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 March 31, 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.
(Name of small business issuer in its charter)
DELAWARE 86-0713506
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
160 MORGAN STREET, P. O. BOX 87
VERSAILLES, KENTUCKY 40383
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: 606-873-5455
Check whether the issuer: (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
YES xx NO
------ ----
APPLICABLE ONLY TO ISSUERS INVOLVED IN
BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS
Check whether the issuer has filed all documents and reports
required to be filed by Section 12, 13 or 15(d) of the Exchange
Act after the distribution of securities under a plan confirmed
by a court.
YES xx NO
------ ----
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the
Issuer's classes of common equity, as of the last practicable
date:
On March 31, 1999, 10,261,074 shares of the Registrant's
Common Stock, par value $.00001 per share, were issued and
outstanding and 230,516 shares of the Registrant's Series 1993 8%
Convertible Preferred Stock were issued and outstanding.
Transitional Small Business Disclosure Format (check one):
Yes ; No x .
--- ---
AMERICAN RESOURCES OFFSHORE, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1999
INDEX
Page
Number
PART I - FINANCIAL INFORMATION 1
Item 1 - Financial Statements (unaudited) 1
Introduction to the Financial Statements 2
Condensed Consolidated Balance Sheets -
March 31, 1999 and December 31, 1998 3
Condensed Consolidated Statements of
Operations - Three Months Ended
March 31, 1999 and 1998 5
Condensed Consolidated Statements of
Cash Flows - Three Months Ended
March 31, 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 14
PART II - OTHER INFORMATION 19
Item 1 - Legal Proceedings 19
Item 6 - Exhibits and Reports on Form 8-K 19
Signature 21
ii
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The Financial Statements of American Resources Offshore,
Inc. ("ARO") for the three months ended March 31, 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 three months ended March 31, 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
AMERICAN RESOURCES OFFSHORE, INC.
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AND SUBSIDIARY
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CONDENSED, CONSOLIDATED FINANCIAL
---------------------------------
STATEMENTS
----------
FOR THE THREE MONTHS ENDED
--------------------------
MARCH 31, 1999 AND 1998
-----------------------
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
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CONDENSED, CONSOLIDATED BALANCE SHEETS
--------------------------------------
ASSETS
------
<TABLE>
MARCH 31,
---------
1999 DECEMBER 31,
---- ------------
(UNAUDITED) 1998(*)
---------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 231 $ 255
Accounts and notes receivable, net 4,615 4,214
Deferred tax asset 333 298
Prepaid expenses and other 524 689
--------- -------
Total current assets 5,703 5,456
--------- -------
Oil and gas properties, at cost
(successful efforts method) 96,770 98,161
Property and equipment, at cost 14,771 14,645
--------- -------
111,541 112,806
Less accumulated depreciation,
depletion and amortization (46,720) (44,253)
--------- -------
Net property and equipment 64,821 68,553
--------- -------
Other assets 1,900 2,215
--------- -------
Total Assets $ 72,424 $76,224
========= =======
</TABLE>
*Derived from audited financial statements.
See accompanying notes to condensed, consolidated financial
statements.
3
AMERICAN RESOURCES OFFSHORE, INC.
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AND SUBSIDIARY
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CONDENSED, CONSOLIDATED BALANCE SHEETS (CONTINUED)
--------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
---------------------------------------------------------
<TABLE>
MARCH 31,
---------
1999 DECEMBER 31,
---- ------------
(UNAUDITED) 1998(*)
----------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Current liabilities:
Current portion of long-term debt $64,639 $ 64,033
Debt in default 18,500 18,500
Accounts payable-Trade 5,138 7,162
Unearned revenue 653 667
Accrued interest 4,867 2,979
Accrued expenses and other 334 610
------- --------
Total current liabilities 94,131 93,951
------- --------
Long-term debt, excluding current portion 16 706
Unearned revenue 1,265 2,971
Deferred tax liability 333 298
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) (47,344) (45,720)
Treasury stock at cost (713) (713)
------- --------
Total stockholders' equity
(capital deficiency) (23,321) (21,702)
------- --------
Commitments and contingencies
------- --------
Total liabilities and stockholders'
equity (capital deficiency) $72,424 $76,224
======= ========
</TABLE>
*Derived from audited financial statements.
