<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 JUNE 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.)
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 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 June 30, 1999, 12,265,767 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.
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
FORM 10-Q
For the Quarter Ended June 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 -
June 30, 1999 and December 31, 1998 3
Condensed Consolidated Statements of
Operations - Three and Six Months Ended
June 30, 1999 and 1998 5
Condensed Consolidated Statements of
Cash Flows - Six Months Ended June 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 15
PART II - OTHER INFORMATION 22
Item 1 - Legal Proceedings 22
Item 3 - Defaults upon Senior Securities 23
Item 6 - Exhibits and Reports on Form 8-K 23
Signature 25
Exhibit Index 26
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The Financial Statements of American Resources Offshore,
Inc. ("ARO") for the six months ended June 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 six months ended June 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.
1
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
CONDENSED, CONSOLIDATED FINANCIAL
---------------------------------
STATEMENTS
----------
FOR THE SIX MONTHS ENDED
------------------------
JUNE 30, 1999 AND 1998
----------------------
2
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
CONDENSED, CONSOLIDATED BALANCE SHEETS
--------------------------------------
ASSETS
------
<TABLE>
June 30,
1999 December 31,
(unaudited) 1998(*)
----------- -------
(Dollars in thousands)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 279 $ 255
Accounts and notes receivable, net 3,112 4,214
Deferred tax asset - 298
Prepaid expenses and other 378 689
-------- --------
Total current assets 3,769 5,456
-------- --------
Oil and gas properties, at cost
(successful efforts method) 93,530 98,161
Property and equipment, at cost 14,808 14,645
-------- --------
108,338 112,806
Less accumulated depreciation,
depletion and amortization (46,364) (44,253)
-------- --------
Net property and equipment 61,974 68,553
-------- --------
Other assets 1,782 2,215
-------- --------
Total Assets $ 67,525 $ 76,224
======== ========
</TABLE>
(Continued)
*Derived from audited financial statements.
See accompanying notes to condensed, consolidated financial
statements.
3
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
CONDENSED, CONSOLIDATED BALANCE SHEETS (CONTINUED)
--------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
---------------------------------------------------------
<TABLE>
June 30,
1999 December 31,
(unaudited) 1998(*)
----------- -------
(Dollars in thousands)
<S> <C> <C>
Current liabilities:
Current portion of long-term debt $ 834 $ 64,033
Debt in default 82,223 18,500
Accounts payable-Trade 2,069 7,162
Unearned revenue 642 667
Accrued interest 6,929 2,979
Accrued expenses and other 465 610
-------- --------
Total current liabilities 93,162 93,951
-------- --------
Long-term debt, excluding
current portion 14 706
Unearned revenue 1,113 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 22,865 22,860
Retained earnings (deficit) (50,787) (45,720)
Treasury stock at cost (713) (713)
-------- --------
Total stockholders' equity
(capital deficiency) (26,764) (21,702)
-------- --------
Commitments and contingencies
-------- --------
Total liabilities and
stockholders' equity
(capital deficiency) $ 67,525 $ 76,224
======== ========
</TABLE>
*Derived from audited financial statements.
See accompanying notes to condensed, consolidated financial
statements.
4
<PAGE>
AMERICAN RESOURCES OF DELAWARE, INC.
