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, 1999
[ ] 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.)
3141 Beaumont Centre Circle, Suite 203
Lexington, Kentucky 40513
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: 606-514-7425
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 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 October 31, 1999, 13,022,147 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.
AMERICAN RESOURCES OFFSHORE, INC.
FORM 10-Q
For the Quarter Ended September 30, 1999
INDEX
Page
Number
PART I - FINANCIAL INFORMATION 1
Item 1 - Financial Statements (unaudited) 1
Introduction to the Financial Statements 1
Condensed Consolidated Balance Sheets -
September 30, 1999 and December 31, 1998 3
Condensed Consolidated Statements of
Operations - Three and Nine Months Ended
September 30, 1999 and 1998 5
Condensed Consolidated Statements of Cash
Flows - Nine Months Ended September 30,
1999 and 1998 6
Notes to Condensed Consolidated Financial
Statements 7
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of
Operations 16
Item 3 - Quantitative and Qualitative Disclosures
About Market Risks 24
PART II - OTHER INFORMATION 24
Item 1 - Legal Proceedings 24
Item 3 - Defaults upon Senior Securities 25
Item 6 - Exhibits and Reports on Form 8-K 25
Signature 26
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
The Financial Statements of American Resources Offshore,
Inc. ("ARO") for the nine months ended September 30, 1999 and
1998 include, in the opinion of the Company, all adjustments
(which consist only of normal recurring adjustments) necessary to
present fairly the results of operations for such periods.
Results of operations for the nine months ended September 30,
1999, are not necessarily indicative of results of operations
which will be realized for the year ending December 31, 1999.
The Financial Statements should be read in conjunction with ARO's
Report on Form 10-K for the year ended December 31, 1998.
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
CONDENSED, CONSOLIDATED FINANCIAL
---------------------------------
STATEMENTS
----------
FOR THE NINE MONTHS ENDED
-------------------------
SEPTEMBER 30, 1999 AND 1998
---------------------------
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
CONDENSED, CONSOLIDATED BALANCE SHEETS
--------------------------------------
ASSETS
------
<TABLE>
SEPTEMBER 30,
1999 DECEMBER 31,
(UNAUDITED) 1998(*)
----------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 601 $ 255
Accounts and notes receivable, net 2,429 4,214
Deferred tax asset - 298
Prepaid expenses and other 1,362 689
-------- --------
Total current assets 4,392 5,456
-------- --------
Oil and gas properties, at cost
(successful efforts method) 79,997 98,161
Property and equipment, at cost 197 14,645
-------- --------
80,194 112,806
Less accumulated depreciation,
depletion and amortization (34,474) (44,253)
-------- --------
Net property and equipment 45,720 68,553
-------- --------
Other assets 167 2,215
-------- --------
Total Assets $ 50,279 $ 76,224
======== ========
</TABLE>
(Continued)
*Derived from audited financial statements.
See accompanying notes to condensed, consolidated financial statements.
3
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
CONDENSED, CONSOLIDATED BALANCE SHEETS (CONTINUED)
--------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
---------------------------------------------------------
<TABLE>
SEPTEMBER 30,
1999 DECEMBER 31,
(UNAUDITED) 1998(*)
----------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Current liabilities
Current portion of long-term debt $ - $ 64,033
Debt in default 70,462 18,500
Accounts payable-Trade 1,678 7,162
Unearned revenue 215 667
Accrued interest 7,931 2,979
Accrued expenses and other 1,932 610
-------- --------
Total current liabilities 82,218 93,951
-------- --------
Long-term debt, excluding current portion - 706
Unearned revenue - 2,971
Deferred tax liability - 298
Stockholders' equity (capital deficiency):
Series 1993 8% convertible preferred stock,
par value and liquidation preference
$12.00 per share; 1,000,000 shares
authorized 1,871 1,871
Common stock, par value $.00001 per share;
50,000,000 shares authorized - -
Additional paid-in capital 22,867 22,860
Retained earnings (deficit) (55,964) (45,720)
Treasury stock at cost (713) (713)
-------- --------
Total stockholders' equity
(capital deficiency) (31,939) (21,702)
-------- --------
Commitments and contingencies
-------- --------
Total liabilities and stockholders'
equity (capital deficiency) $ 50,279 $ 76,224
======== ========
</TABLE>
*Derived from audited financial statements.
See accompanying notes to condensed, consolidated financial statements.
4
AMERICAN RESOURCES OF DELAWARE, INC.
------------------------------------
CONDENSED, CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
-----------------------------------------------------------
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
-------------------------------------------------------
<TABLE>
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------ ------------
1999 1998 1999 1998
---- ---- ---- ----
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Operating revenues:
Oil and gas production $ 2,828 $ 6,702 $12,282 $21,429
Transportation - 206 368 596
Marketing - 1,804 3,795 5,796
Other 153 319 2,125 746
------- ------- ------- -------
2,981 9,031 18,570 28,567
------- ------- ------- -------
Operating expenses:
Oil and gas production 862 1,331 2,306 4,184
Exploration costs 1,625 1,314 2,416 2,324
Transportation - 50 115 180
Marketing 148 1,905 4,192 5,865
Depreciation, depletion
and amortization 2,445 4,156 9,420 12,666
Impairment of assets 319 - 365 2,168
Administrative expenses 955 889 3,266 2,476
Other - 26 56 78
------- ------- ------- -------
6,354 9,671 22,136 29,941
------- ------- ------- -------
Operating income (loss) (3,373) (640) (3,566) (1,374)
Other income (expense):
Interest expense (2,007) (2,122) (6,560) (5,249)
Gain on sale of assets 194 141
Other 12 26 (252) 78
------- ------- ------- -------
(1,801) (2,096) (6,671) (5,171)
------- ------- ------- -------
Income (loss) before
income tax expense
(benefit) (5,174) (2,736) (10,237) (6,545)
Income tax expense (benefit) - (790) - (2,391)
------- ------- ------- -------
Net income (loss) (5,174) (1,946) (10,237) (4,154)
Preferred dividends (7) (21) (7) (49)
------- ------- ------- -------
Net income (loss) attributable
to common shares $(5,181) $(1,967) $(10,244) $(4,203)
======= ======= ======= =======
Per common share:
Basic $ (0.42) $ (0.20) $ (0.92) $ (0.42)
======= ======= ======= =======
Weighted average number of
common shares outstanding 12,442 10,045 11,195 10,022
======= ======= ======= =======
Diluted $ (0.42) $ (0.20) $ (0.92) $ (0.42)
======= ======= ======= =======
Weighted average number of
common shares and dilutive
potential common shares 12,442 10,045 11,195 10,022
======= ======= ======= =======
</TABLE>
5
See accompanying notes to condensed, consolidated financial statements.
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
CONDENSED, CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
-----------------------------------------------------------
<TABLE>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------
1999 1998
---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Net cash provided by (used in) operating
activities $ (161) $ 31,373
-------- --------
Investing activities:
Purchases of oil and gas property
and equipment (300) (86,404)
Proceeds from sale of assets 601 1,251
Other 483 102
-------- --------
Net cash provided by (used in)
investing activities $ 784 $(85,051)
-------- --------
Financing activities:
Proceeds from borrowings - 59,273
Payments on borrowings (277) (5,275)
Deferred financing costs - (1,040)
-------- --------
Net cash provided by (used by)
financing activities $ (277) $ 52,958
-------- --------
Increase (decrease) in cash 346 (720)
Cash and cash equivalents at beginning of period 255 1,181
-------- --------
Cash and cash equivalents at end of period $ 601 $ 461
======== ========
</TABLE>
NON-CASH TRANSACTIONS:
The Company declared stock dividends and issued 18,442 and 19,842
shares of Common Stock to holders of the Series 1993 and Series B
Preferred Stock during the nine months ended September 30, 1999
and 1998, respectively.