See accompanying notes to condensed, consolidated financial
statements.
4
AMERICAN RESOURCES OFFSHORE, INC.
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AND SUBSIDIARY
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CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
- ------------------------------------------------------------
THREE MONTHS ENDED MARCH 31, 1999 AND 1998
------------------------------------------
<TABLE>
1999 1998
---- ----
(Dollars in thousands,
except share data)
<S> <C> <C>
Operating revenues:
Oil and gas production $ 6,526 $6,254
Transportation 177 192
Marketing 2,194 2,164
Other 229 92
------- ------
9,126 8,702
------- ------
Operating expenses:
Oil and gas production 408 868
Transportation 57 58
Marketing 2,202 2,088
Exploration costs 476 -
Depreciation, depletion and
amortization 4,078 3,464
Impairment of assets 45 -
Administrative expenses 1,182 768
Other 29 31
------- ------
8,477 7,277
------- ------
Operating income (loss) 649 1,425
Other income (expense):
Interest income (expense) (2,268) (921)
------- ------
Income (loss) before income
tax expense (1,619) 504
Income tax expense - (202)
------- ------
Net income (loss) $(1,619) $ 302
Preferred dividends (4) (27)
------- ------
Net income (loss) attributable
to common shares $(1,623) $ 275
======= ======
Per common share:
Basic $ (.16) $ .03
======= ======
Weighted average number of common
shares outstanding 10,059,184 9,998,564
========== =========
Diluted $ (.16) $ .03
======= ======
Weighted average number of common
shares and dilutive potential
common shares 10,059,184 10,265,748
========== ==========
</TABLE>
See accompanying notes to condensed, consolidated
financial statements.
5
AMERICAN RESOURCES OFFSHORE, INC.
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AND SUBSIDIARY
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CONDENSED, CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
-----------------------------------------------------------
<TABLE>
THREE MONTHS ENDED
MARCH 31,
------------------
1999 1998
---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Net cash provided by operating activities $ 413 $ 5,107
----- ---------
Investing activities:
Purchases of property and equipment (347) (58,962)
Change in notes receivable (6) (17)
Proceeds from sale of assets - 2
----- ---------
Net cash used in investing activities $(353) $ (58,977)
----- ---------
Financing activities:
Proceeds from borrowings - 58,300
Payments on borrowings (84) (3,288)
Other - (1,008)
----- ---------
Net cash provided by (used in)
financing activities $ (84) $ 54,004
----- ---------
Increase (decrease) in cash (24) 134
Cash and cash equivalents at
beginning of period 255 1,181
----- ---------
Cash and cash equivalents at
end of period $ 231 $ 1,315
===== =========
</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 three months ended March 31, 1999 and
1998, respectively.
See accompanying notes to condensed, consolidated financial
statements
6
AMERICAN RESOURCES OFFSHORE, INC.
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AND SUBSIDIARY
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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 March 31, 1999 and December 31, 1998 and the
results of operations and changes in cash flows for the
periods ended March 31, 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. The
7
AMERICAN RESOURCES OFFSHORE, INC.
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AND SUBSIDIARY
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NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
---------------------------------------------------
(UNAUDITED)
-----------
Company believes that the TECO acquisition provides ample
opportunity to increase reserves, production and cash flow
from development and exploration activities and has
identified numerous drilling locations on the acquired
properties.
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).
The 5 wells that were producing at the time of the purchase
of the TECO properties are currently producing 7 MMcfe/d.
(3) LONG-TERM DEBT
A summary of long-term debt follows:
MARCH 31, DECEMBER 31,
1999 1998
--------- ------------
(DOLLARS IN THOUSANDS)
Borrowings under the Company's
credit facility, as amended, with
DNB, reduction subject to
availability under borrowing
base, $48,173,000 available
borrowing base as of March 31,
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
Note payable to TECO Oil & Gas,
Inc., with a current interest
rate at 16% per annum, increasing
to a maximum of 18% on April 1,
1999. The note matured October
1, 1998. 18,500 18,500
8
AMERICAN RESOURCES OFFSHORE, INC.
