Coast Region wells.
19
<PAGE>
DD&A EXPENSE. DD&A expense increased 107% to $4.2
million for the third quarter of 1998 and was $1.41 per
Mcfe, an increase of 31% from the prior year. The increase
resulted primarily from the TECO acquisition and increased
depletion attributable to the acquisition costs and
successful drilling activities.
INTEREST EXPENSE. Interest expense increased 219% to $2.1
million in the third quarter of 1998. The increase was
attributable to additional borrowings to fund acquisition,
exploration and development activities.
NET INCOME. Due to the factors described above, net income
for the Company decreased to a loss of $1.967 million.
LIQUIDITY AND CAPITAL RESOURCES:
Cash and cash equivalents at September 30, 1998 totaled
$461,482 as compared to $1,180,638 at December 31, 1997.
Historically, the Company has funded its oil and gas exploration
and development activities with operating cash flows, bank
borrowings and issuance of equity and debt securities. The
Company has a $75 million credit facility through DNB with a
$48.2 million borrowing base which has been fully utilized.
Under the credit facility with DNB, the Company is required
to maintain certain ratios relating to debt coverage ratio,
current ratio, tangible net worth, general and administrative
expenses and quarterly interest ratio. Under the covenants, the
financial amounts used to compute the requirements are
specifically defined in the agreement. At September 30, 1998,
the Company was in compliance with all of the required financial
ratios except current ratio. The Company has obtained a waiver
of the compliance requirement from DNB through December 31, 1998,
as further discussed below.
In its Report on Form 10-Q for the quarter ended March 31,
1998, the Company estimated the capital expenditures for its
development and exploratory program to be $34 million in 1998.
The Company currently anticipates a capital expenditure budget of
$38 million for 1998, of which $1 million is allocated to
Kentucky with the balance of $37 million allocated to the Gulf
Coast Region. Through September 30, 1998, the Company has
expended approximately $20 million in its 1998 exploration and
development program. The Company's estimate of its capital
expenditure budget will change on a month to month basis based
upon drilling results and new opportunities. These expenditures
are substantially at the discretion of the Company; and the
Company does not currently have sufficient cash to fully fund the
proposed program. There are no assurances that the funds can be
obtained or that they can be obtained under terms acceptable to
the Company. In the event the Company is unable to obtain
sufficient funds under acceptable terms, it will be necessary for
the Company to adjust the level of the development and
exploratory program.
The $16.5 million in bridge loans from DNB have been amended
to extend the maturity date to December 31, 1998. DNB has also
amended the interest rate to either the prime rate plus 1% or the
LIBOR plus 4% and further agreed to amend the terms of the
Company's credit facility to waive the payment of principal and
the current ratio covenant compliance requirement through
December 31, 1998. Additionally, DNB decreased the interest
coverage ratio to 2.25:1.
The TECO Note in the amount of $18.5 million matured on
October 1, 1998; and by letter dated October 2, 1998, TECO
declared the Company in default. However, TECO is a party to an
agreement between the Company and DNB which substantially limits
TECO's remedies against the Company unless the Bank is paid in
full or declares a default and takes affirmative action against
the Company.
As of September 30, 1998, the Company had total current
assets of $10.7 million and total current liabilities of $70
million. However, of the $70 million in total current
liabilities, $35 million pertains to current maturities of debt
associated with the TECO acquisition, $7.1 million represents
current maturities of other long-
20
<PAGE>
term debt and $27.9 million relates to the Company's ongoing
operating activities, including development of properties
acquired from TECO and other prospects.
The production from the Company's South Timbalier 211 and
148 properties has declined approximately 60% over the last six
months. The operator of South Timbalier 211 is currently
evaluating the A-1 well to determine if the decline is one of
mechanical integrity or the absence of reserves. The operator of
the South Timbalier 148 wells has notified the company of its
intention to rework and recomplete a majority of the wells
comprising the South Timbalier 148 field, and those operations
are expected to commence during the fourth quarter of 1998.
There can be no assurance that the recompletion or reworking of
the subject wells will be successful.