See accompanying notes to condensed, consolidated financial
statements.
6
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
(1) GENERAL
American Resources Offshore, Inc. (ARO or the Company)
(formerly known as American Resources of Delaware, Inc.), a
Delaware corporation organized on August 14, 1992, is an
independent oil and gas company engaged in the acquisition,
exploration, development and production of oil and gas
properties offshore Louisiana and offshore Texas (Gulf Coast
Region). These activities are considered to be one business
segment for financial reporting purposes. Until July 1,
1999, the Company was also engaged in the acquisition,
exploration, development and production of oil and gas in
southeastern Kentucky (Appalachian Region) as well as
gathered and marketed natural gas in the Appalachian Region.
The Company sold its Appalachian oil and gas operations
effective July 1, 1999 and the capital stock of its
subsidiary effective at the close of business on September
30, 1999 (see Note 2).
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with
instructions to Form 10-Q and, therefore, do not include all
disclosures required by generally accepted accounting
principles. However, in the opinion of management, these
statements include all adjustments, which are of a normal
recurring nature, necessary to present fairly the financial
position at September 30, 1999 and December 31, 1998 and the
results of operations and changes in cash flows for the
periods ended September 30, 1999 and 1998. These financial
statements should be read in conjunction with the financial
statements and notes to the financial statements in the 1998
Form 10-K of the Company which was filed with the Securities
and Exchange Commission.
Basic and diluted income per common share were computed
after consideration of dividend requirements on Preferred
Stock, using the weighted average number of shares
outstanding and the weighted average number of common shares
and dilutive potential common shares outstanding,
respectively, during each of the years presented.
Outstanding stock options and warrants are potential Common
Stock equivalents and have been considered when the effect
is dilutive.
Certain reclassifications have been made to the prior period
financial statements to conform with the current period
presentation.
(2) PROPERTY AND EQUIPMENT
On March 5, 1998, the Company purchased interests in 41
leaseblocks in the Gulf of Mexico from TECO Oil & Gas, Inc.
(TECO). The purchase consists of an average 30% interest in
approximately 198,300 acres containing 5 producing wells and
approximately $35 million PV10 of proved reserves as of
December 31, 1997; partnership interests in Louisiana
Offshore Ventures and Texas 3D Ventures and access to
approximately 12,500 square miles of 3-D seismic data. ARO
has participated in the drilling and completion of six wells
on the properties since they were acquired. The development
and completion of three of these wells, Galveston 213 and
West Cameron 172 #16 and #18 wells, has resulted in current
production in excess of 6 million cubic feet of gas
equivalent per day (MMcfe/d).
Currently, 4 wells acquired from TECO are producing 7
MMcfe/d.
7
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
During the third quarter of 1999, the Company entered into
an agreement to sell its Appalachian oil and gas operations
to Nami Resources Company, LLC (Nami Resources), an
unrelated third party, effective July 1, 1999 in exchange
for the assumption of $12.5 million of indebtedness from
DNB. This transaction was completed and is more fully
discussed in the Proxy Statement for the Company's 1999
Annual Meeting of Stockholders (the 1999 Proxy Statement).
The 1999 Proxy Statement was filed with the Securities &
Exchange Commission on November 4, 1999 and sets a date of
December 1, 1999 for the Annual Meeting of Stockholders.
The Company recognized a gain of approximately $990,000
during the third quarter of 1999 in connection with the
sale.
On August 3, 1999, the Company executed a Purchase and Sale
Agreement for the divestiture of an undivided 80% interest
in its Gulf of Mexico properties to Fidelity Oil Holdings,
Inc. (Fidelity) and an Investment Agreement for the sale of
a 75% ownership interest in the Company through the issuance
of new shares of common stock to Blue Dolphin Exploration
Company (BDEX). The total purchase price for the Company's
stock and Gulf of Mexico properties is approximately $30.25
million and is subject to adjustments for operations of the
Company from the effective date of January 1, 1999. The
Closing of these transactions is subject to numerous
conditions, including but not limited to, shareholder
approval, simultaneous closing of each transaction,
satisfaction of all debts and obligations of the Company as
of December 31, 1998 and the consent of the Company's
primary lender, DNB Energy Assets, Inc. (DNB), successor to
Den norske Bank, AS (Den norske). In order to assure that
the Company's representations in the Investment Agreement
will be accurate post-closing, BDEX will acquire a portion
of the secured indebtedness from DNB at a nominal cost to
BDEX. At a post-closing date to be determined, the
Company's indebtedness will be cancelled once BDEX has
confirmed that the Company has complied fully with its
representations, warranties, and obligations. There are no
assurances the Company will be able to satisfy this
requirement; and in that event, BDEX would have the right to
enforce the secured indebtedness. Additionally, prior to
closing, the Company has significant restrictions on its
operations pursuant to the terms of the Investment
Agreement, a copy of which is attached to the Company's
Report on Form 8-K filed on August 6, 1999. This
transaction is more fully discussed in the Company's 1999
Proxy Statement. The Company anticipates that the closing
of the Fidelity and BDEX transaction will occur during the
fourth quarter of this year.
Pursuant to the terms of the Company's Investment Agreement
with BDEX, effective at the close of business on September
30, 1999, the Company sold the capital stock of its wholly-
owned subsidiary, Southern Gas Co. of Delaware, Inc.
(Southern) to Southern Gas Holding, LLC (Holding), a
Kentucky limited liability company which is owned by Leonard
K. Nave and a family trust in which Mr. Nave is the trustee.
Due to the sale of the Appalachian oil and gas operations to
Nami Resources, the only remaining assets of Southern were
volumetric production payments receivable and tax refunds
receivable with an aggregate book value of $226,000.
However, Southern is a party to litigation filed in Federal
Bankruptcy Court by Wright Enterprises, has continuing
obligations under the sale to Nami Resources, has
liabilities of approximately $68,000 and has unknown
contingent liabilities. Mr. Nave is a director of the
Company. Holding acquired the shares for a nominal amount
in return for a full indemnity for all past operations and
activities, a full release from lease obligations on the
office in Versailles, Kentucky, and a termination and
release of any severance rights from Mr. Nave.