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AND SUBSIDIARY
--------------
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
---------------------------------------------------
(UNAUDITED)
-----------
MARCH 31, DECEMBER 31,
1999 1998
--------- ------------
(DOLLARS IN THOUSANDS)
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. 906 987
Other notes 26 29
------- -------
83,155 83,239
Less - Current portion (64,639) (64,033)
Less - Debt in default (18,500) (18,500)
------- -------
Long-term debt $ 16 $ 706
======= =======
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 March 31, 1999, the balance due under the
revolving credit facility was $48,173,000. Additional
borrowings under the credit facility are dependent upon a
redetermination of the borrowing base, which is primarily
dependent upon the value of the mortgaged properties as
determined under DNB's internal lending procedures.
Reductions of the credit facility are also dependent upon
the borrowing base. The borrowing base will be redetermined
semi-annually on each October 1st and April 1st prior to
February 1, 2002.
On March 5, 1998, DNB also provided bridge loans 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. DNB has not yet
demanded payment nor has it agreed to extend the terms of
the bridge loans.
Under the credit agreement with DNB, the Company is required
to maintain certain financial ratios relating to debt
coverage ratio, current ratio, tangible net worth, general
and administrative expenses and quarterly interest ratio.
At March 31, 1999, the Company was not in compliance with
all of the required financial covenants. Additionally, at
March 31, 1999, the Company was not in compliance with
other required financial covenants in the credit agreement;
and the
9
AMERICAN RESOURCES OFFSHORE, INC.
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AND SUBSIDIARY
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NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
---------------------------------------------------
(UNAUDITED)
-----------
Company has also not made the monthly principal reductions
required in 1999. Therefore, this debt is classified as
current in the accompanying balance sheets.
Also in order to complete the acquisition of the TECO
properties, on March 5, 1998, the Company executed a note in
favor of TECO in the amount of $18.5 million (the TECO
Note). As of March 31, 1999, the TECO Note bears interest
at the rate of 16% per annum, which will increase to a
maximum of 18% on April 1, 1999. 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. TECO has not taken any action to exercise its
warrant rights or make any appointments to the Company's
Board at this time; however, TECO has not waived any of such
rights.
(4) STOCKHOLDERS' EQUITY
The Company has authorized fifty million (50,000,000) shares
of Common Stock. Outstanding at March 31, 1999 and December
31, 1998 are 10,261,074 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 March 31, 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 will increase by an additional 5% if the TECO Note is
not paid in full by April 1, 1999 (collectively, Secondary
Warrants). The price per share of common stock evidenced by
the Secondary Warrants is $.00001. As of March 31, 1999,
10
AMERICAN RESOURCES OFFSHORE, INC.
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AND SUBSIDIARY
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NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
---------------------------------------------------
(UNAUDITED)
-----------
TECO had been vested with 600,000 First Warrants and 2,037,006
Secondary Warrants, 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
March 31, 1999 and 1998, respectively.
<TABLE>
Quarter ended Quarter Ended
March 31, 1999 March 31, 1998
-------------- --------------
Net Per Share Net Per Share
(Loss) Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
thousands except
share amounts
Basic earnings (loss)
per share
Income (Loss) available
to common stockholders $(1,623) 10,059,184 $(0.16) $302 9,998,564 $0.03
Potential common shares - - - 267,184
------- ---------- ---- ---------
Diluted earnings per share
Income (Loss) available
to common stockholders $(1,623) 10,059,184 $(0.16) $302 10,265,748 $0.03
------- ---------- ------ ---- ---------- -----
</TABLE>
(5) INCOME TAXES
The Company has not recorded a tax benefit in the quarter
ended March 31, 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 H&N Gas, Ltd. and Superior Natural
Gas Corporation. 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 first
quarter of 1999, ARO's Gulf Coast Region production averaged
25 MMcfe per day. At March 31, 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 1999, ARO sold call options for 20 MMcfe
per day at a call price of $2.70 per Mcf, which expire in
March 2000. In exchange for establishing a ceiling of $2.70
per Mcf over the option term, ARO received an average option
premium of $0.14 per Mcf on the volumes contracted for under
the call option agreement. These contracts were terminated
in January 1999 at a profit of $680,114. In total, $1.8
million of income, included in production
11
AMERICAN RESOURCES OFFSHORE, INC.