------------------------------------
AND SUBSIDIARIES
----------------
CONDENSED, CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
-----------------------------------------------------------
THREE AND SIX MONTHS ENDED JUNE 30, 1999 AND 1998
-------------------------------------------------
<TABLE>
QUARTER ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------- -------
1999 1998 1999 1998
---- ---- ---- ----
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C>
Operating revenues:
Oil and gas production $ 2,928 $ 8,473 $ 9,454 $14,726
Transportation 191 198 368 390
Marketing 1,600 1,827 3,795 3,992
Other 1,744 335 1,972 427
------- ------- ------- -------
6,463 10,833 15,589 19,535
------- ------- ------- -------
Operating expenses:
Oil and gas production 1,037 1,209 1,444 2,077
Transportation 58 71 115 129
Marketing 1,842 1,872 4,044 3,960
Exploration costs 315 1,786 791 1,786
Depreciation, depletion
and amortization 2,897 5,046 6,975 8,510
Impairment of assets - 2,168 46 2,168
Administrative expenses 1,129 819 2,311 1,587
Other 27 21 56 52
------- ------- ------- -------
7,305 12,992 15,782 20,269
------- ------- ------- -------
Operating income (loss) (842) (2,159) (193) (734)
Other income (expense):
Interest expense (2,256) (2,177) (4,553) (3,126)
Loss on sale of assets (53) (53) -
Other (293) 23 (264) 51
------- ------- ------- -------
(2,602) (2,154) (4,870) (3,075)
------- ------- ------- -------
Income (loss) before
income tax expense
(benefit) (3,444) (4,313) (5,063) (3,809)
Income tax expense (benefit) - (1,801) - (1,600)
------- ------- ------- -------
Net income (loss) (3,444) (2,512) (5,063) (2,209)
Preferred dividends - (29) (4) (29)
------- ------- ------- -------
Net income (loss)
attributable to
common shares $(3,444) $(2,541) $(5,067) $(2,238)
======= ======= ======= =======
Per common share:
Basic $ (0.32) $ (0.25) $ (0.48) $ (0.22)
======= ======= ======= =======
Weighted average number of
common shares outstanding 11,062 10,023 10,561 10,011
======= ======= ======= =======
Diluted $ (0.32) $ (0.25) $ (0.48) $ (0.22)
======= ======= ======= =======
Weighted average number of
common shares and dilutive
potential common shares 11,062 10,023 10,561 10,011
======= ======= ======= =======
</TABLE>
See accompanying notes to condensed, consolidated financial
statements.
5
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
CONDENSED, CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
-----------------------------------------------------------
<TABLE>
SIX MONTHS ENDED
JUNE 30,
--------
1999 1998
---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Net cash provided by operating
activities $230 $ 14,737
---- --------
Investing activities:
Purchases of property and equipment (267) (71,421)
Proceeds from sale of assets (124) 1,250
Other (4) 9
---- --------
Net cash used in investing
activities $(395) $(70,162)
---- --------
Financing activities:
Proceeds from borrowings - 59,273
Payments on borrowings (168) (3,992)
Other 357 (1,037)
---- --------
Net cash provided by financing
activities $ 189 $ 54,244
---- --------
Increase (decrease) in cash 24 (1,181)
Cash and cash equivalents at
beginning of period 255 1,181
---- --------
Cash and cash equivalents at
end of period $ 279 $ -
==== ========
</TABLE>
NON-CASH TRANSACTIONS:
The Company declared stock dividends and issued 9,221 and 10,221
shares of Common Stock to holders of the Series 1993 and Series B
Preferred Stock during the six months ended June 30, 1999 and
1998, respectively.
See accompanying notes to condensed, consolidated financial
statements.
6
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(Unaudited)
-----------
(1) GENERAL
American Resources Offshore, Inc. (ARO) (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)
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 Subsidiary,
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 June 30, 1999 and December 31, 1998 and the
results of operations and changes in cash flows for the
periods ended June 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.
7
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(Unaudited)
-----------
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.
On May 21, 1999, the Company entered into a letter of intent
with Blue Dolphin Exploration Company ("BDEX") for the sale
to BDEX of a 75% ownership interest of the Company through
the issuance of new shares of common stock. Concurrently with
and as a condition precedent to the transaction, the Company will
dispose of all of its Appalachian assets to a third party as
well as 80% of its interest in its Gulf of Mexico assets to
Fidelity Oil Holdings, Inc. ("Fidelity"). After closing,
the primary assets of the Company will consist of 20% of the
Gulf of Mexico assets (see Note 8, Subsequent Events).
(3) Long-term Debt
A summary of long-term debt follows:
<TABLE>
June 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, $48,173,000
available borrowing base as of
June 30, 1999, 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 $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 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. 550 550
</TABLE>
8
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(Unaudited)
-----------
<TABLE>
June 30, December 31,
1999 1998
---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Note payable to TECO Oil & Gas, Inc.,
with a current interest rate at 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. 824 987
Other notes 24 29
------- -------
83,071 83,239
Less - Current portion (834) (64,033)
Less - Debt in default (82,223) (18,500)
------- -------
Long-term debt $ 14 $ 706
======= =======
</TABLE>
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 30, 1999, the balance due under the
revolving credit facility was $48,173,000.