8
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
(3) LONG-TERM DEBT
A summary of long-term debt follows:
<TABLE>
SEPTEMBER 30, DECEMBER 31,
1999 1998
---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Borrowings under the Company's
credit facility, as amended,
with DNB, reduction subject to
availability under borrowing
base, $51,223,000 available
borrowing base as of
September 30, 1999; commencing
January 1, 1999, interest
payable monthly at the Floating
Rate, or LIBO Rate plus
2 1/2%; secured by oil and gas
properties, equipment and
receivables. $ 51,223 $ 48,173
Term Loan A payable to DNB,
due December 31, 1998, with
interest payable monthly at
the Floating Rate plus 1%, or
LIBO Rate plus 4% per annum;
secured by oil and gas
properties. - 15,000
Term Loan B payable to DNB,
due December 31, 1998, with
interest payable monthly at
the Floating Rate plus 1%, or
LIBO Rate plus 4% per annum;
secured by oil and gas
properties. - 550
Note payable to TECO Oil & Gas,
Inc., with a current interest
rate of 18% per annum. The
note matured October 1, 1998. 18,500 18,500
Note payable to related party,
recourse only to specific
properties, interest payable at
prime rate plus 1% in connection
with the purchase of oil and
gas properties from Prima
Capital, LLC. 739 987
Other notes - 29
-------- --------
70,462 83,239
Less - Current portion - (64,033)
Less - Debt in default 70,462 (18,500)
-------- --------
Long-term debt $ - $ 706
======== ========
</TABLE>
9
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
On September 28, 1995, the Company entered into a $20
million revolving credit facility through February 1, 2002
with Den norske Bank, AS (Den norske). By November 1, 1997,
the revolving credit facility had been increased to $75
million and the available borrowing base was increased to
$30 million. On March 5, 1998, the borrowing base under the
revolving credit facility was assigned to DNB Energy Assets,
Inc. (DNB), successor to Den norske, and increased to $50
million to facilitate the purchase of oil and gas properties
from TECO. As of June 15, 1999, the Company was not in
compliance with the required financial covenants in the
credit agreement; and the Company had also not made the
monthly principal reductions required in 1999. Therefore,
the Bank declared the Company to be in default under its
credit facility on that date.
On March 5, 1998, DNB also provided bridge loans totalling
$16.5 million in order for the Company to complete the
acquisition of the TECO properties. The bridge loans, as
amended, matured on December 31, 1998. On June 15, 1999,
DNB also declared ARO to be in default under the bridge
loans which had a balance due of $15.6 million.
Effective August 1, 1999, the Company and DNB entered into a
Third Amendment to First Amended and Restated Credit
Agreement which combined the original promissory notes under
the credit facility and bridge loans, with a current
outstanding principal balance of $63,723,000, into two
promissory notes: i) a note in the amount of $51,223,000
which is the primary obligation of the Company; and ii) a
note in the amount of $12,500,000 which is the primary
obligation of Southern and guaranteed by the Company.
Under the terms of the Guaranty Agreement entered into
between the Company and DNB, the Company would be released
from its guarantee of the Southern note at such time as the
Appalachian oil and gas operations of Southern were sold.
The sale of Southern's Appalachian oil and gas operations
was completed; therefore, the Company is no longer a
guarantor of the loan. Due to the fact that the Company's
debt to DNB continues to be in default, it is classified as
current in the accompanying balance sheets.
In order to complete the acquisition of the TECO properties,
on March 5, 1998, the Company executed a note in favor of
TECO in the amount of $18.5 million (the TECO Note). As of
September 30, 1999, the TECO Note bears interest at the rate
of 18% per annum. The TECO Note matured on October 1, 1998,
and is secured by a second lien on all properties of the
Company. On March 6, 1999, TECO sold the TECO Note to R.
Hale Energy Services, Inc. (Hale Energy). Effective July
26, 1999, the Company entered into a Settlement Agreement
with Hale Energy under which Hale Energy agreed to release
the Company from all of its liabilities relating to the TECO
Note in exchange for approximately $990,400 cash to be paid
at or prior to the closing of the transaction with Fidelity
and BDEX (see Note 2).
In addition to the TECO Note, the parties entered into a
warrant agreement, more particularly described in Note 4
hereof, which grants TECO certain rights to acquire stock in
the Company, together with the right to appoint two members
to the Company's Board of Directors. The Company has not
made any payments on the TECO Note; therefore, by letter
dated October 2, 1998, TECO notified the Company that its
nonpayment of principal and interest constitutes an Event of
Default under the Credit Agreement. Therefore, this debt is
classified as current in the accompanying balance sheets.
As of September 30, 1999, TECO has exercised its rights to
acquire 2,751,852 shares of common stock in the Company.
The warrant agreement expired by its own terms on July 1,
1999, and TECO has waived its right to appoint members to
the Company's Board of Directors.
10
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
(4) STOCKHOLDERS' EQUITY
The Company has authorized fifty million (50,000,000) shares
of Common Stock. Outstanding at September 30, 1999 and
December 31, 1998 are 13,022,147 and 10,251,853 shares,
respectively.
The Company has authorized one million shares (1,000,000)
shares of Series 1993 Preferred Stock and two million shares
(2,000,000) of Series Preferred Stock subject to designation
by the Board of Directors:
Series 1993 Preferred Stock is convertible into
one share of common stock with a liquidation
preference of $12 per share. Dividends are
payable semiannually at the rate of 8% per annum
in common stock. 230,516 shares are outstanding
at September 30, 1999 and December 31, 1998.
On January 15, 1999 and July 15, 1999, the Board of
Directors declared dividends payable in Common Stock on
January 22, 1999 and July 22, 1999, respectively, to holders
of the Series 1993 Preferred Stock totaling 9,221 shares and
9,221 shares, respectively.
In conjunction with the purchase of properties from TECO,
the parties entered into a warrant agreement (TECO Warrant
Agreement) granting TECO warrants to acquire 600,000 shares
of common stock of the Company (First Warrants) at a price
of $2.67 per share if the TECO Note was not paid in full by
October 1, 1998. Additionally, the TECO Warrant Agreement
granted TECO warrants to acquire common stock equal to 10%
of the Company's outstanding common stock and options if the
TECO Note was not paid in full by October 1, 1998. This
percentage increased by an additional 5% on January 1, 1999,
and by an additional 5% on April 1, 1999 (collectively,
Secondary Warrants). The price per share of common stock
evidenced by the Secondary Warrants is $.00001. On June 15,
1999, TECO exercised its rights under the Warrant Agreement
to acquire 2,004,693 shares of the Company's common stock.
By letter dated June 29, 1999, TECO exercised the balance of
its Secondary Warrants for 747,159 common shares, and the
shares were issued on July 28, 1999. Therefore, a total of
2,751,852 common shares were issued to TECO pursuant to the
TECO Warrant Agreement. The 600,000 First Warrants expired
by their own terms on July 1, 1999.
The following tables illustrate the reconciliation of the
numerators and denominators of the basic and diluted
earnings per common share computations for (loss) income
related to the unexercised stock options outstanding for the
quarter ended September 30, 1999 and 1998, respectively.
11
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
<TABLE>
Quarter ended Quarter Ended
September 30, 1999 September 30, 1998
------------------ ------------------
Per Per
thousands except Net Share Net Share
per share amounts (Loss) Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Basic earnings
(loss) per share
Income (Loss)
available to common
stockholders $(5,181) 12,442 $(0.42) $(1,967) 10,045 $(0.20)
------ ------
Potential common shares - - - -
------- ------ ------- ------
Diluted earnings
per share
Income (Loss)
available to common
stockholders $(5,181) 12,442 $(0.42) $(1,967) 10,045 $(0.20)
======= ====== ====== ======= ====== ======
</TABLE>
(5) INCOME TAXES
The Company has not recorded a tax benefit in the period
ended September 30, 1999 because there is a net operating
loss carryover for financial statement purposes.
(6) COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company enters into
short-term supply and purchase agreements. These agreements
can stipulate either a fixed contract price or a floating
price based on spot prices.