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AND SUBSIDIARY
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NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
---------------------------------------------------
(UNAUDITED)
-----------
revenues, was recognized in the first quarter of 1999
relating to profits from hedging transactions. There were
no revenues relating to profits from hedging transactions
during the first quarter 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 March 31, 1999, the Company has current liabilities in
excess of current assets of approximately $5.3 million
(excluding current portion of long-term debt), is not in
compliance with its primary credit facility and bridge loans
with DNB in the approximate amounts of $48 million and $15.6
million, respectively, and is in default under its $18.5
million loan with TECO. As more particularly described in
Item 1, "Description of Business--Overview," of the
Company's Report on Form 10-K for the period ended December
31, 1998, this situation is primarily the result of: i) the
lack of available outside funding to complete the scheduled
refinancing of interim loans and capital expenditures
associated with the acquisition and development of
properties from TECO; ii) the decline in oil and gas prices;
iii) the more than 60% decline of production in the
Company's two largest producing fields; and iv) the
approximately $16 million in trade payables incurred as a
result of the capital requirements for the development of
additional wells, a substantial portion of which were
settled subsequent to year-end 1998 for less than face value
and reflected in the December 31, 1998 financial statements.
It is important to note that DNB has not yet demanded
payment nor has it agreed to extend the term of the bridge
loans; and TECO is a party to an agreement between the
Company and DNB which substantially limits TECO's remedies
against the Company unless DNB is paid in full or declares a
default and takes affirmative action against the Company.
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.
12
AMERICAN RESOURCES OFFSHORE, INC.
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AND SUBSIDIARY
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NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENT
---------------------------------------------------
(UNAUDITED)
-----------
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.
The Company's Management continues to explore all
possible alternatives for the restructuring of the
Company, including the refinancing of debt and possible
business combinations with third parties.
The financial statements do not include any adjustments at
March 31, 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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995:
This Quarterly Report on Form 10-Q includes "forward looking
statements" within the meaning of Section 27A of the Securities Act
of 1933, as amended, (the "Exchange Act"). All statements other
than statements of historical facts included in this Report on Form
10-Q, including without limitation, statements under "Management's
Discussion and Analysis of Financial Condition and Results of
Operations," regarding the planned capital expenditures, increases
in oil and gas production, the number of anticipated wells to be
drilled in 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 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, ARO's stock has not
reported a closing bid of $1.00 or greater for ten consecutive
trading days. ARO has requested an oral hearing before the NASDAQ
Qualifications Board with regard to this matter. This hearing is
scheduled for May 13, 1999 and provides ARO with a stay of action
to that date.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 AND 1998:
REVENUES. Total revenues for ARO increased 4.9% to $9.1
million for the first quarter of 1999 compared with $8.7 million in
1998, due primarily to the Company's hedging contracts which
generated $1.8 million of revenue in the first quarter of 1999 (see
Note 5 of the Financial Statements included in Item 1 of this
Report on Form 10-Q) and was partially offset by a reduction in
production volumes as well as lower oil and gas prices. Marketing
revenues increased 1.4%.
OIL AND GAS PRODUCTION REVENUE. Oil and gas production
revenue increased 4.3% in the first quarter of 1999 to $6.5
million. The increase was primarily due to $1.8 million in
hedging income being recognized in the first quarter of 1999
which was partially offset by a reduction in production volumes
and lower oil and gas prices.