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 June 30, 1999, the Company was not in compliance with
the required financial covenants in the credit agreement; and
the Company has also not made the monthly principal
reductions required in 1999. Consequently, on June 15,
1999, the Bank declared the Company to be in default under
its credit facility. Therefore, this debt is classified as
current in the accompanying balance sheets.
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 declared ARO to be in default under the bridge loans
which had a balance due of $15.6 million. Therefore, this
debt is classified as current in the accompanying balance
sheets.
9
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(Unaudited)
-----------
Also in order to complete the acquisition of the TECO
properties, on March 5, 1998, the Company executed a note in
favor of TECO in the amount of $18.5 million (the TECO
Note). As of June 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. 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. See Note 4 for the number of
common shares which TECO has exercised as of June 30, 1999.
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.
(4) STOCKHOLDERS' EQUITY
The Company has authorized fifty million (50,000,000) shares
of Common Stock. Outstanding at June 30, 1999 and December
31, 1998 are 12,265,767 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 June 30, 1999 and December 31, 1998.
On January 15, 1999, the Board of Directors declared
dividends payable in Common Stock on January 22, 1999, to
holders of the Series 1993 Preferred Stock totaling 9,221
shares.
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.
As of June 30, 1999, TECO has rights to acquire the 600,000
First Warrants and additional shares of the Company's
10
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(Unaudited)
-----------
common stock under the Secondary Warrants (see Note 8,
Subsequent Events), all of which are exercisable through
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 June 30, 1999 and 1998, respectively.
<TABLE>
Quarter ended Quarter Ended
June 30, 1999 June 30, 1998
------------- -------------
Per Per
thousands except Net Share Net Share
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 $(3,444) 11,061,531 $(0.32) $(2,541) 10,023,042 $(0.25)
----- -----
Potential common
shares - - - -
------- ---------- ------- ----------
Diluted earnings
per share
Income (Loss)
available to
common
stockholders $(3,444) 11,061,531 $(0.32) $(2,541) 10,023,042 $(0.25)
------- ---------- ------ ------- ---------- -----
</TABLE>
(5) INCOME TAXES
The Company has not recorded a tax benefit in the periods
ended June 30, 1999 because of changes to its valuation
allowance for deferred tax assets.
(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 second
quarter of 1999, ARO's Gulf Coast Region production averaged
20 MMcfe per day. At June 30, 1999, ARO had forward sales
arrangements through August 1999 with respect to 20 MMcfe
per day at an average price of $1.86 per thousand cubic feet
("Mcf"). During 1998, ARO sold call options for 20 MMcfe
per day at a call price of
11
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(Unaudited)
-----------
$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 MMcfe 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. In total, $1.25 million of income,
included in production revenues, was recognized in the first
six months of 1999 relating to profits from hedging
transactions. There were no revenues relating to profits
from hedging transactions during the first six months of
1998. 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 June 30, 1999, the Company has current liabilities in
excess of current assets of approximately $6.3 million
(excluding current portion of long-term debt and debt in
default), is in default under its primary credit facility
and bridge loans with DNB in the approximate amounts of $48
million and $15.6 million, respectively, 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. In the event the Company sells
these properties, the proceeds will be used to reduce
its outstanding indebtedness to DNB, which would also
result in a substantial reduction of interest expenses.
Further, the sale of these properties would result in
an additional reduction of the Company's administrative
expenses (see Note 8, Subsequent Events).
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
12
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(Unaudited)
-----------
wells. This settlement was reflected in the Company's
December 31, 1998 financial statements.
On May 21, 1999, the Company entered into a letter of
intent with BDEX for the sale to BDEX of a 75%
ownership interest of the Company through the issuance
of new shares of common stock. Concurrently with and
as a condition precedent to the transaction, the Company
will sell 80% of its interest in its Gulf of Mexico assets
to Fidelity. After closing, the primary assets of the
Company will consist of 20% of the Gulf of Mexico
assets (see Note 8, Subsequent Events).