ARO sells substantially all of its current Gulf Coast Region
gas production through the respective operators of the
wells. ARO utilizes forward sales contracts for a
significant portion of its Gulf Coast Region gas production
to achieve more predictable cash flows and to reduce the
effect of fluctuations in gas prices. During the third
quarter of 1999, ARO's Gulf Coast Region production averaged
17.1 MMcfe per day. At September 30, 1999, ARO had forward
sales arrangements through August 2000 with respect to 5
MMcfe per day at an average price of $2.75 per thousand
cubic feet ("Mcf"). During 1998, ARO sold call options for
20 MMcfe per day at a call price of $2.70 per Mcf, expiring
in March 2000. In exchange for establishing a ceiling of
$2.70 per Mcf over the option term, ARO received an average
option premium of $0.14 per Mcf on the volumes contracted
for under the call option agreement. These contracts were
terminated in January 1999 at a profit of $680,114.
Effective April 1, 1999, the Company entered into call
options for 10 MMcf of gas per day at a call price of $2.75,
expiring March 31, 2001. In exchange for establishing a
ceiling of $2.75 over the option term, ARO received an
average option premium of $0.055 per Mcf on the volumes
contracted for under the call option agreement. On July 23,
1999, the Company terminated these contracts at no profit or
loss. Effective October 1, 1999, the Company entered into
call options for 5 MMcf of gas per day at a call price of
$3.25, expiring September 30, 2000. In exchange for
establishing a ceiling price of $3.25 over the option term,
ARO received an average option premium of $0.1175 per Mcf.
In total, a loss of $222,126, included in production
revenues, was recognized in the first nine months of 1999
relating to losses from hedging transactions. In the first
nine months of 1998, a profit of $996,494 was recognized.
12
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
ARO continuously reevaluates its sales contracts in light of
market conditions, commodity price forecasts, capital
spending plans and debt service requirements.
Management attempts to schedule deliveries to mitigate any
possible adverse effects of changing prices; however, gas
prices are susceptible to change due to industry supply and
demand positions.
(7) GOING CONCERN ASSUMPTION
As of September 30, 1999, the Company has current
liabilities in excess of current assets of approximately $78
million and is in default under its loan with DNB in the
approximate amount of $51 million as well as in default
under its $18.5 million loan with TECO.
The Company has taken the following measures in an attempt
to remedy the above deficiencies:
On October 29, 1998, the Company's wholly-owned
subsidiary, American Resources Offshore, Inc., was
merged into the Company for the purpose of reducing
administrative expenses; and the Company assumed the
name of American Resources Offshore, Inc. at that time.
During the fourth quarter of 1998, the Board of
Directors authorized and the Company entered into
discussions with third parties for the sale of its
Appalachian properties. During the third quarter of
1999, the Company entered into an agreement to sell its
Appalachian oil and gas operations to Nami Resources,
an unrelated third party, effective July 1, 1999 in
exchange for the assumption of $12.5 million of
indebtedness from DNB. This transaction was completed
and is more fully discussed in the Company's 1999 Proxy
Statement.
During the first quarter of 1999, the Company settled
approximately $12 million of trade payables incurred as
a result of the capital requirements for the
development of additional wells by surrendering its
interest in its Grand Isle Block 55 wells to the
operator of the wells. This settlement was reflected
in the Company's December 31, 1998 financial
statements.
On August 3, 1999, the Company executed a Purchase and
Sale Agreement for the divestiture of an undivided 80%
interest in its Gulf of Mexico properties to Fidelity
and an Investment Agreement for the sale of a 75%
ownership interest in the Company through the issuance
of new shares of common stock to BDEX. The total
purchase price for the Company's stock and Gulf of
Mexico properties is approximately $30.25 million and
is subject to adjustments for operations of the Company
from the effective date of January 1, 1999. The
Closing of these transactions is subject to numerous
conditions, including but not limited to, shareholder
approval, simultaneous closing of each transaction,
satisfaction of all debts and obligations of the
Company as of December 31, 1998 and the consent of the
Company's primary lender, DNB. In order to assure that
the Company's representations in the Investment
Agreement will be accurate post-closing, BDEX will
acquire a portion of the secured indebtedness from DNB
at a nominal cost to BDEX. At a post-closing date to
be determined, the Company's indebtedness will be
cancelled once BDEX has confirmed that the Company has
complied fully with its representations, warranties,
and obligations. There are no assurances the Company
will be able to satisfy this requirement; and in that
event, BDEX would have the right to enforce
13
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(UNAUDITED)
-----------
the secured indebtedness. Additionally, prior to
closing, the Company has significant restrictions on
its operations pursuant to the terms of the Investment
Agreement, a copy of which is attached to the Company's
Report on Form 8-K filed on August 6, 1999. This
transaction is more fully discussed in the Company's
1999 Proxy Statement. The Company anticipates that the
closing of the Fidelity and BDEX transaction will occur
during the fourth quarter of this year.
Pursuant to the terms of the Company's Investment
Agreement with BDEX, effective at the close of business
on September 30, 1999, the Company sold the capital
stock of Southern to Holding, a Kentucky limited
liability company which is owned by Leonard K. Nave and
a family trust in which Mr. Nave is the trustee. Due
to the sale of the Appalachian oil and gas operations
to Nami Resources, the only remaining assets of
Southern were volumetric production payments receivable
and tax refunds receivable with an aggregate book value
of $226,000. However, Southern is a party to
litigation filed in Federal Bankruptcy Court by Wright
Enterprises, has continuing obligations under the sale
to Nami Resources, has liabilities of approximately
$68,000 and has unknown contingent liabilities. Mr.
Nave is a director of the Company. Holding acquired
the shares for a nominal amount in return for a full
indemnity for all past operations and activities, a
full release from lease obligations on the office in
Versailles, Kentucky, and a termination and release of
any severance rights from Mr. Nave.
In July 1999, as part of its restructuring efforts, the
Company reduced its New Orleans office staff to one
geologist and one accountant and moved to a smaller
office within the same building.
Effective July 26, 1999, the Company entered into a
Settlement Agreement with Hale Energy, the assignee of
the TECO Note, under which Hale Energy agreed to
release the Company from all of its liabilities
relating to the TECO Note in exchange for approximately
$990,400 cash to be paid at or prior to the closing of
the transaction with Fidelity and BDEX.
In August 1999, the Company withdrew as a participant
in Louisiana Offshore Ventures and Texas 3D Ventures,
exploration and development partnerships managed by
Houston Energy Development. This action will result in
a savings to the Company of more than $1 million
annually.
Effective August 1, 1999, the Company and DNB entered
into a Third Amendment to First Amended and Restated
Credit Agreement which combined the original promissory
notes under the credit facility and bridge loans, with
a current outstanding principal balance of $63,723,000,
into two promissory notes: i) a note in the amount of
$51,223,000 which is the primary obligation of the
Company; and ii) a note in the amount of $12,500,000
which is the primary obligation of Southern and
guaranteed by the Company. Under the terms of the
Guaranty Agreement entered into between the Company and
DNB, the Company would be released from its guarantee
of the Southern note at such time as the Appalachian
oil and gas operations of Southern were sold. As
discussed above, the sale of Southern's Appalachian oil
and gas operations was completed; therefore, the
Company is no longer a guarantor of the loan.
14
During the second and third quarters of 1999, the
Company settled approximately $3.2 million of trade
payables incurred as a result of work performed on
properties owned by Chevron Corporation, USA.
The financial statements do not include any adjustments at
September 30, 1999, to reflect the recoverability and
classification of assets or the amounts and classification
of liabilities that might result from the outcome of the
Company's uncertain immediate future.