As of October 31, 1998, the Company had current liabilities
in excess of current assets (exclusive of current maturities of
long-term debt) of approximately $17 million, is in default under
the TECO Note with a current arrearage of approximately $19.5
million and has immediate needs with regard to its capital
expenditure budget. Based upon its current cash position, the
Company will be unable to satisfy these commitments without
generating additional funds. In an attempt to remedy these
deficiencies, on October 29, 1998, the Company's wholly-owned
subsidiary, American Resources Offshore, Inc., was merged into
the Company for the purpose of reducing administrative expenses.
Additionally, the Company has entered into discussions with third
parties for the divestiture of its Appalachian properties. In
the event the Company divests itself of these properties, the
proceeds will be used to reduce its outstanding indebtedness to
DNB, thereby resulting in a substantial reduction of interest
expense. Further, the sale of these properties would allow the
Company to effect an additional reduction of its administrative
expenses. The Company plans to continue to review its options
for the generation of additional funds and has not eliminated any
alternatives. There can be no assurance that the Company will be
able to obtain sufficient funds to meet its current cash needs
and other obligations as they become due, which could result in
material adverse consequences.
YEAR 2000 ISSUE. The year 2000 issue relates to the
inability of certain computers and software applications to
correctly recognize and process date sensitive information for
the Year 2000 and beyond. Without correction, the computers and
software applications could fail or create erroneous information.
Since this problem could affect the Company's systems, as well as
the systems of its business partners, the Company is presently
analyzing its internal and external systems, focusing on
minimizing disruptions of the Company's operations as a result of
the millennium change.
The Company uses a PC based network system to process,
record and analyze financial information. A majority of the
equipment and support software has been purchased in recent
years, and its suppliers have informed the Company that it is
year 2000 compliant. The Company's primary oil and gas software
is not year 2000 compliant at this time. In conjunction with an
ongoing review of year 2000 issues, the Company has been in
contact with the oil and gas software provider. The software
provider is currently working towards making its system year 2000
compliant and expects to achieve this by mid-1999.
The Company is assessing the readiness of business partners,
including industrial end-users, joint interest operators, and
outside-operated pipeline and processing facilities as well as
suppliers of goods and services. Interruptions in these services
could disrupt production and delivery of oil and gas. The
Company intends to contact these parties in order to determine
their efforts in becoming year 2000 compliant and ability to
deliver services.
The Company will develop contingency plans to provide
business continuity and to address operations, safety and
environmental concerns. This effort is expected to begin in the
first quarter of 1999 and should be completed by the third
quarter of 1999.
The Company does not believe the costs incurred to address
the Year 2000 issue with respect to its financial, administrative
and operational systems will have a material impact on the
Company.
21
<PAGE>
The Company expects to have all internal systems and
computer equipment Year 2000 compliant by the millennium change.
The Company is relying on its business partners and suppliers to
be year 2000 compliant as well. Failure of significant third
parties to complete their Year 2000 compliance projects could
interrupt the supply of materials and services needed for oil and
gas operations. Disruptions to the oil and gas transportation
networks controlled by third party carriers could result in
reduced production volumes delivered to market. Such occurrences
could have a material adverse effect on the Company's business,
results of operations and financial condition. The analysis of
present internal and external systems for year 2000 compliance is
expected to significantly reduce the Company's level of
uncertainty about the Year 2000 issue.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has previously reported legal proceedings in its
10-K (see the Company's Report on Form 10-KSB for the year ended
December 31, 1997).