See Note 8, Subsequent Events, for additional measures
taken since June 30, 1999.
The financial statements do not include any adjustments at
June 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.
(8) SUBSEQUENT EVENTS
By letter dated June 29, 1999, TECO exercised the balance of
its Secondary Warrants for a total of 747,159 common shares;
however, the shares had not yet been issued as of June 30,
1999. The 600,000 First Warrants expired by their own terms
on July 1, 1999. Thus, a total of 2,751,852 common shares
were issued to TECO pursuant to the TECO Warrant Agreement.
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 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. The
Company anticipates that the closing will occur during
the fourth quarter of this year.
13
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
----------------------------------------------------
(Unaudited)
-----------
The Company also has agreed in principle to the divestiture
of its Appalachian properties to a third party in exchange
for the assumption of $12.5 million of indebtedness from DNB.
The Company anticipates closing this transaction during the
month of August 1999.
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.
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.
14
<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, 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 will 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. The Company has not received
any notices from the NASDAQ Stock Market since the hearing.
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 (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 Common Stock. As of June 30, 1999,
TECO had rights to acquire the 600,000 First Warrants and
additional shares of Common Stock under the Secondary Warrants,
all of which are exercisable through July 1, 1999.
By letter dated June 29, 1999, TECO exercised the balance of
its Secondary Warrants for a total of 747,159 shares of Common Stock;
however, the shares had not yet been issued as of June 30, 1999.
The 600,000
15
<PAGE>
First Warrants expired by their own terms on July 1, 1999. Thus,
a total of 2,751,852 shares of Common Stock were issued to TECO pursuant
to the TECO Warrant Agreement.
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 Common 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 the secured indebtedness. The Company
anticipates that the closing will occur during the fourth quarter
of this year.
The Company also has agreed in principle to the divestiture
of its Appalachian properties to a third party in exchange for
the assumption of $12.5 million of indebtedness from DNB.
The Company anticipates closing this transaction during the month
of August 1999.
In July 1999, as part of its restructuring efforts, the
Company 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, 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.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED
JUNE 30, 1998
REVENUES. Total revenues for the Company decreased 21% to
$15.6 million for the first six months of 1999 from $19.5 million
for the comparable period in 1998. Marketing revenues decreased
approximately $.2 million, or 5%, primarily due to a market
decline in oil and gas prices.
OIL AND GAS PRODUCTION REVENUE. Oil and gas production
revenue decreased 36% to $9.5 million in the first six months of
1999, due primarily to reduced production attributable to wells
which became non-productive in July and August of 1998. This
reduction was partially offset by new wells drilled on acreage
acquired in the TECO acquisition. (See Part I, Item 1, "Financial
Statements -- Note 2," of this Report on Form 10-Q)
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:
16
<TABLE>
SIX MONTHS ENDED
JUNE 30,
--------- % INCREASE
1999 1998 (DECREASE)
---- ---- ----------
<S> <C> <C> <C>
Production volumes:
Natural gas (MMcf*)........ 3,415 5,181 (34)
Oil (MBbls*)............... 150 227 (34)
Total (MMcfe*)............. 4,313 6,542 (34)
Average sale prices:**
Natural gas (per Mcf*)..... $ 2.23 $ 2.28 (2)
Oil (per Bbl*)............. $12.26 $12.95 (5)
Per Mcfe*.................. $ 2.19 $ 2.25 (3)
Expenses (per Mcfe*):
Lease operating (including
production taxes)......... $ 0.34 $ 0.32 6
Depreciation, depletion
and amortization.......... $ 1.62 $ 1.30 25
Administrative............. $ 0.54 $ 0.24 125
</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 $1.87 per Mcf and the average
price per Mcfe would have been $1.90).
OIL AND GAS PRODUCTION EXPENSE. Oil and gas production
expense decreased 30% to $1.4 million, in the first six months of
1999 due primarily to a significant decrease in ARO's production
volumes. Oil and gas production expense was $0.34 per Mcfe for
the first six months of 1999 compared to $0.32 for the same
period in 1998, an increase of 6%.