15
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 for American Resources
Offshore, Inc. ("ARO") includes "forward looking statements"
within the meaning of Section 27A of the Securities Act of 1933,
as amended, and Section 21E of the Securities Exchange Act of
1934, 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 1999 and thereafter, ARO's financial
position, business strategy and other plans and objectives for
future operations, are forward-looking statements. Although ARO
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 ARO. 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 ARO's
expectations are disclosed elsewhere in this Form 10-Q and in the
Form 8-K which ARO filed with the Securities and Exchange
Commission on July 25, 1997.
RECENT DEVELOPMENTS
On January 4, 1999, ARO received notification from NASDAQ
that unless the shares of ARO's common stock, par value $0.00001
per share (the "Common Stock"), report a closing bid of $1.00 or
greater for ten consecutive trading days prior to April 5, 1999,
ARO's securities would be subject to delisting. As of the date
of the filing of this Report on Form 10-Q, the Common Stock has
not reported a closing bid of $1.00 or greater for ten
consecutive trading days. ARO had an oral hearing before the
NASDAQ Qualifications Board with regard to this matter on May 13,
1999 and requested an extension of the deadline to comply with
the continued listing requirements. However, the Company's stock
was delisted on August 19, 1999, due to its failure to comply
with the following requirements for continued listing:
* net tangible assets of $2.0 million, or market
capitalization of $35.0 million, or net income in the
latest fiscal year or in 2 of the last 3 fiscal years
of $500,000;
* a public float with a market value of $1.0 million; and
* a minimum bid price of $1.00.
On August 23, 1999, ARO requested the Nasdaq Hearing Review
Council to review the decision of the Listing Qualifications
Panel to delist the common stock. Since August 19, 1999, ARO's
common stock has been quoted on the OTC Bulletin Board under the
trading symbol "GASS.OB."
In conjunction with the purchase of properties from TECO Oil
& Gas, Inc. ("TECO"), the parties entered into a warrant
agreement ("TECO Warrant Agreement") granting TECO warrants to
acquire 600,000 shares of Common Stock ("First Warrants") at a
price of $2.67 per share if the TECO Note was not paid in full by
October 1, 1998. Additionally, the TECO Warrant Agreement
granted TECO warrants to acquire Common Stock equal to 10% of the
Company's outstanding Common Stock and options if the $18.5
million note in favor of TECO ("TECO Note") was not paid in full
by October 1, 1998. This
16
percentage increased by an additional 5% on January 1, 1999, and
by an additional 5% on April 1, 1999 (collectively, "Secondary
Warrants"). The price per share of Common Stock evidenced by the
Secondary Warrants is $.00001. On June 15, 1999, TECO exercised
its rights under the Warrant Agreement to acquire 2,004,693
shares of Common Stock. By letter dated June 29, 1999, TECO
exercised the balance of its Secondary Warrants for 747,159
common shares, and the shares were issued on July 28, 1999.
Therefore, a total of 2,751,852 common shares were issued to TECO
pursuant to the TECO Warrant Agreement. The 600,000 First
Warrants expired by their own terms on July 1, 1999.
On March 6, 1999, TECO sold the TECO Note to R. Hale Energy
Services, Inc. ("Hale Energy"). Effective July 26, 1999, ARO
entered into a Settlement Agreement with Hale Energy under which
Hale Energy agreed to release ARO from all of its liabilities
relating to the TECO Note in exchange for approximately $990,400
cash to be paid at or prior to the closing of the transaction
with Fidelity Oil Holdings, Inc. ("Fidelity") and Blue Dolphin
Exploration Company ("BDEX").
Effective August 1, 1999, ARO and DNB Energy Assets, Inc.
("DNB"), successor to Den norske Bank ("Den norske"), entered
into a Third Amendment to First Amended and Restated Credit
Agreement which combined the original promissory notes under the
credit facility and bridge loans, with a current outstanding
principal balance of $63,723,000, into two promissory notes: i)
a note in the amount of $51,223,000 which is the primary
obligation of ARO; and ii) a note in the amount of $12,500,000
which is the primary obligation of Southern and guaranteed by
ARO. Under the terms of the Guaranty Agreement entered into
between ARO and DNB, ARO would be released from its guarantee of
the Southern note at such time as the Appalachian oil and gas
operations of Southern were sold. As discussed below, the sale
of Southern's Appalachian oil and gas operations was completed;
therefore, ARO is no longer a guarantor of the loan.
On August 3, 1999, ARO executed a Purchase and Sale
Agreement for the divestiture of an undivided 80% interest in its
Gulf of Mexico properties to Fidelity and an Investment Agreement
for the sale of a 75% ownership interest in ARO through the
issuance of new shares of Common Stock to BDEX. The total
purchase price for the Common Stock and Gulf of Mexico properties
is approximately $30.25 million and is subject to adjustments for
operations of ARO from the effective date of January 1, 1999.
The Closing of these transactions is subject to numerous
conditions, including but not limited to, shareholder approval,
simultaneous closing of each transaction, satisfaction of all
debts and obligations of ARO as of December 31, 1998 and the
consent of ARO's primary lender, DNB. In order to assure that
ARO's representations in the Investment Agreement will be
accurate post-closing, BDEX will acquire a portion of the secured
indebtedness from DNB at a nominal cost to BDEX. At a post-
closing date to be determined, ARO's indebtedness will be
cancelled once BDEX has confirmed that ARO has complied fully
with its representations, warranties, and obligations. There are
no assurances ARO will be able to satisfy this requirement; and
in that event, BDEX would have the right to enforce the secured
indebtedness. Additionally, prior to closing, ARO has
significant restrictions on its operations pursuant to the terms
of the Investment Agreement, a copy of which is attached to ARO's
Report on Form 8-K filed on August 6, 1999. This transaction is
more fully discussed in the Proxy Statement for ARO's 1999 Annual
Meeting of Stockholders (the "1999 Proxy Statement"). The 1999
Proxy Statement was filed with the Securities & Exchange
Commission on November 4, 1999 and sets a date of December 1,
1999 for the Annual Meeting of Stockholders. ARO anticipates
that the closing of the Fidelity and BDEX transactions will occur
during the fourth quarter of this year.
During the third quarter of 1999, ARO entered into an
agreement to sell its Appalachian oil and gas operations to Nami
Resources Company, LLC ("Nami Resources"), an unrelated third
party, effective July 1, 1999 in exchange for the assumption of
$12.5 million of indebtedness from DNB. This transaction was
completed and is more fully discussed in ARO's 1999 Proxy
Statement.
Pursuant to the terms of ARO's Investment Agreement with
BDEX, effective at the close of business on September 30, 1999,
ARO sold the capital stock of its wholly-owned subsidiary,
Southern Gas Co. of Delaware, Inc. ("Southern") to Southern Gas
Holding, LLC (Holding), a Kentucky limited liability company
which is owned by Leonard K. Nave and a family trust in which Mr.
Nave is the trustee. Due to the sale of the Appalachian oil and
gas operations to Nami Resources, the only remaining assets of
Southern were volumetric production payments receivable and tax
refunds receivable with an aggregate
17
book value of $226,000. However, at the time of conveyance,
Southern was a party to litigation filed in Federal Bankruptcy
Court by Wright Enterprises, has continuing obligations under the
sale to Nami Resources, has liabilities of approximately $68,000
and has unknown contingent liabilities. Mr. Nave is a director
of ARO. Holding acquired the shares for a nominal amount in
return for a full indemnity for all past operations and
activities, a full release from lease obligations on the office
in Versailles, Kentucky, and a termination and release of any
severance rights from Mr. Nave.