14
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
MARCH 31
------------------
% INCREASE
1999 1998 (DECREASE)
---- ---- ----------
<S> <C> <C> <C>
Production volumes:
Natural gas (MMcf*) ............... 2,079 2,171 (4)
Oil (MBbls*) ...................... 77 110 (30)
Total (MMcfe*) .................... 2,538 2,835 (10)
Average sale prices:**
Natural gas (per Mcf*) ............ $ 2.85 $ 2.23 28
Oil (per Bbl*) .................... $10.37 $12.77 (19)
Per Mcfe* ......................... $ 2.65 $ 2.21 20
Expenses (per Mcfe*):
Lease operating (including
production taxes) ................ $ 0.16 $ 0.31 (48)
Depreciation, depletion and
amortization ..................... $ 1.61 $ 1.23 31
Administrative .................... $ 0.47 $ 0.27 74
</TABLE>
*(MMcf = million cubic feet; Mbl = thousand barrels; MMcfe =
million cubic feet equivalent; Mcf = thousand cubic feet; Bbl
= barrel)
**Includes effect of hedging (excluding hedging, the average
price for gas would have been $1.95 per Mcf, and the average
price per Mcfe would have been $1.91).
OIL AND GAS PRODUCTION EXPENSE. Oil and gas production
expense decreased 53% to $.4 million in the first 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 $0.16 per Mcfe in the first quarter of
1999 as compared to $0.31 in 1998, a decrease of 48%.
EXPLORATION COSTS. During the first quarter of 1999, costs
of approximately $0.48 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. There were
no exploration costs for the first 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 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. In the first quarter of 1999,
ARO recorded a $45,000 impairment to oil and gas properties while
no impairments were recorded in the same period of 1998.
15
ADMINISTRATIVE EXPENSE. Administrative expense increased 54%
to $1.2 million in the first quarter of 1999 and was $0.47 per
Mcfe, an increase of 74% from the prior year. This expense
increased primarily due to the expanded staffing of the Gulf Coast
office with technical personnel experienced in Gulf Coast Region
exploration and development activities. The per unit increase was
also affected by decreased production volumes.
DD&A EXPENSE. DD&A expense increased 18% to $4.1 million for
the first quarter of 1999 and was $1.61 per Mcfe, an increase of
31% from the prior year. The increase resulted primarily from the
TECO acquisition and increased depletion attributable to the
acquisition costs and successful drilling activities.
INTEREST EXPENSE. Interest expense net of interest income
increased 146% to $2.3 million in the first quarter of 1999. The
increase was attributable to additional borrowings to fund
acquisition, exploration and development activities.
NET INCOME. Due to the factors described above, ARO
recognized a loss of $1.6 million for the quarter ended
March 31, 1999.
LIQUIDITY AND CAPITAL RESOURCES:
Cash and cash equivalents at March 31, 1999 totaled $231,000
as compared to $1.3 million at March 31, 1998. 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. ARO has a $75 million credit facility through
DNB with a $50 million borrowing base which has been fully
utilized.
Under the credit facility with DNB Energy Assets, Inc.
("DNB"), successor to Den norske Bank, AS ("Den norske"), ARO is
required to maintain certain ratios relating to debt coverage
ratio, current ratio, tangible net worth, general and
administrative expenses and quarterly interest ratio. Under the
covenants, the financial amounts used to compute the requirements
are specifically defined in the agreement. At March 31, 1999, ARO
was not in compliance with all of the required financial ratios.
Additionally, at March 31, 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. 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 March 31, 1999 for these loans
was $15.6 million. The financing, as amended, matured December 31,
1998. DNB has not yet demanded payment nor has it agreed to extend
the terms of ARO's bridge loans.
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.
However, TECO is a party to an agreement between ARO and DNB which
substantially limits TECO's remedies against ARO unless the Bank is
paid in full or declares a default and takes affirmative action
against ARO.
In its Report on Form 10-K for the year ended December 31,
1998, ARO estimated the capital expenditures for its development
and exploratory program to be $12 million in 1999. ARO currently
anticipates a capital expenditure budget of $8 to $9 million for
1999, which is allocated to the Gulf Coast Region. Through March
31, 1999, ARO has not expended any funds on its 1999 exploration
and development program. ARO's estimate of its capital
expenditure budget will change on a month to month
16
basis based upon drilling results and new opportunities. These
expenditures are substantially at the discretion of ARO; and ARO
does not currently have sufficient cash to fully fund the
proposed program. In the event ARO is unable to obtain
sufficient funds under acceptable terms, it will be necessary for
ARO to adjust the level of the development and exploratory
program.