EXPLORATION COSTS. During the six months ended June 30,
1999, costs of approximately $.8 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. Costs of approximately $1.8 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 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 six months of 1999, the Company recorded a non-cash
charge of $.05 million 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
46% to $2.3 million in the first six months of 1999, and was
$0.54 per Mcfe, an increase of 125% from the prior year. Total
administrative expenses increased approximately $725,000 between
the six month periods ended June 1998 and June 1999. This
increase was primarily the result of a significant increase in
legal and professional fees and travel expenses as ARO was
involved in several litigation matters. Salaries also increased
approximately $101,000
17
<PAGE>
as a result of the hiring of additional staff for the Louisiana
office, and ARO also paid approximately $109,000 in franchise
taxes in 1999. 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 18% to $7 million in the first six months
of 1999 and was $1.62 per Mcfe, an increase of 25% from the prior
year. Total DD&A expense decreased due primarily to impairments
recognized as of December 31, 1998. The per unit increase
resulted primarily from a significant decrease in production
volumes.
INTEREST EXPENSE. Interest expense increased 46% to $4.6
million, in the first six months of 1999, due to additional
borrowings to fund the TECO acquisition and expanded exploration
and development activities.
NET INCOME. Due to the factors described above, ARO
recognized a loss of $5.1 million for the six months ended June
30, 1999.
THREE MONTHS ENDED JUNE 30, 1999 AND 1998:
REVENUES. Total revenues for ARO decreased 40% to $6.5
million for the second quarter of 1999 compared with $10.8
million in 1998, due primarily to both a decrease in ARO's
production volumes and a decrease in oil and gas prices.
Marketing revenues decreased 12% to $1.6 million.
OIL AND GAS PRODUCTION REVENUE. Oil and gas production
revenue decreased 65% in the second quarter of 1999 to $2.9
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 $607,000.
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>
THREE MONTHS ENDED
JUNE 30,
--------- % INCREASE
1999 1998 (DECREASE)
---- ---- ----------
<S> <C> <C> <C>
Production volumes:
Natural gas (MMcf*)........ 1,336 3,038 (56)
Oil (MBbls*)............... 73 115 (37)
Total (MMcfe*)............. 1,775 3,727 (52)
Average sale prices:**
Natural gas (per Mcf*)..... $ 1.27 $ 2.29 (45)
Oil (per Bbl*)............. $14.25 $13.27 7
Per Mcfe*.................. $ 1.55 $ 2.64 (41)
Expenses (per Mcfe*):
Lease operating (including
production taxes)......... $ 0.58 $ 0.32 81
Depreciation, depletion
and amortization.......... $ 1.63 $ 1.35 21
Administrative............. $ 0.64 $ 0.22 191
</TABLE>
*(MMcf = million cubic feet; MBbls = thousand barrels; MMcfe =
million cubic feet equivalent; Mcf = thousand cubic feet; Bbl =
barrel; Mcfe = thousand cubic feet equalivent)
18
<PAGE>
**Includes effect of hedging (excluding hedging, the average
price for gas would have been $1.78 per Mcf, and the average
price per Mcfe would have been $1.89).
OIL AND GAS PRODUCTION EXPENSE. Oil and gas production
expense decreased 14% to $1 million in the second 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. Oil and gas
production expense was $0.58 per Mcfe in the second quarter of
1999 as compared to $0.32 in 1998, an increase of 81%.
EXPLORATION COSTS. During the second quarter of 1999, costs
of approximately $.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 ARO's accounting method.
Exploration costs were approximately $1.8 million for the second
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
second quarter of 1999, ARO did not record an impairment to oil
and gas properties while an impairment of $2.2 million was
recorded in the same period of 1998.
ADMINISTRATIVE EXPENSE. Administrative expense increased
38% to $1.1 million in the second quarter of 1999 and was $0.64
per Mcfe, an increase of 191% from the prior year. Total
administrative expenses increased approximately $310,000 between
the quarters ended June 1999 and June 1998. This increase was
primarily the result of a significant increase in legal and
professional fees and travel expenses as ARO was involved in
several litigation matters. Salaries also increased as a result
of additional staff in the Louisiana office. The per unit
increase was due primarily to a decrease in production volumes
for the quarter.