In July 1999, as part of its restructuring efforts, ARO
reduced its New Orleans office staff to one geologist and one
accountant as well as moved to a smaller office within the same
building.
In August 1999, ARO withdrew as a participant in Louisiana
Offshore Ventures and Texas 3D Ventures, exploration and
development partnerships managed by Houston Energy Development.
This action will result in a savings to ARO of more than $1
million annually.
During the second and third quarters of 1999, ARO settled
approximately $3.2 million of trade payables incurred as a result
of work performed on properties owned by Chevron Corporation,
USA.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS
ENDED SEPTEMBER 30, 1998
REVENUES. Total revenues for ARO decreased 35% to $18.6
million for the first nine months of 1999 from $28.6 million for
the comparable period in 1998, due primarily to significantly
reduced production from the South Timbalier 148 and South
Timbalier 211 properties and a loss of $222,000 from hedging
activities. Marketing revenues decreased 35% to $3.8 million for
the first nine months of 1999, primarily due to the sale of the
Appalachian oil and gas properties effective July 1, 1999.
OIL AND GAS PRODUCTION REVENUE. Oil and gas production
revenue decreased 43% to $12.3 million in the first nine months
of 1999, due primarily to significantly reduced production from
the South Timbalier 148 and South Timbalier 211 properties and a
loss from hedging activities of $222,000.
The following table summarizes production volumes, average
sales prices and period to period comparisons for ARO's oil and
gas operations for the periods indicated:
<TABLE>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------- % INCREASE
1999 1998 (DECREASE)
---- ---- ----------
<S> <C> <C> <C>
Production volumes:
Natural gas (MMcf*) 4,491 7,431 (40%)
Oil (MBbls*) 227 322 (30%)
Total (MMcfe*) 5,856 9,364 (37%)
Average sale prices:**
Natural gas (per Mcf*) $ 1.97 $ 2.34 (16%)
Oil (per Bbl*) $15.04 $12.58 20%
Per Mcfe* $ 2.10 $ 2.29 (8%)
Expenses (per Mcfe*):
Lease operating (including
production taxes) $ 0.39 $ 0.45 (3%)
Depreciation, depletion
and amortization $ 1.61 $ 1.35 19%
Administrative*** $ 0.56 $ 0.26 115%
</TABLE>
*(Mmcf = million cubic feet; MBbls = thousand barrels; MMcfe =
million cubic feet equivalent; Mcf = thousand cubic feet;
Bbl = barrel; Mcfe = thousand cubic feet equivalent)
**Includes effect of hedging (excluding hedging, the average
price for gas would have been $2.02 per Mcf and the average
price per Mcfe would have been $2.14).
18
***Includes legal, travel, lease termination and employee
reduction costs attributable to the Fidelity and BDEX
transactions of $392,000, or $0.07 per Mcfe.
OIL AND GAS PRODUCTION EXPENSE. Oil and gas production
expense decreased 45% to $2.3 million, in the first nine months
of 1999 due primarily to a significant decrease in ARO's
production volumes. Oil and gas production expense was $0.39 per
Mcfe for the first nine months of 1999 compared to $0.45 for the
same period in 1998, a decrease of 3%.
EXPLORATION COSTS. During the nine months ended September
30, 1999, costs of approximately $2.4 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 ARO's accounting method.
Costs of approximately $2.3 million were incurred in the same
period of 1998.
IMPAIRMENT OF ASSETS. ARO assesses 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 ARO'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 1999, ARO recorded a non-cash charge of
$365,000 representing impairment of non-core oil and gas
properties compared with a charge of $2.2 million for the same
period in 1998.
ADMINISTRATIVE EXPENSE. Administrative expense increased
32% to $3.3 million in the first nine months of 1999, and was
$0.56 per Mcfe, an increase of 115% from the prior year. This
increase was primarily the result of an increase in legal and
professional fees, travel expenses, lease termination and
employee reduction costs attributable to the Fidelity and BDEX
transactions of approximately $392,000, or $0.07 per Mcfe The
per unit increase occurred as the result of the decrease in
production volumes.
DEPRECIATION, DEPLETION AND AMORTIZATION (DD&A) EXPENSE.
DD&A expense decreased 26% to $9.4 million in the first nine
months of 1999 and was $1.61 per Mcfe, an increase of 19% from
the prior year. The decrease in total DD&A expense was due
primarily to a significant decrease in production volumes. The
per unit increase resulted primarily from reserve revisions and
increased provision for future plugging and abandonment costs.
INTEREST EXPENSE. Interest expense increased 25% to $6.6
million, in the first nine months of 1999, due to additional
borrowings to fund the TECO acquisition and expanded exploration
and development activities and an overall increase in interest
rates on the TECO indebtedness.
NET INCOME. Due to the factors described above, ARO
recognized a loss of $10.2 million for the nine months ended
September 30, 1999.
THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998:
REVENUES. Total revenues for ARO decreased 67% to $3
million for the third quarter of 1999 compared with $9 million in
1998, due primarily to significantly reduced production from the
South Timbalier 148 and South Timbalier 211 properties and a loss
of $1,468,000 from hedging activities. Marketing revenues
decreased to $0 for the third quarter of 1999 after having been
$1.8 million for the same period in 1998 due to the sale of the
Appalachian oil and gas properties effective July 1, 1999.
OIL AND GAS PRODUCTION REVENUE. Oil and gas production
revenue decreased 58% in the third quarter of 1999 to $2.8
million. The decrease was primarily due to a decrease in oil and
gas production volumes, a decrease in gas prices and a loss on
ARO's hedging contracts amounting to approximately $1,468,000.
19
The following table summarizes production volumes, average
sales prices and period to period comparisons for ARO's oil and
gas operations for the periods indicated:
<TABLE>
THREE MONTHS ENDED
SEPTEMBER 30,
------------------ % INCREASE
1999 1998 (DECREASE)
---- ---- ----------
<S> <C> <C> <C>
Production volumes:
Natural gas (MMcf*) 1,077 2,326 (54%)
Oil (MBbls*) 78 102 (24%)
Total (MMcfe*) 1,543 2,937 (47%)
Average sale prices:**
Natural gas (per Mcf*) $ 1.15 $ 2.37 (51%)
Oil (per Bbl*) $20.41 $11.61 75%
Per Mcfe* $ 1.83 $ 2.28 (20%)
Expenses (per Mcfe*):
Lease operating (including
production taxes) $ 0.56 $ 0.45 24%
Depreciation, depletion
and amortization $ 1.59 $ 1.41 13%
Administrative*** $ 0.62 $ 0.30 106%
</TABLE>
*(Mmcf = million cubic feet; MBbls = thousand barrels; MMcfe =
million cubic feet equivalent; Mcf = thousand cubic feet;
Bbl = barrel; Mcfe = thousand cubic feet equivalent)
**Includes effect of hedging (excluding hedging, the average
price for gas would have been $2.52 per Mcf, and the average
price per Mcfe would have been $2.78).
***Includes legal, travel, lease termination and employee
reduction costs attributable to the Fidelity and BDEX
transactions of $392,000, or $0.25 per Mcfe.