As of March 31, 1999, ARO has current liabilities in excess
of current assets of approximately $5.3 million (excluding
current portion of long-term debt), is not in compliance with its
primary credit facility and bridge loans with DNB in the
approximate amounts of $48 million and $15.6 million,
respectively, 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.
As more particularly described in Item 1, "Description of
Business--Overview," of ARO's Report on Form 10-K for the period
ended December 31, 1998, this situation is primarily the result
of: i) the lack of available outside funding to complete the
scheduled refinancing of interim loans and capital expenditures
associated with the acquisition and development of properties
from TECO; ii) the decline in oil and gas prices; iii) the more
than 60% decline of production in ARO's two largest producing
fields; and iv) the approximately $16 million in trade payables
incurred as a result of the capital requirements for the
development of additional wells, a substantial portion of which
were settled subsequent to year-end 1998 for less than face value
and reflected in the December 31, 1998 financial statements.
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.
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. In the
event ARO 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 ARO's administrative expenses.
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.
ARO's Management continues to explore all possible
alternatives for the generation of additional funds as well
as the restructuring of ARO, including the refinancing of
debt and possible business combinations with third parties.
There can be no assurance that ARO will be able to obtain
sufficient funds to meet its current cash needs and other
obligations or that it will be successful in restructuring ARO,
which could result in material adverse consequences.
YEAR 2000 ISSUE. The year 2000 issue relates to the
inability of certain computers and software applications to
correctly recognize and process date sensitive information for
the Year 2000 and beyond. Without correction, the computers and
software applications could fail or create erroneous information.
Since this problem could affect ARO's systems, as well as the
systems of its business partners, ARO is
17
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.
ARO's primary oil and gas software 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 mid-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 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.
18
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 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 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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: The following Exhibits are either
attached hereto or incorporated herein by
reference:
16.01 Response letter from KPMG LLP to the
Securities and Exchange Commission
(incorporated by reference to Exhibit 16.01
to ARO's Report on Form 8-K/A filed on
January 5, 1999).
19
(b) Reports on Form 8-K:
On January 11, 1999, ARO filed a Report on Form 8-
K reporting the sale of the Sunrise Prospect, the
change in Certified Accountant, the settlement of
outstanding sales and tangible property taxes assessed
by the Kentucky Revenue Cabinet, the initiation of
litigation by a trade creditor, the maturing of $16.5
million of Bridge Loans with Den norske Bank and the
notification by NASDAQ that ARO's securities will be
subject to delisting on April 5, 1999 unless certain
criteria are met.
On January 15, 1999, ARO filed a Report on Form 8-
K/A which provided a copy of KPMG LLP's response letter
to the Securities and Exchange Commission.
On March 23, 1999, ARO filed a Report on Form 8-K
reporting the settlement of litigation and liens
against ARO's Grand Isle Block 55 property in the
amount of approximately $12 million, together with the
settlement of litigation filed against ARO's High
Island Block 105 property in the amount of
approximately $600,000.
On April 8, 1999, ARO filed a Report on Form 8-K
reporting that it had requested a hearing on its
possible delisting; and NASDAQ has set a hearing date
of May 13, 1999, delaying any action to delist ARO
until after the hearing.
20
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: May 13, 1999 By: /s/ Ralph A. Currie
----------------- -------------------------------
Ralph A. Currie
Chief Financial Officer
(Principal Accounting and
Financial Officer)
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000899717
<NAME> AMERICAN RESOURCES OFFSHORE, INC.
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 231
<SECURITIES> 0
<RECEIVABLES> 4,615
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 5,703
<PP&E> 111,541
<DEPRECIATION> 46,720
<TOTAL-ASSETS> 72,424
<CURRENT-LIABILITIES> 94,131
<BONDS> 0
0
1,871
<COMMON> 0
<OTHER-SE> (25,192)
<TOTAL-LIABILITY-AND-EQUITY> 72,424
<SALES> 9,126
<TOTAL-REVENUES> 9,126
<CGS> 0
<TOTAL-COSTS> 8,477
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,268
<INCOME-PRETAX> (1,619)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,619)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,619)
<EPS-PRIMARY> (.16)
<EPS-DILUTED> (.16)
</TABLE>