DD&A EXPENSE. DD&A expense decreased 43% to $2.9 million
for the second quarter of 1999 and was $1.63 per Mcfe, a decrease
of 21% from the prior year primarily due to impairments
recognized as of December 31, 1998.
INTEREST EXPENSE. Interest expense increased 4% to $2.3
million in the second quarter of 1999. The increase was
attributable to an increase in interest rates.
NET INCOME. Due to the factors described above, ARO
recognized a loss of $3.4 million for the quarter ended June 30,
1999.
LIQUIDITY AND CAPITAL RESOURCES:
Cash and cash equivalents at June 30, 1999 totaled $279,000.
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.
As of June 30, 1999, the balance due under ARO's credit
facility with DNB Energy Assets, Inc. ("DNB"), successor to Den
norske Bank, AS ("Den norske"), was $48,173,000. Under the
facility, ARO is
19
<PAGE>
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 June 30, 1999, ARO
was not in compliance with the required financial ratios in the
credit agreement; and ARO has also not made the monthly principal
reductions required in 1999. Consequently, on June 15, 1999,
DNB declared ARO to be in default under its credit facility.
Therefore, this debt is classified as current in the accompanying
balance sheets.
On March 5, 1998, DNB provided bridge loans totalling $16.5
million in order for ARO to complete the acquisition of the TECO
properties. The balance due DNB at June 30, 1999 for these loans
was $15.6 million. The financing, as amended, matured December
31, 1998. On June 15, 1999, DNB declared ARO to be in default
under the bridge loans. Therefore, this debt is classified as
current in the accompanying balance sheets.
Also in order to complete the acquisition of properties from
TECO, ARO executed a note in favor of TECO (the "TECO Note") in
the amount of $18.5 million. 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.
In its Report on Form 10-Q for the quarter ended March 31,
1999, ARO estimated the capital expenditures for its development
and exploratory program to be $8 to $9 million in 1999. Through
June 30, 1999, ARO has expended more than $1 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. These
expenditures are substantially at the discretion of ARO; and ARO
is limited totally to its existing cash flow or the sale of
properties to fund its capital expenditure budget.
As of June 30, 1999, ARO has current liabilities in excess
of current assets of approximately $6.3 million (excluding
current portion of long-term debt and debt in default), is in
default under its primary credit facility and bridge loans with
DNB in the approximate amounts of $48 million and $15.6 million,
respectively, 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:
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.
At the time of the filing of this Report on Form 10-Q for
the quarter ended June 30, 1999, the Company has agreed in
principle to the divestiture of its Appalachian properties
to a third party in exchange for the assumption of $12.5
million of indebtedness from DNB. The Company
anticipates closing this transaction during the month of
August 1999.
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.
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
20
<PAGE>
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 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. The Company anticipates
that the closing will occur during the fourth quarter of
this year.
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.
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.
If ARO is unable to complete the restructuring with BDEX
and Fidelity discussed above, other measures could be
taken which might include, but not be limited to: (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. A majority of the equipment and
support software has been purchased in recent years, and its
suppliers have informed ARO that it is year 2000 compliant.
However, the primary oil and gas software used by ARO's
subsidiary is not year 2000 compliant at this time. In
conjunction with an ongoing review of year 2000 issues, ARO 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 the third
quarter of 1999.
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
21
<PAGE>
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISKS
There have been no material changes in market risks since
December 31, 1998. As of the date of this filing, ARO has terminated
all forward sales agreements. ARO reocgnized a loss of approximately
$607,000 during the second quarter of 1999 relative to the forward
sales agreements and will recognize a loss during the months of
July through October 1999 of approximately $1 million on the 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 alleges, among other things, that approximately $1.3
million is owed to Sundowner by ARO. ARO has been in contact
with Sundowner in an attempt to negotiate a settlement of the
amount due and believes that the parties will be able to come to
an amicable resolution of the suit such that it will be dismissed
with prejudice for an amount less than the $1.3 million claimed.