OIL AND GAS PRODUCTION EXPENSE. Oil and gas production
expense decreased 35% to $862,000 in the third quarter of 1999
due primarily to a decrease in the costs associated with ARO's
active participation in the exploration and development of the
properties acquired in the TECO acquisition and reduced
production volumes. Oil and gas production expense was $0.56 per
Mcfe in the third quarter of 1999 as compared to $0.45 in 1998,
an increase of 24%.
EXPLORATION COSTS. During the third quarter of 1999, costs
of approximately $1.6 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 ARO's accounting method.
Exploration costs were approximately $1.3 million for the third
quarter of 1998.
IMPAIRMENT OF ASSETS. ARO assesses the impairment of
capitalized costs of proved oil and gas properties and other long-
lived assets in accordance with SFAS No. 121. 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 ARO'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 1999, ARO recorded an impairment to oil and gas
properties of $319,000 compared with $0 for the same period of
1998.
ADMINISTRATIVE EXPENSE. Administrative expense increased 7%
to $955,000 in the third quarter of 1999 and was $0.62 per Mcfe,
an increase of 106% from the prior year. This increase was
primarily the result of an increase in legal and professional
fees, travel expenses, lease termination and employee reduction
costs attributable to the Fidelity and BDEX transactions of
approximately $392,000, or $0.25 per Mcfe. The per unit increase
was due primarily to a decrease in production volumes for the
quarter.
20
DD&A EXPENSE. DD&A expense decreased 41% to $2.4 million
for the third quarter of 1999 and was $1.59 per Mcfe, an increase
of 13% from the prior year. The decrease in total DD&A expense
was due primarily to a significant decrease in production
volumes. The per unit increase resulted primarily from reserve
revisions and increased provision for future plugging and
abandonment costs.
INTEREST EXPENSE. Interest expense decreased 5% to $2
million in the third quarter of 1999. The decrease was
attributable to a reduction of long-term debt resulting from the
sale of the Appalachian oil and gas properties.
NET INCOME. Due to the factors described above, ARO
recognized a loss of $5.2 million for the quarter ended September
30, 1999.
LIQUIDITY AND CAPITAL RESOURCES:
Cash and cash equivalents at September 30, 1999 totaled
$601,000. Historically, ARO has funded its oil and gas
exploration and development activities with operating cash flows,
bank borrowings and issuance of equity and debt securities.
Effective August 1, 1999, ARO and DNB entered into a Third
Amendment to First Amended and Restated Credit Agreement which
combined the original promissory notes under the credit facility
and bridge loans, with a current outstanding principal balance of
$63,723,000, into two promissory notes: i) a note in the amount
of $51,223,000 which is the primary obligation of ARO; and ii) a
note in the amount of $12,500,000 which is the primary
obligation of Southern and guaranteed by ARO. Under the terms
of the Guaranty Agreement entered into between ARO and DNB, ARO
would be released from its guarantee of the Southern note at such
time as the Appalachian oil and gas operations of Southern were
sold. The sale of Southern's Appalachian oil and gas operations
was completed; therefore, ARO is no longer a guarantor of the
loan. As of September 30, 1999, the balance due under the new
note was $51,223,000. ARO's debt to DNB continues to be in
default and is classified as current in the accompanying balance
sheets.
In order to complete the acquisition of properties from
TECO, ARO executed the TECO Note. The TECO Note matured on
October 1, 1998; and by letter dated October 2, 1998, TECO
declared ARO in default. Therefore, this debt is classified as
current in the accompanying balance sheets. On March 6, 1999,
TECO sold the TECO Note to Hale Energy. Effective July 26, 1999,
ARO entered into a Settlement Agreement with Hale Energy under
which Hale Energy agreed to release ARO from all of its
liabilities relating to the TECO Note in exchange for
approximately $990,400 cash to be paid at or prior to the closing
of the transaction with Fidelity and BDEX.
For the nine months ended September 30, 1999, ARO had
expended more than $2 million on its 1999 exploration and
development program. ARO's estimate of its capital expenditure
budget will change on a month to month basis based upon drilling
results and new opportunities. Pursuant to the terms of the
Purchase and Sale Agreement and Investment Agreement entered into
with Fidelity and BDEX, these expenditures are at the discretion
of Fidelity and BDEX.
As of September 30, 1999, ARO has current liabilities in
excess of current assets of approximately $78 million, is in
default under its loan with DNB in the approximate amount of $51
million, is in default under its $18.5 million loan with TECO and
has immediate needs with regard to its capital expenditure budget
as discussed above. Based upon its current cash position, ARO
will be unable to satisfy these commitments without generating
additional funds.
ARO has taken the following measures in an attempt to remedy
the above deficiencies:
21
On October 29, 1998, ARO's wholly-owned subsidiary, American
Resources Offshore, Inc., was merged into ARO for the
purpose of reducing administrative expenses, and ARO assumed
the name of American Resources Offshore, Inc. at that time.
During the fourth quarter of 1998, the Board of Directors
authorized and ARO entered into discussions with third
parties for the sale of its Appalachian properties. During
the third quarter of 1999, ARO entered into an agreement to
sell its Appalachian oil and gas operations to Nami
Resources, an unrelated third party, effective July 1, 1999
in exchange for the assumption of $12.5 million of
indebtedness from DNB. This transaction was completed and
is more fully discussed in ARO's 1999 Proxy Statement.
During the first quarter of 1999, ARO settled approximately
$12 million of trade payables incurred as a result of the
capital requirements for the development of additional wells
by surrendering its interest in its Grand Isle Block 55
wells to the operator of the wells. This settlement was
reflected in ARO's December 31, 1998 financial statements.
Pursuant to the terms of ARO's Investment Agreement with
BDEX, effective at the close of business on September 30,
1999, ARO sold the capital stock of Southern to Holding, a
Kentucky limited liability company which is owned by Leonard
K. Nave and a family trust in which Mr. Nave is the trustee.
Due to the sale of the Appalachian oil and gas operations to
Nami Resources, the only remaining assets of Southern were
volumetric production payments receivable and tax refunds
receivable with an aggregate book value of $226,000.
However, at the time of conveyance, Southern was a party to
litigation filed in Federal Bankruptcy Court by Wright
Enterprises, has continuing obligations under the sale to
Nami Resources, has liabilities of approximately $68,000 and
has unknown contingent liabilities. Mr. Nave is a director
of ARO. Holding acquired the shares for a nominal amount in
return for a full indemnity for all past operations and
activities, a full release from lease obligations on the
office in Versailles, Kentucky, and a termination and
release of any severance rights from Mr. Nave.
As discussed above, effective July 26, 1999, Hale Energy
agreed to release ARO from all of its liabilities relating
to the TECO Note in exchange for approximately $990,400 cash
to be paid at or prior to the closing of the transaction
with Fidelity and BDEX.
Also as discussed above, effective August 1, 1999, ARO
amended its credit agreement with DNB such that ARO is now
obligated in the amount of $51,223,000 rather than
$63,723,000 as a result of the sale of its Appalachian oil
and gas operations.