On May 13, 1998, the Company and its wholly-owned
subsidiary, Southern Gas Co. of Delaware, Inc., were named as
defendants in litigation filed by Wright Enterprises asserting
successor liability to certain alleged obligations of Southern
Gas Company, Inc., the company from which the Company purchased
its Kentucky operations. Based upon the allegations set forth in
the complaint, the Company believes there is a strong likelihood
that it will be successful in the defense of this matter; and the
litigation will have no material impact on the Company's
financial condition, operating results or cash flows.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
On March 5, 1998, the Company entered into the TECO Note and
a credit facility agreement ("Credit Agreement") with TECO. The
TECO Note matured on October 1, 1998, and the Company did not
make any payments of principal and interest pursuant to the terms
of the TECO Note. On October 2, 1998, the Company was informed
by TECO that it is in default under the Credit Agreement;
however, due to limited remedies and restrictions which are more
fully discussed elsewhere in this 10-Q, TECO is restricted from
taking action to enforce the payment of the TECO Note. The
current arrearage at the time of the filing of this Report on
Form 10-Q is approximately $19.5 million.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: The following Exhibits are either
attached hereto or incorporated herein by
reference:
10.88 Press release announcing agreement to acquire
offshore Gulf of Mexico assets from TECO Oil
& Gas, Inc. (incorporated by reference to
Exhibit 10.88 to the Company's Report on Form
8-K filed on January 16, 1998).
10.89 Purchase and Sale Agreement between American
Resources of Delaware, Inc., American Resources
Offshore, Inc., TECO Oil & Gas, Inc. and TECO
Energy, Inc. (incorporated by reference to
Exhibit 10.89 to the Company's Report on Form
8-K/A filed on March 16, 1998).
10.90 Promissory Note from American Resources
Offshore, Inc. in favor of TECO Oil & Gas,
Inc. (incorporated by reference to Exhibit
10.90 to the Company's Report on Form 8-K/A
filed on March 16, 1998).
22
<PAGE>
10.91 Warrant Agreement between American Resources
of Delaware, Inc. and TECO Oil and Gas, Inc.
(incorporated by reference to Exhibit 10.91
to the Company's Report on Form 8-K/A filed
on March 16, 1998).
10.92 First Amendment to First Amended and Restated
Credit Agreement dated March 5, 1998 between
American Resources of Delaware, Inc., Southern
Gas Co. of Delaware, Inc., American Resources
Offshore, Inc. and DNB Energy Assets, Inc.
(incorporated by reference to Exhibit 10.92
to the Company's Report on Form 10-Q for the
quarterly period ending March 31, 1998).
10.93 Amended Purchase and Sale Agreement between
American Resources of Delaware, Inc., American
Resources Offshore, Inc, TECO Oil & Gas, Inc.
and TECO Energy, Inc. (incorporated by
reference to Exhibit 10.93 to the Company's
Report on Form 8-K/A2 filed on May 19, 1998).
10.94 Intercreditor Agreement between American
Resources of Delaware, Inc., American Resources
Offshore, Inc., Southern Gas Co. of Delaware,
Inc., TECO Oil & Gas, Inc. and DNB Energy
Assets, Inc. (incorporated by reference to
Exhibit 10.94 to the Company's Report on Form
8-K/A2 filed on May 19, 1998).
10.95 Certificate of Amendment dated July 2, 1998
amending the Company's Restated Certificate
of Incorporation (incorporated by reference
to Exhibit 10.95 to the Company's Report on
Form 10-Q for the quarterly period ending
June 30, 1998).
10.96 Certificate of Ownership and Merger Merging
American Resources Offshore, Inc., into
American Resources of Delaware, Inc.
(incorporated by reference to Exhibit 10.96
to the Company's Report on form 8-K filed on
November 12, 1998).
(b) Reports on Form 8-K:
On October 1, 1998, the Company filed a Report on
Form 8-K in order to report the extension of the
maturity date on its bridge loans from DNB and the
vesting of warrants in favor of TECO due to nonpayment
of the TECO Note.
On November 12, 1998, the Company filed a Report
on Form 8-K reporting the merger of American Resources
Offshore, Inc., into the Company and the change of the
name of the Company to American Resources Offshore,
Inc.
23
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities and
Exchange Act of 1934, the Registrant has caused this report to be
signed on its behalf by the undersigned, thereunto duly
authorized.
AMERICAN RESOURCES OFFSHORE, INC.
Date: By: /s/ Ralph A. Currie
-------------------------------
Ralph A. Currie
Chief Financial Officer
(Principal Accounting and
Financial Officer)
24
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