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. Based upon the allegations set forth in the
complaint, ARO 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 ARO's financial condition,
operating results or cash flows.
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
22
<PAGE>
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 is seeking
the sum of approximately $29,000 for services rendered.
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
is seeking the sum of approximately $51,000 for services
rendered.
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 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.
As of June 30, 1999, the balance due under ARO's credit
facility with DNB was $48,173,000. At June 30, 1999, ARO was not
in compliance with all of the required financial ratios required
to be maintained under the credit facility. Additionally, at
June 30, 1999, ARO was not in compliance with other required
financial covenants in the credit agreement; and ARO has also not
made the monthly principal reductions required in 1999.
Consequently, on June 15, 1999, DNB declared ARO to be in default
under its credit facility.
On March 5, 1998, DNB provided bridge loans totalling $16.5
million in order for ARO to complete the acquisition of the TECO
properties. The balance due DNB at June 30, 1999 for these loans
was $15.6 million. The financing, as amended, matured December
31, 1998. On June 15, 1999, DNB declared ARO to be in default
under the bridge loans.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: The following Exhibits are either
attached hereto or incorporated herein by
reference:
10.91 Warrant Agreement between American Resources of
Delaware, Inc. and Teco Oil & Gas, Inc.
(incorporated by reference to Exhibit 10.91 to
ARO's Form 8-K/A filed on March 16, 1998).
10.97 Letter of intent dated May 21, 1999 between
Blue Dolphin Exploration Company and ARO
(incorporated by reference to Exhibit 10.97 to
ARO's Form 8-K filed on June 7, 1999).
10.98 Purchase and Sale Agreement between American
Resources Offshore, Inc. and Fidelity Oil
Holdings, Inc. (incorporated by reference to
Exhibit 10.98 to ARO's Form 8-K filed on August
6, 1999).
23
<PAGE>
10.99 Investment Agreement between American Resources
Offshore, Inc. and Blue Dolphin Exploration
Company (incorporated by reference to Exhibit
10.99 to ARO's Form 8-K filed on August 6,
1999).
(b) Reports on Form 8-K:
On June 7, 1999, ARO filed a Report on Form 8-K
reporting the execution of a letter of intent with Blue
Dolphin Exploration Company.
On June 15, 1999, ARO filed a Report on Form 8-K/A
reporting the exercise by TECO Energy, Inc. of certain
rights to acquire Common Stock of ARO and also
reporting that ARO had been declared to be in default
under its credit facility and bridge loans with DNB
Energy Assets, Inc.
On August 6, 1999, ARO filed a Report on Form 8-K
reporting the execution of a Purchase and Sale
Agreement for the sale of 80% of its Gulf of Mexico
properties to Fidelity Oil Holdings, Inc. and an
Investment Agreement for the sale of a 75% ownership
interest in ARO through the issuance of new shares of
common stock to Blue Dolphin Exploration Company.
24
<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 OF DELAWARE INC.
Date: By: /s/ Ralph A. Currie
----------------- -----------------------------------
Ralph A. Currie
Chief Financial Officer
(Principal Accounting and Financial
Officer)
25
<PAGE>
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION OF EXHIBIT
10.91 Warrant Agreement between American Resources
of Delaware, Inc. and Teco Oil & Gas, Inc.
(incorporated by reference to Exhibit 10.91 to
ARO's Form 8-K/A filed on March 16, 1998).
10.97 Letter of intent dated May 21, 1999 between
Blue Dolphin Exploration Company and ARO
(incorporated by reference to Exhibit 10.97 to
ARO's Form 8-K filed on June 7, 1999).
10.98 Purchase and Sale Agreement between American
Resources Offshore, Inc. and Fidelity Oil
Holdings, Inc. (incorporated by reference to
Exhibit 10.98 to ARO's Form 8-K filed on August 6,
1999).
10.99 Investment Agreement between American
Resources Offshore, Inc. and Blue Dolphin
Exploration Company (incorporated by reference to
Exhibit 10.99 to ARO's Form 8-K filed on August 6,
1999).
26
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