On August 3, 1999, ARO executed a Purchase and Sale
Agreement for the divestiture of an undivided 80% interest
in its Gulf of Mexico properties to Fidelity and an
Investment Agreement for the sale of a 75% ownership
interest in ARO through the issuance of new shares of common
stock to BDEX. The total purchase price for ARO's stock and
Gulf of Mexico properties is approximately $30.25 million
and is subject to adjustments for operations of ARO from the
effective date of January 1, 1999. The Closing of these
transactions is subject to numerous conditions, including
but not limited to, shareholder approval, simultaneous
closing of each transaction, satisfaction of all debts and
obligations of ARO as of December 31, 1998 and the consent
of ARO's primary lender, DNB. In order to assure that ARO's
representations in the Investment Agreement will be accurate
post-closing, BDEX will acquire a portion of the secured
indebtedness from DNB at a nominal cost to BDEX. At a post-
closing date to be determined, ARO's indebtedness will be
cancelled once BDEX has confirmed that ARO has complied
fully with its representations, warranties, and obligations.
There are no assurances ARO will be able to satisfy this
requirement; and in that event, BDEX would have the right to
enforce the secured indebtedness. Additionally, prior to
closing, ARO has significant restrictions on its operations
pursuant to the terms of the Investment Agreement, a copy of
which is attached to ARO's Report on Form 8-K filed on
August 6, 1999. This transaction is ore fully discussed in
ARO's 1999
22
Proxy Statement. ARO anticipates that the closing of the
Fidelity and BDEX transaction will occur during the fourth
quarter of this year.
In July 1999, as part of its restructuring efforts, ARO
reduced its New Orleans office staff to one geologist and
one accountant and moved to a smaller office within the same
building.
During the second and third quarters of 1999, ARO settled
approximately $3.2 million of trade payables incurred as a
result of work performed on properties owned by Chevron
Corporation, USA.
In August 1999, ARO withdrew as a participant in Louisiana
Offshore Ventures and Texas 3D Ventures, exploration and
development partnerships managed by Houston Energy
Development. This action will result in a savings to ARO of
more than $1 million annually.
ARO believes that its failure to complete the restructuring
with BDEX and Fidelity discussed above could result in the
following: (i) ARO's creditors could file an involuntary
bankruptcy petition against ARO, (ii) ARO could file a voluntary
petition for reorganization under the protection of the
Bankruptcy Code, (iii) ARO could be unable to pursue acquisitions
or exploit its oil and gas properties, (iv) ARO could lose
business opportunities due to doubt about ARO's ability to
satisfy its obligations, (v) ARO could be unable to realize the
maximum value of its assets, and (vi) ARO could be unable to
invest adequate capital in its business. If a restructuring is
not completed, ARO will most likely file a petition for
reorganization and restructuring under the protection of the
Bankruptcy Code. ARO can give no assurances that a bankruptcy
proceeding will result in reorganization rather than liquidation.
If liquidation were to occur, there is a substantial risk that
little or no value would be available for distribution to the
shareholders.
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 ARO's systems, as well as the
systems of its business partners, ARO is presently analyzing its
internal and external systems, focusing on minimizing disruptions
of ARO's operations as a result of the millennium change.
ARO uses a PC based network system to process, record and
analyze financial information. All of the equipment and support
software has been purchased in recent years, and its suppliers
have informed ARO that it is year 2000 compliant.
ARO 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. ARO
intends to contact these parties in order to determine their
efforts in becoming year 2000 compliant and ability to deliver
services.
ARO will develop contingency plans to provide business
continuity and to address operations, safety and environmental
concerns. This effort began in the first quarter of 1999 and
should be completed by the third quarter of 1999.
ARO estimates that the costs incurred to address the Year
2000 issue with respect to its financial, administrative and
operational systems will be less than $100,000.
ARO expects to have all internal systems and computer
equipment Year 2000 compliant by the millennium change. ARO 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 ARO'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 ARO's level of uncertainty about
the Year 2000 issue.
23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISKS
There have been no material changes in market risks since
December 31, 1998. ARO recognized a loss of approximately
$222,000 for the first nine months of 1999 and a loss of
approximately $1.5 million for the third quarter of 1999 relative
to forward sales agreements.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ARO has previously reported legal proceedings in its 10-K
(see ARO's Report on Form 10-K for the year ended December 31,
1998).
On July 23, 1999, ARO was named as a party defendant in a
suit filed by Sundowner Offshore Services, Inc. ("Sundowner")
which alleged, among other things, that approximately $1.3
million was owed to Sundowner by ARO. ARO has entered into a
settlement agreement with Sundowner for $800,000 plus interest.
Settlement of this matter will be finalized at the closing of the
transaction with Fidelity and BDEX.
On May 13, 1998, ARO 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 ARO purchased its Kentucky
operations. On November 8, 1999, a summary judgment was entered
in favor of the Company.
In the first quarter of 1999, ARO was also named a co-
defendant in litigation filed by the operator of High Island
Block 105 seeking approximately $600,000 for expenses incurred in
the drilling of a well. On March 10, 1999, ARO settled this
litigation by agreeing to convey its interest in the #19 well
located on West Cameron Block 172 to the co-defendant in exchange
for approximately $600,000 and a 25% reversionary interest after
payout. Those proceeds were utilized by ARO to settle this
litigation. At the time of this settlement, ARO was in default
on its obligation to advance an additional $733,752 for
completion cost of the #19 well and did not have the capital to
make this advance. As ARO would have been caused to non-consent
this operation, it agreed to convey its interest to the co-
defendant, who paid the completion costs.
In April 1999, ARO was named as a defendant in litigation
filed by a trade creditor for work performed on behalf of the
Company on Grand Isle Block 55. The trade creditor was seeking
the sum of approximately $29,000 for services rendered. This
matter has been settled by the Company.
In April 1999, ARO was named as a defendant in litigation
filed by a trade creditor for work performed on behalf of the
Company on South Timbalier Block 21 and 27. The trade creditor
was seeking the sum of approximately $51,000 for services
rendered. This matter has been settled by the Company.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
On March 5, 1998, ARO entered into the TECO Note and a
credit facility agreement ("Credit Agreement") with TECO. The
TECO Note matured on October 1, 1998, and ARO did not make any
payments of principal and interest pursuant to the terms of the
TECO Note. On October 2, 1998, ARO 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
24
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 $18.5 million plus accrued interest. Effective July 26, 1999,
Hale Energy, assignee of the TECO Note, agreed to release ARO
from all of its liabilities relating to the TECO Note in exchange
for approximately $990,400 cash to be paid at or prior to the
closing of the transaction with Fidelity and BDEX.
As of June 15, 1999, DNB had declared ARO to be in default under
its credit facility and bridge loans. Effective August 1, 1999,
ARO and DNB entered into a Third Amendment to First Amended and
Restated Credit Agreement which combined the original promissory
notes under the credit facility and bridge loans, with a current
outstanding principal balance of $63,723,000, into two promissory
notes: i) a note in the amount of $51,223,000 which is the
primary obligation of ARO; and ii) a note in the amount of
$12,500,000 which is the primary obligation of Southern and
guaranteed by ARO. Under the terms of the Guaranty Agreement
entered into between ARO and DNB, ARO would be released from its
guarantee of the Southern note at such time as the Appalachian
oil and gas operations of Southern were sold. The sale of
Southern's Appalachian oil and gas operations was completed;
therefore, ARO is no longer a guarantor of the loan. As of
September 30, 1999, the balance due under the new note was
$51,223,000. ARO's debt to DNB continues to be in default and is
classified as current in the accompanying balance sheets.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: The following Exhibits are either
attached hereto or incorporated herein by
reference:
None.
(b) Reports on Form 8-K:
None.
25
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: November 15, 1999 By: /s/ Ralph A. Currie
------------------------------------
Ralph A. Currie
Chief Financial Officer
(Principal Accounting and
Financial Officer)
26
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